Part of the process of structuring your private placement, or offering, is to target an IRR, or Internal Rate of Return.

But unless you’re constantly in the market, you’re probably just taking a shot in the dark. The solution of course is to talk to the market. Go out and have discussion with potential investors about what you are seeking to do and take note of the feedback you receive.

However, you need to be careful that your market intelligence gathering is not misconstrued as offering securities for sale.

The two things I’ve done to avoid this potential problem:

1. Add a watermark on each page of the Executive Summary that reads FOR DISCUSSION ONLY; and

2. Add disclaimer language to the Executive Summary that explicitly states that the document is not an offer to sell or solicit and offer to buy any securities. Also add language before the financial projections and the term sheet.

If you need disclaimer language, you can download it here:

Now go out and gather some market intelligence so you can structure your deal with confidence.

Today I’m going to show you a cool tool right here on TransCapital Pro

My consulting clients have been asking me about Blue Sky laws and what they need to do to be in compliance.

Well, because it would be difficult to be fluent in each states Blue Sky laws, I built this interactive map (thanks to Pat Flynn) where you can click on any state and be taken to that state’s securities regulation division.

And as a side note, the trigger for complying with a state’s Blue Sky law is whether your investor, or prospective investor is a resident of that state.

So for example, I’m a resident of the state of Ohio. But if I were seeking to raise money from investors in Indiana and Kentucky, I would have to make sure I was in compliance with the securities laws of those states.

So lets take a look. You can find the map at TransCapitalPro. I have the page open, but you can click on the navigation, here under Blue Sky.

You can see that the map is easy to use. When you hoover over the map the states get highlighted. And when you click on a state, a new tab opens to the securities division for that state.

If you get a bad link, try the table – that’s where I update the urls.

If you like this tool, please tweet it, like it, plus-on it or share it on LinkedIn.

In the last video we ended with a slide that showed the tremendous leverage that is available on the General Partner’s capital.

Before we dig into the economic mechanics of an investment partnership, we need to understand a few concepts:

• Carried Interest
• Preferred Return
• Waterfall

Carried Interest is defined as a share of any profits as long as i) all capital is returned to the investors; and ii) the investors receive their Preferred Return.

Preferred Return is the return on invested capital before the General Partner receives its carried interest.

The Waterfall defines the priority of the distribution of invested capital of an investment fund in general, and from the exit of each discrete investment in particular. The Waterfall is not just for an investment fund, or blind pool; its also applicable if you are raising money for a single asset transaction – such as a single real estate investment.

So, what does a waterfall look like, in other words, what does the priority of distribution look like?

Below is the “Executive Summary” version of a waterfall from one of our offering memorandum templates:

i.     return of 100% of invested capital;
ii.    the Preferred Return;
iii.  100% to the G.P. as a catch-up until the G.P. has received 20% of distributed profits; and
iv.  thereafter, 80% to the partners and 20% to the G.P.

Traditionally, the carried interest on investment funds is 20%

Also, note that the Partners do not receive their Preferred Return AND an 80% allocation of the profits; they receive 80% of the profits. The Preferred Return is the hurdle rate for the G.P.

For example, if the G.P. has been receiving its Carried Interest in the early years of the partnership, but the the partnership sustains some losses so that the Partners’ return is less than the Preferred Return, then the Partners can “Claw Back” some of the Carried Interest received by the G.P. until the Preferred Return is met.

Towards the end of the video in this post I walk through an example of a fund and show how the dollars flow. I also present the IRR for the fund, the Limited Partners, and the General Partners.

You want to establish an investment fund when you are seeking capital to pool capital for investments that have yet to be identified.

Your investors will be committing capital to you based on your experience, track record and the investment profile, or investment theme that your Investment Fund will be pursuing. Since the investors are committing capital  to yet-to-be-identified investments, an Investment Fund is also known as a “blind pool.”

Investment Funds are established as Limited Partnerships, with investors coming in as Limited Partners (“LP”). You, as the Sponsor of the fund, are the General Partner (“GP”).

The GP manages all fot he activities and affairs of the Investment Fund/partnership.

Sometimes the General Partner is the Investment Manager, and sometimes the Investment Manager is a separate entity.

I’ve seen three ways that the relationship between the General Partner, Investment Manager, and Fund are set up (and I’m sure there are more).

The simplest, and the structure I’ve seen the most, is one where the GP and the Investment Manager are one and same, with the GP formed as an LLC.

The second structure is one that I’ve only seen a few times, and it’s one where the GP is formed as a Limited Partnership. An Investment Manager is formed as a separate entity, usually an LLC, and is the General Partner of the GP of the Fund.

There is a dotted line from the Investment Manager to the Fund, which represents the contractual relationship between the two, with the Investment Manager providing services to the Fund such as deal sourcing, negotiating, due diligence, closing and post-closing portfolio management.

The third structure is one where the GP is formed as either a Limited Partnership or an LLC. The Investment Manager is typically fomed as an LLC, and again having a dotted line to the Fund for investment management services.

Some people are not clear about the mechanics of an Investment Fund. When you close on your fund, you don’t collect the investments from your investors at Closing and then deploy the proceeds into investments over time. When you Close on your fund, you’re closing on “Commitments” from the investors. At Closing there will be some amount that gets drawn down to fund the first quarter of management fees, pay Fund Closing costs, which are mostly legal expenses, and finally, fund any pending investments. As you source opportunities, you will draw down, or “call” on the Limited Partner’s commitments.

Finally, as a preview of the next video, there is tremendous leverage to the General Partner’s capital with an Investment Fund. Typically the General Partner will invest 1% of the total commitments of the Fund, with the Limited Partners committing the remaining 99%. The profits, on the other hand, are allocated 80% / 20%, with 80% going to the Limited Partners and 20% to the General Partner.

In the video in Part I we walked through how to figure out how much equity in dollars you will need to provide to your investors to achieve a certain targeted IRR. This equity give-up is accomplished with a security called a warrant.

In this video we walk through i) how to figure out what percent of equity those equity dollars represent; and ii) how many warrant shares will need to be associated with each note you issue.

I’ve had several inquiries about “Debt/Equity.”

And after either spending time on the phone or through email correspondence, what people were looking for was to issue debt with an equity kicker.

Accomplishing this is easy by issuing your debt with warrants. The yield to your investors then is the coupon on your note plus the value of the warrants.

This short video (less than 5 minutes) shows you how a simple spreadsheet can be set up to calculate the IRR for a debt with warrants issuance.

I was talking with a friend of mine that sits on the board of an angel investor group. He told me that one of the first (and favorite) questions they like to ask presenters is what their “pre-money” valuation is.

Unless you’ve been down this road before, or have been coached, then you might be caught off-guard.

In this short video, which I filmed in my car, I give you the simple formula to calculate your pre-money valuation.

In a nutshell, you take the “Post-Money” valuation and subtract the amount of money you are raising.

Your Post-Money valuation is simply the amount of capital you are raising divided by the amount of equity you are offering.

So for example, if you are raising $500,000 and offering 33% of your company to do that, then:

• Post-Money Valuation is $500,000 ÷ .33 = $1,515,000 (rounded)
• Pre-Money Valuation then is $1,515,000 – $500,000 = $1,000,000 (rounded)