How to Raise Capital from Investors

The very first step that most companies take when seeking private capital is the creation of an executive summary and a business plan. While executive summaries and business plans are an important facet of raising capital they are not designed to be investment documents.

Executive Summaries and Business plans typically just provide general information about the company, its business model, goals, etc. While this information is important to investors, it does not provide a basis or structure for accepting capital investment.

A business plan does not allow a company to accommodate multiple individual investors. Most business plans state an aggregate amount of funding needed, “$500,000″ for example, but provide no structure to allow for fractional investment. This means the company must find one single investor with $500,000 to invest – and the patience to develop the transaction structure and documents to process that investment. This limitation is probably the single biggest reason why so many companies fail at raising investor capital. Raising capital effectively and properly from investors requires very specific documentation that far surpasses what a business plan provides.

Public companies don’t raise capital from investors by putting a business plan in front of them. If you wanted to invest into Dell Computer – do you think Dell would send you a business plan to process your investment? Of course not – you would invest into Dell Computer through a securities offering. The same holds true for private companies seeking capital from investors. Don’t expect an investor to invest unless you have presented them with a securities offering. Business plans serve a purpose (especially for start-up companies) – but they should not be relied upon as investment documents.

The Fundamentals of Raising Investor Capital

There are certain fundamentals that you must have in place in order to raise any amount of capital from investors properly (whether it be one investor or one hundred):

First, you must have proper transaction structure in place before you interact with investors. The overwhelming majority of companies that are just using a business plan to raise capital (whether for $50,000 or $15,000,000) typically have very little transaction structure beyond “we’re selling 20% of the company for $2,000,000″. This is wholly inadequate.

How many shares or units are being sold? Preferred return or common ownership? What is the share/unit price? What is the total authorized share/unit pool and how will it affect future dilution of the investment? What is the exit strategy? How is the investor return modeled? Are the securities convertible?

Not addressing this information places the responsibility for creating proper transaction structure on the investor – which is very unprofessional and reflects poorly on the subject company. To raise private capital successfully you need to go well beyond simply stating to investors an aggregate amount of capital needed and providing information on the business. Do not expect investors to have any interest in your opportunity without providing them concise terms and conditions regarding their capital investment in your company. If you were an investor – would you not want the same information and structure provided for your investment?

Second, proper documentation for raising capital from investors is of critical importance. A business plan is not even the bare minimum needed for raising private funding – of any amount. The specific documents needed for raising private capital are:

• Private Placement Memorandum: The Private Placement Memorandum, or “PPM”, is the document that discloses all pertinent information to the investors about the company, proposed company operations, the transaction structure (whether you are selling equity ownership or raising debt financing from the investors), the terms of the investment (share price, note amounts, maturity dates, etc.), risks the investors may face, etc. Do not confuse the detailed corporate disclosures, SEC disclosures, and transaction structure in a PPM with the general information a business plan provides – they are not the same.

• ·    Subscription Agreement: Business plans do not even provide the documentation necessary to allow the investor to actually invest. Don’t expect investors to provide you funding based on a handshake. Would you invest funds into a company without signing a document that sets forth the terms and conditions of the investment? The Subscription Agreement sets forth these terms and conditions – this is the document the investor signs and returns to you with their investment check. You will have a very hard time raising debt or equity capital without this basic document.

• ·    Promissory Note: In debt offerings you need to have a Promissory Note outlining the terms of the loan arrangement with the investors. The note is the actual “loan document” between the company and the investor. It is impossible to have a “loan” without a “loan agreement” that sets forth the terms and conditions of the loan.

Third, in order to sell securities to investors you must follow the rules and regulations that govern these sales as set forth by the Securities and Exchange Commission and State securities regulators. The SEC has specific rules concerning how a private company solicits capital from investors – even if very few investors are involved. The Regulation D Offering program is the exemption program designed by the SEC for private business. It is the most widely used program the SEC offers and provides the proper exemption needed to raise capital from investors. Not raising capital properly can provide investors with a “right of rescission” in the future – meaning they can get their investment back regardless of the circumstances.

Don’t rely on your business plan to perform a function it was not designed to accomplish. Let us structure a Regulation D securities offering for your transaction and begin raising capital the right way.

This entry was posted on Saturday, September 12th, 2009 at 3:37 am and is filed under Articles. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.