Capital Formation Plan

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Capital Formation Strategies and Best Practices

Capital Formation Strategies • There are a number of choices available

when raising capital • But, they fall within two general categories:

– Debt – Equity

• Defining your optimal capital structure, i.e., the balance between the two at reasonable prices, is the challenge

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Debt Securities • Bonds, notes, or debentures

– Bonds secured by mortgage on company property – Notes / debentures generally unsecured and, thus,

carry a higher interest rate • Terms are based on risk levels • Could be restrictive covenants attached • May require certain financial ratios to be

maintained

Equity Securities • Common and preferred stock, warrants, and

options • Each have separate rights, preferences, and

potential rates of return • Common stock

– Redistributes ownership and control – Can be costly, but provides an increased equity

base on which to grow the business

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Preferred Equity Securities • Preferred stock

– Equity that shares some traits of debt • Preferred stockholders:

– Receive fixed or adjustable rate dividends – Dividends are paid before common dividends – Participate in distribution of earnings on sale

before common shareholders – Have preferential rights (voting, convertibility) – Convertible preferred favored by VCs

Warrants and Options • Both give the holder the right, but not the

obligation, to buy securities in the company at a specified price within a specified time

• Non-exercised warrants / options lapse • If stock price rises above the strike price in

the warrant or option, the holders essentially buys the stock at a discount

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Convertible Securities • In their most typical form, very close to

options or warrants, as they allow the holder to convert into preferred or common stock

• Normally, the conversion price is at a discount to the current priced of the equity into which it is converted

• Advantages include debt with lower interest rates and few restrictive covenants

Your own money/resources (credit cards, home equity, loans, savings)

The resources of your friends, family, key employees, etc.

Small Business Administration/microloans/lenders

Angels (wealthy families, cashed-out entrepreneurs)

Bands of Angels

Private Placement Memorandums

Large-scale commercial loans

Informal VCs - strategic

Seed/early-stage VCs

Institutional VCs

Big time VCs

IPO

Capital Formation Strategic Pyramid

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Capital Formation Best Practices • Relationships are key • Use the pyramid • No room for whiners • Great business plan • Due diligence is a

two-way street • Part preparation, part

presentation, part sizzle • Raising money is no

substitute for making money

• Timing is everything • You are judged by the

team you put together • Fundraising isn’t for the

faint hearted – show passion and demonstrate skin in the game

• Leverage your social and business networks

• Be honest with investors and yourself

• Have fun!

Capital Formation and Business Growth Resources • Literally thousands of organizations

– Trade associations – Networking groups – Venture clubs

• Federal Agencies • Web-based resources (international) • Expert assistance • See Sherman, Chapter 15

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Summary • Entrepreneurs have a number of options

when deciding to raise capital • Optimal capital structure is the proper mix

of all available securities • The challenge is understanding the proper

mix and finding reasonably priced sources • Follow capital formation best practices