There are several obstacles to face with a young start-up company, and typically one of the main concerns is raising capital in compliance with funding law.  One method companies can use is offering the sale of stock or membership interest in their company through private placement offerings to a limited number of private investors.  

A private placement offering is differentiated from a public sale of securities that must be registered with the Securities & Exchange Commission, namely because of the dollar amount being raised and the sophistication level of the investors.  These investors are presented with a Private Placement Memorandum or an Offering Memorandum which contains key information that must be disclosed to the investors to make an informed decision.  This offering memorandum should include such relevant information as the company history, managing team and/or key members, the financial statements, products, and business/marketing strategy. 

Typically costing a fraction of the fees involved in registering securities on the open market, a private placement offering is a fund raising strategy that small to mid-size companies might want to consider if they are seeking a capital infusion.

One of the business law firms located in downtown Indianapolis, Alerding Castor, LLP began in April of 2007 and has now recently added Brian Hewitt as partner.  Under the new name, Alerding Castor Hewitt, LLP, I couldn’t be more enthusiastic to be a part of this legal team.  What I find exceptional about this firm is that we work as a team in order to provide our clients with outstanding legal counsel.   

 

While I practice mainly on the transactional side of the law, working with clients on such projects as: strategizing and negotiating multi-million dollar agreements, preparing private placement offerings in accordance with funding law, and offering legal technology consulting for SaaS licensing, we work collectively as a firm for our clients and have many attorneys who focus more on litigation. 

 

For instance, litigators, who spend most of their lives in the courtroom, have an eye toward recent courtroom rulings and interpretations of the law (because they have spent countless hours researching court opinions and crafting their arguments against opposing counsel).  So, I find that in order to provide my clients with the best possible legal advice, at times it is absolutely essential for me to discuss and carefully consider the perspective of our litigation attorneys – and they are always glad to provide me with that insight.

 

That is what a team is all about: utilizing the strengths of every member for the collective benefit of the team… which ultimately means the client. 

 

As an Indianapolis attorney, I’m proud to be associated with this growing legal team: Alerding Castor Hewitt, LLP.

Here are some of the questions I heard raised on the private placement offerings presented to an angel investor group last Friday:

During the presentation, it is good to focus on the uniqueness of your product (if that is in fact the case), but don’t feel like you have to labor on this too long.  The investors are more interested in a solid business model than just the market splash of a product.  Make the point and move on.  This is typically difficult for the presenter if he is also the inventor of the product.  I thought all of the presenters last Friday did a good job with creating excitement for the product and then went on to the business.

I saw probably the best slide I have ever seen at an investor presentation.  The presenter flashed up a copy of a check from a customer.  What a simple but huge statement.  You are not only telling the group that you have customers, but you are showing them the actual dollars coming in.  Great slide.

I saw some bad things in the presentations too. 

One of the presentations showed a slide referencing the business’s process for making money.  It was a convoluted story board which started in the bottom left, moved around clockwise and ended in the center.  It took me a few minutes just to figure out where to start.  Take note, in America we read from top left to top right, and then down the page in a likewise fashion.  Don’t create a new way to read print.

Also, way too many MBA hockey stick graphs in the presentations.  One of the pre-revenue SaaS presenters was estimating $90,000,000 revenue in five years. 

NEVER use the phrase “Our projections are conservative.”

Finally, if you are not a great presenter, hand off parts of the presentation to a well-polished presenter.  There is nothing worse than sitting through boring presentations – even if the material is great.  This is true anywhere but especially in a presentation to a professional private equity firm which you should be well prepared for.

I am back in Irvine, California this week visiting with two angel investor groups.  One of which invited me and my colleague, Sam Schmutte, to attend their investors meeting this morning.  Yesterday, we had lunch with the two officers of this group.  We spent much of that time discussing the current economic climate and its impact on investment opportunities.

In the wake of Madoff, economic stimulus earmarks, and AIG bonuses the public’s trust of financial “experts” has been shattered.  This is true as well with angel investors.  Most investors have a fundamental distrust of how agents will invest money on their behalf.  It was interesting to see how in this particular angel community, investors were largely distrustful of investment funds.  These are funds where multiple angels pull their money together to make a larger, more significant investment in a particular venture.  Most funds have one to three managers that screen and oversee the investments.  The benefit is that the single fund investment will have higher control over the operations and direction of the business than a collection of individual investments.  The negative is that individual investors have less say over investment opportunities. 

The alternative is for angel investor groups to act as networks – where businesses present opportunities to the group, and individual angels decide whether or not to personally invest.

The good news with this trend is that businesses approaching private equity firms may have a higher chance of getting some capital from each group.  The bad news is that it may not be the windfall amount they are praying for.  So, businesses are required to approach numerous investment groups with private placement offerings to raise the capital sought.

I just returned from a conference in Scottsdale, AZ on raising private equity.  While my wife was off riding horses in sunny, 85 degree weather, I was in an internal conference room with no windows refining my knowledge of how to help clients raise capital through private placement offerings while not committing securities fraud in the process.  That is how much I care about my clients!  Thankfully, I did get out in the sunshine on Friday afternoon as we traveled to Sedona and on Saturday while we rooted for the Cubs in a spring training game in Mesa!  So don't feel too bad for me.

The area of private equity law is a minefield.  Wrong moves are easy to make and hard to repair.  The legal jargon of disclaimers and risk factors in a Private Placement Memorandum actually serve good legal purposes (the primary one being the avoidance of securities fraud), even though from a business perspective we all know it is bunk.

One focus of the conference was on the private offering process for businesses seeking investors.  What I like about this process is that it mirrors the mission of my firm – the key is working through and building relationships.  Only approach those with whom you, your broker or your agent have an existing relationship. 

The panel also discussed the difference between consultants and brokers in the equity raise process – an issue I am running into more and more lately.  Folks need to be careful here.   

This week, a colleague and I are back off to Los Angeles to meet with an Angel Investment Group that is inquiring into making investments in two of our clients – both pre-revenue, Indiana technology, SaaS businesses.  We will head back there for presentations in mid-April.

This is exciting stuff!



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See also:

Funding Law - Buyer's Market
Funding Law - Investing in Midwest Technology Companies
Angels are Still Investing
Private Equity VIII – Environment for Buyers and Sellers

Private Equity in 2009 – Don’t Give Up
Private Equity VII – More on Angel Investors

Private Equity VI - Raising Angel Capital
Private Equity V - Raising Capital and Not Telling Lies
Private Equity IV - Angel Investors Get Picky
Private Equity III
Private Equity II
Private Equity I

 

Does your business need Search Engine Optimization (SEO)?

 

Yes!  Absolutely!  If your business has a pulse, you need Search Engine Optimization.  SEO can add tremendous value to a business’ marketing efforts (this is even more true when tied with a good analytics tool). 

 

The more appropriate question is where should your business spend money on SEO.  The core of my business law practice is in working with small to medium size companies in Indiana technology, software licensing and SaaS markets.  For these companies the question is not whether SEO will help (it will) , but whether the business should fork out it's cash to maximize it's search optimization (i.e., what is the ROI; when does it materialize?).  I help many businesses raise capital through private placement offerings.  On the back side of the equity raise is ALWAYS living to your budget!  So, how should a businesses budget for SEO.

 

There is a helpful article on Small Business Trends on SEO Trends for 2009.  Let's face it, it is valuable and here to stay! Stay on top of the trends.

 

Also, check out Doug Karr’s post on how backlinks and content are more effective places to spend cash than on SEO Experts.  This is a great post, and thank you Doug!  I find that the gut reaction to SEO for most business owners is to throw money at an SEO expert that will presumably take care of the situation but charge a great deal for his services.  For most businesses there are options which cost less and are more effective.

 

Search optimization is based on relevant content (keywords and search phrases, backlinks, recent materials…).  Blogging is a great platform for this as content and keywords are refreshed every time a new post is made.  Also, some businesses can consider adding tools to a website to help third-parties provide content on their behalf.  Take Amazon for example:

• allowing user reviews on all their product pages
• posting full product descriptions (scroll down) from manufacturers
• inviting authors & artists to add content to the site via Amazon Connect
• inviting shoppers to create themed product lists
• creating linkbait, like the current Harry-est Town in America list
• allowing shoppers to upload their own product images
• managing the Amazon Daily blog
• making their URLs much more SEO-friendly than in the “old days”

(source: Small Business Search Marketing).

 

Regardless of the mode, businesses should consider their optimization plan and prepare a strategy for marketing, and more importantly being found, on the web.

I love Africa.  I love it's rawness, beauty, the honesty of it's hardship.  It is opportunity that is constantly bashing heads with turmoil. 

There is an article in this month's Harvard Business Review entitled "Now's the Time to Invest in Africa".  For years I have been involved in building infrastructure in Africa and promoting opportunities for business growth within the continent.  In 2008 my firm handled deals in South Africa, Zimbabwe, Nigeria, Togo and Congo.  In 2009 I expect to handle deals in even more countires.  These transactions are anything from private placement offerings, to oil and real estate, to technology, to Internet, software licensing and SaaS licensing.  Just this weekend I worked with a client on a SaaS law matter for an Internet based technology start-up looking to launch in southern africa in mid-2009.

The gist of the article is that over the last few years trends have developed through Africa to present a prime investment climate.  This includes policital stability, international and economic policies, and business profits and growth.

Here are a few key stats from the article:

• From 2002 to 2007 the average annual return on capital of African companies was 65% to 70% higher than that of comparable companies in China, India, Indonesia and Vietnam.
• The median profit margin for 1,869 businesses survied in sub-Saharan Africa was 11% (based on World Bank data) - better than comparable figures for Asia and South America.
• The IMF projects a 2009 growth rate of 6.3% for sub-Saharan Africa - and more than 8% for Uganda, Tanzania and Nigeria.

Americans as a whole need to rethink opportunities to invest in sub-Saharan Africa.  Not only is the investment climate prime, it is also a better long-term way to help the region achieve its promise by contributing much needed capital, business skills and global connections.

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See also:

International Business Law
Alerding Castor in Africa

A large part of my business law practice consists of providing counsel to business owners on raising capital.  These clients are primarily new ventures in Indiana technology, software licensing, SaaS law and real estate fields.  I assist these businesses in developing strategies for private equity offerings, drafting private placement memorandums and related investment documents and identifitying and presenting the investment opportunties to private equity investors.

It is about impossible to read The Wall Street Journal, The Indianapolis Business Journal or any other business publication these days and not get a bleak picture of the current climate for private equity investments.  These articles, however, primarily apply to (1) small, pre-revenue start-ups with no proven leadership and (2) large businesses seeking excessive venture capital financing.  I believe the market for private equity investments for smaller companies which have solid business plans, proven leadership, and apply the art of bootstrapping is still fairly strong.

Alerding Castor attorneys have helped many businesses raise private equity in 2008, including the last quarter of 2008, and have a few capital raise deals in the pipe line for 2009.  Below is a list of previous blog posts where I address private equity offerings and best practices for raising capital.

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Private Equity VII – More on Angel Investors

Private Equity VI - Raising Angel Capital
Private Equity V - Raising Capital and Not Telling Lies
Private Equity IV - Angel Investors Get Picky
Private Equity III
Private Equity II
Private Equity I

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Also see Anthony Ware's (of S4X Ventures) recent post: Private Equity Has Not Left the Building

December is always an exciting month for entrepreneurial law attorneys.  Most years December is my top month for merger and acquisition deals, private placement offerings and other business collaboration transactions.  This past week my firm closed two multi-million dollar acquisitions, one venture capital transaction, and no less than five significant software licensing deals for our clients.  We also brought in three more acquisition deals to finalize before the end of the month.  This is fun stuff!

Following the closing of one the acquisition deals (which was handled primarily by Sam Schmutte and Janet Croswell of Alerding Castor - great work guys!), our client gave me about the best compliment a client can offer.  He told me that my firm was great to work with every step along the way in this deal; that we gave him a clear assesment of the risks at each step, allowing him to make informed business decisions; and ultimately, we got the deal that he wanted done.

As I stated in a previous blog post entitled The Art of Partnering, every entrepreneur should read Chapter 8 of The Art of the Start by Guy Kawasaki.  He does a nice job of capturing the benefits of "partnering" with clients.  He also captures what I consider key in engaging legal counsel to assist you in realizing your business goals.  He states:

"...find a lawyer who genuinely wants to do deals, not prevent them, and set the right legal framework.  Many lawyers view their role as the "adult supervision" that will prevent stupid deals from taking place.  However, their bias is often that a deal is bad until proven good.  Avoid this kind of lawyer.  Instead, find one who views his role as a problem solver and service function for you, the customer."

This post continues on my two prior blog posts regarding private equity raises (Private Equity I; Private Equity II).  In my business law practice, one of my jobs is to help clients raise capital through selling securities which are exempt from SEC public company filing requirements.  The beauty of these exempt securities is that the company can raise cash without taking on debt and without having to comply with strenuous and costly SEC filing requirements for public companies.  The down sides are that the qualifications for investors under these exemption rules are typically narrow and the type of investor who is willing to invest in private equity can be hard to find.

“Is anyone going to buy it?”  

Finding investors can be particularly difficult with pre-revenue offerings (i.e., start up companies that are not yet at a revenue generating stage of business).  Investors like seeing exactly how a business makes money.  A majority of my practice is in the software licensing industry.  This is a fast moving market.  Everyday somebody comes up with the next HUGE idea that is going to revolutionize some aspect of the industry.  The developer sets up a company, develops a beta product, and begins looking for cash to take the product to market.  This is where the chicken and egg issue arises.  Investors often don’t trust ideas in and of themselves and want to see actual cash coming in – but the company cannot afford to take the product to market and generate revenue unless they have capital.   

Potential Solution: Try to parallel the beta product with a beta market which will generate early revenues for the company.  Anything here will help.  Prove to the potential investors that people will pay for your product.

Economic Considerations

Finding investors can also be difficult in hard economic times.  Over these past few weeks we have noticed this.  When the public markets start falling, investors seem to value liquidity over long term ROI.  That is a problem for raising private equity as most private raises require between a 3 and 7 year capital commitment from the investor.  Reality is, private offerings can offer a nice diversification tool for investors as private investments are less schizophrenic than public markets and often result in a higher ROI over time.

Potential Solutions: Key is to be creative.  We are all in this together - so, try reducing the amount of an investor's minimum investment, reduce the total capital to be raised and tighten the belt on your company's budget (determine "needs" vs. "wants").  Another idea is to look to foreign investors who are less impacted by the U.S. public markets.

As a business law attorney I often get asked by clients who are doing private equity raises if a Private Placement Memorandum (PPM) is necessary.  Let's face it - these are terrible documents that do a poor job of casting a vision for the business, and investors hate reading them as they are "overly lawyered" and thick in regulation.  I am of the opinion that the only reason a PPM does not scare away investors is that most private equity investors have seen a million PPMs in the past and have learned to essentially ignore the disclaimers.

Here is the first line of a common disclaimer section found in a PPM:

THE UNITS OFFERED HEREBY ARE SPECULATIVE, INVOLVE A HIGH DEGREE OF RISK AND SHOULD NOT BE PURCHASED BY INVESTORS WHO CANNOT AFFORD THE LOSS OF THEIR ENTIRE INVESTMENT.

Obviously, no company that is issuing a PPM to raise private equity expects that its investors will lose their entire investment.  So, what is the purpose of including this language?  Only one reason... to avoid a securities fraud claim.

Both federal and state law include anti-fraud requirements for private securities offerings.  The issuer of the securities must not make any untrue statement of a material fact (or omit to state a necessary material fact).  A common example is a stated (or implied) rate of return on an uncertain and high risk investment.  A well drafted PPM can create a written record of what has been communicated to investors with the goal of full disclosure of the risk associated with the investment.  Based on the above disclaimer, for example, each investor was put on notice of the high degree of risk associated with the investment and that no specific rate of return can be expected.

PPMs can serve other more informal purposes as well.  A well drafted PPM can be a "sales" presentation document - presenting a summary of the business plan in a professional manner.  But, the fundamental purposes of a PPM is to present the world of risk to potential investors - allowing them to make a well informed investment decisions regarding the company.

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!