After completing due diligence and selecting portfolio companies, the structure of the investment with the portfolio company must be negotiated and confirmed. The investment instrument should meet both GP and portfolio company financing needs, have a clear process for its deployment, and imply a strategy for ultimate exit.
Deal Structuring: Instruments
As a first step in deal structuring, the fund manager assesses the universe of potentially available investment instruments and determines which is appropriate. Which instrument most effectively allows a fund to benefit from its investment in a growing company? This guide focuses on equity funds, which invest through equity financing, a category of instrument comprising all financial resources provided to firms in return for some ownership interest, or shares, issued to the fund manager.
Deal Structuring: Mechanics
Funds accommodate the needs of diverse portfolio companies by selecting appropriate financing structures, balancing risk and return and attempting to foresee exit strategies. This is a difficult task. Successfully structuring deals requires a fund to have strong communication with its portfolio companies and the entrepreneurs that lead them, and it also requires strong alignment between the financial, strategic, and impact goals of the company and those of the fund.
Deal Structuring: Exits
Exiting from a portfolio company is the culmination and ultimate test of a fund’s ability to create value for its LPs and portfolio companies. Successful exit depends on a shared vision between the fund manager and the entrepreneur, who should have conversations about exit expectations before investment. Without a clear path to exit, many investors will be unwilling to agree to a deal in the first place—a reluctance that applies both to funds looking to invest in companies and investors looking to invest in funds.
Impact funds must consider how impact will be maintained after they exit an investment. According to the GIIN’s 2016 Annual Impact Investor Survey, more than 80% of impact investors believe they have a responsibility to try to ensure continuity of impact after exit. Using data from the Annual Surveys from 2015 to 2017, GIIN research found that sixteen percent of investors use impact data to inform their exit decisions.
Methods of exiting an investment include a trade sale, sale by public offering (including IPO), write-off, sale to another equity investor, or sale to a financial institution. A management buyout (MBO) is one way to democratize companies, especially those that are family-owned where future generations do not want to work in the business.