Making Structural Changes

Making structural changes means altering the deal structure of a securities offering by changing the elements of the pro forma financial projections. The various techniques and the mechanics of this process are disclosed in detail with the instructions to CapPro™.

If you receive a positive indication of interest on one or more of the “Red Herring” scenarios, your direction is clear. Produce your securities-offering documents to those indications of interest, and send it to those potential investors. Don’t over think this. Remember, there are two sides to this equation, what they desire and what you can live with.

Reworking the deal structure prototype, which are defined by your company’s securities’ features and benefits, will be relatively easy once you have entered the financial assumptions into the CapPro™. You can easily run different “what if” scenario.

Maybe a participating preferred stock offering that has a dividend of 8.5% with 20% participation for a total annual-return potential of 30%, with a ten-year Call Price of 120% ($120) of par value, as opposed to the 110% ($110) in the previous example, would be more appealing for the investors. That is the beauty of running the numbers in the first place—you will know what you can afford to give up and how to structure the deal so it sells to your private market or into the public markets.


Notice that with the two most popular deal structures for private or public placements, very little of the voting common-stock equity was relinquished with the limited conversion rights. The company’s voting control remained in the entrepreneur’s hands. Sometimes that is unrealistic especially if the entrepreneur has little or no money in the company.


A prudent investor’s biggest fear is losing their investment. One way to circumvent this fear for a potential investor base is to indicate in your Red Herring research letter or the securities offering document that you will escrow the money. In other words, you provide an escrow clause within the securities offering document, which states unless 100% of the funds are secured, including the bank loan, if appropriate, their entire investment will be returned to them as well as bank interest. Indicate that the money will be safe and only become an investment “if and when” all of the funds have been secured. That approach should calm or mitigate some fears, especially in regards to investing in a start-up. Once again, it really goes back to the entrepreneur’s personal and professional contacts. Maybe a minimum-investment amount you indicated in your research letter was $25,000, and no one in your influence circle can obtain that amount of cash. Maybe a $5,000 or $10,000 minimum-investment amount would have a greater acceptance rate. You are trying to attract investors’ risk capital with securities normally used to attract their larger “safe money” investments, so you need to constantly mitigate risk for them.


Remember, in regards to raising capital, it may be wiser to have multiple investors investing relatively small amounts, as opposed to a few investors investing large amounts in your Company. This concept not only lessens the probability of an 800 lb. gorilla trying to run the show and aggressive lawsuits if things don’t work out, but on a positive note, it enables you to create a growing pool of private-capital contacts to whom you might return in connection with future securities offerings. The more investors you have, the higher the probability of actually raising the capital sought—round after round, which you will need whether or not you think so. By cultivating a large investor pool, you also increase the probability of getting additional investor referrals.


Maybe the IRRs seems too high because the revenue assumptions are perceived too aggressive; or there is too much debt (leverage) in the capitalization plan. You may need to simply increase the equity portion of the capitalization plan or produce an “all-equity” plan. Investors don’t like the idea of being second in line on asset liquidation, so an all equity capitalization plan using preferred equity as the securities to be sold, inherently puts the investors first in line.


If bank debt is really needed for the capitalization plan, consider having a trusted associate or close friend sign a personal guarantee with the bank, so you can obtain a line of credit. (Even SBA-backed credit facilities frequently require personal guarantees, and their likelihood of approval by SBA is enhanced with same.). To induce the co-signor/guarantor, you might have to give them some carried interest plus equity. Incidentally, “carried” interest is the type you pay the co-signer, over and above the bank’s interest rate of 9% (example), for taking on the risk. You may pay them 4% (example) for a loan’s total interest rate of 13%. If so, that may constitute a securities offering, and an accompanying document may need to be produced and regulations followed. Any arrangement to compensate co-signors for bank loans will need to be disclosed with in the securities offering document used to raise the equity portion.


There can be many capital-plan combinations. Remember, there are an unlimited number of ways to structure a deal and formulate a securities offering—so try to keep it simple. Once you get some sales-generated cash flowing into the company, it may become bankable on its own merits for other product and/or service development.


Once again, you need sufficient seed capital to go after larger amounts of development or expansion capital. If you need over $1 million in development capital, raise $200,000 from friends and family. (Use some of that money to register the offering so you can advertise a “qualified” offering.) The [sad] fact is if you want to raise substantial amounts of capital—more often than not—you have to invest time and money in the process. If after you have tested the waters in a public forum—but you are still unsuccessful in garnering sufficient indications of interest for your proposed securities offering—you may need to either rework your offering structure (i.e., your securities’ features and benefits that were offered) and/or rethink your operation mode.

Changing the Mode of Operation


Changing the Mode of Operation means re-thinking how you’ll operate the company and is reflected primarily in the pro forma financial projections. Maybe your company’s operation mode is the real problem. It could be time to rethink your company’s mode of operation, which inherently determines its capitalization needs. Let’s say the current operation mode requires a capitalization total of $10 million to get off the ground. From a potential-investor standpoint, that amount may be too much. Far too many times, our clients have grandiose, unrealistic plans that require millions and millions of dollars. After testing their private market—prospective investors: family, friends, and professional contacts—they soon discovered that rethinking their operation mode for a reduced initial-capital requirement greatly increased their funding probability. Most often, they actually do receive the funding after this conclusion has been reached because they have reduced and adapted their capitalization plan to meet their private capital market’s demand(s).


Additionally, let’s say the original sought-after $10 million was to buy land, building, and equipment to produce your product or service. Could you lease the plant or equipment? Would that bring your capital needs to a total of $1,000,000 due to off balance sheet leverage, such as leasing? If so, maybe you need to raise only $300,000 in equity and obtain an SBA-backed loan from the bank for another $700,000. You can buy the plant and equipment later, after your Company has a few more years of operating history.


Can you rely on independent-manufacturer representatives to sell your product or service line(s), as opposed to hiring an in-house sales force—at least for the first few years? Can you adjust your marketing and sales strategy to be primarily commission oriented? Read up on your industry’s trends, and figure out where you can gain strategic marketing alliances. Think about economies of scale. How can you get more for less? This is known as “bootstrapping.”


Should you actually be trying to build a company, or would licensing your Company’s technology to a strategic alliance require less capital and have a better chance of creating profitability? If so, maybe you need to raise only $100,000, in equity and $100,000 in bank debt, to be spent on legal fees to put together your licensing agreement, travel, lodging, printing, and your salary. Yes, you can have a reasonable salary as long as it’s disclosed in your Company’s securities-offering document.


If you can raise equity capital, raising debt capital is much easier. The point is you can easily increase the equity-raising probability by minimizing your overall, capital needs in the beginning then raise more capital over time. More often than not, most start-up companies require very little capital to get up and running. Once your Company has reached this point, and you can prove there is in fact a market for your product and/or service lines(s), you will further assure a successful placement of equity and/or debt-related securities for further development and expansion. More often than not, investors want to see a “proven economic model” before they commit to invest substantial amounts of their cash. Sadly many entrepreneurs wait too long before the start the capital raising process, and have burnt through critical seed capital without using it to go after development capital.


Before doing anything else, you should reevaluate your operation mode as best you can. For the next week, ask yourself, “How can I make this happen with the least amount of money, the fewest employees, and the lowest overhead?” Afterward, design your capitalization plan around that new set of methods and assumptions. Unfortunately, there is not an unlimited number of ways to change your company’s mode of operation, so you’ll need to concentrate on adjusting what you can while you can.