Issuing Equity Securities Privately

  • Equity financing can be raised by companies through private placement offerings in amounts ranging from less than $500,000 to well over $100,000,000.

 

  • Equity represents an investment in the underlying value of a company.  Therefore, as a company’s financial performance and/or other value indicators improve (i.e. size of a customer base,  growth in brand recognition,  patent creation, etc.), the value of its equity increases correspondingly.

 

  • From the issuer’s perspective…equity financing is generally a more expensive form of capital to raise than debt financing,  given the underlying value creation of a fast-growing company and the “opportunity cost” of selling equity today at a relatively low value relative to its potential, but equity financing is typically the only form of financing available to young companies which have not achieved the consistent profitability needed to service debt obligations.

 

  • Equity can be in “common” form or “preferred”, with preferred having greater privileges for the investors.   These “preferences” typically include priority for payment when a company is sold or otherwise liquidated and also the accrual of (and eventual payment of) preferred dividend payments with rates ranging from 5% to 15% per year.

 

  • Companies which are incorporated as “C” corporationsor “S” corporations issue equity in the form of stock.  Limited Liability Companies (“LLC”) issue equity in the form of “membership interests” or “units”. C Corporations or LLCs can offer preferred equity or common equity.  S corporations can only issue common equity.

 

  • Companies raising capital through private placements of equity typically issue preferred equity rather than common equity, since the preferences enabled by preferred stock are often required to generate sufficient investor demand.

 

  • An equity investment decision by a potential investor involves a comprehensive analysis of five primary aspects of the issuer’s business and the terms provided in its equity offering:
    • Attractiveness and uniqueness of the issuer’s product or service, including its inherent profitability
    • Experience of the founder and/or senior management of the company
    • Market opportunity and sales process for the product or service
    • How the product is created or the service delivered 
    • Specific characteristics of the equity security being offered, including the likely path for selling it within five years.

 

  • The level of private investor demand will be a function of the progress the equity issuer has achieved in building the business, the prospect for significant near term growth and the implied value creation in the equity being offered.

 

  • For private companies which generate consistent revenues and cash flow equity valuations are often determined as a multiple of an historical and/ or projected financial performance indicator.  For companies without revenue of cash flow, the valuation of its equity is much more subjective.

 

  • Since equity does not have a maturity like debt, and since privately placed equity does not have a secondary market in which investors can unilaterally sell the stock they have purchased, issuers should have a plan that would create liquidity for the private equity investors.  This would typically include:  selling the company, publically registering its equity or recapitalizing the business, each within five years from the date of the equity’s issuance. 

 

  • In general, equity securities issuance can be conducted by promising companies with limited operating histories, but debt issuance should be avoided (even if available) given the stricter principal and interest payment compliance requirements of debt and the less proven financial performance of a newer company.