Raising capital through a direct public offering is a great way for
a development stage company to finance the launch of a new business
or product line. However, for many new companies, financing a direct
public offering can prove to be overwhelming without some initial, "seed"
capital. Many entrepreneurs have a few sources - such as friends, family
members, and prior business contacts - that they can tap for that needed
capital. What these entrepreneurs need is a structure in which they
can most effectively tap these private financing sources. A correct
start will avoid costly legal issues, time-consuming additional work,
and unnecessary delays and expenses. Here are different types of offerings:
Discounted Common Stock
Many investors are going to be wary of committing to a seed capital
investment unless they feel that they are really getting a good deal
for their money. When offering common shares of your company to raise
seed capital, particularly when your company is a start-up venture with
little or no track record, it is often prudent to offer common shares
at a substantial discount to what your selling price will be during
the direct public offering. Offering discounted common shares will convince
many potential investors to invest at the seed-capital stage, when their
investment is most needed, rather than to wait for the direct public
offering.
Convertible Preferred Stock
Preferred shares differ from common shares in three main respects.
First, unlike common shares, preferred shares generally have no voting
rights in the company. Second, preferred shares have preference over
common shares if in the unfortunate event that the company is forced
to liquidate its assets. Third, and most important for seed capital
investors, most preferred shares carry provisions for guaranteed rates
of return paid to the preferred shareholders. Convertible preferred
shares are preferred shares that are convertible, either at the option
of the company or the shareholder, to common shares. Convertible preferred
shares give a potential investor the comfort level of guaranteed income
on their investment, along with the option to convert to common shares
when the company becomes profitable.
Stock (common or preferred) plus Warrants
Another option is to offer stock with warrants attached. Warrants can
be defined as an option to purchase additional shares of the company
at a later date at a given price. Warrants can sometimes help induce
investors to buy into an offering at an early stage due to the additional
upside they can provide.
Debt Offerings
Many seed capital investors may prefer to invest in debt rather than
in equity of your company. In return for their investment, the debt
is secured by some or all of the assets of the company, and is traditionally
structured as an installment note at a modest interest rate. This gives
the investor the comfort of being a full-fledged creditor, rather than
a last-in-line shareholder if the company folds. Further, the investor's
payments come off the top, rather than off the bottom, of the profit
and loss statement.
Revenue Sharing Notes
This is a new concept developed for small business financing. A revenue
sharing note is structured as an unsecured note to pay back the principal
over a period of months or years. Like other debt offerings, the revenue
sharing note positions the investor as a creditor rather than as a shareholder.
As an extra incentive, the revenue sharing note also features an agreement
by the company to pay to the investor a percentage of gross sales of
the company, for as long as the note is outstanding. This percentage
is over and above the principal payments. These notes typically pay
around 1% of gross sales.
Revenue Sharing Preferred Shares
These preferred shares work much like revenue sharing notes. Rather
than a set percentage payment, the preferred dividend comes in the form
of a percentage of gross revenues of the company. This investment vehicle
combines the revenue sharing aspects of the note with the equity position
of preferred or convertible preferred shares.
