Hiring a Professional Team During a Transaction
Although raising capital may seem like a one man job where a business owner pitches an idea to potential investors, this is definitely not the case. Failure to associate oneself with proper counsel going into a capital raising pitch and trying to represent the business idea on all fronts is a mistake that many people make that costs them capital.
Hal Katz, partner with Husch Blackwell says it is essential to have legal advisors when raising funds for several reasons.
“One, you want to ensure that you don’t create liability exposure through the process of raising funds for your venture. In the course of soliciting or attracting potential investors, often, statements are made that could be construed as representations, or guaranteeing a return on investment. If unsuccessful, these investors could try and use such statements against the founders or the company when the investor does not make the money they think they will make, or if the venture isn’t successful to the degree expected,” Katz says.
“Two, if not structured properly at the time of the initial funding round, subsequent investors will require restructuring through legal involvement, which is often at far greater expense. There is much more work that has to be done to clean up the corporate or ownership structure of the entity in order to bring in a second round of funding, or just additional funders.”
In raising funds for a transaction, Katz says lawyers get information on the proposed or current structure of the business in question. For example, a lawyer would determine (i) whether separate classes of ownership would be appropriate; (ii) what type of disclosures would be required based upon the number and type of investors; (iii) whether the transaction would be exempt from registration under the applicable securities laws; and (iv) if future funding rounds are likely. The more the lawyer understands the capital needs and business structure, the more effective and efficient the business can be in its fundraising objectives.
“Ideally, we work together with the client to identify what is required for the purpose of raising capital, and we don’t want to create an overly complex and expensive structure to maintain from a legal, tax and accounting standpoint. We want to make sure that we understand the goals of the funding, along with whether there is an exit strategy. We help the client understand the options, and develop a corporate structure that will make sense when soliciting potential investors. This process leads to the creation of the very important offering materials that will be distributed to potential investors, and be relied upon as the basis of their investment decision,” Katz says.
According to Katz, a well-developed set of offeringdocuments protects against possible claims from dissatisfied investors. If there is an investor who claims that promises did not materialize, we can go back to the offering materials and specificallypoint to what was described as the investment opportunity, and the risks associated with that opportunity. That will help minimize potential claims against the company and its principles for misrepresentation or some kind of fraudulent inducement claim that could be brought by an unhappy investor.
“The last step is making sure that the company actually follows the terms of the offering, and the various corporate formalities necessary to effectuate the transactions contemplated. Failure to go through the acknowledged tedious task of doting all of the “I”sand crossing all the “t”s can jeopardize the funding. This means that the offering period needs to be open and closed on the dates provided, minimum and maximum amounts must be adhered to, investment documentsmust be executed by all parties, and corporate approvals must be recorded. Failure to follow the required corporate formalities could result in an existing or new investor challenging the validity of the offering, or the expenditure of significant dollars on legal fees to go through a clean-up exercises on steps that were missed on the front end of the offering,” Katz says.
Carmelo Gordian, a partner at the law firm of Andrews Kurth says if the seller has got serious interests like a venture capital firm, they are going to insist on competent counsel.
“This is a firm that they recognize, a lawyer that they recognize that have done it, do it consistently. This is so the process can be efficient and carried out properly,” Gordian says.
Apart from that, Gordian says there are business ideas that have individual investors early on but not an institution. The problem with this is that the individuals may not have directed the business owner in the proper ways of knowing how to properly structure their capital raising process.
“The reason it’s important is because whatever decisions you make good or bad as it relates to those early investors, you have got to live with down the road. So, you really need to understand, if there are terms that you want,” Gordian says.
Blayne Rush, investment banker, President of Ambulatory Alliances LLC says typically there is an imbalance of knowledge, leverage and experience between a novice seller and buyers that have significant amounts of experience. Just that alone tips the scale significantly, and within healthcare, that is magnified. FMV standard comes into play in some of these deals and a lot of the hospital buyers will use that standard as a hammer to turn around and hammer down the price.
“The hospital will hire an advisor and say “here is the price” but essentially, what that person is, is an advisor to the potential buyer. This is because the process is much more complex than that in the sense that those guys are supposed to be an independent third party, so the negotiations and all of that stuff is supposed to go upfront, be reduced to writing, and then a third party valuator comes into play and looks at all of the facts to determine if the deal conforms with FMV standard or not,” Rush says.
“From the preparation standpoint, which is one of the most important processes of raising capital, you want to go through and identify red flags, tweak and turn your business so that it is presented in the best light. You are not going to cover things up, but identify and know what potential red flags are there, and be prepared to explain those and have some back up data as to why it is there.”
If you have an interest in learning more about the subject matter covered in this article, the M&A process or desire to discuss your current situation, please contact Blayne Rush, Investment Banker at 469-385-7792 or Blayne@AmbulatoryAlliances.com.