So how, exactly, can a company find the right investment bank? With so much at stake, entrepreneurs need to do the same level of due diligence that their prospective investment bankers and investors will undertake regarding them. The National Association of Securities Dealers (www.NASD.org) will provide companies with lists of registered investment bankers -- and it will also run background checks. One smart tactic is to ask for the names of an investment banker's last 10 clients -- that way the banker won't be able to cherry-pick the best deals. A company should also call private-equity investors with whom the investment bankers say they have relationships.
In the end, a company that chooses well is likely to end up with more financing choices than it would have had out on its own. "Our job is to generate options for the business owner, ranging from a small financing to a sale of 100% of the company, to everything in between," says Gardenswartz, of the Sage Group. "Ultimately, it's the owners' decision which of those options is the right one for them, but we put the picture together for them in an honest, straightforward way."
Suzanne McGee was a reporter for The Wall Street Journal for 13 years, most recently covering corporate finance out of New York City.
Negotiating a term sheet for a complex private round of equity has become especially difficult as investors scramble for protection.
Even for the healthiest of companies, capital is not only harder to find these days, but also often comes with some very unpleasant strings attached. The guidance of an investment banker can be all the more important at these times, since most owners of growing companies lack the level of expertise required to negotiate complicated financing deals. Below are a few of the terms and conditions that a company owner looking for private financing may now have to address -- and some of the steps an investment banker can take to contend with them. Hiring an experienced securities lawyer (also an expensive proposition) to work hand-in-hand with an investment banker in negotiating the term sheet may also be a good idea if the proposed conditions are especially tricky.
Liquidation preferences: Liquidation preferences weren't even features of most financing agreements three years ago but now are standard. These preferences give the investor a way to lock in a level of return -- so long as the company, when it's sold, is still worth more than the investment. Consider a private-equity fund that's willing to invest $10 million in exchange for 20% of a company valued at $50 million today. A liquidation preference allows that investor to get all of its money back -- plus a specified additional amount -- in the event of a company sale or liquidation.
Should the company be sold for only $30 million, with no liquidation preference in place, the fund that invested $10 million for 20% of the company would be entitled to $6 million. The fund would have lost $4 million on the deal.
But the investor who received a 2x (two times original capital invested) liquidation preference would come out with a profit: Not only would he recoup his original $10 million, but he would be entitled to an additional $10 million. That would leave the owners of the remaining 80% of the company with just a third of the proceeds of the sale. Recently, liquidation preferences for strong companies have been retreating somewhat -- a deal that might have been done at 2x might now be 1.5x or even 1x. A 1x deal simply gives the investor the right to recoup his entire investment before other shareholders are paid in the event of a sale.
Participating preferred shares: Participating preferred equity is an even newer twist: These structures allow investors to scoop their return off the top in the event of a sale or a merger and in addition, also give them a share of the remaining proceeds. A fund might acquire 2x participating preferred shares for $10 million in exchange for a 20% equity stake. In a $30 million sale, the investor would receive $20 million but also get 20% of the remaining $10 million, taking in 73.3% of the proceeds of the sale.
An experienced investment banker can sometimes negotiate a middle ground acceptable to both company and investor. Last summer, Charlie Manuel of the boutique investment bank Black Point Partners battled against a participating preferred share proposal. The investors eventually agreed to accept less than the 2x liquidation preference and, further, that the participating preferred shares would disappear if the company was sold for more than $100 million. "The goal is to bring it down to the minimum level," says Manuel of liquidation preferences and participating preferred.
Milestone financing: In these arrangements, a company is rewarded (or punished) for hitting (or missing) targets such as achieving a set level of cash flow or number of customers, or launching a new product. Failure can require the entrepreneur to fork over more equity to the investors -- or even give up management control of the company. In some cases, a proposed milestone-financing condition is just a way for an investor to gauge the business owner's willingness to bet on his or her own future success.
"If the entrepreneur balks or seems to be nervous about missing the numbers, the investor's feeling is, 'Well, how confident is he really about his overall business?" says Dan McKinney, executive vice president of T. Williams Consulting of Collegeville, Pa., a management-consulting firm that advises entrepreneurs.
Companies looking for earlier-stage capital do have one trump card when dealing with funders seeking especially severe terms.
"Investors are aware if they demand terms that are too onerous, then it will be harder to persuade other investors to come in for a later round of financing," says Kevin Jolley, of the bank Adams, Harkness & Hill in Boston.
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