Private Equity Financing Structures
There are several Private Equity Financing Structures that are used to provide financing to companies. They include debt financing as well as preferred stock, common stock and even debt that may be converted into common stock upon the occurrence of certain circumstances.
Debt Financing
Private equity financing structures based on debt or a loan are always secured by some form of asset that the company owns. The security my be hard assets like a building, real estate or equipment. It could also be in the form of inventory, especially if the private equity lender is using the proceeds of the loan to purchase additional inventory to keep up with sales.
Smaller companies that need capital and are not seeking a large infusion of capital may seek alternative sources of financing from more traditional lenders such as banks, finance companies and private lenders. If the company and its principals do not have good credit or the company is on shaky ground, the lender will look to secure its loan with as much security as possible. It may require a second mortgage on the homes of the principals and even require the loan be secured against credit card receivables so that a certain percentage of daily credit card receipts are paid directly to the lender. This type of credit card receivable financing is often at a high interest rate and is usually for only 1 to 2 years.
Smaller companies that need capital and are not seeking a large infusion of capital may seek alternative sources of financing from more traditional lenders such as banks, finance companies and private lenders. If the company and its principals do not have good credit or the company is on shaky ground, the lender will look to secure its loan with as much security as possible. It may require a second mortgage on the homes of the principals and even require the loan be secured against credit card receivables so that a certain percentage of daily credit card receipts are paid directly to the lender. This type of credit card receivable financing is often at a high interest rate and is usually for only 1 to 2 years.
Common and Preferred Stock Funding
This type of private equity financing structure is only used if the company is on stable ground or has a big upside, even if it is not yet profitable. Just look at some of the large tech and internet companies that received millions of dollars in funding before they were even profitable. Huge risk, but huge profit potential. These business models were based on a pure growth model with the understanding that if a large enough user base was obtained then at some point a paid subscriber base could be developed or if the numbers were so large then advertisers would pay, especially if users could be targeted based on their age, gender, geographic location, likes and dislikes.
If you are a startup you should also be aware of financing structure tips that are more geared toward early stage companies. Clawbacks and subsequent financing rounds are something you should be familiar with in the beginning and not when it is too late and you are unable to re-negotiate the deal.
If you are a startup you should also be aware of financing structure tips that are more geared toward early stage companies. Clawbacks and subsequent financing rounds are something you should be familiar with in the beginning and not when it is too late and you are unable to re-negotiate the deal.
Joseph B. LaRocco is a business and corporate attorney that handles business contracts, business transactions, entity formations, and corporate governance.
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Convertible Debt
If the lender wants the flexibility of having debt with security in the event of a payment default, but also wants the option of converting into common stock in case the company is a big success and goes public, then convertible debt may be a possible structure that is considered.
Convertible debt instruments can be in the form of a promissory note or a convertible debenture. They allow a company to raise capital but should be carefully structured so that they do not end up severely diluting the company and other shareholders.
Some private equity firms and private lenders will typically use convertible debenture financing structures and require that the company be publicly listed or file for a public listing in the immediate future. Prior to the company going public, the company will be required to make interest payments and possibly even payments toward principal if certain milestones are not met or if the public listing is delayed for any reason. Most likely, even though the debt is convertible into equity, there will still be security required in the event the company defaults.
The startup may be able to negotiate favorable terms when it comes to convertible debt. For instance, if you can pay off the debt or a good portion of it, you just got a strategic partner to help you with your growth and likely only paid a little more interest than what a bank would charge. Try to negotiate terms that allow you to pay off the debt without the investor converting during the first year or two, as long as you meet your monthly or quarterly payments on the debt.
Convertible debt instruments can be in the form of a promissory note or a convertible debenture. They allow a company to raise capital but should be carefully structured so that they do not end up severely diluting the company and other shareholders.
Some private equity firms and private lenders will typically use convertible debenture financing structures and require that the company be publicly listed or file for a public listing in the immediate future. Prior to the company going public, the company will be required to make interest payments and possibly even payments toward principal if certain milestones are not met or if the public listing is delayed for any reason. Most likely, even though the debt is convertible into equity, there will still be security required in the event the company defaults.
The startup may be able to negotiate favorable terms when it comes to convertible debt. For instance, if you can pay off the debt or a good portion of it, you just got a strategic partner to help you with your growth and likely only paid a little more interest than what a bank would charge. Try to negotiate terms that allow you to pay off the debt without the investor converting during the first year or two, as long as you meet your monthly or quarterly payments on the debt.
Other Tips on Private Equity Financing Structures
There are several advantages of seeking hedge fund financing though a hedge fund rather than a private equity or venture capital firm. Hedge Funds can usually make investment decisions and close in a shorter time frame than private equity and venture capital firms. While Private Equity Financing Structures are similar to Hedge Fund Financing Structures, typical Private Equity Financing Structures have longer much more complex term sheets and closing documents. Private equity firms also require much more control and management can lose majority control if the company doesn't perform exactly the way they thought in terms of gross sales or other milestones.
While private equity firms will not require a reverse merger, they typically take several months just to make a funding decision. On the other hand, hedge funds typically conduct due diligence faster than private equity firms, they make decisions faster and are quite capable of closing on the funding and reverse merger transaction in less time than it takes most private equity firms to make a funding decision.
Venture Capital firms tend to be even slower, because of the increased risk they face when dealing with start-up companies. As a result, they conduct an excruciating amount of due diligence and my change the deal terms several times before closing. They will try to justify the new terms or reduced pricing based on risks or problems that were revealed when they were conducting their due diligence.
It is also a double edge sword when dealing with any financial firm because they may have an ulterior motive. It is good to find out what other companies they have financed or funded that may be competitors of yours. Are they seeking information on your company, its strategy and its marketing plan simply because they have already financed or invested in one of your competitors?
As you can see, there are many different types of private equity financing structures and which one will suit the situation depends on numerous factors, but as you may have already figured out, that decision is often controlled by the firm that is writing the check. They often have their own structures and how they typically structure a deal will likely control, with a few reasonable adjustments based on your input and justification for those adjustments.
While private equity firms will not require a reverse merger, they typically take several months just to make a funding decision. On the other hand, hedge funds typically conduct due diligence faster than private equity firms, they make decisions faster and are quite capable of closing on the funding and reverse merger transaction in less time than it takes most private equity firms to make a funding decision.
Venture Capital firms tend to be even slower, because of the increased risk they face when dealing with start-up companies. As a result, they conduct an excruciating amount of due diligence and my change the deal terms several times before closing. They will try to justify the new terms or reduced pricing based on risks or problems that were revealed when they were conducting their due diligence.
It is also a double edge sword when dealing with any financial firm because they may have an ulterior motive. It is good to find out what other companies they have financed or funded that may be competitors of yours. Are they seeking information on your company, its strategy and its marketing plan simply because they have already financed or invested in one of your competitors?
As you can see, there are many different types of private equity financing structures and which one will suit the situation depends on numerous factors, but as you may have already figured out, that decision is often controlled by the firm that is writing the check. They often have their own structures and how they typically structure a deal will likely control, with a few reasonable adjustments based on your input and justification for those adjustments.
