Raising Capital for an Acquisition
When raising capital to acquire a
business, or expand an existing business, you’ll need to view the investment
from the perspective of the investor. To do so, you will need to know
about investment risk vs. return, as every investment has risk. Federally
insured certificates of deposits and interest-bearing bank savings accounts
have risk. Not necessarily principal or interest payment risk, but
inflationary risk. If you are receiving 3% on your money in a two-year CD
at the bank and you are in a combined state and federal marginal tax bracket of
33%, then you are netting out about 2% after tax. If inflation were to
rise to 5%, you would actually be losing 3% on your money in the form of
Conversely, one may view lower-priced publicly traded stocks on the Over the Counter Bulletin Board as a high-risk, high-return investment. These investments generally have a higher principal risk but also have higher return potential. In general, risk and potential return go hand-in-hand. The higher the risk one takes on an investment the higher the potential return should be.
Any new company or venture will
generally be viewed as very high risk by most savvy investors; therefore, a
very high return potential must
accompany that risk, but not too high, otherwise it becomes unbelievable if a
"too good to be true" scenario. The trick to attracting capital
for start-up and early-stage companies is using different deal structures to reduce
the risk components of the securities being offered for the investor while
maintaining the high return potential.
One attractive deal structure is to use a security such as a note, which is convertible to a participating preferred stock. This changes the risk return continuum for the benefit of the investor. A "marketable" deal structure allows for maximum upside while minimizing the downside... by utilizing creative financing structures buyers can create an attractive investment which can effectively compete for funding from individuals.
Simply think of yourself as an investor. How would you like to invest $100,000 in a new company or venture in the following manner: You purchase a $100,000 first mortgage note, with a 10% interest rate, and a first lien position on 100% of the assets of the company? Once the notes are ready to mature, you roll over the $100,000 into a participating-preferred stock being offered by the company that returns 10% in stated dividends and participates in 20% of the net profits of the company. By selecting this combination as your company deal structure, you would have reduced risk while maintaining a high potential return.