Private Placement Term Sheet: Types of Investments to Offer

The term sheet of a private placement memorandum details the specific terms and nature of the investment. This is not as simple as explaining that one share can be purchased for a certain price. Depending on how the business is incorporated, there are different options for the types of equities that can be sold through a private placement.

Equity Shares - Membership Units and Stock

If the business is incorporated as an LLC or limited partnership, shares can be sold in the form of membership units in the company. These membership units can be preferred or general units. Preferred units generally carry stipulations that they will be paid dividends first, but may offer no voting rights (much like a limited partner).

If the business is incorporated as a corporation, shares can be sold directly to investors. In either situation, you are sharing ownership with the investor and must keep in mind that ultimate control goes to the party or parties with more than 50% of the shares. If you are selling more than this, be prepared that you are giving up control.

Convertible Debt

Instead of selling shares directly to investors, convertible debt can be sold. Although there are many types of convertibles, these instruments (sometimes called convertible debentures, convertible loans, or convertible bonds) usually start as loans or bonds with a stated interest rate. This offers investors guaranteed returns over the first few years. At a specified date, the debt may be converted to ownership shares based on some method of valuation chosen previously or the principal can be paid back to the lender. It is up to the investor whether to get his money out at that time or to become a stockholder.

This method shares some similarities with equity and some with debt. Like debt, it lowers the initial risk of an investor by offering a guaranteed return. Like equity, there is greater upside potential in the long-run. This is a good option for cash-generating start-ups who would like to postpone the point of having to value the company until a later date. Hopefully, by the time of the conversion, the track record of sales and profits will support a higher company valuation. This means you will not have to give away as much equity to investors as you would have during the initial capital raising.

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