The True Cost of Capital: “Deferred” & “Participating” clauses and other related costs of private equity

Too many people assume there is no cost to raising capital. Wrong. Marketing PR, regulatory, ownership, profit margin (ROI), and provisional costs are just some of the costs in meeting funding approval criteria for P/E, ABL, or even debt capital.

Each type of capital will differ in the amount of cost. For example; asset-based funding or hard money may cost about 12% and equity will cost at least 25% just for ROI. The average ownership requirement for investments of 100% funding is 51%.

But the odds of getting 1 individual person to fund 100% in anything is “Virtually Never” according to the Chairman of the New York Angels. Details here; http://SinCityFinancier.wordpress.com/2011/08/04/question-on-quoracom-how-often-does-1-angel-i/.

This explains why algorithm and telemarketing are the primary means to communicate to a large audience. Especially for such financial structures like; (a) Private placement memorandums (PPM’s), (b) debt to equity conversion debentures (bonds), and (c) EB-5 foreign investors. Any of these 3 structures will take up to a year to market. And any securities offerings have regulatory registration and auditing costs.

Many assume that telemarketing is free. Wrong. “Boiler rooms” are are a fringe exception in the telemarketing industry in that they do work only on commission. But that cost is high. Usually 50%. Most telemarketing firms to include penny stock promoters usually work on a monthly PR flat-rate. Algorithm marketing is effective but requires client to have proof of 2 prior rounds of institutional funding to even be considered.

Diversified costs like those in investment banking for video game conversion to motion pictures can be 3-fold. These can include 10% commission plus royalties or equity participation up to another 10%. http://SinCityFinancier.wordpress.com/2010/11/28/posterous-Jeff-shares-a-web-site-with-you-94/.

Provisional or triggered event costs like “DEFERRED” or “PARTICIPATING” clauses in your term sheet issued by investors are often an overlooked cost that can dramatically increase the cost of private equity from sophisticated investors. Deferred clauses require “guaranteed ROI’s” to the investor.

Participating clauses essentially say that if the VALUATION of the firm increases then so does the ROI requirement. Triggered events can include going public or being sold. The ROI can then go from 25% up to 70%. We first mentioned guaranteed and triggered costs in March 2007 on our homepage at; http://SinCityFinancier.wordpress.com/2010/05/24/pt3-due-diligence-blog-of-globalcrossroadscap/.

Timelines to close and cost(s) are 2 reasons why equity should always be your last choice and not your first choice for funding. Usually those who gravitate towards equity first (with no purchase orders or existing revenues or tradeable securities) due so because they aren’t eligible or are unfamiliar with other cheaper and more expedient options.

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GLOBALCROSSROADSCAPITAL.COM is a US Vet-owned IR media communications firm catering to both the corporate & government sectors and is not a lender, funder, investor, free advisor/analyst or broker-dealer. If you have any diversified IR contractual client needs; proceed to the CONTACT page at the top of the blogfeed. Or click on the orange url just above.

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