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Twenty-five to fifty
percent of your own money in the business shows a lender or investor that
you are prepared to share the risk alongside his/her money (your
commitment to the project). As the business grows, you should always try
to keep your own equity (ownership) at approximately 25% of the total
project (as per the current balance sheet). Earnings retained in the
business will increase both your equity position and your leverage.
Shareholder Loans
represent equity (and, on occasion, debt) paid into a private company by
relatively few "partners in profit and risk" in exchange for share
ownership. The shareholder loan may be secured by the share certificate(s)
alone or by a debenture. If it is secured by a debenture or something
other than the participation in the profits, then technically it is not
equity. Most financiers of commercial debt will insist on a priority claim
against assets and force this shareholder to a secondary or subordinated
security position.
A stockholder's
liability in a limited corporation is limited to the value of the shares
he/she has purchased. Normally there is no claim by these stockholders on
the business' assets; rather they have accepted the risks and rewards that
go with that business. The rewards are direct participation in the profits
of that business as well as any appreciation in the perceived value of the
shares. The risks represent the possible reality that the share-value
could drop to zero. True equity money is unsecured and directly reflects
the faith of the investor in the business, its management and the
commitment of its principals to it.
Venture Capitalists
could be companies with more retained earnings than they require for
reinvestment into their own operations, holding companies who wish to
diversify their bases; "venture capital corporations" formed for tax
advantage reasons; or individuals seeking to shelter excessive earnings
from high taxes or hedge their fixed incomes against inflation. Venture
capitalists are usually shareholders, secured by share value and legal
agreements.
Sources of Equity
Financing
Family,
Friends, Inheritances & Personal Mortgages
The most
accessible sources of personal money are inheritances, mortgage extensions
(on a personal residence) and family and friends. But venture cautiously,
many cherished friendships and family relationships have been destroyed
through inadequate protection and provision for personal creditor
repayment related to the possibility of a business failure.
If you borrow money
from family members and/or friends, consider setting the loan up on a
straight business basis. You may also want to provide some personal
security or personal guarantee outside of the business itself. The offer
of a deferred repayment scheme of some kind may be welcome.
Most often these
persons are assuming a high risk with little real basis for the investment
as a favour to you. Your concern about protection for their money will go
a long way to ensuring their future cooperation and avoiding dissension.
They will be most favourably impressed if you can show them a well
thought-out and orderly presented business plan, even though they may not
have specifically requested one.
Partners
In seeking out a general equity partner, it will be wise to
identify persons who have not only the money to complement your
contributions (equity), but who are knowledgeable in the industry itself,
connected in the industry and who have expertise in the areas of the
business in which you do not. Limited partnerships have special provisions
to limit the direct involvement of the partner in decision-making as well
as their liability in the debts of the company.
Investors
In seeking active investors (venture capital) for a project,
look first within the industry. Logically, an investor will prefer to
invest in a business he/she understands. You will also have far less
explaining or selling of the concept to do. There is a possibility that
once they have made that investment, they will also be looking
pro-actively to involve your company in the other things they may be
doing, and their influence in the industry may well provide access to
additional contract opportunities in the industry.
In seeking passive
investors who will have little or no involvement in the project, try to
find those groups of professionals who have steady income (to tax shelter)
and a prime responsibility of their own that allows them no time to
interfere in yours (e.g. a doctor or group of medical practitioners, a
dentist with a busy practise, or a lawyer or professional financier
preoccupied with their own activities).
Approaching Equity
Investors
In seeking
partners who will be putting their own money into the venture, you must be
prepared to accept the fact that a partner will most often expect to be
involved in the decision-making process of the venture. At the very least,
they will expect to be kept updated regularly on your activities.
These persons are
being asked by you to take a relatively unsecured position in the company
and should be presented with a sophisticated, detailed business plan that
reveals everything related to the financial basis for carrying on this
business. The prospective investor will rigorously evaluate the abilities
of the management team, the financial strength of the company structure
and principals, and the commercial viability of the enterprise as to the
risk factors portrayed in the projected financial submissions.
This evaluation will
normally require a detailed business plan (in a bound presentation format)
which provides extensive information on the management of the company or
project; a detailed history of the business concept, its products, its
production methods, operations and costs, its target markets and position
in the marketplace; the purpose to which this additional equity (cash
infusion) will be applied (in intimate detail); any assets the company
owns as well as a detailed summary of all liabilities (debt) and
shareholdings etc.; and extensive financial information and projections.
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