(part 1 of 2)
Many people with a great idea, or a great team and an idea, often believe they just have to find the right investor to obtain private funding to get their project launched. While a solid plan and a great team are necessary components to have a solid chance at obtaining private funding, there is a lot more work that needs to be done from business plan presentation to the release of funds for a project. In fact, most business plans are not ready to be funded properly, at least from the perspective of the investor or fund manager.
Entrepreneurs spend thousands of dollars for consultants, boiler plates, legal advice, prototypes, feasibility studies, appraisals, and other supporting instruments and often pay good money to have a “professional” craft a business plan for a pitch. Little do they realize, most business plans are not properly structured to gain the confidence of a private investor, or meet the rigors of qualifications for a hedge fund.
While most business plans are full of great information, appraisals and other supporting facts such as demographics as well as exquisite pictures to visually back the veracity of the business, they are often full of “fluff” and un-necessary, superfluous information that actually reduces the credibility of the plan, the applicants or principals.
Most, possibly as much as 99% of business plans that are presented to investors from entrepreneurs, even those edited by business attorneys and other “business planning professionals” are not even close to being properly structured in order to gain access to a private investor’s funds, or to meet the criteria of a hedge fund. What most people do not realize, is that in order for a business idea or transaction to be privately funded, there are many risk factors and strategies that the private investor or fund must consider before agreeing to fund a project.
The Reality of Structuring
Many people in the investment banking world, or private investment world refer to the concept of structuring the project in order to obtain funding properly. This terms is also referred to as “financial engineering” among investment bankers, SEC attorneys, accountants, hedge fund managers and wealthy private investors. While many entrepreneurs are very savvy within their field of expertise, they often have no background or cognitive framework in the universe of private finance and what must happen before a business can actually get funded from a private investor or hedge fund.
When an entrepreneur looks at his or her business plan, they see a great idea and a hypothetical plan of execution. There can be a certain emotional attachment to it, especially if many, many hours and dollars have already been invested. When an investor looks at most business plans, they are looking for reassurance that their money is going into good hands and that the financial operations are feasible and will ensure a comfortable return on investment (ROI). Many business plans have speculative financial projections / proforma, where the business has not broken ground and there is no proof of concept, whereas a properly structured investment looks very different.
Structuring a business to get funded falls under forensic accounting and business development. It might sound like a great business plan to most, but it must be executable and work realistically within the proper and realistic financial modeling.
When a business plan is pitched, and the investor is interested, there is often a letter of intent or engagement that occurs. The process of the relationship then enters a period of diligence or Due Diligence. During this process, not only must the legitimacy of the business plan be proven out by experts, financial analysis and risk modeling, but the facts that are presented about the project and the legitimacy of the “governance” or management team / applicant must be scrupulously verified.
Many investors and hedge funds will not even accept a business plan that is not properly structured.
Many times, investment bankers and consultants (or investment consultancies) will be an intermediary between the source of funds and the client-applicant to help vet both sides, mitigate expectations, and to help hire necessary support to properly structure a business plan so that investors can and will invest in the project.
While there are many cases of “up-front fee” fraud committed every year, structuring costs do no fall in the category of “up front fees”, but are actually necessary in order to turn most business plans into an actual viable, investable structure that fits the specific criteria of an investor or fund.
Additionally, structuring costs are not going to be covered by the investor, who is already taking the majority risk. It is customary and expected that an applicant or governance (management team) of a business pay the necessary costs of due diligence and structuring costs in order to get proper access to private capital.
In all cases, due diligence costs money and professional man-hours to verify facts.
Additionally, professionals such as Forensic Accountants, SEC attorneys, and other professionals such as MBAs are necessary to investigate and verify the proposed funding needs, financial operational model, funding structure, tax implications to the investor and governance, and the business & market veracity, among other technicalities, before a single dollar is released.
Due Diligence and Proper Structuring are required for any project being presented to a private investor or hedge fund for many reasons:
1- It helps reduce the risk to the investor, since the investor is taking the majority risk, not the applicant
2- It is necessary for creating the proper financial structuring of the business into an investment grade vehicle that is appetizing to the investor or properly aligned with the criteria & standards of the hedge fund
3- It protects the applicant and investor from fraudulent transactions.
4- It uncovers the need for proper corporate restructuring to align with the financial & business goals for the growth of the business.
5- It is required to re-create the realistic financial operations so the fund or investor can clearly see actual projected ROI.
6- It uncovers and corrects any other legal or tax implications that could be detrimental to the business, investor, or the governance (management team).
In simple terms, almost all business plans presented to investors are not in the proper financial and legal form to be invested in, and they need fixed or corrected by qualified, highly skilled professionals including SEC attorneys, specialized and forensic accountants, and qualified MBAs.
Only a handful of very qualified individuals know how to properly restructure these business models into a legal and financial operational structure that can receive proper investment funding. These individuals must be sourced and paid to take a business plan model and structure it properly so that a private investor can have a level of confidence and comfort. Likewise, when these individuals restructure a business plan to approach a hedge fund, their work consists of fixing everything in the plan so that it is 100% compliant to the fund’s criteria in order to get funded.
Once all of the criteria are met, the funding can occur.
In essence, structuring must be done to most business plans to suit the financial goals and mitigate / navigate tax implications for the private investor, or they are corrected and restructured to meet the funding criteria of a hedge fund.
One example of a common mistake many people do is to create an LLC for a small business. In order to structure many projects, they may have to be structured as a C-Corp in order to be a forward thinking company that can grow into a larger company to meet the financial goals that are modeled / projected to the investor or fund. The LLC is a structure that gives immediate benefits to a sole owner, but may not be good for a future phase of the business when it grows. Proper structuring takes into account the life phases of the future of a business as a growth vehicle for all involved, especially the investors or hedge funds.
Most of the critical fixes that business plans need are in the areas of governance, company structure, collateral, financial condition of the company (audits), and viable exit strategies.
Most business plans have flaws in many or all of these areas.
A lot of the structuring strategy may be based on the actual value of the company, cycle of business it is going into. . . all aspects of the life of the business. A lot of projects are in line with the expectations of the client, but it must be looked at from the investor’s perspective.
It’s not just the ROI, but the future value of the business that is critical to the investor as well.
Most business plans use speculative projections of what they dream the business will be worth after a set period of time. Business plans often give projections in idealistic terms, whereas investors want to see the financial operations and risk modeling in reality. From an investment banker’s perspective, the funding party wants to see the true business summary in how it becomes a legal investment entity – and the investment analysis – what kind of an investment it is going to be. Clients almost never provide the true business summary and the investment analysis the way an investor can interpret it as a viable operational financial model or investment grade vehicle.
Professional structuring fixes all of these issues.
The business summary that investors need to see addresses what is actually needed, i.e. the exit strategy (how they will get their money back), collateral, governance (people that control the company), P&L based on actual financial operational models and proof of concept. Many times, the investor wants to give the money to the project, but the background of the managers (governance) is not proven to be capable of handling the money and the responsibility. A lot of investors will utilize an investor consultancy because they vet out the projects based on these key factors.
If business plans are not properly structured, they are either fixed at a realistic cost to the applicant or they are rejected and never reach the investor or hedge fund manager.
In nearly all cases, the business plan must be run through the mill and finely tuned, such as with an investor consultancy, before it can gain the confidence of an investor or fund manager. Since most business plans do not meet the criteria of an investment grade product, clients are charged a structuring fee so that their business plan can be fixed in order to have the best chance at being funded by private sources.
The bottom line is that nearly every business plan that is pitched is a model, an idea on paper, and they almost always have to be fine-tuned or “financially engineered” to suit the investor or to meet the criteria of the hedge fund. Proper structuring costs time, specific expertise and money, and it is customary that the serious applicant be informed and ready to invest in his or her business idea by being prepared to pay professionals for proper structuring in order to obtain private funding.
5th Avenue Capital is in the business of aligning private capital and equity sources from $1Million to $1Billion with the appropriate project for funding. If you have a business plan or acquisition that needs private funding, or you have a project that needs structured so that it can be funded by a private investor or hedge fund, please contact us.
