Harnessing Private Investments: How Private Companies can Source Capital

Last week, I worked with a client of the law firm who was in search of a potential capital source for a private equity purchase. The person I contacted to assist our client was very knowledgeable in the space, with decades of experience in providing capital to private companies.?After spending a few minutes talking about the project, he asked one question -- "Where do you need us in the cap stack?"?

I already understood where this capital source could enter the market, what their risk tolerance was and what type of financing they were likely to provide. I provided the answer and he was in.

One of my favorite maxims is: Preparation prevents poor performance.?

Capital Sources are Unique to Each Industry

Capital sources are similar to other segments of the economy. Using either the restaurant or auto dealer space as an analogy, you go to the place that caters to your specific needs. If you want sushi, you don't go to a Mexican restaurant. If you need a vehicle tough enough to haul construction materials and trailers, you don't go to the Porsche dealership.?

Sourcing capital for private companies is no different.?

What is the Capital Stack for Private Companies?

The capital stack is generally ranked by risk and reward. The greater the risk the greater the return.?

Founder equity, or common stock, generally carries the greatest upside, but also the greatest risk. ?Conversely, commercial banks that lend fully securitized debt do not participate in successful high enterprise value exits. Instead, they are the first to get repaid because of the lien priority on assets and collateral.

?There are also various forms of equity that participate in both enterprise value upside as well as carry coupons or interest-like returns. These equity sources sit above common equity in terms of the priority of repayment.?

How to Organize the Capital Stack:

Whether you are the business owner or an advisor, it's important to be prepared when seeking to reorganize or incentivize capital.

1. What are the Company's needs? Determine the business goals and objectives, revenue targets and forecasting, growth plans, and financial model.

2. Create a Capital Plan. The plan needs to be your plan, not somebody else's. When you go to a capital source, they tend to push capital pricing and structure based on what works for them and will propose solutions that are within their own niche. Start with a capital plan to identify your company's needs.

3. Do your homework on the capital source. Within the last 60 days, I spoke with two different banks about potential real estate financing. One bank said it completely closed off all real estate financing. The other advised that it is “open for business” and welcomed the opportunity to issue a term sheet. ?

4. What growth stage is the Company in? Capital needs vary depending on stage of growth. Many companies continue too long with legacy capital structures even after they move to a more stable growth plan.?

5. Protect the Investors. Certain types of capital will put the company at risk. The ultimate goal of business is to provide goods or services to an economy that will pay fair value. That fair value results in profits, which creates enterprise value for the investors. One definition of success is to grow a business without overburdening the company and creating too much risk for the investors. Keep your eye on protecting the investors.?

When you have clarity on the goals and needs of the business, you have created a Capital Plan and identified potential sources, it's time to create a presentation.

The way a company presents itself and explains capital needs is important. The more organized, professional and well thought out a plan is, the more receptive a capital source will be to providing funding. It is not just about the numbers. I have had many senior lenders at both private capital funders and commercial banks tell me that they rely not only on the financial numbers but also on the skill and capability of the owners.

Packaging and presentation of a capital request builds credibility.?

The Takeaway

Many companies suffer from “this is the way I've always done it” mentality.

When structuring capital, private business owners need an expert. Shields Legal Group has guided numerous restructuring and sourcing of new capital for our clients. When you rely on our expertise, you will have more options when implementing capital solutions.

What are your capital needs??Please reach out to us at 972-788-2040 or send an email to [email protected].