Deal Structure &

Deal
Terms
Deal Structure and Deal Terms

A critical aspect of the entrepreneur’s attempt to obtain resources is the development of an

actual “deal” with the owner of the resources. Typically, the entrepreneur needs a variety of
resources, including dollars, people, and outside expertise.

Entrepreneurs can obtain funds in the form of trade credit, short- and long-term debt, and
equity or risk capital.

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1. What is a Deal?
What is a Deal?

▪ In general, a deal represents the terms of a transaction between two

(or more) groups or individuals. Entrepreneurs want money to use
in a (hopefully) productive venture, and individuals and
institutions wish to earn a return on the cash that they have at risk.
▪ The entrepreneur’s key task is to make the whole equal to more
than the sum of the parts.

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Factors that drive a Deal

In order to craft a deal which maximizes his/her own economic return, the
entrepreneur must:
▪ understand the fundamental economic nature of the business;
▪ understand financiers’ needs, and perceptions of risk and reward; and,
▪ understand his/her own needs and requirements.

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Understanding the Business

The first thing the entrepreneur must do is assess the fundamental economic nature of the
business itself. Most business plans project a set of economics which determine:
▪ the amount of funds required:
▪ the riskiness of the venture:
▪ the timing and potential magnitude of returns.

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▪ A manufacturing business with the following projected cash
flows; including a sale in year 5.

Year 0 1 2 3 4 5

Cash flow ($000) (1,000) 400 400 400 400 5,600

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Now, we can break this cash flow down into its components.

▪ Investment
▪ Tax consequences
▪ Free cash flow
▪ terminal value

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 Year

Cash Flows ($000) 0 1 2 3 4 5

Original investment (1,000)

Tax consequences 300 300 0 (100) (200)

Free cash flows 100 100 400 500 800

Terminal value (after tax) 5,000

Total (1,000) 400 400 400 400 5,600

 The Internal Rate of Return (IRR) for the total

investment = 64.5%
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 Present Value

Element @ 64.5% ($000) % of Total

Tax consequences 263 26.3

Free cash flows 322 32.2

+ Terminal value 415 41.5

Total $1,000 100.0%

 This analysis illuminates the potential sources of return inherent in

the business, as projected

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Understanding Financiers Needs and Objectives

Providers of capital clearly desire a “good” return on their money, but their
needs and priorities are far more complex.

▪ magnitude of return desired; ▪ timing of return;

▪ magnitude and nature of risk which ▪ form of return;
is acceptable; ▪ degree of control; and,
▪ perception of risk and reward; ▪ mechanisms for control.
▪ magnitude of investment;

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Certain investors may want a high rate of return and be willing to wait
a long period, and bear a large amount of risk to get it. Still other
investors may consider any type of investment, as long as there exists
some mechanism for them to exert their own control over the venture.
If we return to our example of the manufacturing business which
requires a $1 million investment, we can see how the entrepreneur can
take advantage of these differences in investor characteristics.

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▪ The tax benefits, for example, are well-suited for sale to a risk-averse wealthy
individual in a high marginal tax bracket.
▪ The operating cash flows would, in total, be perceived as fairly risky. However, some
portion of them should be viewed as a “safe bet” by a bank.
▪ Now, the entrepreneur has raised $825,500 and needs only $174,500 to get into
business.
▪ The terminal value, and the riskier portion of the operating cash flows, remain to be
sold.

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First, we need to see precisely what cash
flows remain:
Year 1 2 3 4 5

Total 400 400 400 400 5,600

- Wealthy investor 300 300 0 (100) (200)

- Bank 60 60 60 60 560

= Remaining 40 40 340 440 5,240

Now, the remaining cash flows in years 1 through 5 have a present value, at the venture firm’s
50% rate, of $922,140. If we need $174,500, we need to give up $174,500 ÷$922,140= 18.9% of
these flows in order to entice the venture investor to provide risk capital

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Understanding the Entrepreneur’s Own Needs
The example we have just worked through was based on the assumption that the
entrepreneur wants to obtain funds at the lowest possible cost. While this is generally true,
there are often other mitigating factors.
However, once the entrepreneur has decided to embark on a particular business, his needs
and priorities with respect to the financing of the venture will vary with respect to:
▪ degree of control desired;
▪ mechanisms of control desired;
▪ amount of financing required;
▪ magnitude of financial return desired; and,
▪ degree of risk which is acceptable
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Alternative Structures

0nce the fundamental economics of a deal have been worked out, the
entrepreneur must still structure the deal. This requires the use of a
certain legal form of organization, and a certain set of securities. The
vehicles through which the entrepreneur can raise capital include the
general partnership, the limited partnership, an LLC, and A “regular”
(or “C”) corporation.

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An Example: A Venture Capital Term Sheet

The specifics of a deal are set out in writing in the form of a

term sheet, which are the business terms of the deal.
The most common form of term sheet is one which is obtained
from venture capitalists (VCs)—or other sophisticated equity
investors—related to an investment in the venture. Such term
sheets are designed to address the important dimensions of the
deal.

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Representations, Warranties and Due Diligence

▪ First, the firm vouches for some of the information it has

provided to the investors during their due diligence,
including a list of the existing shareholders and the number
and type of shares of stock outstanding.

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The Security

▪ The second major aspect of the term sheet is the description of the
security being sold by the firm / bought by investors.
The term sheet will be very specific about the number of shares, price per
share, and other terms, the most common of which include:
 Voting: the voting rights attached to the security.
 Dividends: Whether dividends are paid, how much (in absolute dollars or
percent on the price of each share), and whether dividends must be paid
annually or whether they can accrue over time.

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 Participation rights: Participation refers to the right to “participate” in
the upside of the company.
 Conversion rights: a convertible security has the right to convert to
common stock.
 Redemption rights: Redemption is the “calling” back of the preferred
stock and “paying it off” by the company to eliminate it from the
balance sheet.
 Anti-dilution provisions: Investors may also receive anti-dilution
protection.

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Control

Finally, the document will spell out the rights which the holders have to control, or
at least have a voice, in the company. This included the right to attend board
meetings, or perhaps, to name a board member.

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Other terms and conditions

The term sheet also spells out certain actions that the
company must take either prior to closing, or within
30 or 60 or 90 days.

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Thank You!
Group 7:
▪ Nasayao, Jeana Maica C.
▪ Portuguez, Hanna Melshayne G.
▪ Regencia, Rochelle Marie A.
▪ Reyes, Rosell L.
▪ Sarmiento, Mary Grace P.

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