When an entrepreneur needs financing for his company, there are a variety of factors he must understand in order to craft a beneficial deal. The owner needs to understand the economic nature of his business, the financiers’ need and perceptions of risk and rewards, and his own needs and requirements.
In order to understand the economic nature of the business, the owner needs to know the exact amount he will need to fund the project, the riskiness of the project, and the potential magnitude of the returns. This process may be done by analyzing the potential sources of return and calculating the present value of the internal rate of return (IRR) for each source.
The financiers’ needs and objectives may vary widely. While most expect high returns for their investment, their motivations for investing could rely on other factors. Some may be more concerned with the magnitude or the form of return, others with the degree of control or the perceived risk. In any case, the owners must arrange the deal to reflect the desires of particular investors in order to make the transaction more attractive for them.
On the same token, entrepreneurs must also understand their own needs to make sure the terms of the deal are tailored to their specific requirements. Some of these requirements may range from the degree, or the mechanisms of control desired; to the need of a higher (or lower) amount of capital; or the magnitude of return; to the amount of risk. Once all these basics have been figured out, a deal must be structured.
Structuring a deal requires some legal form of organization, such as general partnership, limited partnership, limited liability company, or a corporation. The specifics of the deal are set out in writing in a term sheet, and usually include standard sections and components.
The “Representations, Warrants, and Due Diligence” section makes sure that all information provided is accurate, and allows for the investors...