|
|
| Return |
| Trends in Venture Capital Terms: New Financing Techniques Emerge to Navigate Bear Market |
 |
As tough economic times continue, private financings have become more complex. Investors require deal terms that enhance protection of their stake. Examples include: milestone financing, liquidation preferences and participating preferred shares. Entrepreneurs seeking financing ought be aware of these techniques to negotiate a fair transaction.
Out of difficult economies are born creative and useful financing structures. Most venture investors are licking wounds created by the tech bubble burst. Even so, many of them still sit on some capital they must deploy to try to recoup their losses. To continue investing, VCs have been using techniques that protect themselves by shifting risk to the entrepreneur. Three such techniques are:
1. Milestone financing: In these arrangements, company management is rewarded (or punished) for hitting (or missing) quantified targets such as profit or number of customers. The objectives can also be qualitative, like launching a new product. Failure to reach the milestones can require the entrepreneur to transfer more equity to the investors or even give up management control of the company. Occasionally, an investor will propose a milestone-financing arrangement just to gauge the entrepreneur’s willingness to bet on his or her own performance.
2. Liquidation preferences: These became popular only in the last three years but are standard now. They let an investor lock in a certain level of return, so long as the company is still worth more than the investment when the company is sold. For example, consider an investment of $1M with a 2x liquidation preference in exchange for 20% of a company valued (post-money) at $5M today. In the event of a subsequent company sale for $4M, the preference allows that investor to recoup its entire $1M investment, plus another $1M (to total 2x the original $1M investment), before other shareholders receive any return. Had there been no liquidation preference in place, the investor would be entitled only to $800,000 (20% x $4M) of return. On the other hand, if the company sold for $10M or more, the return is the same to the investor, with or without the liquidation preference. Recently, though, liquidation preferences have been retreating. A deal that might have been done at 2x might now be 1.5x or even 1x. A 1x deal simply gives the investor the right to recoup his entire investment before other shareholders are paid.
3. Participating preferred shares: Here’s an even newer twist. These structures afford investors the same right as the liquidation preference (to (a) recoup their investment and (b) claim 1st preference on the multiple) but also take its percentage share of the remaining proceeds. Imagine an investor acquires 2x participating preferred shares for $1M in exchange for a 20% equity stake. In a $4M sale, the preference feature snares the investor the entire first $2M of sale proceeds, and the participation feature nabs another 20% of the remaining $2M. That’s taking a total of $2,400,000, or 60% of the sale proceeds.
|
|
| Return |
|
|
|
|
Home