Sponsors and investors help get your deal off the ground, and they’ll want updates along the way. Whether that comes in the form of reliable data, dividends and distributions, reports, or knowing the end game – it requires communication. After all, the odds are that you raised capital under the premise of eventual returns. Updating your business plan with sponsors and investors along the way is not only recommended, but it’s also necessary.
This post will guide you through how to proceed and what your investors are likely to expect, based on the underlying structure of ownership of the merger or acquisition deal in question.
First things first – let’s clear up any questions of multiple classes to avoid confusion. Most syndications are set up with multiple classes.
● Class A – Class A is for private investors only. The preferred returns and/or performance hurdles are tied to investments in Class A. If sponsors contribute capital, they get moved to Class A with the other investors.
● Class B – Class B is for sponsors. Sponsors get to pay their fair amount revenue percentage without the obligation to contribute capital, but if they choose to do so then they switch classes.
We’ve worked with situations with Class A through Class G, depending on how many different sources report and common types of data are involved. Terms change and things get complicated, but the above rules keep the process direct and simple.
Dividends and Distributions
With that out of the way, let’s address dividends and distributions. More specifically – how often are they sent out?
Investors love seeing checks, regardless of the size, as it shows them there’s a significant change in money coming back. With that in mind, we generally recommend sticking to a quarterly schedule, or even monthly if you can swing it. You’re not obligated to keep to a monthly routine but keep in mind that frequent distributions are generally better. However, quarterly is the standard that everybody expects. If you’re considering only doing it once a year or so, it’s perfectly legal to go that route. At that point, it’s an issue of sellability. When are distributions expected to begin? It’s asset dependent, and you’ll want to disclose enough to investors to set the correct expectations. Consider the following examples:
● Multifamily assets – If you’re buying a cash-flowing investment or multifamily maybe it’s only going to be a month or a few quarters to create the cash flow.
● Business Startup – If you’re doing a successful new business startup, you may need years to get your businesses up to the point that you’re breakeven or profitable enough to start making distributions to customers.
● Ground-Up Construction – We will also kind of create this expectation for investors: how long will the value of the company and my money be tied up? An average of five to seven years is a great target.
Short periods are more attractive to investors. They don’t want their funds to be locked up, but five to seven years is very acceptable. Within the documentation, we always lean on the five to seven years.
This is an expectation based on the current market conditions and assumptions of management. We believe everything is going to go right, but the future and what happens in the economy are always unknown. We always include a lot of language to make sure that it’s well communicated. After all, that five to seven-year estimate could be way off. We don’t know how it will work out.
Reporting is similar to the above outline for dividends and distributions, for example, but you don’t want to go overboard. There’s a fine balance between keeping the investor informed and saying enough to cause shareholders and the company administrative headaches.
It can happen often as a business startup or early stages of operations. You provide a quick monthly report to the investors, letting them know what’s up and that you want to keep them informed. That’s a great thing and keeping investors up to date and informed that things are going great (or not going great) is important.
However, it’s generally not recommended that you bind the owners of the company or yourself to monthly reports. Instead, the best practice would be issuing quarterly reports to your investors. In saying “report,” we generally mean non-audited, internally prepared financial statements and a page (or a few pages) of details about what’s been going on with the asset, the business, and surrounding things. The purpose is to have an open line of communication with your investors, and quarterly is the most acceptable amount method of reporting.
With annual reporting, we have some clients that will say their investors really don’t care. They only want to send the required tax documentation or once-a-year financial statements. While that’s fine and legal, it affects the scalability of your deal. It’s not an issue if you have established businesses who’ve already got to know who your investors are, and they’re expecting to only receive an annual update. If you’re looking for fresh blood, so to speak, quarterly reporting is the way to go.
Along with the information about expected dividends and those matters, we will disclose what type of exit plan and business and exit plan and strategies we’re expecting. That could just be a sale, but it could work to build in the expectation of a roll-up, too. That’s a trend, currently, and a lot of these are moving forward as roll-ups right now.
For instance, you have entrepreneurs who might say, “I’m looking to buy HVAC companies throughout. I’m going to roll them all up into one entity that I’m going to take public.” That is happening a lot now. It can also happen in the real estate industry in land of doing portfolio sales, too. You can bring everything together, sell it as a big group, go to initial public offering, etc. There are a lot of different ways to handle it, but generally speaking, we work on disclosing the intention to investors early on.
Investors keep the world (and money) going around, so you’ll need a business exit strategy and good communication and exit strategy too. You want to disclose enough to satisfy them and send along checks so they know what their money is leading toward. At Crowdfunding Lawyers, we have the experience to strike the right balance. If you’re ready to set up your next deal and aren’t sure where to begin, or just want some expert guidance and backing to get you there, set up your free consultation today.