There is no such thing as a "typical" deal when it comes to structuring an agreement between capital providers and business owners. Many books have been written over the years that describe the "10 steps to a venture capital deal," or the "Five steps to raising growth funds." Conceptually, these types of guidebooks can serve as excellent primers to outline key point of the fund-raising process. But most of the time there's a tendency for entrepreneurs to assume that all funding plans happen the same way, as though there's a generic formula that fits every situation. And that is just not the case.
Although financing deals may be quite similar in their "intent," it is very common to find that no two deals for growth capital are ever exactly the same in their line-by-line "content" of terms, conditions and timing. Sure, all entrepreneurs want to attract funding to provide that boost to the venture's growth potential, but each business owner has different priorities and needs with respect to investors. And every source of funds for your firm will work with its own goals, expectations, risk assessment and other criteria for deciding which investments are worthwhile.
What works for one service company may not be the best deal structure for a manufacturing firm. The equity share and four-year earn-out provisions in a high-tech business expansion will be different from a debt-for-equity swap with a producer of appliance fixtures. So is there even a basic outline for a typical growth capital plan? In some regards, yes.
A growth-capital plan has some essential components that are always included in the final deal structure. First, the two parties have to agree on either debt or equity as the primary position for the outside funding provider. And yet many deals are combinations of both. Second, the company owners have to establish a clear projection for the scope of the expected growth and how funds will be spent. Third, the investors need to decide the level of risk and return that are acceptable. Next, the local and macro economy must be factored into the mix with regard to uses of funds, rates of return, and liquidity preferences. Although these items establish an outline for your deal, the specific amounts, terms of transfer and provisions for risk exposure make each funding plan unique to the parties and economic conditions involved. So here's the basic anatomy of a comprehensive funding plan.
The capital provider has a natural attraction to the business strategy and product market of the target firm. How the company will specifically secure the growth in sales is subject to unique circumstances and approaches to management and organization. The ability to impart that vision for growth to the investors is crucial in aligning the right types of funding providers. Entrepreneurs need to work with providers who can wholeheartedly endorse their vision and operations style.
Investors might demand restrictions on the timing stages of spending amounts, or performance targets tied to allocation levels. With the risk and expected returns of the business strategy outlined, the two parties then have to decide the degree to which the local and macro-economic conditions affect sales, costs, recruiting talent and customer buying decisions on both the wholesale and retail level. This level of agreement regarding the perceived links between the economy and the firm strategy will either have the fund providers and firm owners seeing eye-to-eye, or require that further "safeguards" be extended to the investors to protect capital commitments.
At some point, the entrepreneur has to decide whether the financing providers have really "joined" the venture's growth track. They may have cautious apprehensions about the ability of the firm to pull off the growth projections outlined in the business plan. This kind of thinking is always at the heart of whether the funding position is structured as debt or equity. Creditors tend to be more hesitant about becoming a true partner with the firm, so they would rather lend funds (often with tangible assets pledged as collateral on the loan) to provide a greater degree of risk protection. Equity investors, on the other hand, embrace the existing owners' forecasts and strategy in their entirety and share the optimism that a stock position in the company will grow in value over time.
What really sets the tone for your funding deal is the level of agreement about company prospects and the degree of risk exposure everyone is willing to accept relative to the owners' positions. So be prepared to work through all the concerns and issues item-by-item. It's tedious, but the end result will be deal-specifically tailored to the unique situation of your company's needs.
David Newton is a professor of entrepreneurial finance and head of the entrepreneurship program, which he founded in 1990, at Westmont College in Santa Barbara, California. The author of four books on both entrepreneurship and finance investments, David was formerly a contributing editor on growth capital for Industry Week Growing Companies magazine and has contributed to such publications as Entrepreneur, Your Money, Success, Red Herring, Business Week, Inc. and Solutions. He's also consulted to nearly 100 emerging, fast-growth entrepreneurial ventures since 1984.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.