Ice Miller has been active in the private equity industry for over 25 years, representing both management teams building great companies and the private equity firms and individuals that invest in them.  We have extensive experience with all types of funds (formations and operations); mezzanine and senior secured financings; leveraged buyouts, roll-ups, build-ups, and consolidations; divestitures and exits; and complex litigation on behalf of investors and privately financed companies.
 
Read the complete profile of the Private Equity and Venture Services Practice Group.

Janice Wilken is a partner at Ice Miller LLP and editor of Ice Miller's Private Equity/Venture Services blog.  Her primary area of concentration is corporate law. She also handles securities law compliance matters for public companies.

During the financial crisis, private equity, mezzanine and venture capital firms have spent a lot of time "cleaning house."  The financial crisis has made cheap debt less available and thus private equity and other firms are not able to complete deals with the huge leverage ratios that existed prior to the crisis.  So, they have taken a close, hard look at existing investments in order to determine which could be saved and have allocated resources appropriately.  

This sort of review has included, from a legal perspective, review of debt covenants and commercial contracts.  The firms have wanted to determine which of their portfolio companies are in danger of violating a financial covenant or failing to perform under a critical contract. 

Recent reviews have also included analyses of potential exit strategies in a down economy.  The potential strategies include the traditional options of bankruptcy, sale and IPO.  IPO's have been down sharply until very recently, so this option has not been given much consideration.  Sales have continued, but with valuations low, this is often not a favored option.  Bankruptcy is, as always, fraught with difficulties as firms consider the opposition of creditors as well as the value of their secured positions, if any.

Throughout the financial crisis, distressed investing has continued.  With the credit markets tight, private equity and other firms have taken some opportunities to fund companies that have not been able to get credit in the traditional credit markets.  These efforts persist, and the firms continue to focus sharply on the fundamentals of these companies in order to protect their investments. 

If you haven't read the thousands of pages of the current Senate-proposed version of the Patient Protection and Affordable Care Act (that's the formal name of the proposed healthcare reform bill), you might be surprised by the kinds of opportunities that are available for businesses.  This commentary may be a bit premature given that a bill has not been passed, but because the Senate-proposed bill is currently forming the basis for congressional debates, it could become relevant to businesses very soon.

Everyone knows that the bill would require universal health insurance and impose a broad range of new requirements on the healthcare industry.  In addition, the bill has a variety of grants and opportunities it makes available to businesses both within and outside the traditional healthcare field. 

There are numerous grant opportunities for states, and in many cases, the state can allocate funds through a bidding process.  Traditional healthcare organizations such as hospitals are eligible for a large number of grants and funded study and training projects.  Nonprofits have a number of opportunities available, too.  And colleges and universities also can take advantage of a wide range of potential grant and award programs.  Funds are also available for other businesses, such as grants to implement comprehensive workplace wellness programs or contracts to establish Web sites.

It will be an interesting road to see what happens to healthcare reform in the next weeks and months.  We will keep you posted on the funding opportunities that might be available for your business.

According to a recent survey of middle market companies in the southeastern United States, there may be a bit of a debt maturity crisis approaching.  AlixPartners conducted a study of 142 companies and found that there is approximately $6.3 billion in debt scheduled to mature in 2010.  In 2009, those companies had overall debt of $64 billion but generated revenue of only $59 billion.  This, along with a general shortage of working capital within the companies, points to a strong need for credit availability this year.

Now, we all know that the credit markets have opened up a bit.  Both 2009 and early 2010 have certainly been better than 2008.  However, they haven't opened up that much.  As a result, working capital management will be more important than ever as companies try to weather this storm.  According to the AlixPartners study, companies included in the study had only 8.9 days in working capital coverage.  The study stated, "Like the old saying goes, 'cash is king' – and both generating and husbanding cash through all means possible is going to be key for companies in this region this year, starting with having cash for debt service.  That's the only way to make sure this debt powder keg doesn't turn into a bomb."

Move over Sarah Palin. While "Going Rogue" may be the talk inside the beltway, there's a new book that has captured the attention of many on Wall Street: "The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis".  The author, Joshua Kosman, forebodes the possible collapse of many companies owned by private equity firms.  While it certainly isn't clear whether what Kosman's is prophesying about will in fact turn into a significant chapter in U.S. history books, it's an interesting read nonetheless.  A short excerpt on NPR can be found at:

http://www.npr.org/templates/story/story.php?storyId=120391729
 

Well, there are a number of things going on relating to the election of public company directors, but the most significant is the recent amendment of Rule 452.  The SEC adopted that amendment effective for director elections at annual meetings after January 1, 2010.  The new rule eliminates broker discretionary voting authority on the election of directors.  In other words, your broker will no longer be able to vote your shares for you in a director election. 

What does that mean in the case of your everyday retail shareholder (i.e., you or me individually)?  It means that if we do not respond to proxy materials received from the company (if, for example, they end up in the round file), the shares will not be voted at all.  This could affect the ability of public companies to get their directors elected even if there is no substantive reason that they should not be.

The companies most likely to be affected by this rule are the smaller cap companies that tend to have a large retail shareholder base.  In the case of companies with a large number of institutional investors, it will generally be easier to get a response from those shareholders.  Institutional investors tend to vote their shares on their own, although they often follow the recommendations of Risk Metrics, Glass Lewis or other institutional shareholder services organizations.  But, retail shareholders often do not vote on their own.  This could cause smaller cap companies to spend time and resources to prepare follow-up mailings or make phone calls to investors.

It will be interesting to see how this amendment to Rule 452 affects director elections starting in 2010.  Hopefully, as the SEC and other regulators consider some larger issues relating to shareholder voting (e.g., proxy logistics, proxy access and other shareholders' rights), a comprehensive system that considers all the current issues will be implemented.

A recent edition of PitchBook News Private Equity: Basic Edition cited a decrease in 2009 in exits from private equity investments through sales to other private equity firms.  The article stated that these secondary sales are down approximately 22 percent from their levels in 2005 through 2007.  In 2008, many private equity exits took the form of sales to strategic buyers.  In 2009, IPOs increased by approximately 19 percent, according to the article. 

So what does this mean?  Late 2007 saw the beginning of the current economic crisis and, in that time, it appears that private equity firms continued to feel confident in investing their money.  In many cases, they did so by buying out other private equity firms. 

In 2008, when it became clear that the economic crisis would not be short-lived or minor, strategic buyers became the most obvious source for private equity liquidity.  Strategic buyers saw opportunities to enhance their businesses through the synergies offered by private equity portfolio companies.  In addition, valuations were very low:  the perfect formula for strategic acquisitions.

In the later parts of 2009, we have seen the public equity markets bounce back significantly.  Instead of shying away from the public markets' previously unequaled volatility and sharp decreases in value, private equity firms looking for an exit option seem to have again turned their focus to the IPO as a possible exit strategy. 

Hopefully, markets will continue to stabilize, valuations will become more reliable and private equity firms will invest some of the money they are currently holding.  If all these things happen, we can hope to see a return of multiple options for private equity exit strategies.
 

Some studies suggest that the answer is  yes!  In a recent study, the Preqin Research Report Private Equity Investor Survey August 2009, many limited partners (LPs) investing in private equity funds reported that the balance of power in negotiations between the funds general partners (GPs) and the LP's had shifted in favor of the LPs.  In fact, according to the Preqin report, in April 2009, 27 percent of investors thought they had greater negotiating power.  Three months later, in July 2009, 55 percent of investors interviewed by Preqin believed they had greater negotiating power.

Why would that be?  Certainly, one of the reasons is that levels of LP investment have fallen significantly from previous years.  According to the Preqin report, private equity funds raised $194.5 billion in the first quarter of 2008, while they raised only $64 billion in the first quarter of 2009.  The GPs have to compete for the limited LP funds that are actually being invested now.  One of the ways to do that is to offer LPs more favorable terms.

So, cash-rich LPs appear to be returning to the market.  Private equity fundraising has already begun to improve in 2009.  According to the Preqin report, $79.7 billion was raised by private equity funds in the second quarter of 2009 as compared to $64 billion in the first quarter of 2009.

The state in which you form your business may not seem important now, but it could have consequences in the future.  Administrative expenses, tax issues, attraction of future investors and simply the ease of governing your entity can all be affected by the state in which your entity is organized.

That being said, it is relatively easy to change the state of your company's formation.  As your business develops, the important thing is to periodically evaluate whether it continues to make sense to be organized in the state you originally chose.

There are three main issues to consider when determining where to form your business:

• Location of your business
• Tax issues
• Attracting investors

Particularly with new ventures, the location of your business should be a big factor in deciding where to organize.  Your business has to have a registered agent to receive service of process in each state where it operates.  If you organize in the state where your business is physically located, someone at your company can be the registered agent.  However, if you choose to organize in a state other than your "home" state, then you will have to use a paid service to act as your registered agent.  Generally, the fee must be paid for each state in which the service acts as your registered agent.  As you can imagine, this cost can add up quickly for a new business.

Clearly, a start-up business wants to keep its tax bill as low as possible.  Your company will have to pay state taxes in each state in which it operates.  While these taxes are unavoidable, the business can take steps to limit them.  For example, Delaware corporations are subject to the annual Delaware business franchise tax.  However, many states have no franchise tax, or at least a much smaller tax.  While there are certainly valid reasons to incorporate in Delaware, its franchise tax could hit a new corporation with a large tax bill that may be needless.

If you anticipate raising money from outside investors, Delaware might be a good state to choose.  Investors are generally comfortable with Delaware entities because of the certainty that Delaware's business statutes and courts provide. A lot of businesses have formed in Delaware, and that has led to detailed statutes and a well established body of case law.  Investors and businesses can use the relative certainty of Delaware law to plan their relationships in a way that hopefully avoids potential trouble areas and litigation.

We all know that a business owner has hundreds of decisions to make when starting a new venture, and the state of formation may seem inconsequential.  Yet, with a little forethought and periodic monitoring of its situation, a business could save itself a lot of hassle (and money) in the long run.

When you are choosing an entity there are a number factors you should consider.  For instance, you should think of how you would like to manage the business, protection against liability and your preferred tax treatment.  Below are brief descriptions of several business entities that may suit your needs and some of the advantages and disadvantages of choosing those entities.

Sole Proprietorship
The sole proprietorship is the simplest form of business.  A sole proprietorship is not an entity separate from you.  Though the sole proprietorship is a simple and convenient way to operate your business, you should beware, you will be exposed to unlimited personal liability if you operate your business as a sole proprietorship.  The owner of a sole proprietorship is directly and personally liable to creditors and other claimants. 

Corporate Entities

Corporation
A corporation is a business entity created under state law and is as an independent legal "person" apart from its shareholders and directors. A corporation's shareholders are generally not liable for the obligations of the corporation and are thus generally shielded from the corporation's creditors even if the corporation cannot pay its obligations.  Corporations must comply with statutory rules which are typically more restrictive and require considerably more formality than limited liability companies.

C Corporation
The distinction between a C Corporation and an S Corporation relates to the corporation's tax treatment.  Some of the advantages of a C Corporation are that ordinarily you may deduct the entire value of the fringe benefits offered to shareholders who also serve as employees, the number of shareholders the entity may have is unlimited and they may be either individuals, entities, U.S. residents or foreign.  C Corporations also have significant flexibility to carry corporate losses forward to future tax years.  But, operating as a C Corporation usually subjects you to double taxation, i.e., tax at two levels.  First, the net earnings of the corporation are taxed, and then, the shareholders will be taxed on the earnings of the corporation distributed to the shareholders.  For example, if a corporation issues dividends to its shareholders, it has already paid income tax on that money, but the dividends remain taxable as income to each shareholder. 

S Corporation
An S corporation is a regular corporation that has elected "S corporation" tax status. An S Corporation provides the limited liability of a corporation and the tax treatment of a partnership or a limited liability company.  With respect to non-tax considerations, the S corporation is essentially identical to a C Corporation.  The significant tax advantage with the S Corporation is that the corporation does not pay any income tax on its earnings.  Some disadvantages to an S Corporation are that only once class of stock is permitted and you must limit the shareholders to 100 individuals, none of which may be an entity (with the exception of estates and certain types of trusts) and none of which may be non-resident aliens.

Unincorporated Entities - Limited Liability Company
The limited liability company (LLC) has characteristics of both a corporation and a partnership. The primary characteristic an LLC shares with a corporation is limited liability, and the primary characteristic it shares with a partnership is the availability of "pass-through" income taxation.  Unlike a corporation, few of the LLC statutory rules are mandatory and most of its governance is dictated by an operating agreement executed by its members  The management powers in the LLC can be retained by the members of the LLC or centralized within a board of managers (who may or may not be members).  Another advantage of the LLC is that its flexibility allows for much less administrative paperwork and record keeping than a corporate structure.  Some disadvantages of an LLC are that some investors are more comfortable with a corporate structure (although this may only be an issue once the company is ready to take on significant investors and not in the early stages of your business) and some creditors may require that you, and other members, personally guarantee a loan to your LLC. 

Partnerships

General Partnership
In a general partnership, each partner has full and equal control over the partnership.  The partnership is a "pass through" entity for tax purposes.  While partners have considerable flexibility in structuring their relationship, partners run a great risk of loss because there is no limitation to a partner's liability.  Partners have joint and several liability for the acts of each partner within the scope of partnership business. 

Limited Partnership
Under a limited partnership (LP), unlike a general partnership, the limited partners are not responsible for partnership debts, obligations and liabilities.  An LP may have an unlimited number of limited partners, but must have at least one general partner who is responsible for the management of the partnership.  The general partner remains personally liable for partnership debts, obligations and liabilities, but the general partner can be a limited liability entity to add a layer of protection to the individuals managing it.  Like the general partnership, the LP is treated as a "pass-through" entity.  A disadvantage of the LP is that the limited partners must be careful not to become engaged in the decision making of the business or they will run the risk of losing limited liability protection. 

Limited Liability Partnership
A limited liability partnership (LLP) is a variation of the LP which allows a limitation of liability without the restriction on active participation required with an LP.  Under an LLP, partners remain liable for their own acts and are generally not liable for the acts of others, unless the partner has acted negligently or committed misconduct.  As with the general partnership and the LP, an LLP is treated as a "pass-through" entity for tax purposes.

Bottom Line:  There is no "one size fits all" answer to the choice of entity question.  You should give careful consideration to your needs and the needs of your business before settling on an entity.  Since the factors in consideration may be significant and the tax analysis complex, it may be wise to consult your tax advisor or an attorney to assist you in the decision process. 

The two key documents for a new LLC are:

• Articles of organization
• Operating agreement

The articles of organization are filed with the secretary of state.  They contain some very basic information about your LLC, including its name and whether it is managed by a manager or managers.  If the articles do not say that the LLC is managed by a manager or managers, then it is automatically deemed to be managed by the members.  Articles of organization are required to include much less information than is required to be included in the articles of incorporation for a corporation. 

LLCs are also required to have an operating agreement.  The operating agreement does not have to be written.  It can be oral, but a written agreement is better for a number of reasons, including just as evidence of what the agreement of the members actually is.  Because there are fewer statutory formalities around the operation of LLCs than there are with respect to corporations, the operating agreement is a good place to memorialize the members' agreement with respect to the operation and management of the company. 

Matters that are addressed in a written operating agreement include the following: 

• the process for calling and holding members' meetings;
• the powers of the manager or managers and process for holding meetings;
• duties of officers and the process for appointment and removal of officers by the board;
• limitations on members' ability to transfer their ownership interests;
• repurchase rights  on a member's death, permanent disability, termination for cause or resignation from employment with the company;
• preemptive, co-sale, tag-along and other rights (these concepts are discussed in the context of corporations in the previous blog post "I'm Raising Raising Venture Capital for My Company and I Can't Understand Half the Jargon They are Using. Can You Help?");
• governance (for example, the agreement may require that significant management decisions require the consent of some or all of the members or the managers);
• allocation and distribution of the company's income; and
• miscellaneous (restrictions on competition, treatment of confidential information and dissolution of the company).

On May 12, 2009, Indiana Governor Mitch Daniels signed into law Senate Enrolled Act 450, which made several changes to Indiana corporate law effective July 1, 2009.  Most notable was the change mandating that publicly-held corporations stagger the terms of their board members into two or three groups, elected for two or three year terms, respectively, unless the corporation takes action by July 31, 2009 to opt out of this requirement (as further described below).
 
Read the entire article that highlights several of the substantive changes made by this legislation.

On June 29, 2009, the Internal Revenue Service (IRS) issued a ruling stating that it can seize and sell executive stock options regardless of contractual restrictions on transferability of the options.  This could present significant issues for public and private companies in the event their executives become subject to an IRS levy.

In the ruling, the IRS concluded that contractual restrictions on transferability of the options do not bar the IRS from seizing and selling options.  They reasoned that the Internal Revenue Code specifically lists certain types of property that are exempt from levy.  That list does not include stock options, and the IRS refused to recognize any exemptions not included in the statutory list.  Further, the IRS stated that the contractual transferability restrictions are specifically overridden by the terms of the Internal Revenue Code, regardless of the fact that the Internal Revenue Code itself requires incentive stock options to contain transferability restrictions.

Read the entire alert.

It's time to look at the bright side of the recession:  there is no wait for a table at your favorite chain restaurant, parking at the mall is a breeze and—according to Tim Draper—it may be the perfect time to start a business.  Draper is the founder and managing director of VC firm Draper Fisher Jurvetson.  At a recent speaking engagement, Draper told an audience of Seattle entrepreneurs and investors that right now is the "best time ever" to start a new business.

Draper's evidence?  General Electric, Chevron, Coca-Cola, Skype, Microsoft, Hewlett-Packard, Kodak and Adobe Systems.  (If you are wondering why Skype is counted among these giants, Draper was an investor).  All of these companies were founded during depressions or recessions.  Draper argued that "each of these companies had done something to drastically change the way others in that industry were doing business, or that they had created completely new and different categories that solved real-world problems." http://news.cnet.com/8301-17939_109-10250521-2.html

At InsideCRM.com, an article sharing Mr. Draper's point of view provides an overlapping list of recession start-ups, including Burger King, The Jim Henson Company and Federal Express.  Their analysis is that each of the companies on their list saw a market need and filled it; identifying the "need" in the market is the key to success, "regardless of the economic climate."  http://www.insidecrm.com/features/businesses-started-slump-111108/

If you have been sitting on the next-best-thing-since-sliced-bread, you shouldn't use the current economic woes as an excuse not to start your own business.

Mezzanine financing is just what it sounds like.  It is mid-tier financing, i.e., it is subordinated to senior secured debt but has priority over common equity.  That means that, if the company were to liquidate or file for bankruptcy, the senior secured debt would be paid in full first, then the mezzanine debt, then the common equity.  Mezzanine financing most often takes the form of subordinated notes or preferred stock, often accompanied by warrants with a nominal exercise price.

Mezzanine financing is generally considered to be expensive money.  It's typically designed to provide the investor a higher rate of return in exchange for taking on the risk of being subordinated to the senior debt and usually being unsecured.  Mezzanine rates these day are in the vicinity of 12 percent or more, not counting any additional value added by warrants and other payments.

The Alliance of Mergers & Acquisitions Advisors and PitchBook Data recently released a study of the private equity industry.  The study showed that there is an overhang of approximately $400 billion in private equity fundraising.  That means private equity firms have raised about $400 billion more than they have invested.  There's a lot of money out there waiting to be invested.  In fact, it's at an all-time high.  Click here to see a copy of the report.

As tough as times have been, people have continued to give their money to private equity funds.  The funds just haven't found companies that they consider good investments.  So what needs to happen?  According to some, it's a matter of companies lowering their expectations.  Companies can no longer expect to get the kind of multiples or the kind of leverage that were used before 2007.  Others say it's all about the stability of the economy and the re-opening of the credit markets.  Still others say that investors need to change the way they do diligence on a company.  The old methods will no longer work in light of the current economic realities.

So which is it?  Probably a combination of all.  Either way, I look forward to the days when we start to use that $400 billion.

The world of mergers and acquisitions looks a lot different than it did just two years ago.  When credit was easily available to a buyer financing an acquisition, things were easier for sellers.  Now, buyers are looking to sellers to take on more of the risk.

• Promissory notes.  Many buyers are asking sellers to accept part (or even all) of the purchase price as a note.  In other words, the seller gets less cash at closing and only receives payments under the note if the company is able to pay.
• Earn-outs.  An earn-out is a mechanism where a seller receives part of the purchase price over time, depending on how well the business is performing.  Usually, the buyer and seller will agree upon financial measurements that the company has to meet in order for the seller to receive any payment.  Earn-outs can be very complicated and difficult to track and measure after the closing.
• Mezzanine financing.  Because senior debt is not as readily available as it once was, buyers are turning to mezzanine lenders.    Mezzanine capital is generally subordinated to any senior debt but has priority over common equity.  Mezzanine financing generally has a higher interest rate than senior debt.  That may cause the buyer to provide less generous financial terms to the seller.
• Equity rollovers.  The buyer may ask the seller to roll over some of its equity into the new company.  That is, rather than receiving the purchase price that would be attributable to all of the seller's interest in the company, it will receive only a portion of the full purchase price plus some equity interest in the new company.  In an equity rollover, the seller continues to own a portion of the business and bears the risks related to that ownership.

I'm forming a new entity for my business.  What are some of the key documents?

 

The three key documents for a new corporation are:

 

• Articles of incorporation
• Bylaws
• Shareholders' agreement (optional)

The articles of incorporation are filed with the secretary of state of the state in which you are forming your corporation. They contain some basic information about your corporation, such as its formal name, its registered agent for service of process, the number of authorized shares and the rights and preferences of any preferred shares.

 

Most states require a corporation to have bylaws. The bylaws generally set forth the following information: 

 

• the process for holding shareholders' meetings;
• the powers of the board of directors and process for holding board meetings;
• duties of officers and the process for appointment and removal of officers by the board.

A shareholders' agreement is not required by law but is often a good idea. It is an agreement between the shareholders of the company that governs the rights of the shareholders. A shareholders' agreement typically limits if and how a shareholder of the company may transfer his or her shares of stock. It may also contain the following provisions:

 

• Repurchase rights. Repurchase rights typically require the owners or the company to purchase a shareholder's shares in certain circumstances, such as death or permanent disability. A shareholders' agreement also will often require a shareholder to sell his or her shares of stock to the company or the other owners if the shareholder is fired for cause, voluntarily resigns or the breaches the shareholders' agreement.

 

• Preemptive, co-sale, tag-along and other rights. A shareholders' agreement may also provide for preemptive rights, rights of first refusal, tag-along rights/co-sale rights and/or drag-along rights. These concepts are discussed in the below blog post "I'm raising venture capital for my company and I can't understand half the jaron they are using. Can you help?"

 

• Corporate governance. A shareholders' agreement generally governs the manner in which the day-to-day operations of the company will be managed. For example, the agreement may require that significant management decisions require the consent of some or all of the shareholders or the board of directors. A shareholders' agreement may also establish the means by which the directors are to be elected.   

 

• Miscellaneous. Other matters that may be addressed in a shareholders' agreement include restrictions on competition, treatment of confidential information and dissolution of the company.

Many terms of art are used in venture capital transactions that can be difficult to understand. Most of them relate to key issues that may be points of negotiation in your venture capital transaction. Below are a few of the common terms of art used in venture capital transactions and their common meanings:

• Conversion: Conversion refers to the conversion of shares of preferred stock into shares of common stock. Conversion provisions can be optional or mandatory. An optional conversion is when a shareholder has the option to convert its shares of preferred stock to shares of common stock at any time or when certain events happen. A mandatory conversion requires that all shares of preferred stock be converted into shares of common stock upon the occurrence of a certain event, such as consent of the majority of the holders of the preferred stock or a public offering. In a venture capital transaction, the typical negotiation points regarding conversion provisions, in addition to those mentioned under "Anti-dilution", are the events that trigger mandatory conversion, such as a public offering, and the dollar threshold that the event must reach before the conversion is mandatory.
• Anti-dilution: Anti-dilution provisions allow a preferred shareholder to keep the same or a similar ownership percentage in the company when the company sells more stock. This may be accomplished by giving the shareholder preemptive rights (see the definition below). Other terms that you may hear in conjunction with anti-dilution are weighted average and full ratchet. These are two methods for adjusting downward the conversion price per share of stock issued to the preferred shareholder when additional shares of stock are issued to new investors at a price lower than the price the preferred shareholder paid. In other words, if a preferred shareholder purchased its shares for $1.00 per share, and is able to convert its preferred shares into common shares at a deemed $1.00 per common share, the anti-dilution provisions may operate to make that conversion price lower, allowing the preferred shareholder to convert its preferred shares into a larger number of common shares. In a venture capital transaction, a typical negotiation point regarding anti-dilution provisions is whether a weighted average or full ratchet formula is used. A weighted average formula is currently the most common, but there are a number of ways a weighted average formula can be calculated.
• Preemptive rights: Preemptive rights are the rights of a shareholder to purchase its pro rata portion of any new shares of stock issued by the company at the same price and on the same terms as the new shares are being offered to new investors. A preemptive right, if exercised by the shareholder, allows the shareholder to retain its ownership percentage in the company. In a venture capital transaction, the typical negotiation points regarding preemptive rights are (i) who will receive the preemptive rights, such as the venture capital investors, major shareholders or all shareholders and (ii) what issuances are exempt from the preemptive rights.
• Right of first refusal: A right of first refusal gives each shareholder or certain specified shareholders the right to purchase its pro rata portion of shares offered by another shareholder to a third party, on the same terms. The company may have the first right of refusal and the shareholders may have a secondary right of refusal if the company elects not to purchase the shares. In a venture capital transaction, the typical negotiation points regarding rights of first refusal are (i) who is subject to the right of first refusal (i.e., who must offer their shares to the company and/or other shareholders prior to selling to a third party), (ii) who will receive the benefit of the right of first refusal, such as the venture capital investors, major shareholders or all shareholders and (iii) what transfers are exempt from the right of first refusal.
• Tag-along rights/Co-sale rights: Generally, a tag-along right is a protective provision for a minority shareholder. It allows a minority shareholder to sell its pro rata portion of shares of stock along with a selling significant shareholder. This right is often combined with the right of first refusal to allow a shareholder who does not exercise its right of first refusal to sell its pro rata portion with the selling shareholder, on the same terms and conditions. In a venture capital transaction, the typical negotiation points regarding tag-along rights are the same as those for rights of first refusal.
• Drag-along rights: Drag-along rights allows a defined group of shareholders (usually a single shareholder or group of shareholders who own a majority of the company) to require the remaining shareholders to sell their shares of stock in, and/or consent to, a transaction approved by the defined group, such as a sale of the assets of the company or a sale of all of the shares of stock of the company. In a venture capital transaction, the typical negotiation points regarding drag-along rights are (i) who are the shareholders that can initiate the transaction, and (ii) the percentage threshold of such shareholders that must approve (i.e. a majority, two-thirds, etc.).
• Redemption: Redemption happens when the company buys shares back from the investor. Redemption can be mandatory or optional on the part of the company or the shareholders. Generally, the redemption cannot occur before a certain date, such as five years after the first sale of the series of preferred stock, and must be approved by a certain percentage of the shareholders (i.e. a majority, two-thirds, etc.). This is designed the protect the venture capital investors' return on the transaction but also provides the company with some comfort that, absent special circumstances, it will not be required to come up with the cash to redeem prior to the agreed-upon date. There may be more specific negotiated redemption provisions that relate to the occurrence or non-occurrence of certain events by agreed upon dates. For example, if the venture capital is being used primarily to finance a construction project, there may be deadlines that have to be met in order to avoid mandatory redemption. In addition, the company may negotiate provisions that allow the company to redeem at its option after certain time periods have passed or certain events have occurred. In a venture capital transaction, the typical negotiation points regarding redemption provisions are (i) whether and under what circumstances redemption is required or allowed , (ii) the price for which each share is redeemable (e.g., the original purchase price plus accrued dividends or the greater of the original purchase price plus accrued dividends and the fair market value), (iii) the first date on which a redemption may be requested and (iv) the percentage of shareholders that is required to effect a redemption.
• PIK preferred: "PIK" stands for "paid-in-kind". This means that the dividends on PIK preferred are paid in the form of additional shares of preferred stock. In other words, rather than accruing dividends that must be paid in cash now or in the future, the preferred shareholder is deemed to own additional shares. The calculation of the number of PIK preferred shares issued in connection with any particular dividend is a point of negotiation between the parties.

These days, working capital can be one of the most important measures of a company's financial success.  If you're considering buying a company, you should definitely take a close look at its working capital.

Working capital measures cash available for short term operations.  It is calculated by subtracting current liabilities from current assets.  If you are negotiating a purchase agreement with a working capital adjustment, you may negotiate for specific exclusions from the calculation, including deferred tax assets or liabilities or specific assets or liabilities.  But, the basic calculation for financial analysis purposes is current assets minus current liabilities.

In these economic conditions, where most companies' revenues have declined and credit is tight, availability of cash from operations may determine whether a company will make it.  If your company is unable to obtain credit for a while, you want it to be able to continue to operate without needing additional cash from you or another source.  When analyzing the potential buy, you should factor in your plans for growth as well as your cost structure in determining whether the deal makes sense financially.  This will involve some analysis of the direction you plan to take the company as well as your ability to control costs.

Don't forget, the saying "cash is king" has never been more true!