Business

Raising private equity is a hurdle for many new businesses.  This has become a major area of my business law practice, especially in light of today's market where debt financing is harder for new businesses to come by.

When it comes to raising private equity, I very much ascribe to Chris Baggot's philosophy.  Chris wrote a nice article a few months ago describing his approach (See his article here).

The idea is for the company to raise only what it needs for the next step of its business plan.  Be ready - it takes work and humility to differentiate "need" vs. "want".  Plan for business growth and multiple rounds of equity raises, and raise only what you need for each step of growth.  For a growing business, it cost the entrepreneur more to sell equity at early stages than at later stages.  So, sell off a minimum amount initially, more at for the next step, and then more at future steps.  This will allow the entrepreneur to retain a higher ownership percentage of the equity of his company over time.   

Here are my steps for private equity raising:

Step one, determine what you need for a short term business plan (i.e., first stage of growth).  Imagine a new Indiana Technology company which desires to raise capital.  It needs to pay developer salaries.  It needs the equipment and tools for the development project.  There will be certain professional and legal fees.  It should question whether it needs office space now.  It should question whether it needs to begin a marketing campaign now.  Question everything!

Step Two, engage an attorney with experience in equity raises to create the correct infrastructure for the raise (i.e., develop a private placement memorandum, operating agreement...).  Be careful here.  See my previous blog entry on engaging an attorney who understands how to do deals, and beware of attorneys that will crush your deal.

Step Three, raise the equity.  There will be a lot of private conversations over coffee or beer at this step.  Key is that these are PRIVATE conversations.  Don't be afraid to get your attorney involved to help with this.  A good business law attorney should be able to help you find potential investors. 

Step Four, after the cash is raised, execute on your short term business plan!!!  There is no alternative other than success here. 

Step Five, develop a new short term business plan for the next growth stage of your business (e.g., taking the product to a national market).  Then repeat the steps above for a second round of equity raise. 

By step 5, the company already has a product, a market, and a previous track record of success.  Thus, the business is valued higher than previously, and equity purchased in the second round will cost investors more than in the first round.  The result is that the entrepreneur can sell less percentage interests of the securities of the company for higher amounts of capital. 

I find surprisingly few companies and Indianapolis attorneys who do this process well.  Most companies try to raise too much equity too quickly.  The result is an over capitalized business with money to burn.  This leads to inefficiencies and lack of strategic focus for the business.  When done well, an equity raise is motivating to the entreprenuer and creates an advisory group of peers for the business.  Now, let's go raise some cash!