Question about Investors

[sideguy]

I am in the process of starting up a microbrewery. Between my contribution and commitments from family and friends, I have about 400K raised so far. I am looking to raise a total of 600K for startup costs. My question is what is the best way to structure their interest in the company? Offer them equity? If so, how much? I don't want to give away a majority of the company but I know it need to be worthwhile for them also. I know this is a vague question that should be answered by my accountant but I am just trying to get some ideas. Thanks.

[Abovo]

It's all about value

Hi there

Firstly, you have to look at the transaction as objectively as possible. By this I mean that you need to try and set up a proposal to achieve a win-win situation. You have to look at what you are able to offer an investor and then what you expect from said investor. If it is just a monetary contribution then you might offer the investor less equity, however, you must understand that in this instance you are looking at an investor who expects a return.

You have to be able to show the investor that you are able to give them a return and it should be above what they could achieve if they were to invest elsewhere. The investor will look at your business plan to ascertain whether or not you have done your homework. As such you need to ensure that you have all your ducks in a row before you seek external investment.

The other option is if you are looking for someone who is going to add value to the brewery further than their initial monetary investment. Here you might offer more equity but then they have prove they can add the additionaly value. In this instance you would want someone that will have the strengths you lack and importantly, it must someone that you can get along with.

I realise that this doesn't answer your question directly but it should give you another perspective. Ascertaining value, especially in a start up is a very subjective thing and would require far more information. Anyway, I hope this helps.

[tsewong73]

Talk to a good attorney. An attorney will answer the questions you have regarding structure and investment better than an accountant. State and federal securities laws alone can be difficult to understand. Then, there are subscription agreements, partnership or investor agreements and other contracts that will have to be formulated. A good attorney will have the experience to advise you on the proper courses of action throughout your project. And I do mean a GOOD attorney, too. I retained an el cheapo attorney at the beginning of my project and he made a mess of things. It took me months to recover, but I retained one of the best lawyers in town and his counsel has been invaluable. Sure, I'm paying a boat-load of money, but it's well worth it.

When you do talk to your attorney, ask him about a limited partnership. That's how I've structured my company and it seems to be the most equitable arrangement for me and my partners. I get what I want: my own brewery and the control to do as I please; and the partners get what they want: part ownership of assets and profits without the responsibility of sitting on a board of directors or running a company. Most of my limited partners are small business owners who don't have the time or patience to be responsible for a second company. If I'm not mistaken, the Brooklyn Brewery is also a limited partnership.

Take it easy and good luck to you.

Tsewong

[sideguy]

Thanks for the advice. I have a friend who is an attorney and he has been helping me get started. He primarily deals with real estate so he also recommends I hire a good attorney with experience in this field. Any ideas on where to look to find a GOOD attorney? Most likely I won't be able to find one with brewery experience so what type of experience do I want to see?

Regarding the limited partnership; how is yours structured? The idea that the general partner(s) have unlimited liability scares me. Are you structured so that the GP of the partnership is an LLC or a corp to protect you? I was originally thinking about forming an LLC.

As far as eqitable interests are concerned I am really trying to figure out what % is normal for the owner to keep. Bear in mind I will be the one running it and working 100+ hours/week to make sure it succeeds. Also, do you allot yourself a small salary to pay the bills while the company is getting up and running or just live off of savings?

Any insight is welcomed.

[bford]

Another vote for LP

Sideguy,

Our Attorney set us up as an LP. In California, an LLC that grosses over 1mil is subject to a flat 6k fee!

I am the GP of the LP, and I formed an LLC to act as GP . Generally the GP has most of the liability, thus the LLC status. Also, the LLC is a very small % of the capital investment of the LP. I also have a majority equity in the LP, giving me the ability to operate the business and make important decisions.

As far as equitable intrests go, I think it's best to go with the % invested in the project by investors. If you have more time and legwork in than $, you can talk to your partners about founders shares. It's very flexible though.
I would set a fair salary for yourself ( or you could reduce it and take the balance at the end of the year profits) and pay yourself as an employee of the company. You can then take a determined % of profits should there be any at the end of the year. We are taking 20% of the profits and using 80% to payback investors until we reach inital investment funds, then adjusting to 80% for us and 20% to them for a pre-determined ROI.

Of course there are many ways to structure your proceeds, this is just what we choose to do. We are a brewpub, so the overall income will be different than that of a Micro.

Get a great Attorney and look into the LP formation!
Good Luck!

[tsewong73]

I agree with Mr. Ford. What I'm actually doing is setting up an S-corp as the General Partner. I haven't worked out the details yet, but the brewery (the LP) will pay the S-Corp/General Partner a management fee, that is basically my salary, in one payment for the whole year. The S-Corp will then issue weekly paychecks to me with all the attendant taxes withdrawn. Those paychecks will begin as soon as I can break the esrow account (where all the investors' money is kept until I get all my shit together) and can start fitting out the brewery. I chose to form the S-corp. over the LLC because I might want to start one or two more businesses in the future and it's my understanding that I might be limited in that by the LLC status.

As far as percentage of ownership, I chose a 60/40 split. I'm not bringing a whole lot of money to the project, but I'm retaining 60% ownership (60 shares) and selling 40% (40 shares) to the limited partners. According to my attorney, that's pretty standard. Also, 60 shares enables me to sell those shares in the future if I want to raise money for expansion or whatever. Plus, as the GP, I have to power to issue shares in exchange for products or services. For instance, my close friend is a graphic designer and he's designed our labels and logos for free. In order to compensate him and keep him as our designer, I will issue him two shares out of my own "stash." One more thing: one share of the company is the General Partner share. I own that plus 59 Limited Partner shares. I can sell off or give away all 59 LP shares and still maintain control of the company as long as I own that single GP share. Make sense?

As for profit distribution, I'm doing almost the same thing as Mr. Ford. 80/20 in favor of the limited partners until they recover their initial investment, then we'll distribute profits according to how many shares each person owns.

Your attorney doesn't need to have brewery experience. You simply need a good business attorney. Your real estate lawyer buddy should know of one or two good business attorneys in your area.

Also, you might consider talking with local business owners. I spoke with some of the best business people in my community and got some invaluable advice and insight into the local business culture. Everyone I spoke to was pleasant and eager to help. In fact, most of them would actually sit there and brainstorm with me about all sorts of ideas and get really excited about the project. But no matter what you do, always seek the absolute best in advice, professional services, etc. It'll be well worth it in the long run.

Tsewong

[eric@marshallbrewing.com]

bford, You spoke of adjusting to 80% for you and 20% for the investors at a pre-determined ROI. What would be a good range for that ROI and how do you go about pre-determining that?

[Butcher Scott]

One idea I thought about was structuring the investment from outsiders are convertable bonds.

You would essentially issue two classes of convertable debt, one to yourself and the other to the outsiders. Your bonds, as they are paid down, will convert to equity at a higher rate than the other class. In the end, you end up with a higher % equity, while your investors still get their healthy rate of return on the debt plus an equity stake at the end.

I would structure your bonds at a prime minus rate, while your investors are getting a prime plus 5-7%. This insures them a higher "locked in" return in the beginning. When I was structuring my offering (though I ended up not needing investors in the end) I had it converting to a % of equity at the end that netted the investors a 35% IRR on my first 5 years of projected cash flows. To attract investors, I think you'll need to be looking at 30%+ returns.

[sideguy]

OK. It looks like there are a lot of avenues I could go with this. Tsewong, your plan looks good but are you going to be able to attract investors if you are keeping 60% of the company without putting much capital in? I'm not criticizing; just trying to understand. Butcher, how would you plan on making sure you can pay the interest on those bonds for the first few years? Also, what are the benefits of seeking investors verses a loan from the bank for the rest? Thanks. I am learning a lot here.

[Butcher Scott]

OK. It looks like there are a lot of avenues I could go with this. Tsewong, your plan looks good but are you going to be able to attract investors if you are keeping 60% of the company without putting much capital in? I'm not criticizing; just trying to understand. Butcher, how would you plan on making sure you can pay the interest on those bonds for the first few years? Also, what are the benefits of seeking investors verses a loan from the bank for the rest? Thanks. I am learning a lot here.

Well I was looking at the bonds as a way to supplement a bank loan. The convertable bonds would be viewed as equity by the bank, so it would boost the equity portion of your balance sheet.

There is no "making sure" you can pay the interest in anything... after all, the reason the investors want a return is in exchange for the risk they are taking on. How can you make sure you can make the interest payments on your bank note? But in the unfortunate case that you don't make it, the bond holders would have a senoir claim on the company's assets before equity holders.

I understand there should be some equity kickback for the organizer and leader of such an endevor (which I am), but keeping 60% while putting in very little cash does not sound like something an outside investor may be interested in. In my brewpub startup, I am putting up 20% of the equity and eventually I'll end up with a 40% share of the equity (ramping up from the 20% over time).

[tsewong73]

I haven't had any problem or complaint yet about the 60% thing. The potential limited partners recognize the value of my concept, recipes, beer names, company logos, label designs and other intellectual property along with the amount of work I have done, the enormous risk I'm taking in guaranteeing the financing, and the amount of work I'll be doing as the brewer, delivery guy and general manager. Nope, no one's had a problem yet with me keeping 60% ownership. In fact, two guys asked me why I wasn't claiming more. The advice I got from my lawyer and local business leaders was to retain 60%, and they were right.

The potential partners who declined to participate did so either because they couldn't afford to or because their money is tied up in other investments. No one has yet declined because they thought I was being unfair, that I wasn't taking a significant enough risk, or that they wouldn't make an investment without a seat on a board of directors or some other degree of control. Well, OK, one guy didn't like the idea of not having any control, but he's a venture capitalist by trade, so he doesn't count.

At this point, I only have 10 more limited partner shares left to unload - I've completed 75% of the fund raising from partnership capital and I currently have a healthy list of people considering an investment.

[Butcher Scott]

More power to you if you can make it happen!

[bford]

Roi

bford, You spoke of adjusting to 80% for you and 20% for the investors at a pre-determined ROI. What would be a good range for that ROI and how do you go about pre-determining that?

edm1077,

Good question! For us, a lot of it has to do with the individual that is intrested in investing. I have found that certain investors are very passionate about what we are doing and are willing to take a much greater risk to be a part of it, than say an investor that is looking for a certain % on his/her money. We have much more of the former than the latter.

That being said, I believe a fair rate of return for the inherent risk of starting a brewpub (read Restaurant) would be in the 10-14% range. Again, lots of ways to structure returns. Prefered shares, commom shares ect....
I have subcontractors with an equity stake that I will be able to buy out of the LP when I have reached thier ROI.

Hope I answered your question!