Angel Investing & Venture Capital Equity investment into a business

Does anyone have experience or thoughts or buying equity in a business?

An opportunity has come up for us to buy equity in a new healthcare facility.

Two key points:
1. Bonus shares for first round investors
2. Forecasted 300% return over 5 years

This is something very new to us and while resi IP has been very good to us, a lot of people say investing in businesses provides even greater returns (losses).

 

what does the business case look like? Projected cash flow? Profit & loss account?
Would it be safer to loan them the money and take some security?
My father has some negative experience of buying equity in a startup, everything is rosy until they run into cash flow problem and keep asking for more money otherwise the business will tank, my dad got trapped in this BS for a few years before he decided to cut his loss.
In the meantime the owner spend our money in the company to buy a BMW and send his daughter to study overseas etc.
Did I say the owner of the startup is my mum's second cousin?

 

It's a medical practise established over 30 years ago. They're going through a massive expansion of facility and staff.

Profitability/ cashflow/ P&L wouldn't be an issue. The principal is staying on as majority shareholder and will actively be involved in the business.

Having not yet gone into detailed discussion with them, am just not sure why they are seeking equity partners and how we would go about scrutinising and structuring the investment.

 

You would be buying shares in a company it seems - minority shareholder with no control over where the company heads or the expenses incurred.

Is there anything in place to stop the majority shareholder milking it so there is no profit?

How would you inject money, would it be a loan or just buying shares? Any security for your money? Will your money be lent to another company of which you have no control?

 

I have personally invested into quite a few businesses.

The credibility of the CEO is paramount which should be then backed up by solid documentation to protect you.

The equity return for early stage investors should be much much more than a property investment.

And our family says no to these things probably 29 times out of 30. There are a lot of dreamers and people with literally no idea how hard it is to make money.

The main driver of the business needs to have put a lot of real cash into the project. None of this sacrificed wages business.

And getting bonus shares can be a marketing gimmick.

 

@Terry_w @Ross Forrester what is the due diligence or checklist you would do when meeting the stakeholders?

To protect our interests, what professionals ie solicitors, accountants do we need to meet and why?

It's a 10m investment for the principal shareholder, we are only intending to take a 2% stake. Of course, at this point, we don't know how many minor investors they are intending to take on board.

how does projected 300% over 5 years sound?

 

I know nothing about this.

But my first question would be - why are the owners prepared to give up part ownership if the business is so successful?
With such projected returns, why not simply borrow from the bank?
If the bank won't touch it, why not?

Then again, if you are only talking $10K or $20K or so, and you are prepared to have a go, why not? So long as you can afford to take the gamble?

But at the very least, make sure your percentage ownership can't be diluted.
Marg

 

@Marg4000 good questions for us to find out.

It's 200k (2% of 10m)

 

@sanj any input. Just think you might have experience in this

 

what is the due diligence or checklist you would do when meeting the stakeholders?
I won't give out my checklist as it is valuable intellectual property.

To protect our interests, what professionals ie solicitors, accountants do we need to meet and why?
You need a solicitor to check
a) structure of the company
b) constitution of the company
c) shareholders agreements
d) loan agreements
e) advise on what entity the shareholder will be
f) advise on the succession aspects
g) advise on the asset protection risks
h) advise on the contract of sale of the shares
i) suggest strategies to protect yourself

An accountant for
a) checking the financials of the company
b) generally advising on the viability of the investment

Why
Because:
a) they would know more than you do, and
b) have experience in this area

how does projected 300% over 5 years sound?
meaningless. It doesn't sound as good as 400% over 5 years!

What is this figure? Is it growth in share value? If it is how can you benefit from it?

Is it dividends?

Is it interest on money loaned to the company?

 

Credibility of main driver of business, gor thru the books in detail, minutes of prior board meetings, shareholders agreement obviously a big one, will there be other minor shareholders and will you all collectively have enough votes to have a say? all same class shares?

 

I will send through one of our checklists privately on Monday.

Please note that a checklist does not really cut it when undertaking an investigation. Professional judgement and understanding risk is everything.

It is like getting a checklist on how to drive a car and then hoping to win a Formula 1.

However it is a starting point. You can google these things as well.

 

Why would an established medical centre be looking for someone to invest $200K in their business valued at $10m for a 2% equity state.

Maybe I'm wrong, but something is not adding up for me.

 

Appreciate that very much Ross!

 

Maybe the owner has decided to derisk a bit and cash out 10 or 20% in total? maybe the owner has other plans for the funds? maybe owner woke up one day, realise d their entire net worth was tied to the success of their business, which can be edtememwly dangerous. could be a dozen different plausible reasons

 

If I was cashing out 10 or 20% I'd look for one or two cashed up buyers

 

Someone putting in $2m is also likely to want a seat on board and some decent input into operation of the business, that would suit some owner operators and also put off others.

 

@Shawn @sanj the opportunity is only available to medico specialists who will then have preferential rights operating in the new facility. The principals (majority shareholder) are trying to attract specialists to operate in the facility.

For the minority shareholders, the attractiveness is profit sharing.

The 2% is broken down into two parts.
1. Ownership of the land, which would be in a trust. Yield starting at 4-5% with annual increase. Yield is not set in stone.
2. Ownership of the business via shares. Being high upfront costs in constructing, buying equipment etc etc, profit is expected in year 3 and dividends will be paid from there.

@Terry_w There is a revenue, profit and debt projection for the first 5 years. Numbers are based on similar facilities within the region. The 300% growth over 5 years is capital growth. Derived from the forecasted revenue/profit/etc at year 5.

Because it's a niche industry, correct to say not all accountants will be able to provide relevant feedback? not sure...

If we wanted to exit the business, an independent valuation will be obtained for both land + business. Shares will then either go to general pool or absorbed by other shareholders. Is this how it's usually done and a good way of doing it?

Am not sure about dilution of shares?
Am not sure about how we should structure the purchase?
Am not sure about what we don't know?

@Bran being our resident medico specialist, would you do something like this?

 

I've seen people invest in these sorts of things and being left with worthless shares at the end of the first year. Projections always look good, especially when trying to attract investors.

You need to consider how you can get out if need be:
who can you sell your shares to
What if no one wants to buy them
how they will be valued
Who will funder the valuer (expensive)
What if there is a disagreement on value
How you are contributing your funds - will it be a loan?

How much control do you want? You could insist everyshareholder with more than 2% ownership could be a director/appoint a director - and then weigh this up with the risks of being a director. Also this may not be practical if there are 30 shareholders.

 

What an unnecessarily convoluted process.