You don’t have to sell your company for your investors to exit!

You don’t have to sell your company for your investors to exit!

When you raise money from investors, many of them will want to know how they may someday get their money back out of your company.

When people invest in public companies, it is very easy to exit from one investment to another—they just tell their online broker to sell Apple and buy Google.  

But with investments in private companies, the exit may not be so easy.  If you offer debt to investors, the way they will exit someday is spelled out in your promissory note.  At some point, you will pay your investors back their initial investment (principal) plus interest.

What if you offer an equity investment, however?  In the venture capital model, used for high growth tech startups, the exit from an equity investment usually happens when the company is acquired by another larger company.  But what if you don’t want to focus all your energy on that kind of exit?  When you know your investors are expecting you to sell your company to the highest bidder as quickly as possible, you may be forced to do things that are not in alignment with your goals, values, and how you want to live your life.

What if your investors could exit without you having to sell your company?  Well, they can!  There are a few ways this can happen, but in this article, I will focus on redemptions.  A redemption is when you buy equity back from your investors.  You can build this into your investment terms right from the start so that both you and your investors are clear on how they may someday exit.

Your investor’s ability to redeem his or her stock will depend on the exact language you put in your legal documents.  Our clients usually offer the ability for their investors to request a redemption at a certain predetermined price.  If your company is unable to honor the request due to insufficient cash for operations and reserves, you can delay or refuse the redemption or can pay the redemption in the form of a promissory note.  You can also offer a “mandatory redemption right” that requires the company to redeem the equity whenever the investor wants (this right often doesn’t kick in for several years after the initial investment).  Keep in mind though that there is really no such thing as a truly mandatory redemption right.  If your company does not have enough cash to meet its obligations to its creditors, it cannot legally redeem investor equity.

To learn more about all the ways that your investors can exit without you having to sell your company, consider joining our Capital on Your Terms Community—this is a great way to get literate about fundraising and make sure you know all your options for raising money on terms that will be sustainable for you and your business.

Should you provide anti-dilution protection for your equity investors?

Should you provide anti-dilution protection for your equity investors?

Anti-dilution protection is a set of provisions that you can include in your governing document (articles or certificate of incorporation) that are designed to protect equity investors in the case of a reduction in the price of your stock.

Before we talk about anti-dilution protection, we first need to talk about conversion rights.  Conversion rights are the right of your preferred investors to convert their preferred stock to common stock.  Why would they want to do this?  When the company is sold, the buyer generally will want to buy common stock, so at that time, preferred shareholders would convert to common in order to receive their share of the proceeds of the sale of the company.

When you offer preferred stock to investors, they often come with the right to convert the preferred stock to common stock on a 1:1 basis.  So, if an investor has 100,000 shares of preferred stock, they can convert those shares to 100,000 shares of common stock.

Anti-dilution protection is a mechanism that changes that ratio in the case of a decrease in the value of the preferred stock.

There are different formulas that can be used to adjust the ratio.  A very commonly used formula is called the Weighted Average method.  The following formula is used to provide an adjusted number of shares that one share of preferred stock converts into, with the idea that one share of preferred stock will convert into more than one share of common stock as a way to protect the early investors from losing all of the value of their initial investment:

CP2 = CP1 x (A+B) / (A+C)

Where:

CP2    =     Conversion price immediately after new issue

CP1    =     Conversion price immediately before new issue

A        =     Number of shares of common stock outstanding immediately before new issue

B        =     Total consideration received by company with respect to new issue divided by CP1

C        =     Number of new shares of stock issued

Here is an example to illustrate how this works:

When you first start your company, you issue 2 million common shares to the founders.  Then, let’s say you raise $500,000 from investors by offering preferred stock at $1 per share.  One year later, you raise $1,000,000 at $0.80 per share (meaning you sell 1,250,000 shares).

CP1 = $1

A = 2,000,000

B = $1,000,000/$1 = $1,000,000

C = 1,250,000

So, the new conversion price =

1 x (2,000,000 + 1,000,000)/(2,000,000 + 1,250,000) =

1 x (3,000,000/3,250,000) = $0.92

This means that the first preferred stock investors now convert into 1.09 shares of common stock ($1.0 /$0.92 = 1.09).

So, if the company is sold and those investors convert into common, they will get a larger share of the total proceeds from the sale than they would have if there were no anti-dilution protections.

Should you offer this protection to your preferred equity investors?

If you think it is likely that you may sell your company someday and the proceeds from the sale will be an important component of how your investors will be compensated, anti-dilution protection is a nice way to provide some protection to your early investors.  More sophisticated investors might insist on it.

On the other hand, these provisions can be rather complicated and require you to keep track of conversion ratios that might change if you raise more than one round of equity funding.  If you don’t foresee a sale of your company, it could make more sense to leave out provisions related to conversion of preferred stock to common altogether.

If you would like to become an expert on investment terms and other topics related to fundraising for your business, join our Capital on Your Terms Community!  For details, click here: https://www.jennykassan.com/capital-on-your-terms-community/

We Want You…

We Want You…

…to join Angels of Main Street!

It should come as no surprise that the power of our voices grows when we control where money flows. This simple fact is the reason that Angels of Main Street, an investment community that anyone can join, is working to move investment dollars to the people and communities that have been overlooked by the mainstream small business funding ecosystem. 

What makes us think that collectively we can shift massive amounts of money to women and BIPOC led companies? Believe it or not, 2020 was a game-changing year for Investment Crowdfunding, the most scalable alternative we have to venture capital. Investment Crowdfunding attracted $239.4 million in investments in 2020, up from $134.8 million in 2019. And it is predicted that the crowdfunders will invest at least $500 million in 2021.

While it is true that these numbers pale in comparison to investments made by venture capital firms in 2020 ($156.2 billion, up from $138.1 billion in 2019), venture capital funding went to only 11,000 companies with the average investment exceeding $14 million.

Even though the very wealthy are investing ever increasing sums in search of their unicorns, they are not expanding significantly into diverse founders and industries. This will be up to us.

Remember, virtually every adult can participate in Investment Crowdfunding while only about 8% of us are eligible to invest in a venture capital fund. If only 1% of the wealth held in stocks, savings, and retirement accounts were shifted from big banks and Wall Street, we would have a funding ecosystem worth hundreds of billions of dollars. Think of all the inequities we could reverse by simply democratizing what, and who, gets funding.

Angels of Main Street is the place to go if you are ready to dip a toe into investing directly in businesses you love.  We provide an educational curriculum and support our diverse community of investors to work together to make their investments count.

If you have money invested on Wall Street (which is where 99.9% of regular folks’ investments are), your money is not doing anything to contribute to the productive economy.  We would love to help you shift just a small percentage of your investment dollars to businesses that are making the world a better place, innovating, and creating community wealth.

We hope you will consider joining us!  Please click here to learn more and join now.

5-Day Challenge:  Create a Golden Opportunity for Investors

5-Day Challenge: Create a Golden Opportunity for Investors

We just wrapped up a LIVE 5-day challenge—Create a Golden Opportunity for Investors: How to Design a Win-Win Investment Offering.

It was awesome! Hundreds of people joined the challenge where we taught how to design a customized investment offering.  Here’s what they learned:

Day 1—We talked about why it’s so important to design your own offering and how to lay the groundwork to ensure you design the right offering for you.

Day 2—We went over the three basic types of investment offering and how to choose which one you want to offer.

Day 3—We explored how your investors can get paid—spoiler alert: you don’t have to grow fast and hustle for a fast exit!

Day 4—We reviewed the pros and cons of giving investors any control and what that can look like. We also talked about tools to motivate faster and larger investments.

Day 5—We pulled it all together and talked about how designing your offering fits into the larger strategy for raising the right money from the right investors—in a way that lets you stay true to your mission and goals.

It’s not too late to check out the training! The videos and worksheets are still available for FREE for a limited time. Get immediate access to the challenge—start today by signing up here.

How to Make Investing in Your Company a Golden Opportunity

How to Make Investing in Your Company a Golden Opportunity

You’ve built a company with a promising future. You’re ready to start looking for funding. You know there are some folks out there (maybe your customers, suppliers, neighbors, values-aligned supporters, etc.) who will be interested in learning more about the opportunity to invest in your company.

That’s great! But at some point you need to tell them EXACTLY what they will be getting for their investment dollars.

The piece of paper that describes exactly what your investors are entitled to can be called by various names: investment offering, investment instrument, or security. There are many different kinds of offerings, some more commonly known than others. Examples include preferred stock, LLC membership units, convertible notes, revenue-based debt instruments, and SAFEs. Within each category, there are numerous choices to make. For example:

  • Will investors have voting rights and, if so, what specifically can they vote on?
  • How much time can go by before your investors receive payment?
  • How are payments to investors calculated?
  • Are any payments made as the company grows or only when you sell the company?
  • Do all investors have the same rights, or do some have the right to get paid before others?
  • Do you have to set a valuation on the company and, if so, how do you set it?

The options for how your offering can be structured are limitless.

A poorly structured offering can create years of misery when you and your investors butt heads over misaligned expectations, while a well-structured offering can be a win-win for all the stakeholders involved—you, your employees, your investors, your customers, and the long-term success of your business.

So, how do you design a win-win investment offering? We like to break it down into a step-by-step process:

  1. Get clear on the goals, values, and non-negotiables that will inform the design of your offering.
  2. Choose one of the three main categories of offering (equity, debt, or convertible) and make sure it fits with the legal and tax structure of your your business.
  3. Decide on your investors’ rights to get paid—when and how much will they make on their investment.
  4. Decide whether to give your investors any control and, if so, what kind.
  5. Decide whether to offer any perks, in addition to the investment itself, as a way to motivate larger and faster investments.

If you’d like help designing your offering, please watch for our upcoming announcement on a FREE 5-day challenge—Create a Golden Opportunity for Investors: How to Design a Win-Win Investment Offering. During this challenge, we will give you bite-sized lessons and quick daily assignments that will culminate in your having a customized investment offering drafted.

Sign up for our newsletter below to make sure you receive details on how to join the challenge.  

Do I Really Have to Do This? Yes, and It’s the Right Thing to Do

Do I Really Have to Do This? Yes, and It’s the Right Thing to Do

Raising investment dollars for your business is one of the smartest ways to reach your long-term goals. But like most things that are worthwhile, getting investments is work. And it’s not just the work you have to put into finding your ideal investors and getting them on board.  

It’s the things you have to do so you don’t get in trouble. One thing is disclosing information about your company. If you are doing any capital raise, you have to disclose material information to potential investors1. Beyond that general requirement, what you have to disclose varies according to the type of capital raise you do. Some types of offerings require very specific information. Let’s say you do an offering under Regulation Crowdfunding. In that case, you’ve got to tell everyone in the world: 

  • what your business is
  • how you’re planning to make money
  • what you’re planning to do with the funds you get from the raise
  • how much money you made in the last two years
  • and risks that investors would want to know about before they invest

And you need to be pretty sure about all of this. You can’t guess or give answers that don’t have a reasonable basis—and you can’t make important changes after launching your campaign without telling everyone what those are. You can’t claim you are doing things that really you’re just planning to do. (Close enough, right? No.) You can’t omit important risk factors or important information because you think people won’t invest in you. 

Yes, this can seem like a hassle. Yes, it can take time. And yes, it can take money to hire someone to help you do it right.  

You can’t guess or give answers that don’t have a reasonable basis…and you can’t claim you’re doing things that really you’re just planning to do.

So you might say, “I know my company is great. Do I really have to do all of this?” Yes, you really do. If you don’t, you could get into serious trouble with the federal Securities Exchange Commission (SEC), state regulators, and/or your investors.

But disclosure is not just about staying out of trouble. It’s about building an economy that is based on trust, transparency, cooperation, and compassion. 

People don’t tend to talk about the SEC as a warm and fuzzy institution. But, believe it or not, the SEC exists to protect individuals and our economy—in part by insisting on the truth. In the 1920’s, businesses were making extravagant claims, and people from all walks of life were investing like crazy2. But then stock prices fell dramatically; banks failed; and unemployment and hunger abounded3. We entered the Great Depression in part because companies were dishonest4. The laws governing capital raises were enacted to prevent this5. 

If you’re not being straight with the people supporting you, you run the risk of cheating them. That’s no way to make a better world. 

Of course, put your best foot forward. You are one of those special people who have the courage to start a business and make a difference. Be proud. 

But don’t hide your flaws. And don’t make up reasons why you’re great. Be honest with the people willing to be by your side as you navigate the choppy waters of entrepreneurship: the people willing to take a chance on your dream.  

And seek out investors who really believe in you, who know that no one is perfect, and who know that the future is unpredictable. I guarantee that they are the ones who will have your back when the going gets tough. 

We can’t control the future, but we can control how we treat each other now, and we can work toward a future where we all can thrive. 

Be well, stay safe, and keep going. You can do it.

P.S. If you want help figuring out how to raise money and stay out of trouble, give us a shout. We can help you with marketing, deciding what investment to offer, complying with those pesky laws, and coaching you so you can keep your head in the game no matter what’s going on in the world.