April 21st, 2013 16:45 EST
Raising Capital: Institutional Capital and Accredited Investors
Raising Capital is an art form and it has to be executed with great precision in order to be successful. The first decision is where will the money come from? There are two large buckets of capital from very different sources that you might consider for a capital raise. Both have pros and cons, and I`ve laid out a few ideas below.
Institutional Capital is any capital that`s coming to you as a large sum from a company or sophisticated organization. Typically, these are professional investors who tend to be fiduciaries for other people`s money (which is another way of saying they are syndicators). The capital they invest rarely belongs to the investors that you`ll be dealing with which means they have no emotional attachment to it. It matters very little how much they like you " it only matters that they like the investment and the returns you expect.
Because they`re professional investors, they probably have deep experience in structuring transactions, monitoring operations, calculating the expectation of returns and in the exit strategy for their capital. Institutional investors tend not to like to have their capital tied up for long periods of time, so they usually want their money back in five to seven years maximum. Institutions tend not to be greedy about large returns. They prefer more safety for a lower yield. And because of their deep experience in management and sophistication about legal matters, they tend to write agreements that are very unfavorable to the entrepreneur who seeks capital from them. They also might have their own agenda about how and when to exit the company which may not be aligned with the interest of the entrepreneurs.
And by the way, frequently, it is not necessary to go through the private placement process because the institutional investor will be an active partner with you.
I have been known to say that if the entrepreneur falls down and skins his knee, the institutional investor will probably step in and take over ". It is hard to do business with whales because they don`t really need partners. They prefer employees.
I also advise there`s usually not enough room in the deal for two syndicators " meaning your profit will be taken by the institutional player. This is a concept most of our Symposium attendees can`t relate to until they are in the situation. But when they get the concept, it becomes crystal clear.
The other alternative for raising capital typically falls into the category of accredited investors. These are usually individual people who write checks for amounts varying between $25,000 and $1 million though it could be more. These investors are not professionals; they tend to have background and experience in a variety of different capacities but most of the money that they have does not come from investments; it`s from whatever business they specialize in. These people have accumulated discretionary capital to make investments with and the money they have belongs to them. They have an emotional attachment to their dollars and therefore when they interact with the entrepreneur who`s raising capital into a deal, they tend to become involved in the transaction.
Accredited Investors are sophisticated people but they tend not to have the sophistication about operations, management, deal structure, or yield like their institutional counter-parts. And they probably don`t know a lot about appropriate rates of return and risk assessment or analysis. They will have affiliations with attorneys, but even those attorneys tend not to be experts in deal structure or deal analysis in the same way that the teams that work for institutional investors have those skills.
Accredited investors are excellent to work with however. They tend to operate as silent partners but their money is somewhat slower to raise because the checks come in much smaller increments. For this reason, entrepreneurs sometimes think that getting money from accredited investors is less desirable. On the contrary, taking money in from a diverse group of accredited investors very frequently works to your advantage because in this way, the investors do not know each other and no single investor has the ability to control the company through voting or capital. This leaves the entrepreneur squarely in control of his or her company.
Dealing with Accredited Investors also means that you will have to go through the private placement process to sell the shares in your company to raise the necessary capital.
In order to get accredited capital, the steps are not terribly different from the steps of getting institutional money but the following have to be in place before you can meet with accredited investors.
1) You must have some type of marketing material that explains and documents the deal.
2) You must have an offering memorandum including a disclosure document and Operating Agreement so the investor can even begin to entertain writing a check.
3) And above all, you have to have an excellent answer to the very simple questions that every investor will ultimately ask before they write a check. That question is "if I write you a check, what do I get?"
You have to be able to answer that question not only with great specificity, but with great clarity. Getting a piece of a profitable company is not a suitable answer. People want to know what percentage of the deal they get and how the investment works. If you cannot answer this simple question and provide the answer in documentation such as an operating agreement, private placement memorandum, subscription agreement, and collateral marketing materials, there`s very little chance that an investor can say yes ".
This means there`s some preparation that goes into raising money from private investors. And because these investors will be passive, buying shares of stock in a company, these materials require a securities attorney to draw them.
In Joel`s Opinion.
Raising capital through institutional sources for business and real estate transactions and smaller deals is very undesirable, largely because of the issues related to control. There also are significant issues related to compensation and decision making that institutions can make very unfavorable to the entrepreneur. On the other hand, raising money from accredited investors takes more time and there`s some up front expense in preparing legal materials. However, even for an institutional transaction, a lot of up front time has to be spent thinking through the detail of how to construct the transaction.
I recommend dealing with accredited investors. The capital raising process can be more creative and the outcome will be more favorable to the entrepreneur which, in my mind, is always a critical consideration.
We`ll discuss this in more depth at the Deal Making Symposium and Syndication Seminar in just 2 weeks from now.
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If you have an opinion or thought on this topic, please write a comment in the form below. Share this blog with your friends. Thank you for being one of our loyal readers. We appreciate you and are rooting for your success. Often dubbed a "Growth Architect" by his clients, Joel Block advises companies on explosive growth strategies by driving revenues and sales. Well known in the capital markets, Joel is a successful entrepreneur, speaker, advisor and is an astute investor.
Joel is CEO of Bullseye Capital , a full-service real estate company supporting owners and buyers of real estate assets with brokerage, leasing, property management, and mortgage services. Joel is also the founder of the Bullseye Capital Real Property Opportunity Fund, LLC which is an investment company that acquires distressed real estate by working with accredited investors.
A leader in real estate syndication, we offer seminars to assist others in acquiring the skills needed to raise syndicate capital to acquire properties. Imagine knowing how to pool funds to purchase any real estate investment, whether single family, multi-family, commercial, or anything else. For more information and complete details, please go to http://www.syndicatefast.com/.