How To Structure Your Deal
'Deal Structure' refers to the financial plan for
your business and the scenarios you develop before you talk to
investors that put you in a fair negotiating position.
From startup to IPO, most companies need funding more
than once. The obvious times are during the research and development, seed capital
and startup stages. But what about acquisitions, expansion, or going public? At
almost each rung of the entrepreneurial ladder the need for capital must be addressed.
Deal Structure Secrets
What's the secret to obtaining capital from
outside sources when you need it? A key element of the process is your Deal Structure.
The structure of your investment opportunity must show a potential investor the
benefits of taking a risk on you, rather than your competitor down the street.
Your deal structure sets optimum debt
and equity ratios, and
is determined by the type of financing you are seeking or have obtained, the stage
of development, goals for your venture,
and your exit strategy.
Six Critical Deal Structure Considerations
1. You contribute 20%. Let's say you're looking for $1,000,000.
If your company is a startup (the most difficult to fund), an investor will expect
you to contribute 20% of that amount, in terms of energy, efforts and cash.
2. Value of investment dollars. An individual investing
$1,000,000 in your project will have had to earn $2,000,000 in pre-tax dollars
in order to make the investment amount available to you.
3. Competition for investment capital. Financiers have
many opportunities to invest their money. At any given time, real estate, the
stock market, and other ventures will be vying for their attention and capital.
If you were the investor, you would most likely be looking for the most attractive
deal, offering the best return, balanced against the level of risk involved.
4. Opportunity cost. In addition to the actual investment,
investors look at the opportunity cost. Could they have tied up their money in
a safer or more profitable investment?
5. Early investor return of capital. All deals should
be structured so that investors get areturn on capital ASAP! They want to be assured
that they will get the money they invest back before you get your new Mercedes.
6. Keeping control. It's not uncommon for a major impasse
to occur when the entrepreneur is faced with the fact that investors want a larger
portion of the company in return for their investment than the entrepreneur is
willing to give.
Other Considerations
It can be a shock and a deal breaker
for the less sophisticated entrepreneur who is not prepared for this. Making the
deal structure an integral part of the business plan serves as advance warning
that the entrepreneur knows the investment value of the business.
- More than stock.
In addition to a portion of the company's stock, some investors will also want
to participate in the financial management, marketing or other vital areas of
your company. Entrepreneurs should welcome the involvement of a professional with
entrepreneurial experience to assist them.
- Tax and legal considerations including state
securities laws.
When forming your company, study the benefits and drawbacks
of the different types of company structure. Your CPA can
assist you by explaining the differences between LLC
(Limited Liability Company), S Corp., Sub S Corp., and
C Corp.
The Art of The Deal
The Art of the Deal is to have
your parameters set before you
meet with in investor or venture capital company, rather than
asking 'how much will you give me for x% of the company”. Think of it the
same as getting an airplane ticket: you pay a fixed fee for a trip, that is based
on current market conditions,
price wars, and seat class and selection.
When you have thoroughly developed your business
plan and
understand the true value of money versus your idea, you can
often come to a fair valuation and negotiating position. It is
best to suggest an investment scenario based on your current
business plan and assumptions that returns a 40% compounded
return over five years.
While you cannot guarantee a return, that size
of return
provides for the risk, opportunity cost and potential loss of investment that
investors are used to accepting. You must have prepared various scenarios of your
plan for contingencies and arrived at this percentage of stock for investment
using some type of weighted average of value.
Armed with the right information, you will have
much more
confidence in the outcome. You will not 'dive for the check at
any cost', and you will show your company to be sophisticated
beyond 90% of other capital seeking companies.
-William F. (Bill) McCready
Founder/CEO Venture Planning Associates, Inc.
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