Financing Structure Tips

I have advised clients on both sides of the playing field regarding Financing Structure Tips. On one side there is the private company client in the process of raising capital. On the other side there are the investors. Investors include family and friends, Angel Investors, Private Equity Firms and Hedge Funds.

Equity Line Funding, is a structure in which a company sells its common stock (equity). Equity Lines have been used by hedge funds for the past ten years or so to provide funding to small and large companies looking to raise capital. It can be used by small or large companies and can be used effectively in the United States, Australia, Europe, Canada and some parts of Asia. Its use use is now fairly widespread and seems to be growing.Equity Lines are one of the many financing structure tips public companies are using to fund growth and acquisitions.

In the past several years, Hedge Funds and Private Equity Firms have somehow crossed over into each others investment territory. Some Hedge Funds have become a type of "hybrid" in that they provide funding to private, as well as public companies. A good example of a hybrid hedge fund is a PIPE Fund. These hedge funds are usually very flexible in terms of deal structure and will often fund private companies if there is good potential for growth and the company will go public in the near future. Hedge funds need more liquidity than private equity firms so, although they will fund some private companies, they like the liquidity that a public company affords through the sale of its common stock.

Another type of hedge fund that also invests in some private companies is the "Special Situations Hedge Fund". This type of fund looks for a "special situation" such as a merger, acquisition, product launch, corporate restructuring or reorganization.

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 financing structure 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. Large Private Equity Firms will probably require it 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”.This is an important financing structure tip for management to maintain voting control.

Super preferred stock can be structured in many different ways.
Here’s an example: Lets say your company gets funded and Management has 3,000,000 shares of common stock while all outside investors have 7,000,000 shares of common. The Management Team, however, owns nonconvertible preferred stock that gives them additional voting rights for another 10,000,000 votes on any matters upon which the common stockholders can vote. In that case, Management still has voting control because management has 13,000,000 votes while outside investors have 7,000,000 votes.

3. 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. NOTE: Structuring the funding is a very important part of the process and should be examined very carefully. Spending money for a good attorney to advise you on financing structure tips may save you money in the long run. Joseph B. LaRocco, Esq.

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.This financing structure tip can help you buyback a percentage of your company.

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.This financing structure tip can save you alot of aggravation and work later on if you plan well during the first funding round.

7. 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 early on in the negotiation process. This financing structure tip is important for the companies owners, but also for the middle management team.

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.

Hopefully these financing structure tips have given you alot to think about. When negotiating financing structures keep flexible. A good Venture Capital attorney is worth his weight in gold at this point. Once you close on the deal you are going to have to live with that financing structure for a long time. You don't want to have any regrets.

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