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Chapter 1: Introduction
“When it comes to raising capital, there are no guarantees…only degrees of probability. To further ensure success, simply increase the probability to the highest degree possible.”
Timothy D. Hogan, Founder & CEO: Commonwealth Capital Advisors
This book is for serious professionals who desire to capitalize their start-up, early-stage, or even a seasoned privately or publicly held company and would like to increase the probability of raising capital to the highest degree possible. I will introduce you to some of the secrets, techniques and a simple process used by Wall Street investment banking firms to further that goal.
Wait! You do not have to take your company public. The process is for those who need substantial amounts of capital for a start-up or early-stage company or commercial project for which they want to maintain voting control and the vast majority of equity ownership – whether they choose to remain private or go public, later on. This is a process used by Wall Street firms to raise capital for their client companies and you can use it to capitalize your company, as well. As you will see, once you are successful at raising capital in the private markets, opportunities will abound and you may decide to take the company public someday. This process gives you options, not restrictions!
When speaking of raising capital for start-up and early-stage companies, my primary focus is how to raise passive rather than active capital. “Passive” capital means attracting investors who seek relative safety with a better than average rate of return on their investment and are not interested in any active management of the company. These investors are typically known as “Angels.” “Active” capital means attracting professional investors who seek active management and or strategic support (or actual control) of the company. These investors are typically known as “Institutional” or “Professional”. I will address both types of investors throughout this book. Both sources of capital have their place, but in the early stages for most companies, too many cooks in the kitchen can distract from realizing the entrepreneur’s dream.
What is an Angel Investor? Originally, the term “Angel” was coined to refer to the people who financed Broadway plays when all else failed. Today this term has become common among the investment community to refer to a high net-worth individual that invests their own personal funds in various businesses. In the U.S., it is estimated that there are well over 250,000 angel investors that annually invest approximately $20 billion in American businesses. In 2003, over 42,000 new businesses in the United States received angel financing (it is believed this number is much higher as many of these investments go unreported). This amount ($20 billion) represents roughly only 7% of what the banks are investing in, as well. Statistics show that this amount exceeds that of venture capital investing and as much as 30 to 40 times more angel capital is invested annually than venture capital. Some estimate that angel investments have financed approximately twice as many firms as any other form of external equity investment, including institutional venture capital.
To understand and increase your company’s chances of raising capital correctly, you should know how things currently are and what changes are taking place in the private, as well as, the public capital markets and get ahead of those changes to take full advantage of them. This, I explain in the next Chapter. Many concepts have been repeated to help you understand the full magnitude of the process.
A brief history of time that led to this book and the process defined throughout. I started my career in the securities industry in April of 1985 with Merrill Lynch, a venerable giant in the investment banking and securities industry. After the stock market crash of 1987, I joined the legendary E. F. Hutton in February of 1988, which was bought shortly thereafter by another industry giant, Shearson Lehman Brothers, which subsequently was acquired by Smith Barney, which was then acquired by Citicorp. Needless to say, I was heavily involved in an industry that was still in turmoil, due to the market meltdown on Black Monday, October 19th, 1987. I left the major firms in 1990 and joined one of the fastest growing regional investment banks in the Midwest. There, I rose up through the ranks to Director of Compliance within a year and a half. In that position, I oversaw the securities brokerage end of the firm and created and managed the investment banking division, the registered investment advisory division and was in the process of creating the commodities division. As I have said in the past, “my dollar to headache ratio went sour” and I was looking to get out of the industry – for good.
Shortly thereafter, I was contacted by my then step-father, a professional golfer, who had a need to raise several million dollars in equity to secure adequate debt to build, own and operate an 18-hole championship golf course with a surrounding real estate development project. In January of 1993, I left the regional firm and the securities industry for a short time. I created a $2,000,000 private placement memorandum (PPM) for selling securities under Regulation D 506 (an exemption from registration of those securities – the least expensive way to go). The PPM was complete by March 3rd and I immediately proceeded to solicit and sell the $2,000,000 in stock using techniques I learned working for those large Wall Street investment banks. I successfully closed the $2,000,000 in 5 ½ months, by August 14th of 1993 and obtained the necessary debt financing ($527,000) with a commercial bank shortly thereafter. I was able to push the debt amount to the federal legal limit the bank could lend (a small community bank) and I obtained it with no personal guarantees, as well. I was able to do this because I was in the process of creating another PPM to sell debt in the form of 1st mortgage notes to the general public. When the bank caught wind of what I was up to (attempting to compete for their depositors) they quickly assured me that they would fund the debt portion of the financing with no personal guarantees. More on this technique later.
Incidentally, the reason why it took that long to raise the capital, was that we did everything on a shoestring. I managed the company’s overall administrative and construction operations as its CFO and Vice-Chairman in the morning, and physically managed the construction process by operating heavy machinery in the afternoon – it was a blast! One last thing, we built the golf course on time and $386,000+ under budget. Not meaning to brag, but the point is to simply illustrate an answer to the most important question and entrepreneur can ask me: “What separates those who succeed in this effort and those who don’t.” Those who succeed do whatever is necessary to get the job done…period.
Suffice it to say, I received a lot of attention from the local professional community. The next thing I know I’m getting referrals from attorneys, accountants and bank presidents, who had clients that needed an extra million or so in working capital. So, in the subsequent years following up until Commonwealth Capital Advisors was created in the Spring of 1998, I served as a “serial CFO” of sorts, assisting a handful of companies with their capitalization needs.
I founded Commonwealth Capital Advisors in 1998 with a handful of managing directors, which included a corporate and securities attorney and a CPA. We threw up a website (an old one, not the one we use now) and the next thing I know we have entrepreneurs, primarily from California and almost exclusively in the “Dot Com” industry, hiring us to produce the appropriate “marketable” deal structures and creating securities offering documents to sell securities to raise millions for their start-up companies.
Things couldn’t be better. At the ripe old age of 40 I’m playing a lot of golf; we were producing documents and assisting these entrepreneurs in their capitalization efforts. Success was everywhere – until February 2001. That month is generally regarded in the securities industry as the “Tech Wreck” or the “Dot Bomb” era. The “small cap” public markets fell apart and brought start-ups to a screeching halt. Now what to do?
I realized that through that high-flying era of hot dot com speculation, also coined by the then Federal Reserve Chairmen Alan Greenspan as “speculative exuberance” we had far too many prospective clients who simply didn’t have a clue on what we did or how we did it. More importantly, even for those who did know how easy and successful a securities offering to raise money could be, most simply could not afford the process. Something desperately needed to be done.
Enter the creation of the Financial Architect System™ also known by the brand name and our registered trademark-
Putting this extremely arduous and costly process into a do-it-yourself system and selling it over the Internet for an affordable price so that millions of entrepreneurs could use it to create their “dream” company was a great idea. But, putting it into a workable system “so easy a child could do it” was a daunting task indeed. To create a system that is seamless and “so easy a child can do it” is most improbable – no matter the degree of technological sophistication of the platform used for delivery. However, Financial Architect® continues to evolve and is becoming easier to use each and every year.
During the creation of Financial Architect®, I also wanted to grow the firm in several ways. I placed a career advertisement in the regional Wall Street Journal for a Managing Director in the greater Chicago area. Charles D. Dreher was one of the respondents with an investment banking background that I had a keen interest in hiring. During our several interviews, Charles asked me how many securities offering documents the firm created in the past four years, I told him, “Twenty-three.” Then he asked, “What were the amounts of the capital raises?” I responded, “From $500,000 to $20,000,000 and everything in between.” Lastly, he asked, “What percentage of the clients raised all the capital they were looking for?” I said, “78.2%.” He said, “That’s amazing. How’s that possible?” I knew no difference so I hadn’t had an opinion up to this point, but after some contemplation, I answered, “Probably the proper deal structure combined with the client’s commitment to the process.”
Charles then proceeded to tell me that there are 25 million small business owners in America and that 600,000 new businesses are formed every year – these entrepreneurs are the backbone of our country. Can you imagine all the great ideas that go unfunded? Ideas that could eliminate or lessen world hunger, protect the environment, create advances in medicine, and revolutionize communications, not to mention thousands of brilliant inventions that could prove invaluable. Just think how by helping all these entrepreneurs succeed we strengthen the U.S., as well as, the world economy.
He said, “Why not make your system available over the Internet and see if we can drive down the cost?” We spoke to our attorneys and accountants and all agreed we should build Financial Architect®. It has taken over four years to create and beta test the system. The book you are now reading is the first of three interdependent components of Financial Architect® - the educational component. You can judge the balance of Financial Architect® based on what you’re now reading.
What has been accomplished thus far, is the creation of a system that addresses the most important issues needed to start the process and that affords every entrepreneur a chance at a reasonable cost, both in time and money. Financial Architect® is comprised of three interdependent components that serve as the fundamental basis of a successful securities offering. It is, in our opinion, as good as it gets.
Although we are former Wall Street financiers, we, too, are entrepreneurs. We saw a need for both sides of the capitalization issue. Entrepreneurs need capital and financial institutions want to invest it, but only into “quality deal flow”, which means companies that have a real chance of becoming very large, very soon. The problem is that there is a huge gap between start-up and early-stage companies’ need for substantial amounts of capital and the financial institutions’ desire to fund quality deal flow. The main mission of Financial Architect® is to revolutionize the way capital is raised by start-up and early-stage companies, not only in the U.S., but around the world.
Financial Architect® is a patent-pending process designed to significantly reduce the cost and time involved in raising substantial amounts of capital through the issuance of securities and to do so in meaningful ways.
Financial Architect® is not a business-planning program – although it can be used as one if a business plan has yet to be produced. Financial Architect® evolves a business plan into a very expensive securities offering document, using the deal structuring and securities offering document production software templates, for a mere fraction of the standard cost.
More importantly, Financial Architect® instructs the entrepreneur on how to legally and effectively solicit and sell securities in compliance with federal and state securities laws to actually attract investors and raise capital in any market environment, while maintaining voting control and maximum equity ownership of their company.
Although Financial Architect® evolves over time; it is currently comprised of 3 interdependent components that are designed to be used consecutively to enable one to accomplish the task of raising capital.
- The E-Book entitled: “The Secrets of Wall Street – Raising Capital for Start-up and Early-Stage Companies,” is the primary educational piece that is designed to give one the required knowledge to correctly formulate a company’s operational and capitalization plan. This component is fundamental in nature and it rarely changes.
- Securities Offering Document Production Tools:
- Private Placement Producer™
- Public Placement Producer™
- The Seed Capital Bridge Notes™ module, included in the Private Placement Producer™, contains a securities offering document production template with instructions compliant to claim the accredited investor exemption 4(6) to jump-start the capital-raising process within hours. The Private Placement Producer™ and Public Placement Producer™ catapult the company’s larger development and expansion capital-raising effort. The Private Placement Producer™ and Public Placement Producer™ include two interdependent components. The first of which is the Capitalization Planner™ and Pro Forma Producer™ sub-module, which enables one to create a marketable deal structure for a securities offering compliant with GAAP (Generally Accepted Accounting Principles) standards. This sub-module has a complete set of comprehensive instructions that are designed to lead one quickly through, what otherwise would be, a rather arduous process. The second sub-modules are, in addition to other tools, comprised of the securities offering document production text Template(s). These sub-modules have comprehensive instructions embedded into the Template documents, which one simply follows as they go through the process of converting their company’s business plan into a securities offering document. This component is fairly fundamental in nature; however it does evolve over time, so we update the Financial Architect® System as necessary.
- The Commonwealth Capital Club (CCC) is the third and final component. The CCC is a password-protected area on the Company’s website, (See Members Only at http://www.CommonwealthCapital.com). The Commonwealth Capital Club contains the critical Compliance Components, Dealing with Professionals – Attorneys and Accountants, Financial Resource Links, Links to Accredited Investors from around the world, as well as, Securities Selling Techniques, which includes Marketing Strategies from the Zen Masters of Capital. This component is dynamic, fluid and changes often so it is important for a customer to access it regularly.
Financial Architect® is philosophically predicated on one overriding principle: Developing highly marketable securities (deal structures) and selling them through a series of offerings directly to individual (passive) investors.
Financial Architect® is designed to increase your probability of raising capital to the highest degree possible. How can we make such a claim? Because without this process, Wall Street wouldn’t exist. We’ve simply brought the “Wall Street” process to “Main Street” companies.
I can cite many case studies of entrepreneurs who’ve successfully raised capital using Financial Architect® because these are the fundamental processes used on Wall Street. However, their success may not equate to your’s. Without your belief in the logic, dedication and commitment to the process, the case studies are moot.
With that said if you seek case studies, look at the almost 15,000 publicly traded companies listed on the major stock exchanges in the United States. Most have used one or more of the processes described throughout this book. Financial Architect® is a culmination of the most successful processes that have been used by the vast majority of publicly traded companies in their start-up and early stages. This system is not simply a list of processes used by these various publicly traded companies, but a focus on the combination of processes that work best in today’s marketplace for start-up and early-stage companies.
I mentioned that most publicly traded companies have used one or more of these processes. What about the rest? The rest were most likely funded by venture capitalists, and in the end, the owners retained a very small percentage of the company when it went public or was sold to a strategic buyer. In my opinion, that is not a success by any measure.
To be clear, there is no magic bullet. The process involves education, application, commitment, and follow-through: e.g. “work”! Still, it’s by far the most effective means to raise substantial amounts of investment capital while maintaining the vast majority of common equity ownership and voting control.
Anything worth doing involves work, and no one else will do this for you, no one ~ legally that is. That said, you won’t be alone because you will be hiring the right professionals (attorneys and accountants) to assist you and although you will pay for their time with the capital you raise, you’ll still be in control. Your attorney and your accountant will serve as your primary advisors in this process, but you manage the process with the assistance of Financial Architect®. Properly applied, the knowledge you gain using Financial Architect® will make you extremely powerful in regards not only in raising capital, but in building your company, as well.
On Wall Street, we were at the top of the proverbial food chain. Although the issuing company (our client firm) hired us to get the capital raised, we had the access to it, the knowledge to get it and the required administrative protocol to comply with federal and state(s) securities laws, so that they could keep it, and we… our commission. Most often, the Wall Street investment bankers determined who would be the clients’ legal and audit firms. The point being, you will learn the basics that will enable you to stay at the top of the food chain. Our concern is to make sure you are always in control of the process. Seemingly unimportant when you are just beginning and seeking expertise in the field, first hand knowledge of this process will guard you from the inevitable pitfalls of success. When money starts coming in the door – greed is always present. Without practical knowledge on how to maintain control of many matters, you could get taken down…hard.
Our principal aim, delivered through Financial Architect®, is to give every entrepreneur a chance at building his or her dream company. It’s for those who normally could not afford the process, in time or money, to quickly, easily, and inexpensively get the required documents produced at a mere fraction of the traditional cost. To further entrepreneurial success in the capital-raising process, Financial Architect® is not designed to be just a securities offering document production program. It is certainly not just a cheap template. On the contrary, anyone can create a securities offering document inexpensively with ineffective securities offering document production templates and/or services available on the Internet. Financial Architect® is a holistic system of education, document production tools, investor contacts, compliance administration and more importantly; effective securities selling techniques to further assure that you do this right the first time. An old Wall Street mentor of mine used to come into my office at E. F. Hutton and say “Hogan…if you don’t have time to do it right the first time how much time will you have the second time?” The point was taken. Do it right the first time or not at all.
For those who have tried to raise substantial amounts of capital from (and only to be rejected by) financial institutions, the information in this book may, at first, serve only to remind you of the time, money, and effort you have already wasted. On the other hand, you may be glad to finally know you can control the process from now on. For those who have succeeded in raising substantial amounts of capital from financial institutions, such as venture capital firms, only to be hamstrung by ownership and/or voting dilution, this book will show you a way to get those financial institutions off your back…unless it is simply too late!
Know that it’s only too late if you and your management team have lost voting control either through ownership and/or voting dilution or by funding agreements such as term sheets that limit your ability to raise capital or vote. If it’s too late, then next time you build a company you will be armed with a new set of strategies that will enable you to dictate the terms of the deal and maintain the vast majority of your equity ownership and voting control.
For those who are just starting out or have bootstrapped their company to the degree that it can no longer grow with internally generated revenue, you may now realize that you must raise capital to continue building the company. If so, the information contained in this book should serve as an excellent guide for maximizing your productivity in this endeavor and to help you avoid many pitfalls you might otherwise encounter.
Raising capital from institutions or from individual investors is the biggest game in town because it involves the ultimate prize in a capitalistic system—the transference and use of “other peoples’ money.” Although you may have good or even altruistic intentions for your company, its employees, your community, your industry, your country, or for the world, at “the end of the day”, it’s all about the money. You can return money to your employees, your community and various other charities, but for now you need to put your investors’ money first by designing a capitalization plan that ensures relative safety and a very good return on their investment.
Now, I am not writing this book to degrade the value of financial institutions. On the contrary, they have their place and serve many valuable functions. I am writing this book to teach for the benefit of your company. Once formidably capitalized through your company’s own efforts, you may eventually choose to seek funding from these financial institutions. If so, you will be able to from a relative position of strength that allows you to dictate the terms of the deal.
How do you deal with these financial institutions from a relative position of strength? By being in a position where they need you more than you need them!
Have you ever heard the maxim: “Banks will only lend you money when you don’t need it”? In fairness to banks, that’s not entirely true. They do lend money to those who need it; it just never seems to be enough.
The maxim should be “Banks will only lend you substantial amounts of money when you don’t need it.” Fine, how do you get to a position where you don’t need it from them in the start-up or early stages of a company’s existence when revenues, let alone profits, are slim to none? You simply compete for capital from individual investors just as financial institutions do.
Let’s define financial institutions. Those would include traditional banks—commercial, community, or merchant—as well as investment banks, venture capital firms, private equity groups, insurance companies, pension funds, or any other formal institution that has been organized specifically to make investments on behalf of others.
What does “to make investments on behalf of others” really mean? It means that they are chartered through regulatory authority and/or by statute to make investments with funds they raise from individuals for the benefit of those individuals, first and foremost. Being true capitalists, they are allowed to make a profit, or in the case of a non-profit such as a pension fund to create revenue to cover their costs.
These institutions have a fiduciary duty to invest “other peoples’ money” in a prudent fashion with the expectation of a return on investment from the efforts of others (primarily from the management of - publicly traded companies, commercial real estate managed by professional property management companies, and so on). The list goes on and on, but I’m sure you get the idea.
The point: All institutions raise capital from individual investors and your company can as well. At the end of the day, financial institutions do not own any money—people do. And if the institutions that invest other peoples’ money cannot perform to the expectations of the individual investors, (people who ultimately own and control the money) they will move it. They will invest it elsewhere. For many, this is their full time occupation – investing.
So, if individual investors do move it, how can you capture it? By creating and selling securities that meet individual investor demand. More on this in Chapter 10.
Once your company has grown to the point that you have ample capital (either from a securities offering or operational cash flow) and can afford a new management team member, consider creating and staffing a finance department (headed by a VP of Finance) within your company. Hire someone who has investor contacts and the skill sets to perform the tasks of selling securities and administrative compliance. Hiring a Vice President of Finance from the securities industry with the knowledge, skill sets, abilities, and investor contacts can pay huge dividends for your company. Early-Stage Companies should consider this strategy as an option not a necessity. Rarely can a start-up company use this strategy. However, as one moves from start-up to early-stage it should be seriously considered. More on this strategy later .
Okay, that’s all fine and good, but how do you pay for all this? You pay for it with the proceeds from your securities offerings, capital on hand and/or current cash flow. How do I know the securities offerings will be successful? You cannot know. It’s like deep sea fishing. You know there are fish in the ocean and you know they eat. You just need to be able to give them what they want to eat; have enough time to search for the best spot; and/or hire professionals to assist you in the process. You can only increase the probability to the highest degree possible by training someone within your company (most probably yourself during the start-up stage) to handle the task of raising capital using Financial Architect®. You only hire someone new if they have the necessary qualifications and investor connections for the next round of financing. You could hire someone from the securities industry who might have the necessary qualifications and investor connections (with liquid funds for investment in your company) to handle the task. Do they need a securities license? No, as long as they are bona fide employees of your company. Do you need Financial Architect® to go through the process? No, you can learn enough by reading this book, with the example of a Private Placement Memorandum (Exhibit A), and by perusing the Internet to get the job done.
However, if you would like to save a great deal of time, effort and money you can purchase Financial Architect® from our website to create securities offering documents with marketable deal structures. Alternatively, you can hire a team of individual professionals or Commonwealth Capital Advisors to create your finance department and lead you through the process. In any event, it is the same process using the same system.
We, at Commonwealth Capital Advisors, originally conceived Commonwealth Capital Advisors to be the source of quality deal flow for Wall Street investment banks. To achieve that task, we had to address the organizational and capital structuring needs of start-up and early-stage companies. We had the knowledge and skill sets to assist these young companies in properly preparing for the investment banking or venture capital relationship, we simply needed to give them the knowledge and tools to accomplish these tasks and develop the related skills on their own, hence, the need to write this book and to develop of Financial Architect®
By enabling start-up and early-stage companies to self incubate their capitalization needs along with developing the organizational and operational structures that make for “quality deal flow”, we inadvertently became a source for start-up, early-stage and seasoned companies’ capitalization needs.
To further our cause, we had to position our company so as not to compete with other professional service providers, corporate and securities attorneys and accountants, who play a key role in the securities industry. In the natural course of events, we have become a key source of quality deal flow for those professional service providers, as well. Because we teach entrepreneurs to raise sufficient seed capital to employ the services of those professional service providers, these well-prepared and self-incubated entrepreneurs inherently become quality prospective clients for the attorneys and accountants.
We are former Wall Street securities professionals and institutional financiers who have made a 180-degree turn on the securities industry. In the past, it was our job to extract as much flesh (equity ownership) from a company for as little money as possible without killing it. By law, our fiduciary responsibility rested with the investor side of the deal-making equation.
Now, in sharp contrast, our fiduciary responsibility rests with the entrepreneur’s side of the deal-making equation. We have become the proverbial guard dogs for the entrepreneur.
Financial Architect® assists you in addressing all the issues that you’re about to become aware of. However, the true beauty of Financial Architect® is this: Those who can go through this process successfully establish an extremely strong financial structure, which invariably leads to very large competitive advantages for their companies. Those who cannot- do not. For those who can, we have real connections, not only for capital, but in every facet needed to build a great company. When you’re ready to join our secret society we’ll be here.
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