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The Inventors Guide
Equity Financing
Equity financing is an exchange of money for a share of ownership. The money can come from your own pocket or from other parties. Outside investors rely on unproven future cash flow projections for repayment of their principal, plus a rate of return based on the risk. This makes the investment high risk. In the event of bankruptcy, for example, they would only receive proceeds after secured and other debt had been satisfied.
Because of the risk, equity investors seek a piece of the ownership. They become stockholders with shares in your company. Depending on the size of investment and level of risk, they may seek a control position and seats on your company's board of directors. This makes equity one of the most expensive forms of financing.
The benefit is that the funds are normally unsecured and have no registered claim on your company's assets. This frees you to use the assets as collateral for loans - debt financing.
Sources of Equity Financing
Sources of equity financing include your own pockets (and family & friends), angels, going public, private placements, venture capital and strategic alliances. They are defined as follow:
Bootstrapping
Bootstrapping is early financing that most entrepreneurs get by digging deep into their own pockets or collecting ‘love money' from family and friends. This critical source of start-up funds is almost impossible to obtain from any other source.
Angels
Angel financing refers to funds provided by individuals whose assets and income are well above average. Investments may range from $25,000 to $300,000. This is an ideal source of early stage funding because angels often become mentors, and can bring valuable expertise to your enterprise.
Angels are elusive. There are a few programs that match angel investors with companies, but more often you will find them by talking to your business contacts, financial advisors or lawyers. Before you contact a potential angel, though, make sure you're prepared.
Angel Matching Resources
Steps to Growth Capital Program, Industry Canada
http://strategis.ic.gc.ca 
Canadian Environmental Technology Advancement Corporation-West (CETAC-West)
http://www.cetac-west.ca
The Entrepreneur's Resource for Finance
http://www.capital-connection.com
Concept to Capital program, Calgary Technologies Inc.
http://www.calgarytechnologies.com
Deal Generator, Edmonton Alberta
http://www.dealgenerator.com
The Angel Forum (annual event, requires registration)
http://www.angelforum.org
What are angels looking for?
Evidence of good management. Studies have shown that angels would invest more if they could find suitable opportunities. Right now, only one deal in forty is considered. They do not cite a shortage of good ideas, but good management. What you need - a business plan that outlines a sound financial structure and credible exit strategies.
A measure of control. Angels may want some control over the functioning of your company. They may act in an advisory capacity, participate in management or place operating covenants on you. What you need - be prepared to give up some control.
Proof of your investment. Before angels invest their money, they want to see that you have invested your own money. What you need – documents showing how much of your own money you have invested.
Third party validation. Angels are more likely to invest if you have a lead investor, an expert evaluation of your product and market, and expert due diligence. What you need – documents that demonstrate any or all of the above.
Something that grabs their attention. Angels are only human, after all. Their decision will be influenced by intuitive judgment of your abilities, the product's potential and the expected financial reward. What you need – to excite angels about the benefits and rewards of getting your product to market.
Going Public
Many companies raise financing dollars by ‘going public' – that is, allowing the public to buy shares in the company on the public market. The Toronto Stock Exchange (TSE) and TSX Venture Exchange provide such opportunities. http://www.tsx.ca
But a company cannot simply decide to issue and/or transfer shares to investors. There is specific legislation governing how and when companies may go public, and restrictions on the transfer of shares, number of shareholders and advertisement of shares.
Your company will also need a prospectus - a document that provides "full, true and plain disclosure" of company structure, funding, assets, etc. These can be expensive and time consuming to prepare. The Canada Business Service Centre has information on developing a prospectus. An example site is : http://www.cbsc.org/sask
In general, going public is really only a viable option for well-established companies with assets or annual earning records of $500,000 to $2 million.
If you think going public is right for your company, begin by talking to your financial advisor or lawyer.
Types of Companies
To understand going public, you need to understand the differences between types of corporations. Provincially, the Business Corporations Act governs companies; at the national level, it is the Canada Business Corporations Act. Three types are permitted under the business corporation legislation.
Private Corporation - not defined in business corporation legislation but is defined in legislation governing securities (Securities Acts). The Securities Act, 1988 (Saskatchewan) defines a private corporation as a company whose incorporating documents restrict the right to transfer shares, restrict the number of shareholders to 50 less current or former employees and prohibits the right to distribute securities to the public. As an example : http://ssc.gov.sk.ca
Distributing Corporation – has more than 15 shareholders and does not distribute securities to the public. When a company ceases to be a private company and becomes a distributing company (or widely held company), it becomes subject to the Securities Acts and is required to file with the applicable securities commission.
Public Corporation – has shares listed and posted for trading on a regulated stock exchange; must issue annual reports (i.e. published financial information).
Capital Pool Companies
The Capital Pool Company (CPC) is an option for companies not yet ready to go public. The CPC program permits a newly created company with little cash, no assets and no business/operations to raise a pool of funds through an initial public offering (IPO) and achieve a listing on the TSX.
The CPC uses the funds to identify and evaluate assets or a business which, when acquired, qualify the CPC for listing as a regular issuer on TSX. A minimum of $100,000 - $300,000 in seed capital is required by directors and officers, and consists only of common shares issued at a minimum price of the greater of $0.075 or 50 % of IPO price.
The CPC can be a good way to go public, but it is an expensive way to raise money. The Saskatchewan Securities Commission has entered into an operating agreement with the TSX to enable a CPC to make an offering of securities in Saskatchewan.
Private Placements
Another way to raise equity capital is through a Private Placement of securities. To do this, your company must be listed for trading on the TSX Venture Exchange: http://www.tsx.ca
The advantage of a private placement is that it is quicker and less expensive than going public. The use of Private Placements is based on the premise that in certain circumstances, prospective investors do not need the level of disclosure provided by a formal prospectus. It is assumed they are intimately aware of the business affairs of the company or experienced enough to negotiate for themselves, appreciate the risks and bear the potential investment loss.
Securities laws still regulate how a company can issue securities by way of private placement and how the placee can resell the securities. Consult a lawyer before undertaking a private placement, as there are specific requirements and exemptions.
Many companies choose brokered private placements, where a registered broker is engaged to locate and introduce your company to potential investors. The broker is paid a finder's fee in cash, shares or warrants. As an example, for brokerage companies in each province, look in your local telephone directory under "Stock and Bond Brokers". You can also use the directory search feature on your Internet home page.
Sophisticated Investors
The "Sophisticated Investors" exemption allows private placements, again without the detailed disclosure and protection a prospectus, to companies for distributing securities to the following parties.
- Government, bank or insurance company.
- Investor who purchases, as principal, at least $97,000 of the securities being offered.
- Employees, directors or senior officers of the company, or those of its affiliates.
- Existing security holders by way of a rights offering, dividend re-investment plan or stock dividend.
- Investors whose net worth and investment experience allow them to qualify under the law as a sophisticated purchaser.
Other exemptions may be available. Exempt market securities almost always have resale restrictions (i.e., a hold period before they can be sold) and investors usually have access to less information about the company (i.e., the company may not have to publish quarterly financial information).
But unless the investor is a sophisticated purchaser making a very substantial investment or a director, officer or employee of the company, chances are the company cannot legally sell its securities to the investor without a prospectus.
Strategic Alliances
Forming a strategic alliance with a company that can benefit from your product is another way of obtaining equity investors in the early stages.
For example, if your product could reduce insurance costs, contact an insurance company. If your product could reduce manufacturing costs in a certain sector, contact a manufacturer in that sector. Such companies may be willing to fund part of your R&D and commercialization costs.
Where to Look for Possible Alliance Matches
- Trade Directories and Trade Magazines
- Industry Canada
http://strategis.ic.gc.ca
- Patent sites
Canada:
Canadian Patents Data Base: http://patents1.ic.gc.ca
Canadian Intellectual Property Office: http://cipo.gc.ca
United States:
US Patent & Trademark Office: http://www.uspto.gov/
Delphion: http://delphion.com (requires free registration)
World (Europe, Latin America, Asia):
Intellectual Property Digital Library: http://ipdl.wipo.int/
Japan:
Japan Patent Office: http://www.jpo.go.jp/
- Thomas Register of American Manufacturers
http://www.thomasregister.com
- Check the public or business library for Standard & Poor's Register of Corporations, Directors and Executives or Dun & Bradstreet's Million Dollar Directory.
Venture Capital
Venture capital refers to equity and loan capital provided for a new and/or existing business by persons other than the proprietors. Private venture capital firms may look at start-up businesses, but the majority concentrate on companies that are expanding, acquiring other firms, or involved in management/leveraged buyouts.
The typical investment by a venture capital firm is between $500,000 and $3 million.
What are venture capitalists looking for?
Strong Management.
Venture capital firms are vocal about only looking at businesses with strong management teams. This means a management
team whose key people have proven expertise in the fundamentals of the business, financial expertise and sales ability. You can have the greatest product in the world, but without a good management team, you won't get very far.
High Growth Potential - Return on Investment.
Venture capitalists may expect a 25-50% return on their investment. The expected rate of return depends on the stage of the business. The earlier the stage, the higher rate of return the investor will need to compensate for the increased risk of investing.
Differentiated Product.
Your product must be different, innovative and demonstrably better than others in the marketplace. You must be able to clearly articulate its value to the customer.
Intellectual Property.
Your product should be patented or patentable.
A Stake in the Company.
Venture capitalists may expect to participate on your board of directors and acquire a percentage of company stock. There are two basic types of equity ownership for shareholders: preferred shares and common shares.
Preferred shares offer long-term to permanent equity. They pay a fixed dividend or have provisions for a guaranteed rate of return. They confer no voting rights, but have preference over common shares should the company have to liquidate assets.
Through the purchase of common shares, shareholders gain voting rights in your company and an actual ownership in the business. Should you be forced to liquidate assets, common shareholders rank last to other lenders in receiving a return on their investment.
An Exit Strategy.
Venture capital is a long-term investment with a five to 10 year horizon and an established mechanism for pay-out at the end of that time. This ‘exit strategy' is often decided at the outset of the deal. Preferred exit methods include an Initial Public Offering (IPO) or strategic purchase of the company by a third party at the end of the 5-10 year period. They offer the highest rate of return.
Less preferred methods include management buyouts, sale or merger of the company, corporate redemption, forced receivership, sale of shares to principal or to other equity partners.
Shareholder agreements often have a clause whereby if one party offers to buy out another at a certain price, the other party has, within a limited period, the right to either accept the price or buy the offer out at the same price.
Tips
- Look for a venture capital firm that can be a partner for you.
- Look for a match in terms of money, industry sector and stage of growth.
- Look for a company located close to you – you can get more time out of them.
Good Web Resources
NATIONAL
Canadian Venture Capital Association
http://www.cvca.ca
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| Vancouver Enterprise Forum |
University of Saskatchewan Technologies Inc. |
Manitoba Capital Fund Vision Capital Fund |
WESTERN CANADIAN
The following venture capital companies are a few who are willing to look at seed, start-up and early stage companies.
Bank of Montreal Capital Corporation |
Inno-Centre |
Western Technology Seed Investment Fund |
Launchworks |
Ventures West |