Three ways to structure your business investments

01 Jun Three ways to structure your business investments

As a woman Certified Public Accountant located in Weaverville, NC, situated in the greater Asheville, NC market, it is very common for me to interface with start-up companies. Some companies are set up to be one woman or man operation while others are more complex in nature. During this blog, I will review three fundamental structures a company can take and how that will affect your goals of attracting Angel Investors. These structures are laid out in the book “Winning Angels the 7 fundamentals of early stage investing” written by David Amis and Howard Stevenson there are five approaches to valuation.

“The rule is that you use preferred (stock) to attract capital and you use common (stock)to attract staff” Tony Morris

Common Stock:

Common stock provides evidence of ownership in a corporation. Owners of common stock elect the company’s directors and share in the profits of the company through stock dividends. If a business closes, the common stock holders are the last to be paid.

The issuance of common stock is the form that is most often used by friends, family and those with “blind” faith in the owners of the business. This structure is the most simple to set up and operate. The offering agreement can be configured very quickly, and it offers no limits on the company regarding restrictions on raising further capital or on the funds terms. There is no downside protection on this structure. Worst case scenarios are you lose all of your money, and the best case scenario is you make a lot of money with little involvement and limited time investment.

Preferred Convertible Stock:

Preferred stockholders are paid dividends before the common stockholders receive any dividends. They usually receive a fixed dividend rate and do not share in the company’s earnings above their fixed dividend.

This is the most common structure used by venture capitalists and angel investors. The agreements can range from 5 terms up to 40 terms depending on the investor. Standard conditions include information rights, board rights, anti-dissolution, redemption rights, per-emptive rights, and tag-along rights. Worst case scenario is you lose all your money and best case you make a lot of money, including additional rounds, and you feel somewhat secure about it.

Convertible Note (or bond) with Various Terms:

According accountingcoach.com, The holder can exchange a convertible bond (long term note) for a specified number of shares of stock in the company. The convertibility feature usually allows for the bond to have a lower interest rate. The owner of the bond enjoys the ability to watch the stock prices and take advantage of the gain if the stock price increases.

The convertible note is becoming a more common vehicle as financing is occurring in a shorter time frame. This format avoids a negotiation on price, and it limits options pricing issue for the company. Having a note is the most powerful downside protection you can have. The upside often includes the right to participate in subsequent funding rounds with various addendum.

Other Blog Posts of interest:

Methods Investors Use to Evaluate Companies

Funding for Small Businesses

Small Business Retirement Plan Options

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New Business Start-up Tips from a CPA