New Year, New Money?

The start of a new year is often when business owners review their long-term strategic goals. As part of the review process, many companies will consider the need for additional capital that cannot be satisfied by bank debt or further investment by existing shareholders. Before you decide to seek private investment capital, it is important to be informed as to how these transactions are typically structured and what potential investors are likely to expect. Keep in mind that capital raising activities are also subject to federal and state securities laws and it is important to know what you should and should not do in the course of seeking investment capital.

Below are a few frequently asked questions and answers that may help in your decision-making process. For more information, visit http://bit.ly/1eHEOon.

Are outside investors likely to lend money to a company or do they want an ownership interest?

Investing in even the most promising private company involves a high degree of risk. Investors typically want to structure their investments so that their return compensates them for the risk they are taking. This typically translates to either promissory notes which may be converted to preferred or common stock (“convertible debt”) or preferred stock which may be converted into common stock (“convertible preferred”). A variation of this structure is to sell either notes or preferred stock, along with “warrants” (the right to purchase a stated amount of common stock in the future for a stated purchase price). Both structures have advantages and disadvantages and the proper choice depends on the particular facts and circumstances.

How much money should a company try to raise?

It depends on what the money is needed for (e.g., working capital vs. building a prototype for a new product or device). Every situation is different, but you should usually plan to raise enough to carry the company for 6 to 9 months. Remember, the higher the company’s value when you bring in investors, the less equity you will need to give up to raise the money. For that reason, companies often seek investor capital in several smaller installments (“rounds” or “tranches”) rather than all at one time. 

How do potential investors evaluate investments opportunities?

In general, it is much easier to finance a management team with a successful track record than it is to finance a great idea or great technology in a company with inexperienced management. If your company’s management does not have a demonstrated track record (ideally, one of successfully founding, building, and selling a prior company) consider strengthening your management team with experienced outside directors or an experienced advisory board.

How do I find investors and what information should I be prepared to share to prospective investors? 

With very limited exceptions, federal and state law usually prohibits any form of “general solicitation.” Therefore, unless you qualify for an exception to the general rule, you CANNOT use advertising, mass mailings, or email solicitation. The best source for investors is often people who know the company and its management – key customers, suppliers, friends, family, and business associates.  There is also an increasing number of “angel investor” groups that make investments in private companies. If the company limits offers and sales of securities to accredited investors, there are no specific disclosure requirements, nor a mandated form for the disclosures. If a single non-accredited investor is included in the offering, the disclosure that must be given to all investors (not just the non-accredited investor) is much more extensive, must follow certain strict guidelines, and is expensive and time consuming to prepare.

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