All companies need to achieve an effect capital structure, that is, an effective mix of both equity and debt financing that meets they current needs and positions them for the future in a way that trades off the pluses and minuses of debt vs equity capital. The bedrock of company capital is equity capital and unless there is sufficient equity capital or other collateralize-able assets, the company will not be able to borrow short or long term debt capital.
The process of raising capital through the sale of shares in a corporation or membership interests in a limited liability company (“LLC”) is called equity financing. Equity financing involves not just the sale of common equity, like common shares and membership interests, but also other types of equity or quasi-equity instruments like preferred stock, convertible preferred stock, convertible debt, warrants, etc. This variety of financial instruments allow both the company and the investor to create a capital structure that meets the needs of both.
Regardless of the financial instruments used, there are several steps in equity financing as the company grows:
- The first step in the process is that you and your partners invest your own money, other tangible or intangible assets or your time in exchange for a specific ownership percentage in the enterprise.
- Friends and Family. This next step is when you get additional equity capital from family members or close friends. Typically the amount of friends and family capital is small, perhaps tens of thousands or hundreds of thousands of dollars, depending on the financial capabilities of your friends and family. A key concern is how you balance family and friend relationships with a commercial transaction.
- Angels. In most communities in the country, there are wealthy individuals or groups of wealthy individuals that like to invest money in local start-ups or small companies because they expect an excellent return or like to use this investment as a way to get involved in a company, perhaps as a board member or advisor. The amounts from Angels can vary greatly but generally are in the hundreds of thousands of dollars to a few million dollars. Oftentimes these angels demand a board seat as a condition of investing and sometimes they can be helpful to the enterprise and sometimes not.
- Venture Capital. In America there are thousands of individuals or companies that are Venture Capitalists (“VCs”) who investment capital in start-up companies is one or more rounds of investment. These investments are typically in the millions of dollars. These investors are very sophisticated and often bring an excellent set of skills to the company in addition to their money. They tend to drive a hard bargain and demand not only a low price for a large ownership percentage, but also demand many terms and conditions that will protect them and give them the opportunity for a great return. They are typically are looking for a 25% to 35% targeted return on their capital and tend to have a short to medium time horizon.
- At this point in a successful company’s life the next capital steps can include:
- Selling out to another company like a competitor, which is often done so the company founder can either totally exit or partially exit and thus “take some chips off the table”.
- Selling either a control or non-control ownership percentage to a Private Equity Group (“PEG”) as a way to acquire additional growth capital. The founder generally stays with the company and uses the new equity or debt capital to significantly grow the business such that a profitable exit can be obtained in a medium term period of about 3 to 7 years. Like VCs, the individuals in the PEG bring much more than money to the party, they bring lots of business and investment experience that usually supplements the existing owner’s or management’s skills.
- IPO. A small percentage of companies, and generally the ones that have obtained significant size and have excellent growth prospects, take the company public by selling shares to investors. Once public these companies stock trade on one of the stock exchanges.
- During this equity capital raising process, it is important for the business owner and his board to engage competent advisors. This advisors may include a CPA, securities attorney, and investment banker, etc. Their job is to advise and provide the services necessary to effectively build a productive and low risk capital structure.
Corporate Development Capital’s managing directors have experience in this process and can assist the business owner in developing and implementing an effective capital plan. Please contact us for a complimentary discussion regarding how we can help.