Step into the Shoes of an Investor Before You Issue a Private Placement

Entrepreneurs raise money in various ways and from various sources.  One method frequently discussed is a Private Placement.  Entrepreneurs can be better prepared to embark on this expensive and time consuming step, if appropriate, or choose to delay it until success is likely, if they “put on the shoes” of the potential investor first.  What do they look for in a worthy Private Placement candidate for their dollars? What “red flags” would thwart an investment?  Are you ready?

In one paragraph, a private placement means that a company solicits investment from accredited individuals or institutions on the basis of a document called a Private Placement Memorandum (PPM).  The solicitation is private because it is narrow in scope, targeting only known potential investors.  Because it is not a broad, public solicitation, it is not bound by the same disclosure rules (and expenses) such as quarterly and annual reports and independent financial audits filed with the SEC by companies listed on the public stock exchanges.   Should a company blur the distinction between targeted approaches and public solicitations, (such as advertising on its website that it wants investors) it could lose its private placement exemption and have to pay the six figures per year charged public companies. 

The primary document used in private placements is the PPM.  It is a business plan plus other documentation on which investors should be able to make an informed decision about the merits of the management, industry, company and its prospects.  The PPM also includes pages that outline how the company plans to use the money it hopes to raise.  Often it lists the contact information for service providers, such the escrow agent at the bank or the investment bankers or attorneys involved in writing the document or the experts whose research is included.

By knowing what the investor will want to learn before investing (their due diligence), entrepreneurs can make sure that they are able to write and defend an informative and persuasive document.

Do Due Diligence on Your Company Before Someone Else Does

Savvy proprietors of businesses who have been waiting for the right time to sell, merge, or attract investors, do due diligence on their own companies before approaching anyone else.  No manager wants to look like a deer in the headlights when a potential investor asks about an employee with a criminal record, a publicly registered customer complaint, or late property tax payment.  Company leaders need to anticipate the records suitors will request, both from the company and from public sources, like the Internet, the bank, and licensing agencies.  Prepared companies scrutinize themselves, as others with checkbooks invariably will, enabling management to approach suitors with a realistic valuation and a knowledgeable evaluation of the company’s strengths and vulnerabilities.  In addition, the process can save firms tens of thousands of dollars on professional service fees.

 Internal records:

A functional due diligence file will contain about fifteen sections.  A company with few employees and assets can expect to organize about 50 documents, some of which will need to be updated quarterly or annually.  Many companies already have many of these items in separate files, such as “Employees,” “Sales,” “Taxes,” and “Legal.” Pulling them together for a purchasing or investing audience serves two useful purposes: it encourages management to review their records with the eyes of interested outsiders and it reveals gaps that may not be obvious when records are segregated. The files should encompass records of the company’s: 

q  Organization and Good Standing

q  Capitalization and Stockholders

q  Authorization of Acquisitions and the Transactions

q  Financial Statements

q  Tax Matters

q  Employees Records, Benefit Plans, Salaries, Labor Disputes.

q  Material Contracts and Commitments

q  Licenses

q  Insurance

q  Litigation, corporate and personal

q  Patents and Trademarks

q  Real Properties owned and leased

q  Inventory

q  Books and Records

q  Operating Plans

Some information will strike a potential investor differently than a potential merger partner, while other information will be equally important to both groups.  Knowing the interests of each will enable the principals of a company to assemble records that matter to that target group. 

For example:
q  Corporate structure: Is the firm a corporation or a partnership?  In what state?  The answer has implications that make your company more or less attractive to your target audience than competing firms.  Ask your attorney.

q  Stockholders: What do the bylaws say about the rights of major/minor stockholders? Who are they? How many are there? Is management invested? Stockholders, like staff, can be perceived as either an asset or a liability to a deal.  Do the shareholders bring value beyond money or do they have a history of litigiousness?

*Potential buyers will demonstrate particular interests.  One might care about owner expense add-backs or owner assets; another may be concerned about related party transactions.  Others will have strong wishes for management to leave or to stay.  A company can’t anticipate everything, but its records will be scrutinized for “deal breakers,” omissions, and evasions.  Anticipate logical questions.

q  Management: Be prepared for tough questions.  Have background checks, performance reviews, and updated resumes handy.  Explain attrition.  Know which managers wish to remain with the company after a deal is struck and who wishes to leave.  Are non-compete documents in order?

 q  Material contracts and commitments:  Have customer lists, letters of credit, installment plan purchases, and current and pending contracts.  If there are any insider contracts, be sure to show those, too.  Are there any performance guarantees?  Are any deals imperiled by a change in management?  What about agreements with dealers and distributors?

q  Cash flow:  How well does the company manage seasonal or other fluctuations in its costs and cash?  Your accountant can help you design cash flow projections to show likely future scenarios.

q  Licenses:  Technology companies often base their valuations on their intellectual property, so records can quickly inflate or deflate suitor interest. Patents “to be filed” or “pending” are a lot less attractive than patents awarded or defended.  Equally important is who owns the technology.  Is it clearly the company or could it be an employee?  Was it developed in conjunction with another firm or university?  The answers can substantially raise or lower the valuation.  Professional service firms should have current records of all licenses, compliance forms, and proof of professional good standing. 

q  Insurance:  Physical assets can be strengths or liabilities, too.   If the company owns buildings or land, have records of ecological due diligence.  A building with a demonstrated lack of mold or property with no history of chemical storage or oil spills is worth a lot more than one without such a pedigree.  How is inventory insured in case of flooding the day the contract is signed? Does the company have key man insurance?  What about Errors and Omissions?   Such evidence assures suitors that they are unlikely to suffer buyer’s remorse, and therefore, can move a deal along faster than a company that leaves such questions unanswered. 

Public records:

 In addition to organizing records for outsider scrutiny, a company’s strategy should include a survey of its electronic presence.  It is very easy to check up on other companies, so each firm should do a regular Internet search of its company name and staff.  For example, www.hcad.org indicates whether Harris County based companies (and home owners) have paid their taxes for the year, how much they are, and the appraised value of the property. Licensing agencies, like the FINRA, have websites (www.finra.org) on which the public can search for the names of broker-dealers in good standing.  A company’s own website can be very revealing.  Is it current? Clear?  If you contact the business through its website, does someone actually get back to you?  A search on www.google.com or another search engine for the company or management team names can reveal useful information – positive or negative.  For example a Google search for recent potential clients revealed: (1) a businessman who has gotten a Cease and Desist Order from California for a business he was now trying to register in Maryland (2) a CEO who lied about his education background (he made up a university) in his SEC filings and (3) a company seeking investment that hadn’t paid its property taxes for the year.  Surely none of these is the first professional impression one wants to make on the World Wide Web.  Some records can be purged by corrective action; others can be buried by generating appropriate news items, like press releases, speeches, and article bylines.

Entrepreneurs seeking funding from others must be willing to undergo scrutiny from others, so do it yourself, first. 

Angel Investor FAQs: Preparation for investor meetings

Management should prepare strong, SHORT, consistent answers to the logical questions that investors are likely to ask.  SHORT answers enable investors to ask revealing follow up questions.  A long winded entrepreneur loses the opportunity to HEAR useful questions by informed investors. 

Conversations between entrepreneurs and investors are inherently uneven.  The investor has money.  The entrepreneur wants some of it.  So bear in mind that behind every stated question by an investor is the unstated question, “What’s in it for me?”  Effective answers should be attentive to the investor’s interests and concerns.

Explicit questions about the investor’s interests might be worded:

 “How is my investment secured?” 

“How long before the company is in the black?”

“What is your competitive advantage?” 

“Let me see the financial projections.”

“What will you do with my money?”
 

Implicit questions about “what’s in it for me” might be worded in a variety of ways.  Some examples of questions and approaches to answers:

“Tell me about your management team.”  This question is not about biographies.  What does the investor want to know?  Is this team going to be effective in this endeavor?  Is it going to make him rich or lose his money?  Consider answers that demonstrate why this management team is the best one to preserve the investor’s money and marshal it to a lucrative end.  Is the management team invested in this deal?  Consider the terms of the management’s compensation from the investor’s perspective.  Will its fortunes rise or fall before or after the investors?  Is this deal raising money first for management salaries? 

“Who is your competition?”  Never say no one.  This answer implies tunnel vision.  Rather, identify those companies that the public might perceive to be competitors, and then briefly explain either niche differentiation or your ability to deliver faster, cheaper, better, or with an enviable barrier to entry, or a low cost/high margin solution.  If an investor is interested in your industry but finds your answers weak, s/he might consider investing in your competition!  Besides, “smart money,” – investors who know your industry well - are testing your knowledge when they ask this question, and comparing it to their own.  Satisfied “smart money” investors do not have to do as much due diligence, and will often write a check sooner than investors outside of the industry.  Know what they know, about you, your competition, the market.  

“What is the structure of the deal.”  The investor wonders what he’ll be left with if the company’s potential is unfulfilled and the deal fails.  How attractive are the terms to the investor?  For example, what is the security of the investment, the use of funds, the seniority of the debt or equity, what are the interest payment terms?  Are there any tax write off advantages if he loses money?  Is his investment leveraged in any way, by the state, a grant, or other means.  The use of minimum/maximum funds raised will traverse what path to profitability?   Will the investor’s money pay salaries, buy assets or build inventory?  Does the state of incorporation protect the rights of investors?     

Naturally, entrepreneurs are optimistic about their future success; otherwise they wouldn’t be pursuing it!  Entrepreneurs are also ACCOUNTABLE for optimistic projections.  Written and verbal answers to investors ought to be delivered as though to the investor’s attorney, CPA, or banker, because sooner or later, they will be.  The bigger the deal, the longer the investor will spend on due diligence.  His research should mirror your research.  Verbs like, “believe, project, hope, anticipate, plan, expect” are to be expected in forecasting future business conditions.  Verbs like “will, promise, guarantee, know” could be construed, in retrospect by a disgruntled investor, as fraud or misrepresentation.  Also pay attention: the SEC holds entrepreneurs accountable BOTH for errors of commission (saying something that is false or misleading) and errors of omission (not mentioning something material to the investor’s decision making process).  Obvious examples of omission include suits against the company or members of the management team.  Less obvious examples might include “sweetheart” deals with friends and family of the management team for products and services targeted as a use of investor funds.  It is more appropriate to disclose this before you take a check, rather than afterward. 

By the time you are ready to approach investors, your company should have developed a due diligence file of documents about your own company that investors are likely to want to see.  By developing a logical list of “who, what, when, where, why, how” questions for these files, and prepping your management team on the appropriate responses to them, your company will convey an impression of knowledge, integrity, and full disclosure.

Read Three Different Versions of the Ten Commandments in Exodus and Deuteronomy

The list of Ten Commandments is presented in three different stories.  Read below to note the differences.  Which version have you never heard?  Why?   The sections A, B, and C function as dividers since the wording is longer in some versions than in others.

Do some versions seem more primitive or more sophisticated?  Could this reflect the date of writing or the social development of the source? Why did the editors of the Bible include all three versions?  For clues, read the passages before and after these commandments.  How is Moses depicted?  Aaron? The Jewish population? How does God interact with the people?      

Exodus 20                19:24  Yahweh told Moses, “come up again bringing Aaron with you.”  --------------------------------------------- 20:  Then God spoke all these words.  (A) He said, “I am Yahweh your God who brought you out of the land of Egypt, out of the house of slavery.  You shall have no gods except me.  You shall not make yourself a carved image or any likeness of anything in heaven or on earth beneath or in the waters under the earth; you shall not bow down to them or serve them.  For I, Yahweh your God, am a jealous God and I punish the father’s fault in the sons, the grandsons, and the great-grandsons of those who hate me; but I show kindness to thousands of those who love me and keep my commandments You shall not utter the name of Yahweh your God to misuse it, for Yahweh will not leave unpunished the man who utters his name to misuse it. (B) Remember the Sabbath day and keep it holy.  For six days you shall labor and do all your work, but the seventh day Is a Sabbath for Yahweh your God.  You shall do no work that day, neither you nor your son nor your daughter nor your servants, men or women, nor your animals nor the stranger who lives with you.  For in six days, Yahweh made the heavens and the earth and the sea and all that these hold, but on the seventh day he rested; that is why Yahweh has blessed the Sabbath day and made it sacred.  © Honor your father and your mother so that you may have a long life in the land that Yahweh your God has given to you. You shall not kill.  You shall not commit adultery. You shall not steal. You shall not bear false witness against your neighbor. You shall not covet your neighbor’s house, wife, servant, man or woman, ox, donkey, or anything that is his.

Deuteronomy 5            Listen, Israel, I stood all the time between Yahweh and yourselves to tell you of Yahweh’s words, for you were afraid of the fire and had not gone up the mountain.  He said: --------------- (A) I am Yahweh your God who brought you out of the land of Egypt, out of the house of slavery.  You shall have no gods except me.  You shall not make yourself a carved image or any likeness of anything in heaven above or on earth beneath or in the waters under the earth; you shall not bow down to them or serve them.  For I, Yahweh your God, am a jealous God and I punish the fathers’ fault in the sons, the grandsons, and the great-grandsons of those who hate me; but I show kindness to thousands, to those who love me and keep my commandments.   You shall not utter the name of Yahweh your God to misuse it, for Yahweh will not leave unpunished the man who utters his name to misuse it. (B) Observe the Sabbath day and keep it holy, as Yahweh your God has commanded you.  For six days you shall labor and do all your work, but the seventh is a Sabbath for Yahweh your God.  You shall do no work that day, nor your son nor your daughter nor your servants, men or women, nor your ox nor your donkey nor any of your animals, nor the stranger who lives with you.  Thus your servant, man or woman, shall rest as you do.  Remember that you were a servant in the land of Egypt and that Yahweh your God brought you out from there with mighty hand and outstretched arm; because of this, Yahweh your God has commanded you to keep the Sabbath day. © Honor your father and your mother, as Yahweh your God has commanded you, so that you may have long life and may prosper in the land that Yahweh your God gives to you. You shall not kill. You shall not commit adultery. You shall not steal. You shall not bear false witness against your neighbor. You shall not covet your neighbor’s wife, house, field, servant – man or woman- ox, donkey, or anything that is his. These are the words Yahweh spoke to you when you were all assembled on the mountain.  He added nothing, but wrote them on two tablets of stone which he gave to me. 6: These then are the commandments, the laws and customs which Yahweh your God has instructed me to teach you that you may observe them in the land which you are going to make your own.  Thus, if you fear Yahweh your God all the days of your life, and if you keep all his laws and commandments, you will have a long life, you, and your son, and your grandson.

Exodus 34                  32:  Yahweh spoke to Moses, Go down now because your people whom you brought out of Egypt have apostasized…Leave me, my wrath shall blaze out against them and devour them; of you however, I will make a great nation… Moses pleaded. Yahweh relented. Moses made his way down the mountain with two tablets.. Aaron had allowed them to lapse into idolatry with enemies all round them.  Moses threw down the tablets, broke them, burned the calf they had made, grinding it into powder.  Yahweh said to Moses, Cut two tablets of stone like the first ones and come up to me on the mountain, and I will inscribe on them the words that were on the first tablets, which you broke.  ---------------------------------------- (A) 34:14:  You shall bow down to no other god, for Yahweh’s name is the Jealous One; he is a jealous God.  Make no pact with the inhabitants of the land or, when they prostitute themselves to their own gods and sacrifice to them, they may invite you and you may consent to eat from their victim; or else you may choose wives for your sons from among their daughters and these, prostituting themselves to their own gods, may induce your sons to do the same.  You shall make yourself no gods of molten metal. (B) You shall celebrate the feast of Unleavened Bread; you shall eat unleavened bread as I have commanded you, at the appointed time in the month of Abib, for in the month of Abib you came out of Egypt. All that first issues from the womb is mine: every male, every first-born of flock or herd.  But the first-born donkey you must redeem with an animal from your flocks.  If you do not redeem it, you must break its neck.  You must redeem all the first-born of your sons.  And no one is to come before me empty-handed. For six days you shall labor, but on the seventh day you shall rest, even at plowing time and harvest. You shall celebrate the feast of Weeks, of the first-fruits of wheat harvest, and the feat of Ingathering at the close of the year. Three times a year all your menfolk must present themselves before the Lord Yahweh, the God of Israel.  When I have dispossessed the nations for you and extended your frontiers, no one will covet your land, if you present yourselves three times in the year before Yahweh your God. You must not offer the blood of the victim sacrificed to me at the same time as you offer unleavened bread, nor is the victim offered at the feast of Passover to be put aside for the following day. You must bring the best of the first-fruits of your soil to the house of Yahweh your God.  You must not boil a kid in its mother’s milk.  ---------------- Yahweh said to Moses, “Put these words in writing, for they are the terms of the covenant I am making with you and Israel.”  He stayed there with Yahweh for forty days and forty nights, eating and drinking nothing.  He inscribed on the tablets the words of the Covenant – the Ten Words.

Match the Biblical Men and Women's Names with their Meanings

Bible Stories for Grown Ups:  Matriarchs and Patriarchs

               Names                               Match #        Meanings    

1 Aaron 14,15 Bitter(ness)  2 Abraham 16 Drawn Out or Son of 3 Dinah 18 Ewe 4 Esau 2 Father of Multitudes 5 Hagar 5 Flight 6 Isaac 7 God Hears 7 Ishmael 4 Hairy 8 Israel 8 He Who Fights with God 9 Jacob 10 He Who Opens 10 Jephthah 12 He Will Add 11 Jesus 9 Holder of the Heel (or Supplanter) 12 Joseph 3 Justice 13 Leah 6 Laughter 14 Mary 19 Princess 15 Miriam 11 Salvation 16 Moses 17 Small or humble 17 Paul 13 Weak eyed, weary 18 Rachel 1 Unknown 19 Rebecca 19 Captivating 20 Sarah

Review Questions                          Answer Number

Who killed his daughter?               10

Who nearly killed two sons?         6

Who was struck white with temporary leprosy?      15

Who was raped?                             3

Who were imprisoned?                  12, 17

Who were sold into slavery?         12,  5?

Who were given to other men by their husbands?  19, 20

Who tricked his father?                  9

Who was tricked by his father-in-law and his sons?  9