Crafting and Negotiating the Deal

Chapter 11Crafting and Negotiating the DealCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedChapter OverviewThe Business EntityThe Debt-Equity MixNegotiating LoansNegotiating the Equity InvestmentCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedBusiness Entity SelectionKey issues to consider:The ability to easily add outside investorsLiability protectionTax advantagesManagement controlCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedSole ProprietorshipOnly one ownerAdvantages DisadvantagesSimple and inexpensive to form Unlimited liabilityFlexible Responsible for all lossesFreedom to make decisions Expertise of only one individualFreedom to make changes Resources of only one individualNo red tape or bureaucracy Limited lifeKeep all profitsProfits are not taxed twiceCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedPartnershipFormed when two or more persons or entities come together as co-owners of a businessA partnership is a legal entity that can own property, borrow money, and take actions just as individualsA partnership can sue or be suedCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedTypes of PartnershipsGeneral PartnershipUnlimited personal liabilityMutual agency allows one partner to act on behalf of the entire partnershipLimited PartnershipProtects limited partners from personal legal liabilityLimits the ability of limited partners to participate in the management of the businessCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedPartnership Advantages and DisadvantagesAdvantagesRelatively easy to establishLimited partners have limited liabilityProfits are not taxed twiceRelative flexibility in decision makingLow level of bureaucracy and red tapeShare resources and expertise with partnersDisadvantagesLimited lifeGeneral partners have unlimited liabilityOne partner can obligate the entire partnershipCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedCorporationSeparate legal entity which can act on its own or on behalf of the shareholdersIt can borrow money, acquire assets, and enter into legally binding contractsIt can sue or be suedCan be publicly or privately heldCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedCorporation Advantages and DisadvantagesAdvantages DisadvantagesContinuous life Double taxationLimited liability Relatively complicated to formSeparate legal entityEase in raising capitalEase in transferring ownership Operated by a board of directorsSignificant red tape and bureaucracy Copyright © 2007 by John Wiley & Sons, Inc. All rights reservedS-corporationProvides limited liability for the owners of the corporation and tax advantages to a partnershipProfits are distributed directly to shareholders and not taxed at the corporate levelCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedS-corporation QualificationsHave 75 or fewer stockholdersBe a domestic corporation that is not a subsidiary of a larger companyHave only one class of stockHave only individuals, estates, and certain trusts as shareholdersHave only US residents as shareholdersCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedLimited Liability Company (LLC)Qualifications for an LLC are similar to an S-corporation, except an LLC can haveMore than 75 shareholdersMore variety of ownersAvoids double taxationAll shareholders enjoy limited liabilityHas a limited lifeCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedDebt and Equity MixBorrower needs to calculate their equity position by following these steps:Calculate the maximum amount of money that can be borrowedSubtract the loan amount from the project cost to determine the amount of equity requiredCalculate the annual ROI and IRR and determine if they meet the investor’s hurdle rateIf they exceed the hurdle rates, the cash flow projections support a carried interest in the dealCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedCommon Loan Agreement TermsPrincipalInterest ratePoints paid up-frontLength of loanAmortization rateCollateralPersonal loan guaranteePre-payment penaltyCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedTerms of Lender ImportancePrincipalLender wants to loan as much money as possibleInterest ratePrice of the lender’s productPoints chargedA point is equal to 1.0% of the loanPoints raise the effective rate of interestCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedTerms of Lender ImportanceCollateralAsset that the lender is asking the borrower to put at risk in the event they default on the loanPersonal guaranteeAllows the lender to look to personal assets of the guarantor to repay the loanCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedOther Lender IssuesTerms of less importance to the lender include:Length of the loanDetermined by the purpose of the loan, conformity guidelines, and trendsAmortization rateSpeed at which the borrower is required to repay the loanPrepayment penaltiesCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedNegotiating the Equity Investment Deal sponsor’s goalsReduce the amount of equity they need to raiseReduce WACCMaximize their ROI and IRRReduce the percentage of ownership given to investorsCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedImportant Issues toEquity InvestorsAmount of EquityEquity investors want to spread their money and risk over several investmentsPercentage of OwnershipInvestors want the highest amount of ownership for the least amount of moneyThe deal sponsor must receive their ownership in the dealCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedImportant Issues toEquity InvestorsInvestor Hurdle RatesProbability of the investor’s ROI and IRR hurdle rates being achievedExit StrategyEquity investors want to know the exit strategy, timing of the strategy, and who controls the exit decisionCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedNegotiating SkillsBorrowers must be preparedLearn about the person they will be negotiating withUnderstand the issues they are prepared to compromise onAnticipate the questions of the lender or equity investorCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedNegotiating SkillsBorrowers must be professionalThink and dress like a lender or equity investorSpeak the lender and equity investor’s languageDress professionallyCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedNegotiating SkillsBurrowers must use proven selling skillsBegin presentation with an initial benefit statementAlways be alert to objectionsListenUtilize a trial closeSummarize the benefits of the deal and offer two favorable optionsCopyright © 2007 by John Wiley & Sons, Inc. All rights reserved