How To Structure Your Deal

 

'Deal Structure' refers to the financial plan for your business and the scenarios you develop before you talk to investors that put you in a fair negotiating position.

 

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.

 

Deal Structure Secrets
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.

 

Six 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), an 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 areturn 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.

 

Other Considerations
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. It is best to suggest an investment scenario based on your 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. 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. 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.

 

-William F. (Bill) McCready, Founder/CEO Venture Planning Associates, Inc.