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2.7 Consider the Entrepreneur and Investor
Financing options and capital structure and mix must suit both owners
and investors. In thinking of how to approach potential investors, consider
both:
What to Consider From Your Perspective
Which approach - matched, aggressive or conservative — is best suited
to your company? Which mix of short-term and long-term obligations and
of debt or equity financing best meets your needs, goals and constraints?
Which is more suitable: high, medium or low leverage? The answers depend
on several factors.
- Costs
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The more debt you assume, the bigger your fixed cash servicing burden.
However, the actual cost of debt is lower than the cost of equity.
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- Risk
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If you add more debt to your company, you're adding risk because you
lock the company into scheduled interest and principal payments. If
you default on a loan agreement, the lender may force you into liquidation
or bankruptcy.
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- Options to Protect Your Downside Risk
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If you're in a cyclical industry, consider using more equity. If your
company or project is very sensitive to increases in interest rates,
consider using fixed rate, long-term financing or interest rate protection
products. If you have a ratchet clause as part of your financing agreement,
protect your downside risk. Ensure there is a ceiling on how much equity
the investor can own if you don't meet your projections.
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- Relationship With Third Parties
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A private equity investor will probably want greater management and
decision-making involvement in your company than other types of investors.
Some debt arrangements hold onerous reporting requirements (e.g. asset-based
lenders may monitor your inventories and receivables as often as daily).
Can you live with these arrangements?
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- Collateral
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Providing assets for collateral ties up the asset for future financing.
If an asset secures debt, the lender might seize that asset in the event
of default. The leasing option is particularly vulnerable in this respect.
And there may be pre-existing contractual
constraints that limit the types of funding you can pursue.
What to Consider From the Investors Perspective
To assess whether your investment opportunity will meet a prospective
investor's criteria, consider these issues. (Some of them are dealt with
in other Steps.)
- Rate of Return
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Determine if your company can generate a sufficient rate of return
on the investment (an equity investor will usually require a minimum
return of between 25% and 40% per year). Assess if the rate of return
is appropriate with the overall level of risk.
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- Control
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Some investors require a certain level of profit sharing, management
involvement and decision making. You must determine what you are prepared
to relinquish and at what level. Potential investors often require some
level of involvement.
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- Exit Strategy
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There must be a plan for the investor to exit. High-risk investors,
at some point, want to gain from their investment. The nature, timing
and liquidity of this exit plan must be consistent with your perspective.
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- Shareholder's Agreement
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In raising equity, it's wise to establish a shareholders' agreement
to define your roles and any restrictions. It will also help to avoid
any future misunderstanding.
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- Legal and Legislative Issues
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Mandatory requirements. Assess whether there are any legal or legislative
restrictions that make you and a potential investor incompatible. See
our Legal and Regulatory Overview Tool for more
information.
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