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Glossary

By MICHAEL CARTER

Most business owners think of venture capital or their family as the only sources of private equity capital.   In fact, private equity is available from many other sources, with terms and conditions that vary significantly, depending on the need and circumstances. 

When To Used Private Equity
Private equity is often used in the following situations:

1. Company with strong growth prospects that needs to be financed with a combination of debt and equity.
2. Company's bank is at its comfort level and will not lend any further.
3. Company is not yet bankable.
4. Public equity is not yet available due to the current IPO market conditions, company's present size, and/or recent track record.
5. Company expects to experience rapid appreciation shortly. Therefore, the company should grow, either internally, or externally via acquisitions, and then enjoy a first class IPO.
6. Strategic acquisition is available that needs a quick turnaround and can not be financed with bank and/or seller financing.
7. Company is quietly growing, and may want to maintain this growth while maintaining a low profile.

Advantages
Relative to going public, private equity capital provides the following advantages:

• Ability to maintain your company's growth without going public
• Ability to grow your company and command a better price in a more significant IPO
  with a higher quality underwriter in the future.
• Ability to make acquisitions, either to consolidate an industry or for strategic purposes.
• To provide liquidity to one or more of the owners.
• Less time consuming and attention diverting than an IPO.
• Lower transaction costs and lower on-going expenses (i.e. reporting expenses).

Relative to raising debt, private equity provides the following advantages:

• Stronger balance sheet
• Ability to leverage the equity and access additional capital.
• Partner to rely upon.
• Less restrictions, such as financial and non-financial covenants.
• No debt service requirements (unless structured as debt).

Sources

• Venture Capitalists
• Individuals-"Angels"
• Corporate Venture Capital
• Strategic Alliances/ Corporations
• Government (State/ Federal/ Local)
• Small Business Investment Companies
• Leveraged Buyout Firms

Investment Criteria

1. Competent, experienced, motivated management team
2. Strong prospects for profitable growth
3. Attractive industry niche
4. Solid business plan with a well defined strategy.
5. Exit strategy

Principal Terms of Private Equity
Below are the highlights of a "typical" term sheet. Although every transaction is different, the following characteristics are common:

Security:  Private equity capital is typically structured as convertible preferred stock.

Preference: The preferred stock is senior to the common stock in the event of the company's sale, merger, liquidation, or dissolution.

Conversion: A one for one conversion which allows the preferred investor to convert one share of preferred to one share of common.

Dividends: Key issues are how much, when they are paid, and in what form.

Voting Rights: It is not unusual for the preferred stock holders to vote as a separate class, and effectively have veto power over certain basic issues.

Board of Directors: Preferred stockholders depending on their importance to the capital structure will want representation on the board.

"Put" Provision: A "Put" is an investor's right to be paid in full at a negotiated price, often at market value,in year 5-7.

"Call" Provision: A "Call" is a company's right to pay back the investor prior to maturity or "put" date.

Anti-Dilution Provision: Protects the investor against new issues of stock in connection with stock splits, stock dividends, stock sold below the conversion price, stock sold below the issuance price, or in some cases, all new issues of equity

Representations and Warranties:  Relatively boiler plate.

Key Man Life Insurance: On key individuals, payable to the investors.

Material Information Rights:  Interim and annual financials, budgets, etc.

Registration and Piggyback Rights: Some investors want the ability to take control of the company if management fails to meet certain pre-defined criteria.