A simple solution to a tough problem

John Paul- Of smallstarter business
One of my clients got an offer from an interested investor who wants to provide 100% of the capital (over $200,000) for his start-up rice production business.

It’s not every time you find an investor who believes so much in your business and is willing to take all the risks by providing all the capital.

But wait.That’s not all.

There’s a catch:

The investor wants something BIG in return for his investment.

I think it’s better you hear directly from the source, so here’s an excerpt from the email I received:

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Hi John-Paul,

I had a presentation with an interested investor and he is ready to finance 100% of the capital but with a condition.

The investor insists that the business has to be under his company name instead of mine.

I made it clear to him that I don’t want to be an employee but a partner. I also made it clear that he can't interfere with the operations and major decisions in the business.

If I accept this deal, I intend to limit the association to three years. However, my initial reaction is to reject the deal until I get advice from you.

What do you think?

Thanks for all the support.

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On the surface, this deal doesn’t look like an investment.

It smells like a takeover!

For many entrepreneurs, this is a VERY tough problem.

As entrepreneurs, we’re usually deep in love with our business that the thought of having another person’s name on it smacks of an abomination.

But remember, the name of your business or company doesn’t matter.

What really matters is that you raise enough capital for your business to actually survive and succeed.

So, the problem here is not the name of the business.

The real problem here is OWNERSHIP and CONTROL.

It’s who owns and controls the business that really matters and not whose name the business bears.

Let’s talk about both factors.

I’ll start with Ownership.

The owners of a business are the people who hold equity in the business.

So, if you take this investor’s money as equity, it’s likely he could own a significant chunk of the company.

But what if you don’t have to give him equity?

You can make his investment a loan instead.

A loan (debt) does not give the investor a right of ownership in the company.

With a loan, the entrepreneur retains ownership of the business as long as he/she satisfies the conditions of the loan and pays back the loan as agreed.

Knowing this, you can play your cards right.

As long as his investment is a loan, your company can take on the investor’s name but that doesn’t give him any real ownership in the business.

This move is likely to serve his ego and earn him bragging rights, but you still own the company.

This is in line with one of the core principles of a win-win negotiation:

“Give the other party what they want as long as you get what you want.”

By getting his investment as a loan, the investor can have his name on your business while you get the capital you need and retain ownership of your business.

It’s a win-win for both parties.

The main problem with this option is that loans are not patient. The terms of a loan can be too harsh on a startup business.

Rather than reinvest profits into growing the business, paying back a loan will suck badly-needed cash out of the business.

So, unless you can negotiate favourable loan terms, the loan option may put too much burden on a young business.

This leaves us with another interesting option.

It’s time to talk about Control.

The people who control a company are its directors.

And guess what?

The directors are appointed by shareholders who hold equity in the business.

So, we’re back to the problem of equity again.

If you want the investor’s money to be patient and give your business enough time to grow and succeed, then equity is usually better than loans (debt).

But remember, if you accept his investment as equity, you may be giving up ownership of the company.
The good news is, there is a way around it.

There’s still a way to retain control of a company even if you have a major investor on board.

It’s called preference shares.

There are two types of equity in a company: ordinary (common) shares, and preference shares.

As the name implies, investors with preference shares get 'preference' over ordinary shareholders. For example, preference shareholders get paid before ordinary shareholders.

But the downside is, preference shares don’t usually come with any voting rights. Only ordinary shareholders have voting rights.

This means that while preference shareholders own part of the company, they can’t control the company because they can’t vote.

And because they can’t vote, they don’t control anything. Only ordinary shareholders can make all the big decisions.

Only ordinary shareholders can appoint directors and managers, and make all the big decisions about the company.

Do you see where this is going?

You have the option of taking the investor’s money and give him preference shares.

On top of that, you can accept that the company bears his name.

And as long as you hold most of the ordinary shares, you still retain full control of the company even though the investor owns most of the capital.

Makes sense?

To learn more about the upsides and downsides of preference shares compared to ordinary shares, I have included a link to good resources below.

It’s time to recap…

Raising capital is about negotiation. It’s give and take.

There are interesting ways to give investors what they want while you get what you want.

Remember, your main goal is to raise as much capital without losing both ownership and control.

A loan (debt) allows you to raise capital without losing ownership or control.

But depending on the stage and situation of your business, the terms of a loan may be too heavy a burden.

But equity can be a better option.

If you’re going the equity route, here’s my advice:

You can lose ownership OR control, but you can’t afford to lose both!

So, if you present these two options but the investor rejects them, then it's possibly a strong signal to walk away.