Most people and companies who have a vision of starting a company, acquiring a stabilized commercial real estate property, or getting their mobile app funded will face many difficult hurdles and decisions on the path to realizing their success. Being prepared up front is the key to successfully navigating the world of private capital and equity.
Having a knowledgeable partner like 5th Avenue Capital is also invaluable, as an experienced partner will have faced and overcome many of the hurdles you will have to overcome in order to reach your success goals. Commercial and public lending sources are very different from private capital and equity routes, and you will need to know a few things before-hand so you are well equipped for success on your path to project funding.
In the Private Capital / Equity world, we not only receive a lot of requests for funding, but we also work with an incredibly diverse group of applicants, projects, as well as private investors and opportunity/ hedge funds. Many of the brokers or principals who submit projects have not navigated the world of private funding enough to understand and adequately prepare for a successful and informed funding process.
Of all the requests we receive for private project funding capital, we often see the same 4 hurdles that hinder principals from obtaining the funding they need to realize their funding goals. At 5th Avenue Capital, it is our goal and service to educate our client and broker relationships as much as possible, in order to help them overcome personal hurdles so they can realize their project goals. In most cases, projects do not get funded because the applicants and brokers are not equipped or prepared to carry out the entire process, from inception through due diligence to a successfully funded project.
Almost all project hurdles and challenges do not come from the private investor or the fund source, but come from challenges in the applicant’s verification of facts, resourcefullness, and ability to meet the qualifications for the specific fund or private investor due diligence process. Most of these hurdles are amenable, but it requires some education and persistence, as well as flexibility and patience on behalf of the applicant and broker team. After all, the majority risk is taken on by the private investor or fund, which is why they often require stringent structuring, due diligence and other qualifications, such as due diligence fees and retainers to filter out the serious applicants from those who will most likely not finish the funding process.
In our experience, most projects do not get funded for 1 of 4 reasons:
1- Misunderstanding of the private funding world and/or impatience (inflexibility) on behalf of the applicant or applicant’s broker;
2- Applicant’s inability or lack of due diligence funds, commitment and ancillary fees required to get funded;
3- Lack of experience within the applicant/management/principal team in the industry for which they are requesting funding;
4- And lack of clear exit strategy or solid plan to ensure confidence that the private investor will receive his or her ROI.
By educating oneself to the real world of private capital/equity, the applicant, management and broker team can be better equipped when (not if) the project funding pathay faces some hurdles. Remember, when your project is funded, everyone involved in the process wins. Our goal, and the goals of our funding sources are to help navigate this path with you, as we are all on the same team, seeking the same end result.
Misunderstanding the private funding world
One of the first hurdles we face as a team with our applicants and introducing brokers is that they are mis-informed or have unrealistic ideals about the private funding realm. Many applicants want the convenience of getting a personal or collateralized loan from a local bank without paying the 20% to have access to the other 80%. They want to “have their cake and eat it too.” What they often overlook is that in order to get access to SBA or non-private, commercial loan routes they would need a down payment or commitment of nearly 20%, which in almost all cases will destroy the deal. They do not fully appreciate or realize that the investor is taking the majority risk, and that having access to $50 or $100 Million dollars is a privilege at only a fraction of the cost it would require to achieve these funds through more traditional routes. Additionally, these loans are usually non-recourse, which means if the project fails, the recourse is on the project and not the principal. Again, the risk is mostly carried by the investor or fund.
Most projects that do get funded through private equity / capital face hurdles and issues that need fixed or resolved. Only a small fraction of projects that are submitted are ready to go directly to the funding stage without addressing and fixing some of the issues with the business plan, structure, or princpipal team. 99% of those issues are on the side of applicant misinformation or issues with the business structure so that the project is indeed an “A-grade” investment for the private investor or private hedge fund. When you deal with private investors, you are dealing with an individual. . . a human being who has specific likes, dislikes, as well as good and bad days. He or she may fund one project within a week, while taking 5 or 6 months to get comfortable with another project. The pros of working with a private investor is that they are often more flexible and can fund projects without specific hurdles or structures required by private hedge fund procedures. Private investors will often invest in a diverse portfolio of projects whereas a hedge fund will have guidelines that are established and a board and manager make decisions on funding projects based on how well they are aligned to the target and qualification guidelines of the fund. Some of the cons of working with a Private Investor is that you are also working with an individual human being who has specific idiosyncrasies as well. They can be much more flexible, but can also be picky and sometimes inconsistent. When working with a structured fund, your project either aligns to the qualifications of the fund or they do not. If they do not, they can often be remedied. This remedy or re-structuring of the business project takes time and money.
As an applicant, broker and management/principal team, not only must you expect to face some issues, you must be prepared to remedy them and be able to front the expenses to remedy them in order to make your project a reality. It is not realistic to expect a private investor to bear the burden of risk to fund your project, and also pay you to get it in suitable shape to get it funded. The up front work, and amending any issues that surface during due diligence, is the sole responsibility of the applicant and you must be prepared both mentally and financially to amend whatever needs to be amended to successfully fund your project.
The Due Diligence Challenges . . .
If a private investor or fund manager took applications from every person who wanted to gain private funding, they would be overwhelmed with unqualified projects and would lose a lot of valuable time. As much as applicants like to vett funding sources, funding sources must filter and qualify applicants very selectively.
Private investors and many fund managers require that projects be submitted in specific ways, or they require that businesses be structured in certain ways in order to mitigate their own risk of losing funds to bad projects or unscrupulous borrowers.
Additionally, investors fall under more scrutiny legally, and must abide by several laws through the due diligence process so they can be assured that their monies are not being distributed to illegal recipients. Some private investors fall under the Gramm–Leach–Bliley Act (GLBA), also known as the Financial Services Modernization Act of 1999 because they operate in more than one method or mode of banking.
Some private investors and investment banks also offer financial services such as cost segregation, which included sensitive business tax information, and therefore fall under the watchful eye of the IRS due to IRC Section 7216(a) which gives strict requirements relating to the disclosure or use of tax return information for individuals or businesses.
Additionally, due diligence helps investors abide by many banking and lending regulations/laws, including Anti-Money Laundering laws (AML) that are regulated by FINRA (Financial Industry Regulation Authority). Specifically, private investors and investment bankers who are also registered and carry out other functions, besides private investing, must comply with FINRA Rule 3310, which essentially requires that members “develop and implement a written anti-money laundering program reasonably designed to achieve and monitor the member’s compliance with the requirements of the Bank Secrecy Act (31 U.S.C. 5311, et seq.)”
Private investors cannot just make a hand-shake, fall in love with your project and cut a check. They have to protect their business, their money and their reputation by doing their Due Diligence on every project and applicant. This requires a lot of time, resources and money, and private investors are not in the business of losing money.
Often, applicants will request references from private investors or capital sources, not realizing they could face serious fines or imprisonment for divulging the private contact information of clients and businesses they have served as well as violating their NCNDA agreements that are executed before formal business engagement commences. Think about this. . . applicants would not walk into a bank and ask for the private contact information of the last 3 home mortgages they issued, or the last 5 personal lines of credit they extended to their other customers.
Why would it be reasonable to expect a private investor to divulge this same kind of information and put their entire livelihood and reputation at risk?
For these reasons, private investors will require that applicants pay reasonable due diligence fees, as well as other ancillary fees to adjust or fix the business structure if needed, in order to make the project a sound investment and to mitigate or minimize risk for the investor.
Often, applicants will not want to pay or not have the resources to make it through the due diligence process. Knowing these fee ranges up front, and even having an equity partner on your executive team who can help with some or all of these fees can arm you and your investor or investment banker, consultant or firm to give your project the best chance at getting funded.
Additionally, some “green” investors / investment bankers who have not initially required due diligence fees quickly learn to require them when they take a client all the way to the funding table, investing much of their own time and money to get to the finish line, only to have the client balk or get “cold feet” at the issuance of funds. Due Diligence fees are a little more than insurance that the applicant will not bail at the last minute, wasting precious time and resources of the private investor and the investment banker, firm or private equity consultant.
Regardless of your type of project, there are no serious private investors, firms or investment bankers who will allow clients to engage without these fees.
Experience that can get to the finish line
Many projects that are submitted for funding lack proof of experience on the executive or management team in the given industry or field. Although this kind of project will not get funded in its current state, this is not an insurmountable hurdle. If you do not have the experience, there are several options. . .
You can team up with an individual who has a great track record of succes in the field of your project, and allow them to have an equity stake in your company in return for their expertise on the executive team. Of course, you will want to do your own due diligence and obtain legal counsel as to the structure and contractual arrangement before giving away a portion of your future company.
You can also be willing to give a substantial amount of equity, usually a controlling majority to a company or fund that specializes in your project industry. Many entrepreneurs and applicants are not willing to give up a lot of equity in return for getting their project successfully funded, however, if structured properly, you can use the proceeds and experience to get a second, third or many successive projects funded whereby you will have a greater portion of the equity and control. There are many private funds that specialize in acquiring or investing in projects.
Another creative option is to obtain an LOI (letter of interest or intent) from a management company and include it as part of your Executive Summary and Business Plan. For example, to run a hotel, your management team must have specific experience and the hotel will require specific licenses depending on amenities. You may decide to interview several hospitality management companies and select one that fits your game plan and allows you to operate your project at solid profit margins.
The more you learn and the more experience you can secure on your executive/management team, the more appetizing your project will look to investors who are seeking to put their money to work on solid, lower-risk projects. Do your best to poke holes in your business plan and figure out how to make the entire package bullet-proof. Look through your plan as an investor would, and find out how to mitigate every aspect of real or perceived risk. Then, make the necessary changes to your team and plan so that any serious investor would have a difficult time turning your project away.
Be ready to answer the question on exit strategies where necessary. Be sure to have more than one possible exit strategy. Also, be sure you can show the investor through proforma and industry comparables and regional demographics, exactly how they will receive their ROI with realistic margins. If you are able, hire specialists or specialists who have expertise with the accounting, business modeling and tax structures with projects similar to yours. Have them put your plan through the “grinder” and allow them to help you refine your plan so that it is structured as a sound investment vehicle for the private investor. Then, be able to show the investor how your business project will be structured to address their best interests as the major bearer of risk.
In summary, put your project and executive team through the “mill” and make all necessary improvements. Be sure to answer the following questions thoroughly before submitting your project for funding.
Does your team have the financial and professional ability to commit to due diligence?
Does your team truly understand the private investor / private hedge fund side of the business?
Does your project make sense to an investor?
(Is the business / project structured so that an investor has confidence in obtaining his or her ROI)
5th Avenue Capital specializes in funding projects through private investment relationships and private managed funds across many industries. Whether your project is the launch of a new airline, a gas and oil foray, the development of an exotic island resort, or the acquisition of a multi-unit apartment complex, the experts at 5th Avenue are ready to guide you through the process.
