Raising Equity Capital: Part 3 of 4


This is Part 3 of 4 Parts

Warning: There is a considerable amount of information here and in the other sequential Parts concerning the process and issues involved in raising equity capital. I understand how important this information is to you when making up your mind as to who can best help you with the expansion of your business. Consequently, as the guide covers a lot of ground, expect a long read.

Part 3: The mechanics of the process

The Class Order Compliant Document: your offer information statement

Speed & flexibility. Through Class Order 02/273, I can process your equity funding requirement relatively quickly, much more quickly in fact than the process of preparing and registering an expensive prospectus or product disclosure statement with ASIC. In the place of the expensive prospectus, I personally prepare a Class Order Compliant Document (COCOD), so named because it complies with the terms of ASIC Class Order 02/273. ASIC Class Order 02/273 contains the regulations that govern my work to raise equity capital on your behalf.

The COCOD. The COCOD sets out broad details of your company, your business objectives and how you will achieve them, the anticipated financial returns and details of your equity offer to investors. It further identifies for investors your company’s corporate structure and commercial governance requirements, and includes other important information such as board representation, senior management experience and financial performance.

The COCOD is a complementary document to your business plan. Occasionally, they can be combined into one document for convenience.

The Class Order Compliant Document: preparation

The process is this: Based on detailed discussions with you about your broad longer-term commercial objectives, I initially help you to identify the key elements necessary to enhance an equity raising program designed to achieve those longer term commercial business objectives. These key elements will include, but not be limited to:

  • the amount of equity capital to be raised,
  • the type of shares to be issued,
  • the number of shares to be allocated to investors,
  • the number of shares to be retained by the foundation shareholders, and
  • the offer price to be asked for the sale and purchase of these shares.

Obviously, these key elements cannot be determined with any credibility until we finalise your business plan and the associated financial forecasts and projections.

Let’s look at an example of how this works. Say we determine after evaluation of your venture that your company needs to raise equity capital of $2,000,000. These funds could be raised through the sale of 2 million Ordinary Shares at an issue price of $1.00 per share. The funds could just as easily be raised through the sale of 20,000,000 shares at a sale price of $0.10 cents per share.

Share price flexibility. The funds could also be raised through the issue of a combination of Ordinary Shares and Convertible and/or Redeemable Preference Shares. The use of Convertible and/or Redeemable Preference Shares is explained elsewhere in my website, see my webpage Debt SecuritiesThe decision concerning the initial share price offer however, has important managerial implications that you need to carefully consider. I will come back to this point shortly.

Investors’ shares. Having determined the number of shares to be sold to raise the equity funds needed, you will then have to decide how much equity in your company you will need to give to the investors in return for their financial contribution. This is a very difficult question to answer. In the first place, you cannot definitively answer the question without finalising your business plan’s financial forecasts and projections. In the second place, the higher the percentage of shares that you allocate for investors (which is the equity in your company you are offering investors), the more financially attractive your equity offer will be to investors.

Importance of investors’ ROI. The venture’s forecast profit levels will heavily influence this percentage figure. This is important because you have to keep in mind that most professional investors will want a certain minimum rate of return that will generally lead to their exit from your business (either in part or in full) after anything from three to five years. Some investors of course will stay much longer, but for business planning purposes, you should work on the assumption that the investors will want to retire from the investment in your company in three to five years time.

Prepare for investor exits. During this period, you need to take appropriate action so that you can pay out the investors at their nominated point of retirement. There is no ‘best way’ to deal with the retirement of investors. It’s a decision that will depend upon the circumstances existing at the time.

Investors should get new shares

When you come to sell shares to an investor, you will create new shares, so although your own equity percentage in the company will reduce, your number of shares held will remain constant. This does not mean that your share value is reduced. When Bill Gates started Microsoft, he was reputedly a 48.5% shareholder in a company operating from his parents’ garage. Over the years, as equity funds were raised to finance Microsoft’s expansion, his equity percentage reduced, but his number of shares owned remained substantially constant.

Today, his percentage equity shareholding is probably miniscule in comparison with the total number of shares issued by Microsoft, yet it makes him one of the richest men in the world.

Valuing your venture to support your equity offer

Are you still with me? Wow, is this stuff heavy-going or what? And we’re not finished yet by a long-shot. But take heart; this is all information that is vitally important if you are genuine about pursuing an equity raising program.

Let’s return to the decisions concerning the amount of equity to be raised, the type and number of shares to be issued, and the price to be asked for the sale and purchase of these shares. I said earlier that these decisions have important managerial implications for you that need to be carefully considered.

Venture notional valuation. The relevance of these decisions is that they are based on a notional valuation of your company or venture that must support the equity raising. This notional value does not purport to be a formal (accountant’s) valuation of your company or venture as it stands now or in the future. It is simply a process to establish a practical foundation for the determination of the base ‘value’ of the company in terms of the number and value of the shares to be created or issued.

The notional valuation is important to investors. From the decisions concerning the amount of equity to be raised, the type and number of hares to be issued, and the price to be asked for the sale and purchase of these shares, we can notionally value the company by multiplying the number of shares to be issued issued (including your own) by the price paid by investors for their shares. The importance of this figure is that it is an influential factor to potential investors. If the notional valuation is set too high in relation to the size of the investment, that will naturally be a turn-off for investors.

Keep your long term future in mind. There is another interesting point here that you must consider. Where your venture has a high growth potential that could lead to an eventual stock exchange listing (IPO) for your company or a takeover by a larger expansionist company, it would be more beneficial to you in the long run to keep the sale price of the shares as low as practicable so as to create the maximum number of shares.

If an IPO or a takeover becomes an attractive business proposition at some point in the future, the large number of shares will help maximise the long-term capital growth of your company as well providing you personally with the opportunity to ’cash-in’ and reap a substantial financial reward for the ‘blood, sweat & tears’ that you put into the business. Accordingly, the business options I suggest generally reflect an initial share value of between 5 and 20 cents per share.

Foundation shareholders rewards

Founders’ rewards. A very important point that seriously impacts upon your hip pocket nerve must be highlighted here. Equity funding through this process is the only funding process that allows the foundation shareholders (i.e. you and any colleagues who have developed the venture to this point) to be paid a premium for the ‘blood, sweat and tears’ that you have put into the venture’s evolution to the present day.

Debt funding. Traditional business funding through bank, finance company or private sources borrowing will not give foundation shareholders any financial benefits or credit for their business development efforts to date. Bank or finance company borrowing is of course based on concepts of ‘bricks and mortar’ collateral, and entrepreneurial companies in their early stages of growth generally do not have much to offer by way of physical assets that can be used as collateral for loans. In any event, debt or loan funding will never fully reimburse business owners for the blood, sweat and tears poured into a business venture.

The Exclusive Appointment to Act Agreement 

Accountability in equity raising activities. I have earlier mentioned the importance of formally appointing me as your equity raising consultant. There are some significant technical reasons for my making that recommendation to you. I explained to you that I work under ASIC Class Order 02/273, which imposes a number of duties and responsibilities on me. Those duties and responsibilities include the fact that I must accept accountability for ensuring that equity raising activities in which I am involved are conducted lawfully. In order to effectively carry out equity raising activities therefore, I must have effective control of the equity raising process.

Operating agreement. This means that I need to be given an Exclusive Appointment to Act Agreement by you. In formal terms, this Exclusive Appointment to Act Agreement appoints me as your consultant to prepare a COCOD for the issue of the securities (shares), and then to undertake the subsequent marketing of your equity offer.

Necessity for formal appointment. This Exclusive Appointment to Act Agreement is vital. Its importance lies in the fact that it is the key document that provides me with two things. The first is that it confirms my role as a business matchmaker under ASIC Class Order 02/273 and secondly, it provides the basis for my exemption from having to comply with the Australian Corporations Act 2001 in respect of raising equity capital for your venture. It is the document that I would have to produce to ASIC if there was a challenge to my fund raising activities under ASIC Class Order 02/273 or ASIC conducted an audit of my activities.

Nothing can happen without the Exclusive Appointment to Act Agreement. Specifically, the Exclusive Appointment to Act Agreement is an agreement between you and me that enables me to commence the equity raising program through the issue of a COCOD. It enables me to make offers to the public at large to invest in your business. ASIC has set some parameters for my fundraising activities on behalf of clients, and I will come back to this point later. For now, let me just say that because of the strict rules set by ASIC Class Order 02/273 and S.708 of the Australian Corporations Act for corporate fundraising (and there are some built in regulations in the system designed to protect both companies seeking equity capital and investors seeking opportunities) it is important that I am in a position to retain overall control of the fund raising process.

It’s a question of control. If I don’t have control, and others are involved, breaches of the fundraising regulations may occur without my knowledge. In that circumstance, I would be the one accountable. In a worst case scenario, I could lose my ability to work in this field if the breaches were serious. This does not mean that you or your friends and colleagues cannot assist in the equity raising process; it just means that we all have to work together under my co-ordination to make sure that all the fundraising regulations are followed.

The business plan & the COCOD

Your business plan. To draft the COCOD, I would need access to all relevant documentation and information that may be able to be used advantageously in promoting the equity offer. It is important that the COCOD co-ordinates very closely with your venture’s formal business plan, because a venture capital firm or private investor will expect to receive both documents. It is therefore important that your business plan be comprehensive, and of a standard expected by venture capital firms and private investors.

Your business plan must be investor friendly. On that point, business plans prepared in-house by business owners and entrepreneurs often do not meet venture capital firms and private investor requirements. It’s not so much that the business plan will be wrong in some way – it’s more a question of ensuring that all information relevant to an investment analysis is included and how that information is presented advantageously so that it reflects venture capital firms’ and private investors’ expectations. In-house writers are not always au fait with venture capital firms’ and private investors’ investment criteria and information requirements, and this factor can be crucial in whether your funding proposal is initially accepted for review or not.

Your business plan must be comprehensive. The comprehensive business plans that I prepare are generally quite substantial documents. This is because the business plan has to pre-empt investors’ queries by answering investors’ questions before they even take form in the investor’s mind. If an investor has to ask many questions about a venture after reading the business plan, it suggests to the investor that the business owner or entrepreneur is not across the detail of their own venture and this can have fatal consequences for the funding proposal.

… this is the end of Part 3: where would you like to go next? Please select from the following options: 

Yours sincerely,

Graham  Segal

Chiron! the business doctor.™ ... relieves business pain!™ 


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© Graham Segal, Author. March 2013. All Rights Reserved

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This website and the associated webpages content are produced by Graham Segal trading as Chiron! the business doctor.™. They are licensed under a Creative Commons Attribution-NonCommercial-NoDerivs 3.0 Unported License based on Graham's work at https://chironthebusinessdoctor.com.

Date this webpage last reviewed/updated: 5 May 2013

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