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A Private Equity Firm is a firm that manages the investment of equity securities in corporations not listed on the public exchange through various strategies. Each firm employs several Private Equity Funds, which are the projects jointly led by the firms and limited partners. These limited partners are often public or corporate pension funds, foundations, insurance companies, wealthy individuals, etc. Private Equity Firms receive shares in the profits earned from each of the funds they manage as well as administration fees for the investment strategies they engage. PE is normally catered towards more matured companies rather than early stage business.

Private Equity Firms are known to buy and invest in underrated and undervalues companies with little stock power. Once bought, the companies are then removed from the public stock market so that the private equity firms can make shifts in internal procedures and management without releasing information to stockholders. Similar to house-flipping, the private equity firms implement common strategies to renew the company and then will either bring in new investors that will buy the company for a desirable profit, or take the company public again in the stock market.

Common Investment Types

1. Growth Equity (also called growth capital and expansion capital): investments that focus on slightly matured companies that are looking to grow and restructure their firms, as well as enter new financial markets. These companies are typically stable and sustainable yet lack the capital to head on major projects and expansion efforts. This equity type is structured as either common or preferred stock (although some instances of hybrid structures have been noted).
2. Venture Capital: investments towards young and fast growing early-stage, high risk/potential startup companies. Read more about Venture Capital here.
3. Leveraged Buyout Investing (LBO): the strategy of acquiring the controlling majority of a company’s equity or shares through leveraged (borrowed) financials. Attractive buyout candidates include companies that have potential for new upper management, capital assets like buildings and property used for collateral, and depressed value of stock prices. PE Firms finance LBO with a hybrid structure using syndicated loans that deliver revolving credit and high-yield bonds.
4. Recapitalization: the restructuring of debt and equity without disruption to a company’s balance sheet. Generally used by private companies, this form of refinancing issues bonds that increase money which allows for the buying of stocks or paying of dividends.
5. Mezzanine investing: a type of debt financing that allows the lender claimed rights in a company if their loan is not paid back. Frequently used to finance acquisitions and buyouts, mezzanine financing is operated about 6-12 months before a company goes public so that profits from a public offering will repay the debt. This equity type is structured as either debt or preferred stock.

Corporate Investing is when larger corporations seek investment in smaller external start-up companies. The reason for these investments is often a combination of financial gains and strategic management. First, like regular venture capital, the financial return on investment in these companies would be beneficial for large corporations. Secondly, in a strategic sense, corporate investing would also allow big companies to retain partial control over potential changes in their target market and industry. It is a great way for a developing company to create a relationship with an established company, especially if their good or service will directly impact the mutual industry or corporation. These types of strategic investments can range from a couple hundred thousand dollars to a few million. According to data from the National Venture Capital Association, the largest portion of corporate investing goes towards companies in their Expansion or Later Stage cycles of business.

Investment into start-up companies is referred to as Corporate Venture Capital (CVC). Although not all companies have established CVC departments or entities, many of these corporations are willing to invest and fund smaller businesses should the opportunity present itself. As long as you can clearly illustrate how your company will benefit their industry, or give them a competitive advantage over other competitors, larger corporations will become very receptive towards investments.

Industries of CVC

Currently, the top industries of CVC are Biotechnology, Software, Telecommunications, and Media/Entertainment. Some of the big names in Corporate Investors are computer firms such as Microsoft, Acer, and Intel who capitalize in new companies in order to apply emerging technology towards their own efforts. Most notable is perhaps Intel’s CVC entity Intel Capital who, since 1991, has invested over 10 billion dollars in over 1,100 companies.

As an entrepreneur, there’s a good chance that you are going to need some outside funding. If you are looking for rapid expansion, venture capital may be for you.

Venture capitalists, also known as VC’s, are people who work for institutions that make investments in early-stage companies (like yours). These VC firms are not investing their own money, but instead represent others such as pension funds. And unlike SBA Loans, venture capitalism is a high risk, high reward game. Banks go through a thorough checklist before they even think about approving a startup for a SBA Loan. VC’s, on the other hand, know that if their investment pays off the return on investment will be 10, 100, or even 1000 times what they put in. According to the National Venture Capital Association, VC fundraising totaled $18.17 billion from 169 funds in 2011.

What Are Venture Capitalists Looking For?

Different VC’s may have different criteria when it comes to deciding whether a startup gets funding or not, but there are general rules that most venture capitalists follow.  The general rule is that they would like to get at least 30 times their money back in 5-7 years. Consequently, VC’s tend to focus on high-tech companies that have scale, speed and exit potential. For example, according to Price Waterhouse Coopers the Software industry received the most venture capital in the 3^rd quarter of 2010, getting $1.0 billion in investments.  The Biotechnology industry followed collecting $944 million and the Medical Devices and Equipment industry collecting $573 million.

VC’s also consider a company’s management team before they invest. They are looking for a team that knows how to execute and has years of professional experience in the field. It also helps if there is someone who has had prior positions in the field and knows all the ins and outs of the industry.

Pros and Cons of Venture Capitalism

                While there are many potential upsides to getting VC funding, it is not a perfect system. As a result, going with a VC firm might not be the right choice for you for several reasons. First off, it takes a lot of hard work to get money from a venture capitalist. You have to be able to prove that your company will grow rapidly so that it can either be bought by a larger company or have an initial public offering so that the VC’s can get their money back. Therefore, you need to have a great business plan and need to be able to “sell” your business to these firms. Also, when a VC invests in your company he or she partially owns your startup, which means that venture capitalist can exert some control on company decisions.

Still, there are major upsides if you decide to go with a venture capitalist. The most obvious advantage of VC funding is that these firms have DEEP pockets and can invest millions of dollars if they believe you can lead your company to success. Equity investors are also invested in the same thing as you: the growth of your company. For that reason, VC’s can be a great source of advice and can help you make new connections that will help you build your business. Finally, you don’t have to pay periodic principal and interest payments with equity investments. In fact, most venture capitalists do not require you to pay them their money back!

What Do You Need?

If you think VC funding is right for your startup, there are 6 presentation materials you should have before you even consider reaching out to venture capitalists. These include:

1. A High Concept Pitch: This is pitch is less than 1 sentence and should make it clear to anyone who hears or reads it what your company does. For example, Dogster sold itself as “Friendster for dogs.”
2. An Elevator Pitch: An elevator pitch is different than a high concept pitch. These are generally one minute long and tell a VC the benefits of your product or service, the difference between your company and others, and what unfulfilled need your company meets.
3. A Teaser Email: A short email that, again, sells your company and makes the VC want to contact you for more information.
4. A Business Plan: You want your business plan to be as realistic as possible. For more information on how to write a business plan, visit our “What is in a Business Plan?” blog series.
5. An Executive Summary: A brief summary of your business plan that gives a VC everything they need to know on one page.
6. A Slide Presentation: This presentation should highlight the important pieces of your business plan, like you did in your Executive Summary.

After you have created these 6 ingredients, you can now begin to reach out to VC’s. Make sure that you also put the time in and research all of the venture capital firms that you are interested in so you can tweak your presentation toward the VC’s interests.

Angel Investor Groups are organizations made up of individual accredited angel investors brought together under the purpose of creating efficient financing presentations, pooling investment funds, and learning from one another. Angel Groups saw a huge rise around the 1980s and 90s as the Internet bubble burst and helped to establish and bring together networks of private investors. Because many individual angel investors are not listed in local directories, angel groups are an easier way for entrepreneurs to get their foot in the door with angel investments.

Reasons for the Growth of Angel Groups

1. Time Efficiency: For both entrepreneurs and angels, an established angel group will provide the most efficient way of finding an investment relationship. This is due to the fact that entrepreneurs can present their business plans to many angels at once. For example, an entrepreneur can present to roughly 50 potential investors at once – much more effective than 50 individual presentations. It also allows for angels to hear multiple presentations within a day and be able to measure their options against a broad spectrum of choices.
2. Pooled Investments: As stated in our last blog, an average angel will invest $364,000 in a company, compared to a VC, which would give millions. Because of these monetary limitations, individual angels can collaborate and pool their funds into large VC-like business ventures when they are networked together within the same angel group. This would usually increase the amount of investment into the enterprise at hand as well as increase the power of the angels’ negotiation terms.
3. Due Diligence: By working together to conduct due diligence, angels research and validate financial and legal documents as well as marketing strategies presented by an entrepreneur from their established pool of experts in each field of study. A comprehensive background check allows members with expertise in various areas to assess the best investment strategies into an enterprise.
4. Social Benefits: Information flow and learning from one another is a large benefit of being involved in an angel group. These organizations often provide specific training services, group and committee meetings, as well as lectures and discussions that would broaden knowledge and enrich the investment experience for members. Finally, there is a large underappreciated social benefit of surrounding yourself with people of similar interests – here, mentors can be found, business relationships jump-started, and friendships created.

Important References

1. Angel Capital Association (www.angelcapitalassociation.org)
2. Angel Resource Institute – formerly called the Angel Capital Education Foundation (http://www.angelresourceinstitute.org/)

Just to recap where we are, over the last few blog posts we have discussed the difference between debt and equity funding and given examples of both. Next on our discussion list is another source of equity funding known as Angel Investing.

Angels are well-known in the entrepreneurial world as private investors that financially back startup companies. They are typically around 45 years old and have already made a good amount of money in some sort of entrepreneurial adventure. Being a successful entrepreneur, they feel that they should give back to others in that are in the same situation that they were once in. Like venture capitalists, angel investing is a high-risk, high-reward game since the likelihood that a startup will fail is so high. And just like Venture Capitalist’s, angels do not expect all of their money back from a startup they invest in.

However, there are some distinct differences between angels and VC’s. For instance, angels are not professional investors that represent an outside company. Instead, they are putting their own money into the company.  As a result, angels tend to give less money to entrepreneurial companies than VC’s do. According to Venture Research at the University of New Hampshire, 2008 saw angels donate $19.2 billion into the hands of new ventures.

Angel investors finance entrepreneurs for many different reasons. First and most importantly, angels are looking for a great return on their investment. Second, an angel will sometimes back a company because they trust the entrepreneur behind it. They also believe that they can be valuable and give the startup advice and knowledge that will help it succeed. Finally, angels also invest in companies for the thrill of it. They love taking chances with their money and see investing in entrepreneurs as a higher risk game than the stock market.

What Angels Are Looking For?

Like venture capitalists, angels check to see if your company can be liquidated quickly and for a big return before they finance your company. On average, an angel investor will get about a 30% return on their investment. Therefore, a startup needs to show that it can be bought by another company or be put up for public offering so the investor can get his or her money back. An investor also checks to see if you have a strong management team, a good exit strategy, and that your asking price is not too high. But one of the most surprising statistics when it comes to angel funding is not how profitable you are to an angel, but how far you are. According to the Centre for Venture Research, 70% of all angel transactions are given to companies that are less than 50 miles away from the angel’s home or business.

The type of industry a startup is in is another main motive angels have when giving a startup their money. Like VC’s, angles tend to concentrate on high-tech startups because of their huge potential. As a result, angels like to invest in healthcare, software, biotech and energy ventures. This is not to say that angels are solely focused on high-tech, though. Actually, a good number of them focus on low-tech companies as well, such as retail and media ventures.

Pros and Cons of Angel Investing

As mentioned before, angels are not giving startups money out of the goodness of their heart. These are individuals who are counting on you to make them money. As a result, you have to prove to an angel that your business can grow, prosper and be bought in a short amount of time, which means that you have to put a lot of work in a strong business plan. Small businesses who submit their start-ups to angel groups only get accepted 2.3% of the time. Also, angel investors tend to give entrepreneurs less money than VC’s do. An average angel will invest $364,000 in a company, compared to a VC which would give millions. Angel investors are harder to find than VC’s as well. While there are some angel groups in the United States, many angel investors are not listed on websites or in directories. This means that you have to spend time at networking events in order to find a potential angel to financially back your new venture.

The key positive of angel investing though, is that your company will still get a fair amount of cash if an angel likes your enterprise. Angels can also give you a vast amount of guidance that can help you be more successful and you do not necessarily have to pay them their money back. And, as mentioned before, angels are not necessarily totally interested in profits. While money is a big factor for an angel, often times he or she is just trying to help an entrepreneur out because they have been in that spot themselves.

What Do You Need?

If you like the idea of angel funding, you are going to need these 5 ingredients to attract an investor to your startup:

1. A Business Plan:  Many people think that a business plan is old school and not needed in today’s world of PowerPoint presentations and flashy animations. Well, from now on take advice from those people with a grain of salt, because they couldn’t be more wrong. A business plan shows investors that you put the time in to research every possible market your company can exploit and every competitor your company will contend with. In short, your business plan lets angels know that you know what you are doing.
2. Private Placement Memorandum:  PPMs are fancy documents that protect you, the entrepreneur, while an outside investor is putting money into your company. Basically, a PPM includes your business plan plus a Summary of Subscription, Summary of the Offering, the risk factors involved, use of the proceeds, management compensation, principal shareholders and capitalization table, subscription agreement, and an actual subscription form that the angel signs.
3. Due Diligence Documents: Before an angel gives you money, he or she will perform what is known as due diligence. Essentially, the angel is doing more research into your startup to make sure he or she didn’t miss anything. Make sure you have the following prepared so angels can perform their due diligence without a hitch.
1. Background of the company
2. Background of management
3. The company’s business plan
4. Financials
5. Management discussion of the company performance
6. Capitalization table
7. Leases
8. Employment agreements
9. Purchase or sale agreements
10. Previous letters of intent
11. Legal Counsel: Make sure you hire an attorney that you are comfortable with and an accountant. These two new team members will become crucial when it comes to reviewing your PPMs and due diligence documents.
12. Realistic Investment Terms: This may not be a formal document but it is a crucial step that you and your team must discuss. Unlike VC’s who have set terms, individual angels often try to negotiate with a startup. Therefore, it is important to have terms already that have been mapped out ahead of time to present to angels. Remember, keep your terms realistic! You did not create unrealistic financial projections, so go through the same process when it comes time to make these terms as well.

If you are having trouble finding individual angels, try building out your network through networking events. If someone says “no” to investing in your company, always ask if the person knows an angel that would be interested. To learn more about Angel Investor Groups, our next blog posting will explain key differences to note between individual and group angels.

Friends and Family Financing is the means of receiving initial investment funds from close confidants – this means friends, family members, or co-workers. Funding from friends and family is often limited and not the sole form of initial investment, although it is known as the most common startup financing route. According to a survey in the 2004 Inc. 500, half of the CEOs of the nation’s fastest growing companies stated that family was involved in regards to start-up capital. With Equity Investments, you are selling stakes of ownership to your friends and family, integrating them into your business. This is not to be confused with loans from Friends and Family and Debt Financing.

Handling an Equity Investment

1. Hire an attorney

All equity investments must be formally documented; because you and your investors have a lot of money and ownership shares at stake, it is important to clearly define boundaries and responsibilities. The key document for selling shares is a Stock Purchase Agreement. This agreement form includes the terms of purchase, such as date, conditions, and purchase price, as well as conditions and statements about the business that both parties verify as true.

Your attorney will also help you comply with specific laws that deal with shares. The law refers to Corporate Shares as “securities” and your attorney will register you with the Securities and Exchange Commission (SEC) so that you may begin to sell them securely and legally.

Because things can easily get complicated with paperwork and legal issues, it is important to protect your family and friends, as well as your relationships with them by treating them with the same business respect and guidelines you would give to any other investor.

 2. Know that you are Sharing Ownership

When you sell equity to your company, remember that you are giving your friends and family shared ownership and shared decision making in your company. Choose your investors wisely because while some people can offer valuable advice and input, some investors can choose to be nitpicky with their financial updates or vote casting. Be sure to include family and friends that can offer the right kinds of services and attitude for your management needs.

 3. Know what your Investor is looking for

With equity financing, there is a high risk for investors because if your company goes bankrupt, so do they. Equity investors do not get paid back because they invest into the ownership of the company and thus the company’s failure is their failure as well. Because of this high risk, equity investors look for an attractive return on investment, or “ROI.” Be able to offer your friends and family an attractive return rate that makes up for the high risk they incur by giving you capital.

For example, let’s say your father-in-law decides to buy 10% of your company’s shares into your business valued at $50,000. If in three years, your business has grown to be worth $200,000, your father-in-law’s original $5,000 investment in the company would now be worth $20,000. It was a high risk to completely lose his $5,000 if your company went bankrupt, but the investment was made in the hopes of a high ROI.

 Delivering the Kitchen Table Pitch

Compared to an elevator pitch, the Kitchen Table Pitch is an investment pitch that adapts to the pre-established relationships with potential investors. These pitches are geared towards informing family and friends of your business idea and opening the door to discussion on official deals and loans.

Read tips on preserving relationships at our entry discussing Family and Friends Loans.

In this next section we will delve further into each of the six factors of using Equity Capital for funding your business. Below is a brief overview of the blog posts soon to come!

1. Friends and Family

Friends and Family Financing is the means of receiving initial investment funds from close confidants – this means friends, family members, or co-workers. Family and Friends are great resources for startup funding because they are easy-to-find sources that tend to have less stringent payback requirements. Funding from friends and family is often limited and not the sole form of initial investment, although it is known as the most common startup financing route. According to a survey in the 2004 Inc. 500, half of the CEOs of the nation’s fastest growing companies stated that family was involved in regards to start-up capital.

2. Angel Investors

Angels are private investors that financially back startup companies. Like venture capitalists, angel investing is a high-risk, high-reward game since the likelihood that a startup will fail is so high. Angels are not professional investors that represent an outside company. Instead, they are putting their own money into the company.  As a result, angels tend to give less money to entrepreneurial companies than VC’s do. On average, an angel investor will invest $364,000 in a company and get about a 30% return on their investment.

3. Angel Investor Groups

Angel Investor Groups are organizations made up of individual accredited angel investors brought together under the purpose of creating efficient financing presentations, pooling investment funds, and learning from one another. By allowing entrepreneurs to efficiently line up presentations, it funnels and screens candidates towards angels that may pool their funds together and use each other’s knowledge into a new business investment.

4. Venture Capital Firms

Venture Capitalist Firms are institutions that make investments in early-stage companies. VC firms are not investing their own money, but instead represent others such as pension funds. Unlike SBA Loans, venture capitalism is a high risk, high reward game; VC firms know that if their investment pays off, the return on investment will be 10, 100, or even 1000 times what they put in. When a VC invests in your company he or she partially owns your startup, which means that venture capitalist can exert some control on company decisions. They would like to get at least 10 times their money back in 5-7 years. According to the National Venture Capital Association, VC’s gave over $28 billion to 3,808 companies in 2008; roughly $7.4 million per transaction.

5. Corporate Investors

Also known as Strategic Investors, Corporate Investors are corporations that seek investment in smaller start-up companies. The reason for this is to firstly gain financial returns, but to also retain partial control over potential changes in their target market and industry. It is a great way for a developing company to create a relationship with an established company, especially if their good or service will directly impact the mutual industry or corporation. These types of investments can range from a couple hundred thousand dollars to a few million.

6. Private Equity Firms

A private equity firm is a corporation that manages a collection of operating partners that have invested in a specific enterprise. They manage investments of private equity which can be defined as the private ownership and securities of a corporation. Private equity firms raise cash and loans, opposite to that of stock ownership which handles stocks and bonds.

Friends and Family Financing is the means of receiving initial investment funds from close confidants – this means friends, family members, or co-workers. Family and Friends are great resources for startup funding because they are easy-to-find sources that tend to have less stringent payback requirements. Funding from friends and family is often limited and not the sole form of initial investment, although it is known as the most common startup financing route. According to a survey in the 2004 Inc. 500, half of the CEOs of the nation’s fastest growing companies stated that family was involved in regards to start-up capital.

Legal Issues

• Monetary Gifts: The IRS pays particular attention to family gifts because IRS rules state that you may only receive up to $13,000 each year from one person tax-free. Any amount over this threshold requires a gift tax return file submitted to the IRS – the giver will then be assessed a federal “gift tax” which is calculated at the same rate as an estate tax.
• Loans: To ensure and protect intrafamily transactions, it is a smart business idea to create a legal paper trail with promissory notes. A promissory note is a traditional signed legal document outlining a loan’s repayment schedule – its formal tone will set loan expectations, as well as encourage borrowers to successfully repay loans.

Deciding Loan Terms

There are some key issues that should be considered when discussing the terms of your loan. The promissory note should include, in detail:

1. The names of the borrower and lender
2. Payment frequency and timeframe
3. Amount per payment
4. Interest Rate
5. Consequences of missed or late payments
6. Offered Collateral

Loans from friends and family can be a good source of debt financing.  In addition you may want to consider equity financing with friends and family.  For more information see our blog post on equity financing with friends and family.

The main difference between a credit card and a charge card is the lack of interest rates and spending limits offered by charge cards.  Charge cards have no interest rates because the borrower is required to pay off the entire balance on the card each month.  There is no option to pay the minimum amount as with a credit card.  There are however, fees associated with failure of payment. 

Charge cards are a good source of funding for short-term purchases that can be repaid within a limited amount of time.  Some businesses prefer a charge card for a self-imposed fiscal restraint because the card must be paid off in full every month.  Depending on the issuer, some charge cards have greater reward benefits or other advantages like enhanced tracking, though this is dependent on the issuer.  American Express is the only major credit card issuer to offer charge cards.