Put Pencil to Paper Before Issuing Private Debt

You need to have an "Ask" when you're seeking to raise capital. Know how much you are looking for, and describe the terms under which you will be accepting investors. Going through the process of writing a term sheet will crystallize your Ask and help you better frame your capital raising efforts.

I see a lot of posts on forums where people are asking for investors to invest in their idea or business. Too often it appears that they haven't thought about what they are asking for. All you'll see is requests for a "partner", or promises of a good return.

The problem is that there is nothing to frame the conversation. Having an "Ask" will do that; and the best way to have an Ask is to sit down and draft a term sheet. A term sheet will force you to articulate the type of deal you are willing to strike. And more importantly, your prospective investors now have something to judge whether your terms match up with their risk profile. (Your term sheet is not a stand-alone capital raising document, but a part of your Private Placement Memorandum, or PPM.)

And, don't fall into the trap of leaving it up to the investors to tell you what they want - you'll end up with as many different structures as prospective investors you talk to. Beside, they'll still tell you what they want, but when you define the terms, at least you will have framed the conversation.

For example, if you are looking to issue debt (yes, you are issuing a security when you raise capital), there are several pieces of information that should be incorporated, as well as terms you will need to think about.

First don't assume that your investor knows about your company. Tell them who the Issuer is and how it is organized. You may want to state something like - "Blue Widget, Inc. is an Ohio corporation. All references to "Issuer", "we", "us", "our" or "BWI" refer to Blue Widget, Inc."

How much capital are you looking to raise? You'll want to state a range of how much you are looking for. Make sure your minimum is sufficient to achieve your overall objectives for raising the capital in the first place. For example, if you need $300,000 to expand your facility to meet increased demand, don't set your minimum at $200,000 unless you address how you plan to meet the gap.

Be clear about why you are seeking to raise capital. Your investor will want to know what you plan to do with the money you raise, so state the purpose of your capital raising efforts. Are you expanding your facility; making an acquisition; paying off other debt that's coming due; purchasing new equipment? Whatever it is, state the purpose clearly and succinctly. It doesn't have to be more that a few sentences. You'll go into more detail in your PPM.

Some of the salient terms you should address include the interest rate you are willing to pay on the Notes. Whether the interest rate is paid in cash, accrued, or a combination. How often the interest is paid - is it paid monthly or quarterly? Will the interest rate be fixed or will if float at some spread over an index such as Prime?

Will your Notes be secured or unsecured? The answer to this question will have implications on the rate of interest you will have to pay. One thing lenders (whether private investors of institutions like a bank) want is protection of principal - they want to make sure they can get their money back. Having collateral gives the lender comfort that if the business cannot afford to repay the loan, they can liquidate the collateral for repayment. No collateral means higher risk, which means a higher interest rate.

If your Notes will be secured, you will need to describe what the collateral is and whether the Note holder(s) will be in a primary position or in a secondary position.

How will your Note be repaid? Don't think all Notes are repaid on a fixed, monthly schedule basis. You have a lot of options when it comes to repaying your Note. You can have scheduled installment payments that amortize the loan on a monthly or quarterly basis over the term of the loan. These payments do not have to be in equal installments. For example, you may want to have lower quarterly payments in the first couple of years of your loan, and higher installments in the later years. You can also structure your Note so that there are no scheduled payments, but the repayments come out of some percentage of the Issuer's free cash flow. Or, you can pay interest only and have a balloon payment at maturity.

This just scratches the surface, but you can see that there are plenty of issues to think about. When you sit down to write your term sheet, you have a clean sheet of paper. Just make sure that it works for you and for the investors.