Private Equity/Venture Services

Ice Miller has been one of the most active law firms in the private equity industry over the last decade, representing both entrepreneurs 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.  In addition, over the past 10 years, Ice Miller has represented hundreds of emerging growth businesses in various industries on such matters as entity formation, capitalization, capital raising, alternative financing, intellectual property rights and protection, growth and exit strategies, corporate governance, tax matters, and many other legal issues that are critical to the growth and success of an emerging company.
 
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.

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

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.

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!

In technical terms, working capital is the excess of a company's current assets over its current liabilities.  Current assets are generally cash, cash equivalents, inventories and receivables.  Current liabilities are those payable within one year.  Working capital measures a company's operating liquidity, i.e., the cash it makes available for use on a short term basis.

A company can be profitable but still have a working capital deficit, but a company like that won't survive for long without outside help.  As a result, companies generally work hard to manage their working capital.  The goal is to make sure that the company has enough cash to pay operational expenses and to satisfy debt that will soon become due.  Management can do this by managing cash, inventory levels, customer credit policies and short-term financing.  Most companies use a combination of those methods.

As we all know, we are in a recession.  In these difficult economic times, everyone is wondering where we can find money to help start or grow our businesses.  It seems that everyone is holding their money close to the vest.  In reality, however, there are many different places where a company can obtain equity or debt financing to help its business.  The key is understanding what type of money is available.

Traditionally, the first place to find money when starting a new business is from family and friends.  Obviously, investments from family and friends are made in large part upon the relationship you have with those individuals, but you need to be careful to comply with federal and state securities laws.  This usually means that you want to make sure you investors are accredited investors and that you conduct your private offering in compliance with an exemption under Regulation D  of the federal securities laws.  There are limits on the number of investors and the amount of financing a company can receive in order to fall within one of the many exemptions.  Family and friends are still providing capital during the recession, however the amounts that can be raised from family and friends have diminished as individual investment and savings accounts took a beating from the drop in the equity markets over the last year.

If you do not have close friends or families with the available cash to invest in your business, "Angel investors" can be and are a still a great source of capital.  Angel investors are high net worth individuals that can provide large tranches of capital through equity or convertible debt investments.  Typically, angel capital is the second round of capital that start-up companies and businesses receive and can provide capital in the range of $500,000 to $2,000,000 depending on the needs of the company and the willingness of the "angels" to invest.  Although angel investors are more selective in these economic times, angels are still investing and are looking for the right opportunities and the right companies.  Once again, when raising money from angels, you need to comply with federal and state securities laws and structure your offering to comply with on the private offering exemptions.

Venture funding is another source of capital that can be very advantageous for start-up companies.  Venture funding comes at a price.  Generally, venture capital firms will require a seat on the board, veto rights on major decisions such as additional financing and sale of the company, and a high return on their invested capital.  There are numerous venture capitalists looking to deploy money right now.  They are more selective in these economic times, but the venture capital firms typically do have the money to invest.  Venture funding is one of the key types of financing that provides the necessary capital infusion to allow a company to take the next step.

Private equity capital is generally available for more mature companies that are looking to expand and grow.  Private equity investments can take a variety of forms and generally involve a buy-out or a purchase of a majority equity interest in a company.  As with venture funding, there are numerous private equity funds with millions of dollars to deploy right now.

Traditional debt financing from institutional banks is available to companies as well.  The credit markets have suffered through the banking crisis and the recession, but the current administration's policies have encouraged banks to loosen the reigns to start lending money again.  It remains to be seen whether that will work.  A bank will generally require security interest the company's assets including inventory, real estate and/or accounts receivables, pledge of stock or a personal guaranty.  Bank financing will also require meeting certain financial covenants.

A venture capital firm usually wants to receive "participating preferred" stock.  The term describes rights that can become important in liquidation and, sometimes, dividends.

If the company liquidates, participating preferred stockholders will have an advantage over common stockholders.  First, the preferred status means that the company must pay a specified amount to the holders of the preferred stock before any holders of common stock receive any money.  That preferred amount (called a liquidation preference) may be measured in relation to the preferred stockholders' initial investment plus accrued and unpaid dividends but may be more than that.  When the preferred stock is participating preferred, the holders of the preferred stock will share the remaining pot of cash along with the common stockholders, in addition to the liquidation preference already received.  This means that less money will be available for the holders of common stock.

Participating preferred stock also sometimes (but less often) participates in dividends.  This participation is in addition to the normal preference for dividends that generally accrue on preferred stock.  If and when the company's board of directors decides that the company will distribute dividends to its stockholders, holders of participating preferred stock have priority over holders of common stock with respect to accrued and unpaid dividends.  Plus, they may also "participate" with the common stockholders in the same manner as they participate with the common stockholders with respect to liquidation.

Venture capital firms generally demand a number of rights to protect their investments.

Venture capitalists usually receive shares of preferred stock when they invest in a company, while the founders and other initial investors hold common stock.  Of course, if you raise successive rounds from venture capital firms, you will likely end up with several different series of preferred stock with different rights and preferences.  Preferred stock has certain advantages over common stock, particularly dividend and liquidation preferences.  This means that if the company decides to distribute dividends to its stockholders, or sell its assets and distribute the proceeds to its stockholders, the holders of preferred stock will have priority over the common stockholders.  They will be entitled to receive some portion (or even all) of the dividend or sale proceeds before any of the common stockholders receive any money at all.

Preferred stock will probably have better voting rights as compared to common stock.  For example, the company will have to get approval from the holders of a certain percentage of the preferred shares to take major corporate actions, such as approval of the annual budget, amendment of articles or bylaws, liquidation of the company, creation of a new class of securities with rights equal to or better than the preferred stock, sale of the company or acquisition of another company.  This structure lets the venture capital firm have a say in decisions that will have a large impact on the company.

The venture capital firm will also likely demand representation on the company's board of directors.  The number of members will vary depending on the current structure of the company and the amount of capital invested by the venture capitalists, but at least one, and often more than one, spot on the board will probably be reserved for members elected or appointed by the venture capital firm.

Also, venture capital investors will want information and reports about the company so it can track its investment.  For example, the company will likely have to deliver its quarterly and annual unaudited financial statements.  Many venture capital firms will demand audited financial statements, which can be a significant expense for the company.  Plus, venture capital investors will expect some other rights, such as the right to force the company to register its common shares with the Securities and Exchange Commission under some circumstances or to participate in any registration initiated by the company (registration rights), the option to purchase shares of stock of the company that other stockholders want to sell (right of first refusal), the right to purchase any new shares issued by the company (preemptive rights) and an adjustment of the conversion to common stock price in the event the company sells stock at a lower valuation (anti-dilution protection).

Looking at all of the ownership and control pieces likely to be obtained by a venture firm, it will probably end up exercising a lot of control over the company.  Such is the price of venture capital.  However a venture capital firm will probably allow the day-to-day operations of the company to continue to be handled by the business people.

Most business owners eventually deal with the issue of their company's worth, whether in establishing a strike price for options or in trying to sell or raise money for their companies. Stating the obvious, the value is what a willing buyer would be willing to pay and a willing seller would accept. That said, business owners are often understandably frustrated when they see the lack of objectivity in determining the value of their business. Unfortunately, like valuing baseball cards, valuing a business is less of a science than an art.

This is not to say that valuations do not have mathematical explanations, nor that there are not industry starting points (as discussed below), but all of that is academic without a willing buyer or investor making a real offer. Using the right advisors, particularly valuations experts, can add to your bargaining leverage, ground negotiations on both sides, offer a variety of creative methods and financing options, and introduce new potential investors.

There are several well-accepted methods of valuing a company in both an investment and a capital raise context. Buyers and investors often use one of the following valuation methodologies: (i) a negotiated multiple of EBITDA (earnings before interest, taxes, depreciation and amortization); (ii) a discounted cash flow analysis (which is often used in the leveraged buy-out setting where acquisition debt payments need to be covered from free cash flows); and (iii) market comparables (where comparable businesses are identified and their stated valuations are used as a basis, and differentiating your business may be the primary point of negotiation). A good valuation expert can help identify other valuation methods that would be most favorable to your company.

The different methodologies rarely have the same outcome. The above methods are all attempts to create some kind of baseline which can be useful to both buyers or investors and sellers.

Once a business decides to raise money, management is left to figure out how to make it happen.  Strong advisors help, but there are some steps that any business can take to make it easier to raise funds.  Collecting information to give to investors is a good place to start. 

Regardless of who invests, the information that investors will want to see will be pretty much the same, and the business can get this ready ahead of time.  The information should be readily available to the business.

Managers can be surprised at the amount of information they need to provide.  When a business takes money from an investor, it gives something back – an interest in the business.  What the business gives back – whether it's called "stock," "partnership interests," "LLC interests," "notes," or some other name – is often a security.  When the business gives a security to the investor for their money, the investor is protected by securities laws.  One of the protections provided by securities laws is that, before the investor decides to invest, the business has to tell its investors everything material about itself – that is, it has to make a "full disclosure." 

Many managers see full disclosure as the opposite of marketing.  Sure, full disclosure includes the good parts about the business.  But investors will need to know all of the bad things too, as well as all of the indifferent but important things about the business.  To some managers, it seems that after convincing the investor that buying into the business is a great idea, the manager then needs to tell the investor all of the reasons that they should not invest.  Although this can be contrary to a sales mentality, investors should be left with a complete picture of the business – the good, the bad and the material.

The way you end up raising the money will impact how the information about the business is presented.  But the basic content that a business must provide will largely stay the same.  Time invested collecting this information early is well spent, and will save time later.  At minimum, any business looking to raise money should be sure to have the following available:

Financial Statements:  These are the basic financial statements for the business.  Investors will typically want to look back up to five years (if the business has been around that long).  If the financial statements are audited, investors will want to see the audit reports as well. 

Organizational documents:  These are the official documents that govern how the business exists and will vary depending on what kind of business it is.  For example, if the business is a corporation, they would be the articles of incorporation, bylaws, amendments, board minutes and resolutions, shareholder minutes and resolutions, etc.  If the business is a limited liability company, they would be the articles of organization, operating agreement, amendments, minutes and resolutions, etc.  These are often compiled in a "minute book" for the business.  Many businesses operate with multiple companies – subsidiaries, holding companies, etc.  If this is the case, you should keep one set of organizational documents for each subsidiary.  Investors will want to review these documents, as they are important to the kinds of investments that can be made.

Tax information:  This includes tax returns, tax registrations, tax ID numbers, listings of taxes for which the business has registered, etc.  Many businesses have tax advisors; if yours does, the advisor should be able to help compile and present them.  Investors will probably want to look back three to seven years.

Information about legal proceedings:  Investors will want to see if the business is in the middle of any lawsuits or if it has been threatened with a suit.  Lawsuits involving major owners and managers could be important as well.  The lawyer representing the business can help prepare the information that most investors would seek.  Working with the lawyer to put it together is usually advisable to protect against losing attorney-client privilege or disclosing things against the business's interests.

Information about real estate:  Investors will want to see a listing of all of the properties where the business has an interest.  Does it own the land?  Is it leased?  This will include all leases, deeds, mortgages, etc. on the properties.

Material contracts:  Investors will want to understand the business's important contracts.  Examples can include employee contracts, contracts with key customers and suppliers, leases, licenses, and other arrangements that are important for the business.  You probably do not need to include the office copier lease.

Regulatory issues:  Investors want to confirm that the business has the right authority to do its business.  It is helpful to prepare a listing of all of its applications, licenses and permits that the business has.  This can cover anything from investment advisor registrations to elevator permits.

Intellectual property (IP):  As IP continues to be critical in the economy, investors are sensitive to it.  It is helpful to have a list of any patents, trademarks, copyrights, licenses and any other registrations and applications that the business keeps.  It is also important to include any contracts that let the business use someone else's IP.

Insurance:  Prepare a listing of all insurance policies the business has of any kind.  It is also helpful to get a current insurance certificate for each of the business's policies as well.

Employee benefits: Prepare a list of the business's employee benefit plans, including health plans, retirement plans, 401(k)s, employee discounts, etc. and get copies of all of the plan documents (contracts, summaries, etc.). 

These are general rules that can help any kind of business get ready to work with its investors.  Every business is different, so not all businesses will have all of the information discussed above.  Others will need much more detail about some or all of these categories.  So the listing above is not a checklist but rather a guide to start reviewing your own business.  By preparing and collecting these materials ahead of time, businesses can better balance the burdens of raising funds, save time later in the process and reduce professional fees to collect these items.