Structuring the Sale of a Company

I wanted to create a quick and timely post to fill in some blanks about how a company might structure an investment from say, a Private Equity Fund. Reading my description of a Balance Sheet may help.
First, let's assume that if you are large enough to attract the attention of a PE Fund, then you are already Incorporated with an existing Share Structure. This Share Structure typically has two classes of shares, Common and Preferred. Common Shares are voting shares and usually where the value of a company is reflected as price per share.
Preferred Shares are non voting shares, but in some instances (especially involving outside investors) can contain all of the company value in the form of asset backed interest bearing shares that must be paid before any dividends are paid to common shareholders.

If a PE Fund wanted to invest in an existing incorporated coffee company, they would set up a separate corporation with a common share structure that reflects the final ownership percentage. The fixed assets of the original corporation would be held within this company as security to offset the cash investment of the PE. For example, if the ownership is 50/50, and the value of the company is determined to be $1,000,000 and the PE fund wanted to invest a further $1,000,000 , the common shares would be split 50/50, and the preferred shares would be set up so the cash infusion of $1,000,000 would be offset by a balance sheet entry of equal Preferred Share Value, and the Fixed Assets brought into the new corporation would also be offset by $1,000,000 balance sheet entry of Preferred Shares.

If the PE fund wanted to invest more than the value of the company, but the existing owner didn't want to give up more than 50% ownership, the common shares could still be distributed 50/50, but the PE fund could have more (even all) Preferred Shares. The value of the Preferred Shares would be secured by the balance sheet assets and a Shareholder Agreement drawn up to protect the investment by precluding dividends until Preferred Shares are converted to Treasury Shares or retired. The original owner could also completely cash out the value of the original company balance sheet by selling the assets to the PE fund, and the transaction reflected by placing the whole value in Preferred Shares owned by the PE fund. The common shares could still be distributed 50/50. In this instance, the PE fund may also have provisions written into a Shareholder Agreement that would permit the conversion of Preferred Shares into Common Shares if some "triggering" event should occur. Last, some investors may look to have a "shotgun" clause written into a deal which permits either party to submit an offer to purchase the other party's shares which must either be acted upon, or the recipient of the offer becomes compelled to purchase the other party's shares under the same terms that were offered.

Believe me, the Devil in any deal is in the details. No matter what anyone says, only the parties involved actually would know how any deal is structured, but more often than not, the stroke of a pen leads to unintended consequences.

Raising Capital

There are many reasons a coffee company may wish to raise money including purchasing new equipment, opening a new location, purchasing another company or expanding the business in another way. If you are looking to raise capital to support a failing business, stop right now and remember the old adage, "when you find yourself in a hole...stop digging". If this is the case, please read my post on Controlling Costs. It is my opinion that using your accumulated profits to fund growth is the best way forward but here are some other options if this is not possible.

When raising funds the first place a business owner would think to look is the bank where your daily deposits go. This is a great place to start given your account manager can quickly access your account to determine consistency of deposits and net change in cash position on a monthly basis. Getting a loan from your financial institution comes with standard repayment terms and rest assured that they don't want to run or seize your coffee business, they just want to be paid on time. Interest paid on financed debt is deductible before taxes, and is on the whole a less expensive option than issuing Equity. The problem with banks and other financial institutions is they are fickle and prone to turning off the tap if they themselves are facing difficulty. The credit crisis of 2008 to present is a great example where money went from being abundant to scarce overnight. During this period, most businesses were forced to cut expansion plans and conserve cash as a self preservation mechanism knowing the banks wouldn't be there for them. A last note about banks, don't ever sign pledge your personal assets in order to obtain a loan. This is one of the reason's why you should incorporate your coffee company and sequester your personal assets from the reach of creditors should your business fail...which unfortunately does happen.

Family and friends are useful sources of cash, but beware of the impact it can have on your personal life. People who are not entrepreneurial view cash differently than business owners and expect to see the money on demand. Use this source of cash only as a last resort, and always provide a written term sheet detailing repayment details. I want to emphasize that this can be the most costly type of cash you'll ever access, and in many, many instances is not worth the cost.

Issuing Preferred Shares is a more complicated method of raising money but in a lot of cases is a great way of establishing a relationship with savvy investors without giving up any control of your coffee company. Preferred Shares are a special class of Shares in a corporation that do not have voting rights to make decisions for the company. Instead these Shares have a higher claim to the company assets should liquidation be necessary, and either a yearly dividend or other monthly income provision. Preferred Shareholders are always paid before Common Shareholders, and therefore will receive their money before the owners can receive any. Any investor in Preferred Shares will normally demand that management/owners wage and salary be capped to protect the value of their investment. This is a more expensive method of obtaining cash since payments dispersed to Preferred Shareholders are made after tax as opposed to pre tax for interest on loans.

I am constantly amazed at the clever ways a determined entrepreneur employs to raise funds. I have heard of pre-selling customer cards at a discount which gives the business immediate access to cash on goods to be delivered in the future. Selling under applied assets and equipment is another valid way of creating cash quickly. Some companies have used their connections to wealthy patrons to create "founders clubs" that act as informal Preferred Shares by offering the founders extra bonuses and services plus repayment terms. No matter how you raise cash, it all has a cost that should be studied and examined to determine how it will impact your Income Statement and Balance Sheet.