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Managing Your Investors/Shareholders. Part of the MBA Lite Series: Manage Your Business. Patrick H. Gaughan, J.D., M.B.A. Youngstown State University Coffelt Hall Youngstown, Ohio 44555 440 829 7010 [email protected]

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Managing Your Investors/Shareholders

Part of the MBA Lite Series: Manage Your Business

Patrick H. Gaughan, J.D., M.B.A.

Youngstown State University

Coffelt Hall

Youngstown, Ohio 44555

440 829 7010

[email protected]

The Hudson Library & Historical Society/ Burton D Morgan Center For Entrepreneurial Research

Who am I, what do I do?

  • MBA and licensed attorney.

  • Co-founder of the Garden Club Angels.

  • Recently Exited East Palestine China Decorating, LLC (a successfully restarted business).

  • Offices at

    • YSU Graduate Studies,

    • YSU Williamson College of Business &

    • Youngstown Business Incubator.

  • I work with entrepreneurs and angel investors.

  • Help structure and facilitate deals.

  • Work with high and low tech companies.

Before We Start… a few words about the Pros and Cons of Different Investors.

  • Friends & Family

  • Customers / Suppliers

  • Angel Investors

  • Venture Capitalists

Friends & Family


  • Informal

  • Easy Impressed

  • May invest regardless of opportunity


  • You’ll see them forever

  • They probably don’t understand

  • Investment value likely cash-only



  • Understand proposed service

  • Understand market

  • Have vested interest in success


  • Have conflicts of interest

  • May overvalue contribution

Angel Investors


  • May have outstanding contacts

  • May have relevant experience


  • May insist on participating/controlling

  • Can be annoying and intrusive

Venture Capitalists


  • Have resources to grow big fast

  • Have experience troubleshooting

  • Make Angel Investors appear reasonable


  • Are certain to professionally negotiate tough terms

  • Are impatient

  • Can and do replace underperforming management

  • Time wasted trying to get initial deal

For ALL Investors…

  • Understand their risk tolerance.

  • What are their liquidity needs as relates to investment period?

  • What do they expect for a return?

  • What role do they expect to play?

  • How accountable/responsive do they expect you to be?

  • What, besides money, are they willing/able to contribute? [See Investor matrix].

So, What’s “Managing Shareholders/Investors” All About…?

  • Personalities

  • Goals

  • Contributions

  • Valuation

  • Structure

  • Exit Arrangements

1 of 6: Personalities

  • Notwithstanding everything else in this presentation, never maintain a Shareholder/Investor relationship with someone you don’t respect and/or with whom you can’t maintain a working relationship.

  • Insist on integrity. Look for past examples.

  • Make sure the respective roles are agreed upon and respected too.

  • If respect/relationship is lost – exit.

  • Repeat the bullets above as necessary.

2 of 6: Shared Goals

  • At the initiation of the relationship, clearly confirm agreement on the purpose/goals of the organization.

  • Possible goals:

    • Profit Maximization

    • Market leadership

    • IPO

    • Civic Contribution

    • Economic Development

    • Education

    • Respect and Envy of the Neighbors

    • Quality of Life

  • Once agreement is achieved, be very careful in monitoring how the goals evolve. Seek consensus.

3 of 6: Contributions

  • It is a mistake to view the contribution of a shareholder only in cash.

  • Alternative potentially valuable contributions:

    • Cash

    • Information

    • Technical Know-How

    • Managerial Know-How

    • Contacts (customer, employee, distribution, etc.)

  • Agree on the opportunity and how the investor can contribute value to it.

3 of 6: Contributions (part 2)

  • Key - Match what the Shareholder/Investor wants and is able to give with what the Company needs to achieve its goals.

  • Pay only for what is actually delivered AND that the Company values (while being respectful).

  • Think about the Investor Matrix (next slide)

  • Remember The Step Function Relating Company Value To Time (slide after that!)

The Investor Matrix

An Example of the Relationship of Company Value To Performance Benchmarks

3 of 6: Contributions (tie-up)

  • Secret is to tie the contributions of the Shareholder/Investor to the increase in value of the company.

  • If no delivery, no additional interest.

  • If delivery, some to Shareholder/Investor; some to company.

4 of 6: Valuation

  • No way to cover in 75 minutes!

  • Theoretical basis:

    • Firm Value =

      NPV (future net profits discounted by Risk)

    • Where i/y = minimum return

  • Practical basis:

    • Firm Value =

      cost of building/acquiring a competitor (are there barriers to entry stopping this?).

  • It depends on the circumstance.

5 of 6: Structure

  • Understand your corporate structure

  • Understand your deal structure

Your Corporate Structure

  • Are you a C or S corporation?

  • Are you an LLC? Managed or Member operated?

  • How many authorized shares do you have? How many are Issued? Voting? Rights of participation? Dilutable?

  • Are their any liens against company assets?

  • Have you adopted Regulations/By-laws/Operating Agreement?

  • Are there any Buy-Sell Agreements? Non-competition agreements?

Your Deal Structure (1 of 7)

  • Pick A Structure That Fits Both the Company’s and the Investor’s Goals.

  • Be consistent on terms across Investors

Your Deal Structure (2 of 7)

  • General options

    • Common equity

    • Preferred equity

    • Convertible Notes

    • Options/warrants

  • This are discussed over the next

Common shares are highest risk (3 of 7)

  • Last to be paid upon liquidation of the company

  • Liquidity totally unknown

  • Payout generally pro rata to all other issued shares

  • However, can be appropriate if buy-laws/regulations are in place

Preferred Shares (4 of 7)

  • Have benefit of preference as to dividends, liquidation, etc.

  • Require two classes of shares (impacts S corps)

  • Requires a certain level of investor sophistication

  • As equity, dilutes ROE calculations but reduces balance sheet leverage

Convertible Notes (5 of 7)

  • Treated as debt with right to become equity

  • No voting rights until conversion

  • Preference upon liquidation

  • Value is certain prior to conversion.

Promissory Notes w/ Warrants(6 of 7)

  • Provides best of debt and equity

  • Increases leverage on balance sheet

  • Complicates bookkeeping for diluted shares (like convertible notes)

  • Warrants (put or call)

Guarantees, Security Interests and other stuff. (7 of 7)

  • Personal guarantees on corporate debt – watch out.

  • Security Interests – provide a right to proceeds upon liquidation before all others.

  • Loan covenants – place management and financial restrictions

  • Full & Half Ratchet Provisions – Adjusts equity valuation for early-stage investors

  • Rights of Participation – assures the right to invest in a particular round

6 of 6: Planning The Exit

  • Nothing lasts forever; plan the exit before anyone enters.

  • Discuss valuation issues upon entry.

  • Understand the ways deal structure and management can change deal value.

6 of 6: Address company valuation issues

  • What is your company worth?

  • What is the basis for your valuation?

  • What will the company be worth as you hit each benchmark?

  • What will it be worth if you fail to reach a benchmark as scheduled?

6 of 6: Ways of Establishing/Increasing Value

  • Don’t need investment (seriously)

  • Comparable valuations

  • Established strategic purchase value

  • Believable profit projections

  • Deal structures minimizing risk

  • Compelling management team track record

  • Pre-sold customer ‘orders’

  • Multiple completed steps in implementation plan

In Review: “Managing Shareholders/Investors” Is About:

  • Matching Personalities

  • Sharing Goals

  • Agreeing On Contributions

  • Sharing Views On Valuation

  • Establishing Structure

  • Plan For The Investor’s Exit Before Entry

Any questions?

Patrick H. Gaughan,J.D., M.B.A.

Youngstown State University

Coffelt Hall

Youngstown, Ohio 44555

440 829 7010

[email protected]

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