What's It Worth?

Let's Make A Deal

To get such a deal done, an entrepreneur needs three ingredients: two banks and one guarantor. Lipper says providing loan guarantees to high-growth companies is a very subjective undertaking for investors, and there are several ways a deal might be structured. However, he says a typical one-year loan for $1 million might be put together as follows:

First, the investor purchases a letter of credit from his or her bank. This letter of credit stipulates that the investor's bank will pay to the entrepreneur's bank $1 million one year from the date of the agreement.

For the bank to issue such a letter, it will charge 1 percent to 2 percent of the amount of funds being guaranteed--in this case $10,000 to $20,000--as a fee. But also, because it's a bank (and banks tend not to take risks), it will also require the investor to deposit $1 million in government securities or $2 million of marginable securities into the bank. (So-called "marginable" securities are those that can be borrowed against, a determination made by the Federal Reserve.) These assets collateralize the letter of credit the bank issues.

With a rock-solid letter of credit for $1 million protecting it, the entrepreneur's bank will then lend the entrepreneur the $1 million he or she needs to grow the business.

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This article was originally published in the May 1998 print edition of Entrepreneur with the headline: What's It Worth?.

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