You’ve started your new enterprise by bootstrapping—quitting your day job, investing your own money, even employed a round of friends-and-family financing. While you’ve made significant progress, cash remains tight and if you had enough money, you could be on your way to financial freedom through a liquidity event of your choosing (by going public or selling your company). Cash is extraordinarily important in our industry, to create recurring monthly revenue or develop new technology, and you might need help to get to the level you need. Can you borrow more or do you really need an infusion of equity? And would you benefit from the expertise and resources an equity investor would bring to the table?
Here’s some good news: even in this economy, a significant pool of private equity capital exists, sitting on the sidelines waiting to be deployed. Here’s a primer on the players in the U.S. private equity market to help you begin your exit strategy.
The overall category of private equity includes venture capital and other sources of public funding. If you need early-stage funding, one possible source may be an angel investor—often high net-worth individuals (many who have created and sold their own company) looking to invest some of their capital (and possibly that of others) into early-stage ventures. The typical angel investor invests between $100,000 and $750,000 and often receives convertible shares in the enterprise, giving them the right to convert their shares into additional shares, usually for no additional money.
Start-ups can also participate in business incubators. Sponsored by business schools or agencies engaged in economic development, these programs help start ups to hone their skills and determine if their business plan has potential to be backed by other investors.
Venture capital (VC) funds provide high-risk equity capital to start-up and early-stage companies (In contrast, private equity generally funds later-stage, more mature enterprises, use a wider variety of deal structures and are more likely to raise money from large institutional investors. For the purposes of this article though, we’ll treat the two terms interchangeably.) Venture funds often raise money from private investors and large institutions and seek to invest in companies developing novel technologies or a new business model, often focusing on a particular form of technology or industry. Like most equity investors, VC funds plan to exit their venture in a liquidity event within three to eight years (one recent report pegs the average at 6.5 years) and expect an average return on their investment of 45 percent. VC funds often receive convertible instruments, preferred shares (they get paid before you do in a liquidity event) or warrants for future shares, giving them more of the company and more money in liquidation.
Another type of investor is the strategic investor, typically an established company in the same industry that invests in the development of a complementary product or service.
What they need to make a deal
All private investors make investments based objective factors including historical operating statistics, future performance indicators and projections and various industry multiples, as well as subjective factors, including the background and track record of management, intellectual property rights, technology, the likely path to liquidity and present and future capital needs.
Having more than one potential investor puts you in a better position to negotiate terms and conditions. Be candid in your disclosures—if you close the deal, these are your new partners—and make sure you have a first-rate confidentiality agreement (not the one provided by the investor). Your new investors will want a seat on your board of directors, to participate in the company’s management and to have full access to financials. Your company will not be able to undertake material actions without the investor’s consent, and you may be limited in distributing cash or dividends, or changing your compensation or perks. You will be required to sign (and negotiate) a set of deal documents providing investors certain protections and imposing obligations and potential liabilities on you, so make sure you are represented by experienced counsel.
