Center for Management of Emerging Companies

Emerging Company Capital Raising Under New JOBS Act

Extensive, and somewhat controversial, changes were made in the regulatory framework for financing of emerging growth companies when the President signed the ‘‘Jumpstart Our Business Startups Act’’ (“JOBS Act”) into law on April 5, 2012.  This report describes some of the main features of the JOBS Act, which includes easing requirements for going and being public, permitting “general solicitation” of investors in Rule 506 and 144A offerings under certain conditions, creating a new “crowdfunding” procedure to allow issuers to raise up to $1,000,000 if extensive disclosure and reporting obligations are satisfied, creating a new exemption that parallels existing Regulation A that would facilitate raising up to $50,000,000 in capital and increasing the maximum number of shareholders for private companies to 2,000.

Financial Support for New Businesses in Israel

A group of Israeli experts ranked the area of financial support in Israel for new businesses higher than all of the other countries included in the global survey of entrepreneurship conducted by the Global Entrepreneurship Monitor (GEM) in 2007 and this report provides an overview of the availability of equity funding and credit for new and growing companies in Israel.

Seed Financing from Wealthy Individuals and Angel Investors

Wealthy individuals have always been benefactors of fledgling businesses, particularly when a company is involved in an area in which the individual has substantial prior experience.  In addition, so-called “angel” investors, who are high net worth individuals, often businesspeople or professionals with high incomes or individuals from wealthy families, may have an interest in participating in high-risk/high-return investment opportunities.  This report provides an introduction to some of the key characteristics of angel investor preferences and contributions to a firm and describes several financing structures might be appropriate for the company and the members of an angel investor group.

Evolution of the Finance Function

The role, size and organizational structure of the finance function will change dramatically as the company evolves and expands it operations into multiple business units and launches activities in new geographical areas.  Learn more about the evolution of the finance function in this report.

Summary of Terms and Conditions for Commercial Syndicated Loan Transaction

In my last post I discussed the content and negotiation of an engagement letter with the lead bank in a commercial syndicated loan transaction.  I mentioned that one of the key elements of the engagement letter is a proposed summary of the terms and conditions of the credit facility which will have been negotiated during the period prior to the signing of the engagement letter and should be attached as an exhibit to the engagement letter. While some parties will use a short-form summary of terms and conditions and provide that everything else will be "as is customary," the better practice from the borrower's perspective is to insist on a detailed description of the proposed provisions in those areas that are of greatest concern to the borrower. The time to iron out potentially sticky issues with respect to covenants and borrowing base is before the engagement letter is signed, not afterwards. In fact, counsel for the borrower may demand that certain key definitions, such as the definition of "accounts receivable" and "inventory" for the borrowing base, actually be agreed on in advance and included as an appendix or exhibit to the summary of terms and conditions.

Regardless of its length or level of detail, the summary of terms and conditions of the credit facility will usually cover the same standard set of issues and terms. Obviously, the size of the credit facility (i.e., the maximum amount that can be borrowed) will be specified along with the term of the facility and the identity of any guarantors (e.g., a parent of the borrower and/or material subsidiaries of the borrower). The fees and expenses associated with the credit facility, including the interest rate, commitment fees and other charges, should be set out in detail. The availability of sub-facilities for letters of credit and foreign currency loans should also be described. Reference will be made to the collateral for the loan, typically accounts receivable and inventory of the borrower meeting specific conditions established by the lenders. Financial and operating covenants should also be described in the terms and conditions, and this is an area where the borrower may also require more detailed language to ensure that it understands all of the restrictions that might be imposed on the operation of the business while the loan is outstanding. The borrower will be required to prepare and submit various financial reports and notices and certifications relating to the events associated with its business and the value and condition of the borrowing base. Finally, the terms and conditions will touch on the circumstances that might trigger acceleration of payment of the outstanding balance of the loan (e.g., default by the borrower or bankruptcy or other material adverse change in the business or financial condition of the borrower).

The engagement letter, as well as the summary of terms and conditions, will include a list and brief description of the key conditions precedent to the obligation of the lenders to close the credit facility. In addition to completion of the due diligence investigation, the results of which must be satisfactory to the lenders, it is common to require an audit of the proposed collateral for the loan (i.e., accounts receivable and inventory), updated financial information, an opinion of counsel for the borrower, certifications from officers of the borrower regarding various factual matters and the absence of any material adverse change in the financial or business condition of the borrower and completion of arrangements to pay off certain existing debts of the borrower. In addition to the credit agreement, the parties will need to negotiate, prepare and execute the documentation necessary to perfect the security interest of the lenders in the assets of the borrower. If there are existing liens on those assets, they will need to be removed or, in some cases, subordinated in accordance with documentation satisfactory to the lenders.

Negotiating the engagement letter and summary of terms and conditions can take several weeks, or even months, depending on the number of prospective lenders involved and the urgency for the borrower in enlarging its credit facility. It is generally a good idea for the borrower to begin the process well in advance of the termination date of an existing credit facility to allow sufficient time to consider all the alternatives. Once the engagement letter and summary of terms and conditions have been finalized, the syndication process moves forward and the borrower will provide information to prepare a disclosure document, sometimes referred to as a "bank book," that will be circulated to prospective syndicate members. Prospective syndicate members will attend presentations by the senior managers of the borrower; and, as the syndicate comes together, discussions will occur regarding the proposed terms and conditions. While hopefully the terms and conditions in the final credit agreement will mirror those described in the summary, the engagement letter will make it clear that the final terms and conditions will be determined by negotiations with the other banks. If it appears that there will be problems putting together the syndicate based on the terms and conditions in the summary, the lead bank may return to the borrower to discuss necessary changes; however, the borrower would not be obligated to accept those changes nor would the lead bank be liable to the borrower if the marketplace is unwilling to agree to the terms and conditions demanded by the borrower.

The content in this post has been adapted from material that appeared in Business Counsel Update (October 2006) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

Drafting Engagement Letters with the Lead Bank for a Syndicated Loan

In my last post I began discussing the process of organizing and closing a syndicated commercial loan with a focus on selecting the lead bank.  In this post I will provide details on the first document in the syndication process: the engagement letter between the company, referred hereafter as the "borrower," and the lead bank, referred to hereafter as the "primary lender." The engagement letter typically covers several key issues and will be accompanied by a detailed summary of terms and conditions (to be discussed in my next post) reflecting negotiations between the primary lender and the borrower leading up to the execution of the letter. First of all, the engagement letter should refer to the size and type of credit facility, such as a revolving credit facility in a maximum amount of $100 million. The primary lender will make it clear that the letter is not intended to be a binding commitment and that the summary of terms and conditions should not be relied on as the definitive description of the terms and conditions that would be included in a legally binding credit agreement. At best, the primary lender can only advise that it intends to seek credit approval for that portion of the total amount of the revolving credit facility that it intends to underwrite on its own. The remainder of the commitment would need to be underwritten by other financial institutions interested in joining the loan syndicate and entering into the credit agreement.

The second issue that will be dealt with in some detail in the engagement letter is the activities that will be undertaken by the primary lender with respect to syndication of the credit facility. The primary lender will serve as the lead arranger of the credit facility and will assume management and control over all aspects of the syndication, including decisions as to the selection of proposed syndicate members (and any titles offered to proposed lenders such as "co-lead"), when commitments will be accepted, and the final allocations of the commitments among the lenders. The primary lender would have exclusive rights to act on behalf of the borrower during the period that the engagement letter remains in effect. While the language generally provides that the primary lender will have the right to form the syndicate, as a practical matter, the borrower will generally have the ability to veto any proposed members and will also have the ability to provide input to the primary lender regarding other banks that the borrower would like to have included as part of the syndicate. In fact, the engagement letter or the terms and conditions will include a statement that the members of the syndicate must be "reasonably acceptable" to both the primary lender and the borrower.

The primary lender will receive a fee for acting as the lead arranger and the terms and conditions of payment of this "agent's fee" are often laid out in a separate fee letter executed at the same time as the engagement letter. In addition, the primary lender will generally also have the right to act as the "administrative agent" for the credit facility once it is in place. The administrative agent manages all aspects of the credit facility, including communications with members of the syndicate to coordinate the fulfillment of their obligations under the credit facility. The administrative agent is also entitled to a separate fee for such services on top of the interest and commitment fees that must be paid to all members of the syndicate on a pro-rata basis in relation to their commitment.

The third, and related, issue is the obligations of the borrower during the syndication process. Obviously, the cooperation of the borrower is crucial to the success of the syndication, and the engagement letter will usually set out several general duties and responsibilities for the borrower, including assistance in preparing an information memorandum to be circulated to potential syndicate members and making its senior officers and managers available to participate in due diligence meetings during the period that negotiations are being conducted to fill out the syndicate. As with any deal and memorandum process, the primary lender will deliver a due diligence checklist to the borrower that will describe the items the primary lender needs for the memorandum and preparation of the credit agreement. The primary lender will also prepare a calendar of activities that will establish milestones leading up to a projected closing date. The target closing date is generally thirty days prior to the termination of the engagement letter to allow for unforeseen delays in filling out the syndicate and/or finalizing the credit agreements.

Finally, the engagement letter will include several representations and warranties from the borrower for the benefit of the primary lender and other prospective lenders as well as an undertaking to indemnify the beneficiaries of the representations against damages they may suffer in the event that the representations turn out to be untrue. Obviously, the borrower will be required to represent that all information, financial or otherwise, provided to the primary lender and the prospective lenders was complete and correct in all material respects and did not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements contained therein not materially misleading under the circumstances. In addition, the borrower should confirm that there are no other fees or payments owed to any third party with respect to the completion of the syndication process. The indemnification rights will survive termination any closing of the credit facility. 

The content in this post has been adapted from material that appeared in Business Counsel Update (October 2006 and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

Syndicated Commercial Credit Arrangements

For many companies, the primary source of funds for working capital is a credit arrangement with one or more commercial lenders. When the company is small, it will deal with a single lender, typically a local bank, and the documentation associated with the loan will be relatively straightforward. For example, the president and/or chief financial officer will discuss the terms of the loan with one of the bank's loan officers, and the parties will reach agreement on a short summary of terms of the proposed loan before entering into a formal loan agreement accompanied by a promissory note and security agreement. The documentation will be based largely on the bank's standard forms with few, if any, changes; and the closing of the transaction normally occurs fairly quickly. As the company grows, however, its capital requirements may expand significantly and exceed the amount that any single bank is willing to lend on its own to a single borrower. At that point, the company will be faced with seeking a loan from a syndicate of banks who combine their financial resources to extend the necessary credit to the company. It should come as no surprise that the syndication process may be lengthy and that the documentation involved increases significantly.

The first step in the process is locating and interviewing prospect candidates to serve as the "lead bank," which is the bank that will be responsible for making sure the loan syndicate is formed and that will be most involved on a day-to-day basis with the company once the loan has been funded. If the company already has an existing banking relationship, it may be appropriate for that bank to serve as the lead bank assuming that the company is satisfied with the service that it is receiving and the bank is able and willing to complete the syndication process. This type of arrangement may be necessary when the capital requirements of the company outgrow the credit limits that the bank is willing to offer to a single customer. In some cases, the company may seek a different bank to lead the syndication if it believes that other banks are better positioned to meet the needs of the company in the future. For example, a change may be warranted if other banks offer more sophisticated technology or the ability to make and service loans in foreign countries in which the company intends to expand its business. If a change in lead bank is made, the existing bank may nonetheless continue to work with the company as a member of the syndicate, although its role will be much more passive.

Even if the company intends to stay with its existing bank, it should generally take the time to interview at least three or four candidates to get some idea of the prevailing economic terms in the marketplace and have an opportunity to get to know the personnel who would be responsible for the relationship with the company. In most cases, the company can use this period to negotiate specific terms of the loan, such as the interest rate structure and the covenants, and may want to elicit proposals from several banks that can be used to improve the terms offered by the preferred bank. At the end of the process, a bank will be selected; and the focus of attention then turns to the syndication process. At that point, the bank will bring in a team from its syndication department that specializes in carrying out the various tasks associated with putting together a bank group, and the company will find itself doing many of the things that might be expected of a company looking to sell securities to the public or to sophisticated private investors. It is a time-consuming process that requires the attention of the company's finance and legal groups and participation from other members of the senior management team who will be called on to explain their roles and the outlook for the company's business to prospective members of the loan syndicate.  In my next post I’ll discuss drafting the engagement letter with the lead bank.

The content in this post has been adapted from material that appeared in Business Counsel Update (October 2006) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

The Budgeting Process

The budgeting process is an essential element of strategic business planning that involves the development of the goals and objectives of the company; the formulation of specific department and overall organizational budgets; and the reporting and follow-up of budget variances and revisions.  The goals and objectives of the company should, of course, be based on an assessment of the marketplace, the operational activities and strengths of the company, and the long-term business objectives of the stakeholders of the company.  These goals and objectives are needed in order to give direction to the budgeting process.  Operational objectives could include such things as controlling inventory levels and carrying costs and, if so, the budget should include all the indicators necessary to monitor inventory-related performance.

Analysis of variances is absolutely necessary to evaluate the integrity of the budgets as well as overall performance of organizational operations.  By identifying and analyzing material variances, management can determine if the budget needs to be revised and/or other operational decisions are required.  In order for the budgeting process to be most effective it should be done on a continuous basis as opposed to episodically or once a year so that the budget becomes a tool for regular feedback and improvement. 

Fixed budgets are generally used in situations where the sales volume of the company is relatively stable and predictable.  Fixed budgets are based on the estimated or standard unit costs, selling expenses and administrative expenses that correspond to a specific projected volume of sales.  A fixed budget serves as a profit plan--assuming that the estimated costs and expenses are less than the projected sales revenues—and can be used as the basis for cash flow forecasting; however, the utility of a fixed budget depends heavily on the accuracy of the assumptions regarding sales volume.  Accordingly, if the actual sales volume differs substantially from the projections, either due to unforeseen circumstances or faulty assumptions, then a fixed budget will immediately require modification—particularly if sales are depressed and cost cutting is needed in order to avoid substantial losses.

The alternative to a fixed budget is a flexible, or variable, budget.  This type of budget is useful for controlling expenses and evaluating managerial performance.  Development of a flexible budget begins with allocation of expense items to three different categories: fixed, semi-variable and variable.  Each expense item has its own specially developed formula that is used to forecast costs and expenses based on the actual level of sales or production.  Allocation of expense items and development of formulae can be a challenging process since it is often difficult to determine whether an expense is fixed or variable or choose whether the formulae should be based on sales or output.  However, the time and effort invested in creating a flexible budgeting process is generally comparable to that associated with a fixed budget if one factors in inevitable modifications to the original fixed budget in light of actual operational performance.  In fact, flexible budgeting is probably the preferred approach for smaller companies that are growing since there is bound to be unpredictability with respect to sales and output and the inherent flexibility lends itself to the management of change that is so necessary during the earlier stages of the company’s development.