This is Part Three in a series discussing steps in a business transaction. In Parts One and Two, I discussed term sheets and definitive agreements. In this part, I’ll discuss financing considerations.
There are several methods of financing. Having the money required to complete the transaction available in your company or personal account certainly simplifies matters from a legal and paperwork point of view. However, there may be good business reasons that you want to use other sources of money for your transaction.
Other forms of financing include, private investor financing, venture capital financing, bank financing, and seller financing. These are the forms of financing most commonly used by my clients; however, the list is not exhaustive. Each method offers pros and cons.
Private Investor Financing. Taking private investors offers tremendous structural flexibility to the small business. Investors in small and start-up companies are often the family and friends of the business owners. As long as investors receive adequate disclosures, the small business can keep control of the company, sell shares at a price that may actually be higher than fair market value, and include a provision that eventually allows the small business to buy back the shares.
The con with respect to private investors is the necessity
of complying with federal and state securities law - which can get
complicated. On the plus side, many
small businesses can avoid the more onerous and expensive securities compliance
procedures because their financings qualify as private offerings and are
subject to less regulation than a sale of stock offered to the public.
Venture Capital Investor Financing. Financing through venture capitalists is a form of private investment. However, unlike many of your family and friends who might invest in your company, venture capitalists want more control so this model carries the risk of the founders of the company losing control and being pushed out. Also, venture capitalists typically only want to hold the investment for about three to five years so they’re interested in investment only when there’s a clear path to “cashing in’ on the investment.
Bank Financing. Bank financing is a loan so obtaining such financing usually requires a financial track record that convinces the bank the company will be able to pay back the money within the term. On the plus side, while the bank will insert a number of prohibitions into the loan documents on actions you may not take (such as borrowing large amounts of money from other sources), the bank will be less involved in the day-to-day operations and activities of the company.
Seller Financing. Seller financing functions as a loan from the other party in your transaction. It’s a good option for small businesses expanding through acquisition. The small business making the purchase pays a portion of the purchase price at closing and pays the remainder over a period of years at a market interest rate.
Many parties use a combination of financing methods. If closing the transaction requires a significant monetary payment, the other party probably required some assurances in the term sheet that you have or would be able to acquire the financing.