Investing in Private Companies: Owner-Managers vs. Investors
| Author | A. Paul Mahaffy |
| Pages | 251-272 |
Investing
in
Private
Companies:
Owner-Managers
vs.
Investors
A.
Paul
Mahaffy
A.
INTRODUCTION
Many
private companies arrive
at a
stage when they have
to
look
beyond
the
family
and
friends
of
their founding shareholders
as
sources
of
additional equity financing
and
seek deeper pools
of
capital. They
may
attempt
to
find
a
wealthy individual
to act as an
"angel"
and
make
an
investment using
his own
personal
funds.
But
such
an
individual
is
not
easy
to
find. Private companies
are
more likely
to
approach profes-
sional
fund
managers
who
invest other people's money.
Attracting
the
attention
of one of
these professional investors
is not
easy,
especially when
the
criteria they
set can be
difficult
for
many pri-
vate companies
to
meet. Chances
are
that
a
company will have
to
have,
at a
minimum,
a
highly marketable product
or
service,
an
achievable
business plan,
an
experienced
and
capable management team,
and the
potential
to
generate
$75 to
$100 million
in
revenue within three years.
The
company should also have
a
network
of
sophisticated strategic
A.
Paul
Mahaffy
practises
business
law
with Bennett Best Burn
LLP of
Toron-
to,
with particular
emphasis
on
purchase
and
sale agreements,
business
suc-
cession,
private comany
governance,
technology transfers, joint
ventures,
and
financing.
He can be
reached
by
e-mail
at
pmahaffy@bbburn.com;
his
recent
publications
can be
viewed online
at
251
252 A.
PAUL MAHAFFY
partners
and a
board
of
well-connected
directors,
and
preferably
be
placed among
the top
three
in its
market space.
Whenever
the
company satisfies these criteria
and
gets
the
attention
of
a
professional investor willing
to
invest,
the
basic terms
of the
pro-
posed investment
are
often
set out in
what
is
commonly called
a
"term
sheet."
The
term sheet
is
intended
to be
replaced
by a
number
of
more
comprehensive,
definitive
agreements,
including
a
subscription
agree-
ment
and a
shareholders' agreement, along with amendments
to the
company's articles
and
bylaws,
as the
parties
get
closer
to
finalizing
the
investment.
The
term
sheet
may or may not be
legally
binding,
although
it
may
well
be
both, containing some items that
are
binding
and
many
items that
are
not.
This
paper
will review
the
basic terms generally governing
an
equi-
ty
investment
in a
private company
by a
professional investor.
It
will
discuss
how
these terms
are
viewed
by the
owner-managers
of the
com-
pany
as
well
as by the
professional investor,
and
look
at the
variations
that each
may
propose
to the
other
during
the
negotiation
of the
invest-
ment.
This
paper
will
assume that
the
investment
is
being made
by way of
convertible preferred
shares,
although some
of the
terms
discussed
may
be
relevant
to an
investment made
by way of
common shares,
or by
debentures
or
other debt instruments convertible into common shares
or
accompanied
by
warrants
to
acquire common shares.
It
will also assume
that there will
be
only
one
holder
of the
company's
preferred
shares
(Investor),
despite
the
common practice
of
having more than
one
profes-
sional investor
"co-invest"
in a
company
at the
same time.
This paper
will
also consider
a few of the
terms requested
by
U.S.-
based investors, since such investors
often
co-invest with,
and
sometimes
invest directly
on
their
own
without participation
by
Canadian-based
investors.
An
initial public
offering
by a
Canadian company that allows
an
investor
an
"exit"
from
its
investment
may
just
as
likely
take place
on
an
American stock exchange, such
as the
NASDAQ,
as on a
Canadian
exchange.
B.
OWNER-MANAGER
VS.
INVESTOR
PERSPECTIVES
While
the
owner-managers
and the
Investor
may
want
the
company
to
grow
and
prosper, their interests
are not
always aligned,
and the
Investor
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