I'm opening an amusement park with startup costs of $4.2 million, of which investors are contributing $1.1 million. What would
constitute a reasonable equity-distribution plan for my investors?
-- K.G., Houston
In a venture as risky as a new amusement park, private investors will likely want somewhere near 60% equity and returns of three to
five times their original investment over three to five years, say experts.
If you do not want to give up so much equity, you can structure the investment as mezzanine financing, where you make monthly
interest payments (known as "current coupon") out of cash flow. The advantage? Mezzanine investors will typically demand less equity,
and it will be in the form of warrants (which give them the right to buy as much as 25% of the company at a discount), which they
exercise when the company is sold or becomes profitable enough to repay the principal. The disadvantage of debt financing compared to
equity is that you have to make payments at a time when cash could be tight for your business.
If you believe that your venture will generate sufficient cash flow to pay your investors back more quickly, they might agree to
take less equity because a shorter loan term is less risky than a longer one. Be careful what you promise, however. If your business
plan is flawed or things don't take off as quickly as you hope and you fall behind in payments, your investors may exact monetary
penalties that could severely strain your company, or they may demand more equity.
"It's better to give away more equity upfront and give yourself a buffer when it comes to payback," says Peter Cowen, a strategic
planner and investment banker based in Westwood, Calif., who specializes in early-stage companies. "Be cautious. If you think you can
give your investors liquidity in the first year, wait two years. And if you can't ensure current income to the investors at all,
that's O.K. too." The lesson? Think twice before you put your amusement park on the investment roller-coaster.
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