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Bill McCready
How to Structure Your Deal
"Deal Structure" refers to the financial plan for your business.
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.
The Secret
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.
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), in 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 a return 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.
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. We have
found it best to suggest an investment scenario based on our
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.
As stated in other articles, 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. Our Business
Plan Packages http://www.ventureplan.com/business_plans.html
provide worksheets and scenario testing for this type of
valuation.
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.
Venture Planning Associates, Inc., http://www.ventureplan.com
Tel. 858.457.3434 / efax 425-955-7531
capital@ventureplan.com
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