ou are now 18 months into your new venture. You have made some mistakes but at last you have your first satisfied customers, some new products are nearly ready to add to your first offerings, and you are beginning to attract the attention of the business press. Jeb has taken on a more strategic role in the company while you have focused on operations. He has convinced you that you need to lease some expansion space to accommodate your impending growth. He happens to have an aunt that has space available and that is reasonably priced. Although you have probably taken on more space than you will need for at least two years under even the most optimistic scenario, you both have just signed a five year lease.
You both realize that you will need some more cash to fund the business; in fact it looks like you will need up to a $1 million within six months. Jeb has spoken with the bank and they indicated that they will provide a line of credit for half this amount if a) you and Jeb use your houses as collateral to secure the debt, and b) you raise the other half of the needed cash from equity. Jeb suggests that he approach his Aunt Marie again, as she just might be interested in making an equity investment. You both meet with her. She is clearly a shrewd businessperson and sees that your company may be an interesting investment. She immediately picks up that your weakness is the thinness of the management team, and suggests that you find someone with experience to take over the sales management role while you go back to doing what you are best at – product innovation and mentoring new hires. In fact, she has a close friend, Alex, who may be the perfect fit – she suggests that you take a look at him for the role. Alex is the sales manager for a direct competitor called “Great Guns” located in a nearby town. He is willing to join your company as he is “disenchanted with the management at Great Guns” and your company offers an upside if you are willing to provide him with some stock rights in the company. He is willing to take a salary cut in moving.
Jeb is enthusiastic about this hire; you feel that his judgment may be clouded a little by the need to get the funding. When you meet Alex alone, you are not entirely comfortable with him, but you cannot find any real reason why he could not have done a good job, and frankly, you are getting really frazzled with the 16 hour days that you are putting in. Alex can relieve the stress immediately.
a) Do you agree to hire Alex? Provide your reasoning. If yes, how would you structure his compensation package at this stage of the company? If no, how would you handle the situation with Jeb? His Aunt Marie? You still need a sales manager; what would you do to find and hire an alternative to Alex?
Whether or not you hire Alex you still need to sell $500,000 of equity in the company, and Jeb’s Aunt Marie hasn’t made any firm commitments one way or the other. A couple months go by, and through a chance meeting at a local fund raiser for the area Humane Society animal shelter you make the acquaintance of Dr. Lucas Furber, a noted orthopedic surgeon who has built a highly successful sports medicine clinic and who has a soft spot for young go-getters trying to carve out their own places in the world. He is incredibly well-connected in the local entrepreneurial finance community, has made a number of Angel investments in the past, likes your story, and is willing to consider investing in your company. However, in exchange for the $500,000 he wants a 33.33% stake in the company and a seat on the board. He argues this equity stake is justified, given the early stage of your company and the risk he’d be taking (and knowing your lack of concrete alternatives and need for an investor in order to get the bank financing). He points out that this puts the valuation of your company at $1.5 million, and that your own $200K investment has just increased in value 150%.
About this time, Jeb informs you that the cash is running out faster than anticipated and the company needs to close on funding within four weeks. The bank seems to be lined up, and Jeb has offered to use his new house as collateral. For the sake of the partnership you have decided, with some trepidation, to match this with your home as an additional pledge against the loan. Your spouse is not too happy about this but agrees to go along. You have both set up a meeting with Aunt Marie at the end of the week to go over your progress and see whether or not she is interested in investing in the company, and what terms she will be seeking.
b) How are you going to handle this meeting? Assuming Aunt Marie is interested in investing, what kind of terms do you offer her? Which potential equity partner is more attractive to you, and why? How will you use the two potential equity investors in your negotiations with each of them? What terms and conditions are you willing to accept from each investor? Are they the same? Explain why or why not.
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