Article 66: SME Business Legal 101 (Part 3): Raising private equity for your business

Raising Private Equity for your business: This is the third part of a series of articles on SME Business.  In this article, we will discuss when and why you should be raising convertible debt for your Singapore business.  We will also highlight some key commercial terms that you need to understand when commencing negotiations for funding.

Most businesses whether SME businesses in Singapore or start-ups will need to raise equity funding as their revenues/net profits grow or when they need more cash buffer to acquire additional inventory as they scale up and grow. 

Raising Private Equity for your business : If your business is willing to take in external funding and by virtue of that external control /influence /board members, growth private equity funding is applicable to you.  Such investors look to take small minority stakes in companies with the view that such companies will grow larger and then list on a stock exchange or sell to a third party via a trade sale or repay a loan.

If the controlling shareholder is looking to exit the business, you should be looking for a buyout fund to acquire your stake instead.  That will be the subject of a separate article.

Investment instruments for growth private equity

For a growth minority stake private equity firm, most of them typically would invest via a mixture of convertible bonds and/or warrants.  Most of such firms have an internal targeted return of between 20% to 25% for their investors so you should note that such funding is not cheap from a weighted average cost of capital perspective.  Most firms that take such funding usually use this for project level property developments / solar farm development projects or as a bridge loan between priced funding rounds.

Convertible Loans: These are debt instruments with a fixed principal and repayment period and interest rates.  The debt and interest will be convertible (usually upon the occurrence of an exit event like a trade sale or listing of the company on a stock exchange) or at the election of the investor into shares in the capital of the company.  If the convertible loan is not converted at the end of the term of the loan, the company needs to repay the investor the principal amount and any interest which has accrued thereon.

Warrants: These are convertible instruments which allow the holder to convert into equity in a company.  This allows the holder of such instruments to acquire shares in the target company with the hope that the valuation of such company will grow over time and the holder gets to participate in the upside growth of the target company.

Raising Private Equity for your business – Controls by growth private equity firms after they invest

In the legal documentation, an investor will typically have some or all of the following rights:

1. Board Reserved matters: These are veto rights whereby the board director (usually appointed by the investor) has the right to say no to certain decision of the board.  Board reserved matters usually relate to operational matters of the company and an experienced corporate lawyer will be able to tell you what is market standard for your type of business;

• Shareholders’ Reserved matters: These are veto rights whereby a shareholder (usually the investor or their corporate entity) has the right to say no to certain decision of the company.  Shareholder reserved matters usually relate to capital structure matters of the company and an experienced corporate lawyer will be able to tell you what is market standard for your type of business;

• A class of preference shares that allows for liquidation preference which is superior to the other classes of shares (in liquidation);

• The right to appoint a director and/or a board observer to monitor the status/operations of the Company;

• Default rights: In some extreme case, the investor will have the right to appoint the majority of the board upon the occurrence of certain event (such clauses became popular after the Wework case);

• Information rights: This is the right for the investor to get monthly/quarterly information rights.  We have seen some companies give this information rights to all their investors which is not correct as early stage angel investors may not need to receive so much information.  We would suggest that you speak to your corporate lawyers to amend the provisions at an early stage in the growth of your company so that only institutional investors get the detailed information and the early stage investors get information in accordance with the Companies Act (i.e. once a year).  It makes sense to give the right amount of information to the relevant parties.

In conclusion, taking in growth private equity capital for a business means that a business may have to be subject to external party’s corporate governance.  But if the external investor can add value to the business, for a company to take in such an investor’s money brings with it strategic importance.  Choose your external growth funding counterparty well and once you have found the right investor, spend some time to find the best corporate legal counsel who can understand your business to work with you to work on the legal documentation.

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Click here to speak to a specialist Corporate Law Practitioner today to advise you on your corporate transaction today.  The corporate law team has acted for a diversified client base including transactions involving several hundred startups across the startup eco-system in Singapore and for private equity fund deals and is well placed to help you in your corporate transactions.