Copyright © 2007 by John Wiley & Sons, Inc. All rights reserved Chapter 11 Crafting and Negotiating...

Copyright © 2007 by John Wiley & Sons, Inc. All rights reserved

Chapter 11

Crafting and Negotiating the DealCrafting and Negotiating the Deal


Chapter Overview

• The Business EntityThe Business Entity

• The Debt-Equity MixThe Debt-Equity Mix

• Negotiating LoansNegotiating Loans

• Negotiating the Equity InvestmentNegotiating the Equity Investment


Business Entity Selection

• Key issues to consider:Key issues to consider:

– The ability to easily add outside investorsThe ability to easily add outside investors

– Liability protectionLiability protection

– Tax advantagesTax advantages

– Management controlManagement control


Sole Proprietorship

• Only one ownerOnly one owner

AdvantagesAdvantages DisadvantagesDisadvantages

Simple and inexpensive to form Simple and inexpensive to form Unlimited liabilityUnlimited liability

FlexibleFlexible Responsible for all lossesResponsible for all losses

Freedom to make decisionsFreedom to make decisions Expertise of only one Expertise of only one individualindividual

Freedom to make changesFreedom to make changes Resources of only one individualResources of only one individual

No red tape or bureaucracyNo red tape or bureaucracy Limited lifeLimited life

Keep all profitsKeep all profits

Profits are not taxed twiceProfits are not taxed twice


Partnership

• Formed when two or more persons or Formed when two or more persons or entities come together as co-owners of a entities come together as co-owners of a businessbusiness

• A partnership is a legal entity that can own A partnership is a legal entity that can own property, borrow money, and take actions property, borrow money, and take actions just as individualsjust as individuals

• A partnership can sue or be suedA partnership can sue or be sued


Types of Partnerships

• General PartnershipGeneral Partnership

– Unlimited personal liabilityUnlimited personal liability

– Mutual agency allows one partner to act on behalf of Mutual agency allows one partner to act on behalf of the entire partnershipthe entire partnership

• Limited PartnershipLimited Partnership

– Protects limited partners from personal legal liabilityProtects limited partners from personal legal liability

– Limits the ability of limited partners to participate in Limits the ability of limited partners to participate in the management of the businessthe management of the business


Partnership Advantages and Disadvantages

AdvantagesAdvantages

• Relatively easy to establishRelatively easy to establish

• Limited partners have limited liabilityLimited partners have limited liability

• Profits are not taxed twiceProfits are not taxed twice

• Relative flexibility in decision makingRelative flexibility in decision making

• Low level of bureaucracy and red tapeLow level of bureaucracy and red tape

• Share resources and expertise with partnersShare resources and expertise with partners

DisadvantagesDisadvantages

• Limited lifeLimited life

• General partners have unlimited liabilityGeneral partners have unlimited liability

• One partner can obligate the entire partnershipOne partner can obligate the entire partnership


Corporation

• Separate legal entity which can act on its Separate legal entity which can act on its own or on behalf of the shareholdersown or on behalf of the shareholders

• It can borrow money, acquire assets, and It can borrow money, acquire assets, and enter into legally binding contractsenter into legally binding contracts

• It can sue or be suedIt can sue or be sued

• Can be publicly or privately heldCan be publicly or privately held


Corporation Advantages and Disadvantages

AdvantagesAdvantages DisadvantagesDisadvantages

Continuous lifeContinuous life Double taxationDouble taxation

Limited liabilityLimited liability Relatively complicated to Relatively complicated to formform

Separate legal entitySeparate legal entity

Ease in raising capitalEase in raising capital

Ease in transferring ownership Ease in transferring ownership

Operated by a board of directorsOperated by a board of directors

Significant red tape and bureaucracySignificant red tape and bureaucracy


S-corporation

• Provides limited liability for the owners of Provides limited liability for the owners of the corporation and tax advantages to a the corporation and tax advantages to a partnershippartnership

• Profits are distributed directly to Profits are distributed directly to shareholders and not taxed at the shareholders and not taxed at the corporate levelcorporate level


S-corporation Qualifications

• Have 75 or fewer stockholdersHave 75 or fewer stockholders

• Be a domestic corporation that is not a Be a domestic corporation that is not a subsidiary of a larger companysubsidiary of a larger company

• Have only one class of stockHave only one class of stock

• Have only individuals, estates, and certain Have only individuals, estates, and certain trusts as shareholderstrusts as shareholders

• Have only US residents as shareholdersHave only US residents as shareholders


Limited Liability Company (LLC)

• Qualifications for an LLC are similar to an Qualifications for an LLC are similar to an S-corporation, except an LLC can haveS-corporation, except an LLC can have

– More than 75 shareholdersMore than 75 shareholders

– More variety of ownersMore variety of owners

• Avoids double taxationAvoids double taxation

• All shareholders enjoy limited liabilityAll shareholders enjoy limited liability

• Has a limited lifeHas a limited life


Debt and Equity Mix

• Borrower needs to calculate their equity position Borrower needs to calculate their equity position by following these steps:by following these steps:

– Calculate the maximum amount of money that can be Calculate the maximum amount of money that can be borrowedborrowed

– Subtract the loan amount from the project cost to Subtract the loan amount from the project cost to determine the amount of equity requireddetermine the amount of equity required

– Calculate the annual ROI and IRR and determine if Calculate the annual ROI and IRR and determine if they meet the investor’s hurdle ratethey meet the investor’s hurdle rate

– If they exceed the hurdle rates, the cash flow If they exceed the hurdle rates, the cash flow projections support a carried interest in the dealprojections support a carried interest in the deal


Common Loan Agreement Terms

• PrincipalPrincipal

• Interest rateInterest rate

• Points paid up-frontPoints paid up-front

• Length of loanLength of loan

• Amortization rateAmortization rate

• CollateralCollateral

• Personal loan Personal loan guaranteeguarantee

• Pre-payment penaltyPre-payment penalty


Terms of Lender Importance

• PrincipalPrincipal

– Lender wants to loan as much money as Lender wants to loan as much money as possiblepossible

• Interest rateInterest rate

– Price of the lender’s productPrice of the lender’s product

• Points chargedPoints charged

– A point is equal to 1.0% of the loanA point is equal to 1.0% of the loan

– Points raise the effective rate of interestPoints raise the effective rate of interest


Terms of Lender Importance

• CollateralCollateral

– Asset that the lender is asking the borrower to Asset that the lender is asking the borrower to put at risk in the event they default on the loanput at risk in the event they default on the loan

• Personal guaranteePersonal guarantee

– Allows the lender to look to personal assets of Allows the lender to look to personal assets of the guarantor to repay the loanthe guarantor to repay the loan


Other Lender Issues

• Terms of less importance to the lender Terms of less importance to the lender include:include:

– Length of the loanLength of the loan• Determined by the purpose of the loan, conformity

guidelines, and trends

– Amortization rateAmortization rate• Speed at which the borrower is required to repay

the loan

– Prepayment penaltiesPrepayment penalties


Negotiating the Equity Investment

• Deal sponsor’s goalsDeal sponsor’s goals

– Reduce the amount of equity they need to Reduce the amount of equity they need to raiseraise

– Reduce WACCReduce WACC

– Maximize their ROI and IRRMaximize their ROI and IRR

– Reduce the percentage of ownership given to Reduce the percentage of ownership given to investorsinvestors


Important Issues toEquity Investors

• Amount of EquityAmount of Equity

– Equity investors want to spread their money Equity investors want to spread their money and risk over several investmentsand risk over several investments

• Percentage of OwnershipPercentage of Ownership

– Investors want the highest amount of Investors want the highest amount of ownership for the least amount of moneyownership for the least amount of money

– The deal sponsor must receive their The deal sponsor must receive their ownership in the dealownership in the deal


Important Issues toEquity Investors

• Investor Hurdle RatesInvestor Hurdle Rates

– Probability of the investor’s ROI and IRR Probability of the investor’s ROI and IRR hurdle rates being achievedhurdle rates being achieved

• Exit StrategyExit Strategy

– Equity investors want to know the exit Equity investors want to know the exit strategy, timing of the strategy, and who strategy, timing of the strategy, and who controls the exit decisioncontrols the exit decision


Negotiating Skills

• Borrowers must be preparedBorrowers must be prepared

– Learn about the person they will be Learn about the person they will be negotiating withnegotiating with

– Understand the issues they are prepared to Understand the issues they are prepared to compromise oncompromise on

– Anticipate the questions of the lender or Anticipate the questions of the lender or equity investorequity investor


Negotiating Skills

• Borrowers must be professionalBorrowers must be professional

– Think and dress like a lender or equity Think and dress like a lender or equity investorinvestor

– Speak the lender and equity investor’s Speak the lender and equity investor’s languagelanguage

– Dress professionallyDress professionally


Negotiating Skills

• Burrowers must use proven selling skillsBurrowers must use proven selling skills

– Begin presentation with an initial benefit Begin presentation with an initial benefit statementstatement

– Always be alert to objectionsAlways be alert to objections

– ListenListen

– Utilize a trial closeUtilize a trial close

• Summarize the benefits of the deal and offer two favorable options

Copyright © 2007 by John Wiley & Sons, Inc. All rights reserved Chapter 11 Crafting and Negotiating...

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