Planning for Closely Held Business Owners - 1 Financial Methods

Question 1

What is an Angel Investor?

Answer 1

they typically form groups to provide equity financing to start-up companies. Angels should be considered if the new business owner(s) cannot qualify for adequate bank financing, but still require outside financing. Because angels can set their own terms, care should be taken when negotiating this financing.

Question 2

What do the tax implications of Preferred Stock Recapitalization look like?

Answer 2

The owner must retain the right to receive dividends at a fixed par value on cumulative preferred stock at least annually.

Question 3

what are some common financing methods used by closely held business
owners?

Answer 3

Mezzanine financing, Venture capital funding, Leveraged buyout, Restructured debt (or operations), Angel investor, and Preferred Stock Recapitalization

Question 4

What is Venture capital funding?

Answer 4

Not always a monetary vehicle. This could include support in terms of leadership or technical advice. Whatever is provided is exchanged for ownership in the company or a share of the earning potential.

Question 5

What is Restructured debt (or

operations)?

Answer 5

Can include a sale of equity to new investors and hiring of new leadership as a response to financial issues created from the failure of a product or a way to improve the business.

Question 6

What is a Angel investor?

Answer 6

This investor uses his or her own money and is less concerned with future profit in lieu of innovation. The investor’s portfolio usually contains less than 10% in this type of investment.

Question 7

What is mezzanine capital?

Answer 7

This agreement is set up such that the lender can convert debt to equity interest should the company default on the loan. A high-risk, private placement, often used by smaller companies.

Question 8

What is Preferred Stock Recapitalization?

Answer 8

To employ this strategy, a business owner recapitalizes stock into voting preferred shares and non-voting common shares. The owner then gifts the non-voting common shares to children. The business owner’s retention of cumulative preferred shares provides a qualified payment because the owner retains the right to receive dividends at a fixed par value.

Question 9

What is the Minimum Value Rule in a Preferred Stock Recapitalization Method?

Answer 9

the gift tax value of the common stock must be at least 10% of the total value of the business owner’s stock.

Question 10

What are the Effects of Recapitalization?

Answer 10

The value of the gift is the value of the stock reduced by annual exclusions and applicable discounts. Without a qualified payment, the business owner would have a retained interest of zero and the value of the gifted stock would be the FMV of the closely held business. Recapitalization also freezes the value of the preferred shares at par value no matter how much the business grows, which further reduces the value of the stock in the owner’s gross estate at death.

Question 11

What are some characteristics of Angel Investors?

Answer 11

• Most of them are small business owners
• Most tend to sell locally
• They tend to seek opportunities to help out the community
• Angels will want to assist with advising the business; however, they do not seek control
• may also set certain contingent guidelines and goals for the business

Question 12

What rate of return are angel investors looking to receive on their investment?

Answer 12

3-5 times the orginal investment

Question 13

What are advantages of working with angel investors?

Answer 13

new business will benefit from sound advice and potential connections to suppliers, attorneys, etc.

Question 14

How does one locate angel investors?

Answer 14

To find angel investors, the would-be entrepreneur should network within his or her business community. Potential angels may be found through a variety of sources, including business associates, trade associations, bankers, accountants, attorneys, and Chambers of Commerce. Angel investors may also be found through the Angel Capital Electronic Network at www.activecapital.org.

Question 15

When obtaining financing from other than a bank or lending institution, the business owner(s) must negotiate the form of that financing. What two types of financing are available?

Answer 15

debt or equity

Question 16

(T or F) Most angel investors will want some type of equity ownership with a guaranteed exit provision.

Answer 16

True

Question 17

What provisions allow for an angel investor to exit an ownership interest?

Answer 17

1) A mandatory redemption, or buyout
2) Put “Option”
3) A public stock offering
4) A merger or acquisition

Question 18

What fraction or percentage of new businesses are funded through the owners own resources?

Answer 18

75% or 3/4

Question 19

What are Ventue capital firm?

Answer 19

Venture capital firms (VCs) provide financing for high growth companies in exchange for significant equity.

Question 20

What type of returnsare Venture Capitals looking for?

Answer 20

VCs typically strive for annual returns of at least 20 percent to 40 percent with investment periods ranging from three to seven years.

Question 21

The process undertaken by VCs normally involves:

Answer 21

1. Identify market opportunities within various business categories.
2. Identify rapid growth potential companies in need of alternative financing.
3. Analyze the specific company (or companies) identified.
4. Negotiate an equity interest of 30 percent to 60 percent.
5. Negotiate for exit terms within three to seven years.
6. Negotiate for management input. 7. Negotiate for at least one Board position.

Question 22

(True or False) A company considering VC financing must be willing to accept the following:
* Loss of control over the timing of selling out or going public.
* Loss of independent management control.
* Loss of a significant portion of equity.

Answer 22

True

Question 23

Who is a good candidate for Venture Capital Financing?

Answer 23

an existing business with several years of operations or a start-up company with something positive to offer, like a marketable

Question 24

What are 4 types of private equity?

Answer 24

1) Venture Capital
2) Leveraged Buyout
3) Distressed or special situations
4) Mezzanine capital

Question 25

What is a Leveraged Buyout?

Answer 25

At its most basic level, an LBO is a method of acquiring a company with money that is nearly all borrowed. This allows investors to make a large acquisition without committing a lot of capital. The acquirers of the target company often attempt to sell or take the target company public after five or ten years in the hopes of making sizable profits. Doing an LBO can be expensive and complex, but if successful can provide considerable returns. One of the most famous LBOs was the $25 billion takeover of RJR Nabisco by private equity firm Kohlberg Kravis Roberts in 1989.

Question 26

How long after aquiring a targeted company, will it be sold?

Answer 26

5-10 years

Question 27

What is one of the most famous leveraged buyout?

Answer 27

One of the most famous LBOs was the $25 billion takeover of RJR Nabisco by private equity firm Kohlberg Kravis Roberts in 1989.

Question 28

What are Distressed or special situations?

Answer 28

This is a broad category referring to investments in equity or debt securities of financially stressed companies. Since this area focuses on investing in entities that are in default, under bankruptcy protection, or headed in that direction, investors must evaluate not only the ability for the entity to make a comeback but also which class of securities might be more beneficial to hold during a restructuring process.

Question 29

What is Mezzanine capital?

Answer 29

These are typically structured as either a subordinate debt or preferred stock investment with claims below that of the other debt issued by the entity but above that of the common stock holders. Entities that obtain financing in this manner must pay a higher cost due to the investor’s junior position.

Question 30

How is Mezzanine capital debt usually financed?

Question 31

What types of transactions does restructuring include?

Answer 31

mergers, acquisitions, divestitures, recapitalizations, leveraged buy-outs, reorganizations, downsizings,

Question 32

What are other private equity strategies?

Answer 32

real estate, energy and power, merchant banking, and infrastructure