How much do I owe my investors?

Discussion in 'Growing and Managing a Business' started by devsharon, Nov 11, 2011.

  1. devsharon

    devsharon
    uix_expand uix_collapse
    New Member

    Joined:
    Nov 11, 2011
    Messages:
    3
    Likes Received:
    0
    I have an idea for a business that is pretty much no-fail, however I have no money to start it up with. I have a few sources of possible 100% financing for what I would guess to be from 100 to 200 grand to get it up and running. What would be a good deal for the investors as a return... what do I have to offer them? I would like to obviously keep as high percentage of the business as possible. Do I offer them a percentage of the first three locations without an overall percentage of the business? an entire location? any good advice? It is definitely a business that I intend to make national.
     
  2. ArcSine

    ArcSine
    uix_expand uix_collapse
    Member

    Joined:
    Jun 2, 2010
    Messages:
    233
    Likes Received:
    187
    Fortunately or unfortunately (depending on one's perspective, natch) those particular questions (what %-age to offer the investors; how should the investor deal be structured? etc.) are ones for which specific advice can't come drifting in from a distance. Deals are snowflakes and the investor deal structure has to be built to specifically suit the particular situation. Anything less would be suboptimal.

    The percentage return that must be promised to an investor is primarily a function of the uncertainty and unpredictability of the future cash flows. That risk factor could be anywhere across the spectrum, of course, depending on what kind of business it is, the maturity of the industry, the state and strength of the competition, the average credit strength of the targeted customer base, economic indicators and forecasts, the liquidity of the underlying assets, patents and noncompete protections, ...., ad infinitum. All of these issues, at least to the extent that they're applicable to the scenario at hand, have to be examined before making any guesses as to what kind of risk-adjusted returns would be appropriate (and attractive enough to draw in sufficient capital).

    But details aside, there are a few generalities that might be useful. For one, debt is generally safer for an investor than equity. If an investor has seniority in the capital structure (say, he's received promissory notes in exchange for his cash) he'd likely demand a lower return than the %-age he'd require for an equity investment. The logic, of course, is that if cash flows don't live up to forecasts, he'd get his money back before the equity players get theirs; hence he's got a safety net of sorts underneath his investment. That's why debt capital is cheaper for you than equity capital, all else equal.

    Additionally, debt typically doesn't participate in management decisions (if it does, it runs the risk of being viewed by a court as de facto equity, in the event of financial distress, and thereby lose its seniority standing in the liquidation proceedings). So you give up less managerial control if you can obtain more of your capital in the form of loans, and correspondingly less in the form of equity.

    But it's certainly not a case of "if some is good, then more is better". Too heavy of a debt-to-equity ratio raises a whole 'nuther set of risks (which = more cost to you) so don't go overboard.

    Also, if within your investor group there are some with a particular expertise that would be valuable in your proposed business, you might consider making sure those folks receive some meaningful shares of equity. They'd then have a financial incentive to make the company (and thereby their own shares) as valuable as possible.

    A parting word: When you're dealing with outside investors, certain things become more complex and much more important. You WILL need a tax advisor, an accountant, and an attorney with experience in crafting partnership / corporate shareholder agreements. To the extent you can get one or more of these advisors involved in the pre-launch planning, the smoother it'll be down the road. Even more true given your intention of scaling this thing to a national scope. Good advisors will help you get the bugs worked out before you come of the gate, which will minimize the re-tooling you'll have to do every time you wanna take it to the next level.

    Best of luck with your plans!
     
    • Like Like x 1
  3. devsharon

    devsharon
    uix_expand uix_collapse
    New Member

    Joined:
    Nov 11, 2011
    Messages:
    3
    Likes Received:
    0
    Thank you. This is all somewhat confusing but helpful in the parts I understand. I definitely know I will need a team of advisors.
     
  4. ArcSine

    ArcSine
    uix_expand uix_collapse
    Member

    Joined:
    Jun 2, 2010
    Messages:
    233
    Likes Received:
    187
    Sorry for the confusion, but perhaps it hints at the complexities lurking underneath a seemingly simple question ;).

    Picture your question as a tree trunk which looks very straightforward, as long as you don't let your eyes go above 6 feet or so. But in trying to give even a simple answer, one must follow the trunk upwards a bit, and that's where the fun (?) begins.

    The trunk immediately forks out into 7 limbs. Go up another couple of feet, and each of those limbs splits out into 11 or 12 branches. Then from each branch sprouts 15 sub-branches and twigs, and so forth. Dang, even each leaf shows an interesting array of veins branching in all directions, when you bring out the magnifying glass.

    And so it goes with the issue of how best to structure an arrangement involving outside investors and external financing. Multi-volume, dictionary-sized books have been written on the topic, and your advisors---who'll be able to see your particular tree up-close---will be able to keep you from falling out of the tree head-first.

    On the other hand, those simple rules of thumb that sound so easy at a cocktail party ("yeah, all ya gotta do is offer 'em a 20% return, and don't sweat the details") is the perfect way to construct a tree that topples over at the first wind, and falls squarely on your new company.

    Having said that, though, questions concerning specific aspects of your company or your investment structure are easier to address in an informal medium such as a forum, so don't hesitate to ask. Cheers!
     
  5. devsharon

    devsharon
    uix_expand uix_collapse
    New Member

    Joined:
    Nov 11, 2011
    Messages:
    3
    Likes Received:
    0
    Ha. I like the analogy. It's precisely what I was afraid of.... But it doesn't hurt to hope for a simple answer. Thanks again.
     
  6. td2011

    td2011
    uix_expand uix_collapse
    Member

    Joined:
    Apr 14, 2011
    Messages:
    182
    Likes Received:
    12
    Yes some areas of business can be very complex. I don't think you need to be a genius to understand it and obviously you'll gain knowledge from your experience. Sometimes you have to just learn for yourself. Though it does help to be given a heads up about issues you can end up facing
     

Share This Page