Accessing Equity Capital

If you have encountered difficulty obtaining bank financing to help your company grow or if you are already highly leveraged but have a bevy of growth opportunities in front of you, you may need to pursue equity financing.

Business service firms tend to be small, local operations. Therefore, most firms will not qualify for the “typical” outside equity investment. However, if you want to make the leap from a small consulting type or construction small job shop with historical revenues of $3 Million or less to one with $30 Million or more and you believe you need equity investors to do so, you need to address the investors concerns. You must first create the vision and goals, then the plan to achieve your goals. If necessary, engage business consultants and coaches who can help you identify the company’s and your weak areas and put the procedures, processes, management team, etc. in place that will lay the foundation to help you achieve your goals.

If you only reached $3 Million in all of the last ten years, and now you want to make the jump to $30 Million in five years, you must address the huge credibility gap you are now burdened with. Utilizing consultants and coaches will get you there sooner. These entities can also help you write a plan that incorporates the necessary changes and address any inherent operational issues that may impede your progress.

If you have been on the path to larger revenue from the beginning, then you do not have the credibility gap with an equity source. However, you must clearly understand and cogently communicate how you are different and how you will achieve revenues of tens of millions when the vast majority of your peers will never come close. This is not to discourage you but to simply help you understand what the investor’s point of view will be.

For all private sources of equity, it is crucial to find investors who share the vision for the growth and direction of the company. Since these entities will have significant ownership stakes, they typically will have one or more board seats and significant voting impact. Essentially, these entities or their representatives will be a defacto member of the management team. If the goals of the investors or investment organization are not aligned with those of the company’s management, the company’s growth will likely falter. If the relationship derails beyond the point of no return, depending on the terms of the investment agreement and the ownership stake of the firm, the company’s current management could be forced out.

Your company must be properly structured for equity investment. If you intend to sell shares to a number (i.e., more than ten) of investors, you should choose a corporation legal structure for your company over a limited liability company (LLC). LLCs do not allow the flexibility of share structure (i.e., preferred class A, preferred class B, common) that corporations allow. Angels and private equity investors typically want to ensure that they are re-paid before any of the owners / founders of the business or before the money is used for other non-essential expenses. Therefore, they typically demand preferred treatment for their investment funds represented by preferred shares.

In addition, you must structure (or re-structure) the company to allow the issuance of ten million or more shares. The shares will not be issued at once but will be issued as new equity financing is obtained. If you only have 1,000 shares and you issue 800 to you and your relatives, you only have 200 to issue to outside investors. That would be totally unacceptable to any interested sophisticated investor. (However, this may be fine for your friends and family who do not know any better.)

You can see clearly how this transforms into a very unwieldy situation in no time. How would the follow-on investors obtain shares in the company? Consult with a corporate or small business attorney to set up your corporate structure and designate the appropriate number of shares. If you have already formed a corporation with 10,000 shares, consult the attorney to make the requisite changes and amend your corporate documents.

The equity investor is there to make money on their investment. Some investors are very hands off and serve as advisors or relationship connectors when needed. Others are very involved and actively participate in driving the growth of the company. Companies need to be aware of the type of investor the equity provider is (detached, actively involved, or somewhere in the middle). For those companies that have been sorely lacking a strong advisory board, a highly active investor may be just what is needed to catapult the company into high-level growth. In the end, the decision rests with the owners. Therefore, owners seeking equity must clearly understand the mission of the company, the goals of the company in terms of growth, market focus, market penetration, the uses of the capital, and the exit strategy.