Contingent-Capital Solutions for Mitigating the
Investment Risks of a Private Placement Stock

Abstract

The final negotiations between angel investors and a company following a thorough due diligence usually involve the following impasse: The angel investors on one side and the company on the other are in disagreement regarding the company’s valuation because the company’s expectations are more optimistic than the investors’. There is no feasible solution. In this article, the author proposes a model that a mediator may use to help the two parties come to a settlement. For the model, we show why traditional instruments of equity or notes are oftentimes infeasible and how feasible solutions—solutions that are currently not considered in negotiations—may be uncovered. With this model, a mediator may at least get one side to understand the implication of the terms to his or her future ownership of the firm, the (in)feasibility of the offering, and more importantly, where the other side is coming from. Better yet, with the model, the mediator may be able to persuade the contending parties to jointly consider alternate feasible solutions, to add their own constraints, or to move their expectations (which are functions of their beliefs about capital needs, risk profiles, intellectual property, etc.) closer to each other in order to get to a quicker settlement.

TOPICS: Private equity, theory, factor-based models