And a public company faces certain incremental costs after the issue, like administration costs and legal fees that increase with the need for more extensive reporting to comply with the SEC. The recipient of the funds shoulders all these costs.
The demands on time and money are unavoidable. What entrepreneurs can avoid is the tendency to underestimate these costs and the failure to plan for them. You Have No Privacy Convincing a financial backer to part with money takes a good sales job—and information. And you will have to hand over your personal and corporate financial statements.
Revealing such guarded secrets makes entrepreneurs uneasy, and understandably so. In one instance, a startup team in Britain had devised a new automatic coin-counting device for banks and large retailers. The product had a lot of promise, and the business plan was sound. When the lead investor was seeking coinvestors, he shared the business plan with a prospective investor who ultimately declined to participate. The deal came together anyway, but months later the entrepreneurs discovered that the investor, who had decided not to join, had shared the business plan with a competitor.
In another instance, an adviser was helping an entrepreneur sell his business to a Midwestern company. The chance that information will get into the wrong hands is an inherent risk in the search for capital—and is one reason to make sure you really need the money and are getting it from highly reputable sources.
While you cannot eliminate the risk, you can minimize it, by discussing the issue with the lead investor, avoiding some sources that are close to competitors, and talking to only reputable sources. Experts Can Blow It Decisions about how much money to raise, from what sources, in debt or equity, under what terms—all limit management in some way and create commitments that must be fulfilled.
These commitments can cripple a growing business, yet managers are quick to delegate their fund-raising strategies to financial advisers. Unfortunately, not all advisers are equally skilled. Opti-Com the fictitious name of a real company was a start-up spun off from a public company in the fiber optics industry. Though not considered super-stars, the start-up managers were strong and credible.
The fact is, the business proposal was not a mainstream venture capital deal, yet the search included none of the smaller, more specialized venture capital funds, private investors, or strategic partners that were more likely to fund that type of business. Furthermore, the deal was overvalued by three to four times, which undoubtedly turned off investors. Opti-Com eventually changed its adviser.
This was the right fit. The point is not to avoid using outside advisers but to be selective about them. One rule of thumb is to choose individuals who are actively involved in raising money for companies at your stage of growth, in your industry or area of technology, and with similar capital requirements.
If you overlook considerations such as whether the partner has experience in the industry, contacts with potential suppliers or customers, and a good reputation, you may shortchange yourself. How fast the investor can respond is sometimes another crucial variable.
It did not have enough time to put together a detailed business plan but presented a summary plan to five top venture capital and LBO firms. They focused their efforts on two investors with experience in telecommunications and got a commitment expediently. Yet another entrepreneur had a patented, innovative device for use by manufacturers of semiconductors.
He was running out of cash from an earlier round of venture capital and needed more to get the product into production. His backers would not invest further since he was nearly two years behind his business plan.
When the well-known venture capital firms turned him down, he sought alternatives. The Search Is Endless After months of hard work and tough negotiations, cash hungry and unwary entrepreneurs are quick to conclude that the deal is closed with the handshake and letter-of-intent or executed-terms sheet.
They relax the street-wise caution they have exercised so far and cut off discussions with alternative sources of funds. This can be a big mistake. An entrepreneur and one of his vice presidents held simultaneous negotiations with several venture capitalists, three or four strategic partners, and the source of a bridge capital loan.
After about six months, the company was down to 60 days of cash, and the prospective backer most interested in the deal knew it. The managers felt that while the deal was not cheap, it was less expensive than conventional venture capital, and they had few alternatives since none of the other negotiations had gotten that serious. Yet the entrepreneurs were able to hide their bargaining weakness. Each time a round of negotiations was scheduled, the company founder made sure he scheduled another meeting that same afternoon several hours away.
He created the effect of more intense discussion elsewhere than in fact existed. By saying that he had to get to Chicago to continue discussions with venture capitalist XYZ, the founder kept the investors wondering just how strong their position was. The founder finally struck a deal with the one investor that was interested and on terms he was quite comfortable with. The company has since gone public and is a leader in its industry. The lead entrepreneur understood what many others do not: you must assume the deal will never close and keep looking for investors even when one is seriously interested.
While it is tempting to end the hard work of finding money, continuing the search not only saves time if the deal falls through but also strengthens your negotiating position. Because you are the one who has to live with them. Deals are structured many different ways. The legal documentation spells out the terms, covenants, conditions, responsibilities, and rights of the parties in the transaction.
The decision-making power usually rests with the individual or small group holding the majority of equity in the firm. Investing in Privately Held Companies PHBs may offer a variety of types of investment, both for angel investors acting on their own, or for investors who access them through a venture capital firm. Having chosen your access route, there are still a variety of choices to make regarding your level of investment.
For example, you can choose to be an " arm's length " investor with no active participation in the operations or decision making within the PHB. This is much the same as owning a few shares of a publicly-traded company. With a small or family-owned business, however, you may be employed in the management of the company — in other words, your investment might come with a job.
For an investment of significant size relative to the total capitalization of the company, you may be expected to participate as a member of the company's board of directors to advise on the policies and direction of the firm and to review management performance. When it comes to a family-owned firm if it's your family , other family-oriented considerations may dictate your level of participation and authority within the firm.
After taking into account the considerations above and making a decision to go forward, you must decide on whether you are looking for a minority position or a majority ownership position and the responsibilities and risks that go along with being the principal owner, if applicable. There are many business categories and some of them overlap, but the list below provides an overview of each: Startups Startups tend to be high risk with no management track record or proven business model. Many startups fail.
On the other hand, startups with no proven track record or business model that are operating in new paradigms have produced many millionaires. Superstars such as Microsoft, Google, Amazon and Apple are good examples. Second-Level Capital Acquisitions This category includes companies that have gotten off the ground with their first capital infusions, but now need more capital to grow.
These companies have a performance record, and while they are usually less risky than a startup, investment debt or equity may be subordinate to that of the original investors. Turnaround Companies requiring turnaround are in failure mode. If cash flow and the business model and fundamentals are good, however, bad management decisions can be fixed, and you as an investor can make it happen.
If cash flow and fundamentals are bad, prospects for recovery are extremely limited. Successful turnarounds offer high return on investment. Growth Opportunity Companies whose growth is being stymied by a lack of capital may be good investment targets if their fundamentals, track records and resident management are capable of handling the growth.
The markets for the growth need to be assessed to determine the feasibility of the growth plan and potential. Bankrupt Bankrupt firms can provide great value at a low price. Here, the question is "why did the firm go bankrupt? This is a high-risk investment that can require high personal involvement.
It can be very lucrative or devastating. The Pros and Cons of Privately Held Businesses We have looked at the types and categories of investment in PHBs and can now review some of the overall pros and cons of investing in privately held businesses versus publicly traded companies.
Pros Investing in a PHB allows you to set an upfront exit provision for your investment.
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Before working as an editor, she earned a Master of Public Health degree in health services and worked in non-profit administration. Learn about our editorial policies Overall, it is much easier to invest in a publicly traded firm than a privately-held company. Public companies, especially larger ones, can easily be bought and sold on the stock market and, therefore, have superior liquidity and a quote market value.
Conversely, it can be years before a private firm can again be sold and prices must be negotiated between the seller and buyer. In addition, public companies must file financial statements with the Securities and Exchange Commission SEC , making it easy to track their highs and lows on a quarterly and annual basis. A major criticism of many public firms is that they are overly focused on quarterly results and meeting Wall Street analysts' short-term expectations.
This can cause them to miss out on long-term value-creating opportunities, such as investing in a product that may take years to develop, hurting profits in the near term. Private firms can be better managed for the long term as they are out of Wall Street's reach. Being an owner of a private firm means sharing more directly in the underlying firm's profits. Earnings may grow at a public firm, but they are retained unless paid out as dividends or used to buy back stock.
Private firm earnings can be paid directly to the owners. Private owners can also have a larger role in the decision-making process at the firm, especially investors with large ownership stakes. For instance, when an entrepreneur is first starting a business , they usually receive funding from a friend or family member on very favorable terms. This stage is referred to as angel investing , while the private company is known as an angel firm.
Past the start-up phase is venture capital investing when a group of more savvy investors comes along and offers growth capital, managerial know-how, and other operational assistance. At this stage, a firm is seen to have at least some long-term potential. Past this stage can be mezzanine investing , which consists of equity and debt, the last of which will convert to equity if the private company can't meet its interest payment obligations.
Later-stage private investing is simply referred to as private equity ; it is a roughly two trillion dollar business with many large players. For investors, the stage of development a private company is in can help define how risky it is as an investment. For instance, around three quarters of angel investments fail. The risk falls the more developed and profitable a private company becomes. Although the goal of many private firms is to eventually go public and provide liquidity for company founders or other investors, other private businesses may prefer to stay private given the benefits discussed above.
Small business investing involves investors contributing funds to a small business with high growth potential through either debt or equity investing, or a combination of both. The goal is to earn returns through either a percent of profits from business revenue or from repayment of principal and interest on loans. Equity Investment One of the most well-known investment opportunities for businesses is equity investing.
Equity investing is the riskiest investment in business opportunities. In turn, this ownership gives you the right to a percentage of the profits. The percentage of profits is typically equivalent to the percentage of the share you hold in the company. Caution: An equity investment in a small business can give you the highest returns but has also the largest risk. In fact, to invest in a local business you can also use what is known as sweat equity.
Debt Investment Definition: A debt investment is when you give a small business a loan with the expectation of being paid back the loan in full plus interest. The loan will typically be repaid in installments over a specific time period. In other words, if the company can, it will repay its debtors first and its equity investors last.
Equity-Debt Hybrid Investment If you want to be an investor in a small business without committing to just equity or just debt financing, I have a solution for you: The equity-debt hybrid.
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