These relationships are all over the map. Here are some of the arrangements we've recently heard of: an engineering consultant offering to cut his up-front rates to a start-up in exchange for promises of future work; a package-design firm taking its fees from a start-up and investing the equivalent sum back into the business (thus permitting the start-up to get a tax write-off for the consulting costs); and a consultant taking part of his payment in a royalty interest on sales of a specific product.
Some businesses, of course, have more opportunities to structure deals than others do. First, find the managers or experts you might be interested in working with -- headhunters and outplacement firms would have some leads. To make sure you're not exposing your company to unforeseen risks, run your ideas by an adviser you trust. Once you come up with a plan, make a proposal. The worst that can happen is that you'll get no for an answer.
Turning Assets Into Cash
With royalty deals (S, M, S-U) Looking for money to market your product or to do further development or expansion, but cool to the thought of selling equity? An alternative is to give investors a royalty interest in a product or an area of the business. Unlike equity, you don't dilute your ownership. And in contrast to debt, there's no fixed obligation; you pay a slice of the revenue stream. (Royalties are also tax deductible.)
The deals are often set up as limited partnerships with one or more investors. Recently, we've seen them in software companies, but also with consumer products and service businesses. In setting the royalty rates and other terms, think about the potential revenues and the time it might take to reach your sales target. Also, think about whether you want to put a ceiling on how much money investors stand to make if revenues take off. One possibility is to build in an option to buy out the investors at a set price before a certain date. You'd offer them an attractive price, perhaps even some stock, in exchange for some long-term flexibility in case you want to restructure the royalty deal to attract other investors.
By selling licenses or marketing rights (S, M, S-U) If you're a young company or a start-up with an interesting product in hand -- or even in the works -- you might look into raising money by selling off the rights to market your product in geographic areas or industries secondary to the ones you're aiming for. Consider, for instance, a new filtration technology that has potential applications in several industries. Assuming you don't have the money to tackle every market at once, find someone to license the product in, say, pharmaceuticals. Or you could decide to sell marketing rights for your product in Europe or Asia. Either way, think of this as trading markets for money. As lawyers and others who have hammered out these deals will tell you, you can structure them in any number of ways. You can set them up as exclusive or nonexclusive agreements, get the cash up front, or take it in yearly license-renewal fees or as royalties on sales.
With licensing deals, you retain the equity. But there is an Achilles' heel. We've heard several companies complain that their early licensing agreements turned off later potential investors who felt there wasn't enough of an up side left for them. If at all possible, then, try to sell nonexclusive licenses or work out legal provisions for amending deals to attract future money.
By selling a department (S, R, M) If you're looking for a quick shot of cash, here's a technique that's just emerging. It's suitable for companies that rely heavily on their data-processing departments, and so far we've seen it primarily on the East and West coasts. The idea is to sell the department off to a company specializing in data processing, then contract with it for the services you need. Initially, it will deliver the services using your people and systems on-site; eventually, however, it will almost certainly make changes, which might include reassigning your former employees, weeding out those who aren't needed, and having people work on multiple accounts at once. To protect key employees, you may be able to negotiate management contracts.
People who have engineered these types of deals say the players pursuing the arrangements most aggressively are companies like EDS and IBM. How much you can expect to raise is tied to the size of the department. A five-person department with a payroll of, say, $200,000 (the smallest payroll of the deals we've heard about), could be worth around $1 million if you're willing to sign a 10-year service contract. To do a deal like this, you need to feel comfortable that the data-processing people will no longer be under your direct control.
By selling equipment and leasing it back (S, R, M) Suppose you have some assets you want to continue using, but you also have a pressing need for cash. One battle-tested technique is the sale-leaseback. It works the way it sounds: you sell the piece of equipment or real estate to an investor (a bank, a finance company, or even a wealthy individual); the investor gives you money, takes title to the property, then leases it back to you. If you want access to the asset for an extended period and want to keep your payments low, arrange for a long-term operating lease (which assures the lessor of a payment stream for the length of the lease).
Whatever cash you get from the sale improves your balance sheet, while the leases may not have to be on it. (That depends on some intricate accounting rules.) Many investors are wary of deals involving real estate, but opportunities with computers and other equipment exist. The financial benefits aside, you often can pass off to the lessor the risk of your equipment's becoming obsolete.
The big downside? That you'll need to replace the equipment at the end of the lease (operating leases don't have bargain purchase options), or that you won't need it for the full term of the lease. Also, because of some recent bankruptcy-court decisions, leasing companies and investors are extremely reluctant to do sale-leasebacks in many states. (Without modifications to the uniform commercial code in those states, courts have said, even after sale-leasebacks, the lessees still own the equipment.) If you're interested in talking to someone about a sale-leaseback, start with your banker or accountant. If neither does this sort of transaction, chances are good that one or the other will know someone who does.
