Financing Structure Tips
Let us first examine the various parties involved in a financing transaction. On one side of the playing field there is the private company in the process of raising capital. On the other side there are the investors. Investors may include, family and friends, Angel Investors, Private Equity Firms (also known as Venture Capital Firms) and Hedge Funds. Keep in mind that negotiating a Financing Structure truly is an art. Your Management Team needs to think three steps ahead just like in a chess game. Although the majority of Private Equity Firms may use the convertible preferred stock financing structure most often, there is a wide range from firm to firm on what the final structure will look like. Here are some tips to think about when structuring your financing to help Level the Playing Field: 1. Voting Control. Giving up voting control is not a bad thing. If you can further expand your business and ultimately the net profit, so that your reduced percentage of ownership in the company will actually be worth more than it is now, that should be viewed as a good thing. Large Private Equity Firms will probably require voting control if it is a large funding and especially if you are a start-up. For example, say there are 3 key management people in a company who currently own 20% each of a company that is valued at $5,000,000, but they will be reduced to 10% ownership once they are funded. If the company used the funds wisely and increased its value to say $15,000,000 then although management lost control, their value actually increased. 2. Super Preferred. If Management has to give up the majority equity position in the company, see if the investor will let you maintain voting control. This way the investor does not have control over business or management decisions and the Management Team technically maintains control of the company. This can be accomplished through the use of what I call a “super preferred”. 3. Long Term Employment Agreement. If the private equity firm won’t go along with the super preferred idea see if they will agree to 3 year employment agreements for management so management feels safe with the funding arrangement and not being replaced 6 months after funding (assuming you have given up voting control). Management Teams feel very uneasy when an investor has voting control. They are always worried they will be replaced after all their hard work building up the company. This concern clearly needs to be addressed and covered. 4. Pre-Qualify them as a Suitable Investor. Try to get as much information about their financing structure before you give them too much confidential information or spend too much time and effort with them. Just imagine spending four (4) grueling months of discussions and due diligence with a particular private equity firm. Then you learn they don’t fund any companies unless they get at least 70% equity and voting control when your Management Team already agreed amongst themselves that they would never give up voting control. 5. Always ask for a “Clawback”. A clawback provision allows you to buyback shares from the investor at a minimum price if you achieve a certain milestone, thereby increasing your percentage of ownership and voting rights in the company. Here’s an example. If you reach $4,000,000 in gross revenues in the second year after funding, then your company may repurchase 10% of the shares from the private equity firm for a nominal value, like $.10 per share. 6. Subsequent Rounds of Financing. If they won’t fund you the full amount you are looking for see if they will fund you in a second and third round if you hit certain milestones based on gross revenues or net profits. Private Equity Firms shouldn't have a problem agreeing to incentive based financing in a second or even third round. 7. Get a Good Attorney. Get a good venture capital attorney experienced in representing clients in these types of transactions. If you ask him what a “clawback” or “super preferred” is and he doesn’t know then look for another attorney. Spending a little more money for a good attorney will save you money in the long run. 8. Get a Good Accountant. Get a good tax accountant who may be able to make a few simple suggestions in the financing structure. It may help you tax wise if you get warrants or stock bonuses structured a certain way. Better to plan ahead and know the tax implications before you finalize the transaction. Joseph B. LaRocco - Visit http://www.netskyholdings.com for more information. Mr. LaRocco has represented and advised private and public companies concerning the internet, securities and investments. He also has extensive experience advising hedge funds on numerous trading and investment strategies. Mr. LaRocco is an attorney who practices law in New Canaan, CT, and is currently General Counsel and a Director of NetSky Holdings, Inc. (Symbol: NKYH). |
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