Ebook Raising Capital

Commonwealth Capital Advisors Architects of Finance™

A

Financial

rchitect®

4.0 RAISING CAPITAL FOR

START-UP, EARLY STAGE & SEASONED COMPANIES

The Wall Street Process Of Raising Capital for Main Street Companies™

Table of Contents Dedication

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Chapter 1: Introduction Brief introduction on Commonwealth Capital Advisors & The Financial Architect 4.0 program

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Chapter 2: The 5 Most Important Concepts When Raising Capital What to consider when raising capital for your company

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Chapter 3: Raising Capital in the United States The three ways to legally raise capital in the U.S. is overviewed

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Chapter 4: Rules of the Game 10 “rules” on raising capital are defined

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Chapter 5: The Top 15 Reasons Why Entrepreneurs Fail to Raise Capital The top 15 reasons are identified and solutions defined.

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Chapter 6: The Four Professional Functions of a Securities Offering The 4 functions involved with creating a successful securities offering

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Chapter 7: Organizational Structures The three types of organizational structures in which you can sell an ownership interest is reviewed.

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Chapter 8: Deal Structuring Creating a marketable deal structure to further a successful securities offering

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Chapter 9: Investment Risk vs. Return View your securities offering from the perspective of the investor

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Chapter 10: The Three Most Popular Deal Structures for Private or Public Placements Notes with Equity Kickers, the Royalty Financing Contract, and the Participating Preferred Stock structures are defined

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Chapter 11: The R&D of Debt Capital The “Testing of the Waters” for use of debt capital is explained

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Chapter 12: The R&D of Equity Capital The “Testing of the Waters” for use of equity capital is explained

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Chapter 13: Making Structural Changes Changing the deal structure to meet market demand is explained

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Chapter 14: Changing the Mode of Operation Re-thinking the company’s mode of operation to enhance the deal structure

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Chapter 15: Instructions to Producing Pro Forma Financial Projections Financial Projections Preparing Your Workplace Running the Numbers Calculating the Internal Rates of Return

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Chapter 16: Company Valuation and Securities Pricing The Fundamentals of Pricing Securities Using the Master Templates

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Chapter 17: Securities Offering Document Production The 7 questions that should be answered by the offering document Preparing the securities offering document for legal counsel review

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Chapter 18: Soliciting & Selling Securities to Raise Capital The Key Points to Selling a Private Placement of Securities How Stockbrokers Sell Securities Productive Prospecting Getting the Message Through The Seminar Approach Proactive Prospecting Prospecting in Everyday Life The Follow Up

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Chapter 19: Compliance with Federal and State Securities Laws Direction & Conclusion

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Exhibit A: Sample Private Placement Memorandum

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Dedications This book is dedicated to my wife, Nadine, for her enduring patience, and to all of my family for their love and support. The instructional manual to the securities offering document templates portion of this book is dedicated to my friends and colleagues who put up with my constant refining of the manual and the Templates. Thanks to Nicole Komisarski, Bruce Kaufmann, Charles Dreher, George P. Psoinos, Esq., Lynn Stedman, Esq., Bill Romanos, Esq., Ronald Alderman, CPA, and Carol Brubaker, CPA, for their enthusiastic support and assistance in the development of this program. Thanks to Robert Kuntz for the development of the company’s web site and our e-commerce operation. Thanks to all our Managing Directors, who have been instrumental in the continued growth of the Company. Special thanks to our investors, Michael, John, Charles, Roberto, Sine, Bob and Joan, who have placed their confidence in us, as well as, their capital. Thanks to GOD, may this program further His glory.

Author: Timothy D. Hogan, Chairman & CEO Commonwealth Capital Advisors, LLC

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Introduction Entrepreneurship is the single most powerful force in the American capitalistic economy. Statistics from the U.S. Small Business Administration show that during the decades of the 1980s and 1990s it was the small business sector, not big businesses, that generated nearly all of the new jobs in the United States. In fact small business accounts for over half of the nation’s Gross Domestic Product. We revere all those brave souls that have taken on the incredible risks of building businesses and salute their continued dedication in their search for the American dream. Commonwealth Capital Advisors has become “The Advocate of the Entrepreneur” for one purpose. That purpose is to accelerate the entrepreneurial drive that makes this U.S.A. so great. Our contribution to further that goal is to bring the Wall Street capital raising processes, techniques, and strategies to Main Street companies. Until now, these processes, techniques, and strategies have only been reserved for big business due to prohibitive related costs for small businesses. Our admiration goes to all those who invent new products and services, develop new technologies, create jobs, build companies and drive the American dream of individual financial freedom. Financial Architect® 4.0 should serve you in many ways beyond just showing you how to successfully raise capital. Although reference is made primarily to Start-Up and Early Stage Companies, Financial Architect® 4.0 can be used for Seasoned Companies as well. Although it may sound like it, the following is not an advertisement of our services. It is simply an explanation of who we are, what we used do, and why we did it. Commonwealth Capital Advisors, LLC, is a Michigan Limited Liability Company, “Doing Business As” Commonwealth Capital Advisors. The Company is comprised of Managing Directors located throughout the United States. Our Managing Directors include individuals from the Investment Banking, Securities Brokerage, Legal, Accounting, Information Technologies and Marketing professions. Most of us are entrepreneurs who have successfully raised capital for other start-up, early stage, and seasoned companies, as well as for our own companies. Collectively, we have over 147 years of experience in business organization deal structuring, securities offering document production, and capital procurement through the solicitation and sales of securities. For Start-Up, Early Stage & Seasoned Companies, as well as, Selected Real Estate Development Projects, we served our client firms in two capacities: 1. We served as the “Architects” of capitalization planning, deal structuring, securities creation, pricing and offering documentation production for legal counsel review. We valuated the Company and priced its securities using only the Wall Street company valuation and securities pricing models.

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2. We, through our affiliated SEC registered investment bank, served as a wholesale placement agent to sell your company’s securities if your company qualified for an NASD Member (stockbrokerage firm) syndicated selling effort. We rarely engage client firms anymore because our business model has changed. The company has moved away from the securities offering document production & investment banking advisory services as the Company is increasing the sales and distribution of the Financial Architect® and third party provider product lines to assist the entrepreneurial community in the capital raising effort en masse. The company’s mission statement has evolved to: “As a company we level the playing field for the average entrepreneur by taking extremely complex and expensive legal, accounting, and investment banking processes and convert them into inexpensive, easy to use software template programs.” These programs enable any entrepreneur to compete for capital at a fraction of the standard cost. We do not compete with the legal, accounting, venture capital, investment banking, commercial banking communities or any professional engaged as a service provider for the small business community. We actually enhance and expand the practices or operations of these service provider communities because our programs cater to entrepreneurial clients and prospects that would not necessarily be able to afford the costs associated with these processes. Therefore, as affiliated distributors of the Company’s products, these professional communities are able to benefit by tapping into a completely new market for their products and services. Our product lines act as a catalyst for creating a breeding ground of new clientele for attorneys, CPAs, private investment firms, venture capitalists, investment and commercial banks. See “Affiliate Program” on our website: www.commonwealthcapital.com for more information on professional affiliations. This Ebook serves as the instruction manual for this comprehensive educational program, which is designed to guide the entrepreneur through the complicated process of how to effectively and legally raise capital in the United States through the issuance of securities and by other means. This program educates the entrepreneur on how the world of capitalization works, especially when it comes to raising capital for start-up and early stage companies. This Ebook is only one of three components that make up the Financial Architect® 4.0 program. The other two critical components are the Securities Offering Document Production Templates and the Commonwealth Capital Club. The Financial Architect® 4.0 is designed to enable the vast majority of entrepreneurs to succeed in regards to the arduous and difficult task of raising capital. By completing this program you and your company’s management team will make a quantum leap in your ability to raise capital. There are no guarantees when it comes to raising capital, only degrees of probability. This program will help you and your company achieve the highest degree of probability, in regards to raising capital, possible. How can we make such a claim? Because this is the Wall Street process boiled down to main street applications. If this process didn’t work, then Wall Street wouldn’t exist.

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Let me give you a little background on myself. I started my career in the securities industry in the spring of 1984. I was trained by and obtained my experience from a few of the largest investment banking firms, such as Merrill Lynch, E.F. Hutton and Shearson Lehman Brothers (now known as Solomon/Smith Barney, a Member of Citigroup). I am a licensed General Securities Principal at an SEC registered investment bank and securities brokerage firm and retain six securities licenses and NASD registrations. After years with the large firms, I joined a smaller regional investment-banking and securities brokerage firm in the Midwest in the early nineties. There, I took the position of Senior Trading Principal, Director of Compliance, and Chairman of the Investment Policy Committee for the company’s affiliated Registered Investment Advisory firm. At that time, I was the proverbial “gatekeeper” for that brokerage firm. All capitalization deals and securities offerings had to go across my desk for approval before our stockbrokers were allowed to sell the client firm’s securities to their brokerage clients. I saw hundreds of deals and the rejection time for about 90% of them took about five minutes. The rejection rate was high and quick because the average entrepreneur did not understand how the world of private and public capital markets work, especially when it came to start-up and early stage companies. Most entrepreneurs do not know how to properly structure a start-up or early stage capitalization plan. That lack of knowledge was the determining factor in our approval or “dis”-approval process. Many of the concepts, products, and services of these start-up or early stage companies had validity and merit on their own, but the deal lacked the proper structure. Most proposals were submitted to us as if we were supposed to figure out the structure of the deal. Furthermore, we, as an investment banking operation, needed to charge about $20,000 on average to put together deal structures and securities offering documents for these firms who simply couldn’t afford it. After I left the regional firm, I became involved with a few private deals of my own. I’ve personally raised substantial amounts of capital through the private placement of securities and have assisted clients in doing the same. I know how difficult the process is. In fact, the first capital raising effort you conduct will probably be the most difficult thing you ever do, as it was for me. Take heart; the second effort is easier as is the third and fourth. In addition, if you develop the ability to structure deals and raise capital you will eventually have sources of capital come to you. Banks are more apt to lend you money if you have the ability to raise equity or debt capital through a private or public offering of securities. Entrepreneurship built this country and it seems that when it comes to raising capital, no one is on the entrepreneurs’ side of the table. This is due to the nature of securities laws and the burden of fiduciary duty that those laws carry. By law, single sources of equity and occasionally debt capital, such as venture capital firms and securities brokerage firms, have a fiduciary duty to the investor side of the equation. Pension fund and state retirement system trustees have a fiduciary duty to their entities’ employees. Endowment and foundation fund trustees have a fiduciary duty to their

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contributors. Insurance companies, mutual funds, small business investment companies and other companies that may provide investment capital have a fiduciary duty to their shareholders. Commonwealth Capital Advisors, by contract, has a fiduciary duty only to the entrepreneurs and their companies. No other entity that we know of operates in this fashion to the degree that we do. Most securities attorneys cater only to publicly traded, or the larger privately held companies, because that is where the money is. Securities law practitioners generally have unusually high mal-practice insurance premiums because of the risks associated with this type of practice; therefore, they need to be able to charge appropriately to cover those premiums, so they tend to deal only with client firms that have the funds to afford their time. Those securities attorneys who do deal with smaller companies are able to produce the required securities offering documentation; however, they generally follow the capitalization plan and the deal structure that is determined by the client firm, which most often is not marketable. We see many securities offering documents that are sent to us by prospective client firms that fail to raise capital simply because those documents have a bad capitalization plan or deal structure. Most accountants can produce pro forma financial projections, but rarely are able to determine and formulate a marketable deal structure for a securities offering. Most investment bankers can determine and formulate a marketable deal structure because they are in touch with the private and public securities markets on a daily basis. However, like securities attorneys, they too deal primarily with larger companies because it generally requires the same amount of time to place $100,000,000 in securities for a well-seasoned company as it does to place $1,000,000 in securities for a start-up or an early stage company. Once again, they go where the money is. Most stockbrokers can sell securities to raise capital, but they generally will not do so for start-up or early stage companies because they do not want to risk losing their client’s money. They know that, on average, 85% of start-up or early stage companies will fail within their five years. They are also reluctant to tie up their clients’ money in private illiquid securities. How many great inventions do not make it to market due to the lack of capital? From our vantage point far too many great technologies, processes, products, and needed services fail to make it into the marketplace due to the lack of capital. We are the “Advocate for the Entrepreneur” because we believe that far too many benefits to the American and to the International culture are being lost due to the inability of these young companies to prosper because of the lack of adequate capital. These young companies need help raising capital like never before. We believe that our Financial Architect® products fill a void that would otherwise be left empty. That is why we do what we do. We exist to revolutionize the way capital is raised for start-up and early stage companies. Until February 2003 we had never advertised our services. Until then, 100% of our business came through referrals. These referrals came from investment banks,

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venture capital firms, securities attorneys, and accountants, as well as, from management team members of our previous client firms. (See Testimonials on our Website). The reason that we had never advertised or promoted our services was that we believed we could not handle the volume of business that we may attract. While conducting market research over most of 1997 and 1998 for our services, we found that there was an enormous demand for our type of service. The demand for our services was and probably still is far greater than we could ever handle without taking on additional fixed costs. In addition, and unfortunately, the vast majority of entrepreneurs seeking capital could not afford to pay us for our services. That is the main reason that we created Financial Architect® 4.0 which serves as your personal “Do it Yourself” kit. By the end of this program you should have a keen understanding on how the process of raising capital for start-up, early stage, and seasoned companies works. You should be able to: 1.) Value your company and price its securities; 2.) Test the private capital markets with prototypes of securities offerings – “Red Herrings”; 3.) Produce your own securities offering documents for Private Placement and attorney review; and 4.) Successfully raise capital for your start-up, early stage, or seasoned “privately held” company. By creating your own deal structure and securities offering documents you should be able to save at least $10,000 in legal fees, $5,000 in accounting fees and $5,000 in Investment Banking consulting fees, while greatly improving the probability of raising the desired amount of capital and maintaining control of your company. This program is for any level of entrepreneurship; from those who simply have an idea for a product or service that they’d like to produce and market to those who have a business plan, a basic understanding of the concept of equity and debt, and are past the R&D stage of their product or service. It is designed for the recent business college graduate who is having trouble finding employment, who may need $20,000 to $50,000 in equity capital to open up his or her own business. It is also designed for the retired executive who is bored with playing too much golf and could use $5,000,000 in capital, without risking home equity or retirement nest egg to get back in the game. This program is not limited to new companies or ideas; it is also designed for those who already have or are running a company with annual gross sales of $100,000 to $5,000,000 that simply want to reduce debt by raising additional equity capital; or raise additional capital (debt or equity) for product line expansion; to companies with $20,000,000 in annual revenue, but need additional capital to launch a new product or project with “off balance sheet” or joint venture financing. This program is for any company that would like to know how to value their company and price its securities, properly structure capitalization plans, produce securities offering documentation for legal counsel review, and get those securities placed in the private and public securities markets to raise capital. In this first part of this program we start with the five most important concepts when raising capital and the top 15 reasons why entrepreneurs fail at their attempts to

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raise capital. We will then cover the “Way It Is” for start-up and early stage companies seeking capital in the private and the public securities markets, review different organizational structures, and show why we recommend certain structures for certain types of operations. We will also cover capitalization planning or “deal structuring,” the philosophy of deal structuring and the three most popular and successful deal structures for start-up and early stage companies. Then we will review how investors view risk and return, how the different types of securities work, how to research both the private and public equity and debt markets and how to develop deal structures that fit the demands of those markets. Once your management team’s private capital markets demand has been ascertained, we will instruct you on how to make structural changes and how to change your mode of operation, if necessary. The Financial Architect 4.0 program will walk you through, systematically, the process of producing pro forma financial projections with the use of the program’s GAAP compliant Microsoft Excel Templates. You will learn about the mechanics of securities offering document prototype development and production. The program will walk you through the processes of valuing your company, pricing its securities, producing your securities offering prototypes (Red Herrings) for test marketing your company’s securities offering and then how to produce your company’s securities offering documents for soliciting and selling securities to capitalize your company. The program will instruct you how to legally solicit and sell securities, in compliance with federal and state securities laws, rules, and regulations, to successfully raise capital. Finally, the program will instruct you on your company’s administrative responsibilities to maintain compliance with federal and state securities laws, rules, and regulations. Of course, your attorney must be involved throughout the entire process, however, you will gain an advantage by being able to communicate with your attorney at a higher level of understanding and since you’ll be preparing most of the initial documentation you should save on those legal costs. This program contains very valuable Templates in the Templates Folder as part of this program, which are to be run on Microsoft Office software components MS Word and Excel. You will use these Templates to produce your company’s securities offering document(s). Please be patient and do not jump to conclusions. Read the entire manual first and you will realize that at the end of this program, everything will fall into place and you will be armed with the most effective means of raising capital possible. By the end of this program you should be able to produce a series of securities offering documents that are exempt from federal or state registration and produce a marketable deal structure with the use of GAAP pro forma financial projections. You will be developing a five-year capitalization plan with differing securities offerings and the related documents, to be issued at various stages over the five-year plan. Once you have completed the process, you will have literally produced over a $100,000 worth of securities offering documents in one session. I can only imagine the look on your attorney’s face when you ask him or her to review your company’s final securities offering documents. He or she will invariably ask you “Where did you get these documents? You can say, “I wrote them!” If that doesn’t further the quality of your relationship, nothing will.

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Many times throughout this program, we will reiterate concepts, ideas, and positions. We have done this intentionally. We believe it is important to further your understanding of this process by using repetitive reminders, as the information can become overwhelming to some and reminders of past sections are warranted. Yes, we hope to pound this information so it sticks in your head and you succeed in your capital raising efforts. Throughout the program we will use the terms generally associated with the development of a corporation as the organizational entity to be capitalized. However, the Templates are formulated to serve LLCs and Partnerships as well. Simply use those templates and follow those instructions when producing your deal structure and securities offering documents. One more thing before we begin. You should view this program as your secret weapon in the process of raising capital for your company. Copying it and distributing it is not only illegal, but by doing so you will be shooting yourself in the proverbial foot. The private capital markets are finite and you don’t need competition in this arena. In addition, to avoid any piracy of this program, we have included a private password protected area on our web site known as the Commonwealth Capital Club, which adds massive value to this program. If you cannot enter the Commonwealth Capital Club, you may have received a pirated copy of this program. If so, contact us through our website, as we offer a reward for information leading to the conviction of the offenders. The critical Compliance Section is included as part of the Commonwealth Capital Club and is available only to our Members. It is web based so that we can further maintain up-todate compliance information for our Members. In addition, the Commonwealth Capital Club contains links to “Angel Networks” throughout the U.S. and beyond. If you would like to make money with our programs, simply become an affiliated distributor to earn a commission on each product you sell and let us deal with all the administrative work, accounting, product upgrades and other activities involved with running a company. (See Affiliate Program on the website).

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The Five Most Important Concepts When Raising Capital The five most important concepts when raising capital for any company are: 1.)

Thinking of a securities offering as a new product or service launch where a research and development process precedes the actual production of the product, in this case the securities offering document. This may prevent one from making critical deal structure mistakes. One should produce securities offering prototypes, as one would conduct market research for a new product or service launch. Selling securities to raise capital is like any other marketing effort, except it is done in a highly regulated environment. Simply think of it as selling a product or service line. Could you move an additional $1,000,000 in products without an increased marketing budget?;

2.)

The use of “Seed” capital to obtain your company’s development or expansion capital is absolutely critical;

3.)

The re-thinking of the mode of operation that your company will engage in to lower the required amount of capital needed to achieve increased revenues and profitability;

4.)

It may be better and wiser to have many investors invested in your company with relatively small amounts of capital, as opposed to a few investors with large amounts of capital. By doing so, you can control the terms of the deal, while building a growing pool of capital contacts, which you will need for additional future rounds of financing in the company’s early existence; and

5.)

You should always deal from a “Relative Position of Strength” when seeking capital if you want to increase your probability of success while controlling the terms of the deal. Exercising the first four concepts as your primary discipline will further your company’s relative position of strength.

The first two of these concepts are logical in light of a new product offering. We want you to view raising capital the same way you would view the launching of a new product or service line. Remember the old adage in business in regards to making money that states, “You’ve got to spend it to make it.” It is the same way when it comes to raising substantial amounts of capital for your company. Although a successful securities offering is very much like a successful product launch, until recently that approach to raising capital for start-up and early stage companies was very much cost prohibitive. In the past, one may have spent as much as $20,000 in legal, accounting and investment banking fees to simply test a securities offering in the private or public markets. We have seen entrepreneurs that have paid huge sums in legal fees and never even received their securities offering documents. One

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entrepreneur we know of hired a big shot law firm out of Washington, D.C., was billed over $200,000 (not a typo) in legal fees, and never received the finished work product. He actually paid $180,000, ran out of funds and the law firm refused to deliver the document. This individual thought that the law firm’s name on the document would benefit his capital raising effort. In reality, the “Big” law firm’s name means very little for start-up and early stage companies. The Wall Street capital raising process has become recently affordable for the average entrepreneur, in light of new technologies which allow us to effectively produce and distribute Financial Architect® 4.0. The program is designed to allow you to “Do it Yourself” with the aid of your company’s legal and tax counsel. You may elect to hire a CPA to help you with developing your pro forma financial projections, in the beginning of the process, which could reduce potential errors and mistakes in your financial assumptions. You will need your own attorney review your completed securities offering document, so be sure to get your attorney involved at the end of this process to save both time and money.

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Raising Capital in the United States Let us get one thing straight up-front. If you think that you can get around this process, you are just kidding yourself, unless of course you have really rich relatives who really like you a lot. For all practical purposes, there are only three ways to legally raise capital in the United States. When we refer to raising capital, we mean raising Substantial Amounts of capital for traditional working capital used to build “for-profit” organizations. There are only three ways to legally raise capital in the United States. When we refer to raising capital, we mean raising Substantial Amounts of capital for traditional working capital used to build “for-profit” organizations. When we refer to Substantial Amounts of capital, we mean more than you would normally be able to borrow from a bank based on the equity of your personal assets or your company’s assets and cash flow. We do not consider grant monies available from governmental or other organizations a form of capital for a start-up, early stage, or even seasoned companies. However, we do encourage the attainment of such funds, under the right circumstances, which means after you have raised enough capital to get involved with the red tape associated with those programs. We consider any commercial lending activity as part of a capitalization plan or deal structure, which would include SBA sponsored bank loans and lines of credit. To legally raise capital in the United States, you must do one of the following: 1.) Produce a business plan and submit it to institutional sources of equity and/or debt capital, such as venture capital firms, commercial banks, pension funds, trusts, endowments, insurance companies, angel investors, family offices, private equity firms, etc. and allow them to offer the terms of the financing. When they make the offer of terms by issuing a term sheet to your company, it is not considered a securities offering because your company is not making the offer. On average, these single sources of capital fund less than 1.5% of all the projects or companies they review, and they rarely fund start-ups. In any event, they may demand voting control of the entities that they fund. 2.) Alternatively and a more successful way to raise capital is to conduct a securities offering. There are only two ways to legally conduct a securities offering within the United States: • •

Register the securities on the federal and/or state level; or Issue a private placement of securities, by qualifying for an exemption from federal and/or state registration.

Under the Securities Act of 1933, (“The Act”), as amended, and in the interest of promoting entrepreneurship within the United States, the federal government and most state governments allow small issuers to legally solicit and sell limited dollar amounts of 14

securities, under certain circumstances, in the private and public markets without the need to fully register such offerings. Full registration of your company’s securities is an extremely expensive process and for most small issuers it is cost prohibitive, henceforth, the need for the exemptions from registration for the small issuer. To legally conduct a securities offering in the United States you must produce a securities offering document that either qualifies as a registration statement, or qualifies for an exemption from registration. Registered securities offerings require the most amount of time and money to produce, while private placements, which are generally exempt from registration, are relatively inexpensive and take far less time to produce. Registered offerings can be advertised through the general media, while private placements cannot be advertised. The private placement of securities under Regulation D, 4(2), and/or 4(6) of the Securities Act of 1933 will generally be exempt from registration if the document provides for sufficient disclosures and disclaimers and where compliance with the “Notice of Sales” filings requirements are adhered to. Both offerings must be accompanied by a securities offering document that complies with the various federal and state(s) laws, rules, and regulations. Both offerings can be sold by your management team or through NASD Member firms. Be sure to check with your attorney before conducting the actual offering of securities, as securities laws, rules and regulations can change at any time. 3.) A third way to raise capital is to sell Charter Memberships, which entitles the Members to discounted pricing on your products or services. The best analogy to this approach would be selling Real Estate Condominium Units at pre-construction prices. This approach can be applied to most operating companies as well. This approach also requires the proper documentation so that this capital raising effort does not inadvertently become a securities offering with insufficient securities offering documentation and filings, which may violate any federal or state securities laws. Selling Charter Memberships also takes a sales and marketing effort with the related expenses as well. Therefore, we generally advise our client firms to raise sufficient seed capital through a private placement of securities first, then conduct a private or public placement of securities or sell Charter Memberships as a second, third or fourth round financing effort. Charter Memberships are highly customized contracts, which have not yet been produced through a Template system. Not yet, because we’re still thinking about it. More on “Raising Capital in the United States,” is further defined in the “Rules of the Game.”

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Rules of the Game Rule #1. For the vast majority of start-up and early stage companies, which include most firms with less than 5 years of operating history and less than $5,000,000 in annual sales, substantial amounts of institutional equity or debt capital is generally not available. Institutional equity or debt capital means capital secured through venture capital firms (VC firms), family offices, private equity investment firms, retirement or pension accounts, insurance companies and capital secured through the sale of securities offered through investment banking firms. Seeking capital from these sources is simply a waste of time at the early stages of a company’s existence. There are many reasons why, but basically start-up and early stage companies are just too risky for these “single sources” of capital. Companies with at least five years of operating history, at least five million in annual sales revenue with EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) of at least one million dollars are generally considered seasoned, although just barely. It is a given in the capitalization industry, that on an annual average, less than 1.5% of all start-up and early stage companies searching for capital receive their needed funding through any institutional source. The competition for this type of capital is far greater than most entrepreneurs realize. The term Venture Capital is a misnomer. They don’t throw money around in an “adventurism” manner. On the contrary, they have always been very sophisticated and fairly conservative. They generally search out syndicate deals to lessen their risk while maintaining their propensity for producing large returns. A syndicate example would be when a VC firm is engaged by a company that is grossing $50 million in annual sales and needs $100 million in capital for a one-year bridge loan to prepare for an Initial Public Offering. Many times, a hundred VC firms will put in $1 million each. That is an exaggerated example; however, the point is that VC firms like to diversify among many companies that have an established record of sales or a “Proven Economic Model” to mitigate the risk associated with the ownership position of a single company with other VCs for diversification to further mitigate their company “selection” risk. You may be thinking... “But I read in all the trade magazines that venture capital groups are funding start-up and early stage companies left and right.” You’re reading about the rarities. Remember, the publishers of these magazines need to sell their publications. Consider the source of your information before you jump to conclusions. Rule #2. If your start-up and early stage company is within the lucky 1.5%, the institutional equity capital source will most likely control the terms of the deal and they will most often demand voting control. You may have to give up substantial equity and upside participation to seal the deal. This “single source” of capital may also dictate your compensation, overhead allocations, and be at odds with your concept of the American dream.

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You may be thinking...“But we’re different… we’re being romanced by a couple dozen venture capital groups right now.” Sorry, it’s generally a false romance. VC’s must generate quality deal flow so that they can “Cherry Pick.” It costs them very little to keep you hanging on. Out of 500 deals they review each year, they will generally fund three, maybe four a year. You can’t blame them because if you were running a VC firm, you would soon realize that your VC firm would need to operate in the same manner simply to survive. The competition for quality deals is enormous. You may find you can raise sufficient capital without giving up substantial amounts of common equity interests through the issuance of hybrid securities such as convertible preferred stock, notes, bonds, non-voting common stock with married put options, participating preferred stock, notes with equity kickers or through issuing royalty financing contracts. If you want to control the terms of the deal and maintain control of your company’s destiny while increasing the probability of being funded, then you will need to conduct a securities offering. Searching for capital in any other fashion generally results in everyone attempting to change the terms of the deal, which results in lost time and money, and can be extremely frustrating. The bottom line question of the day to you is “do you want to dictate the terms of the deal, maintain control of your company while increasing the probability of receiving the needed funding to the highest degree possible?” If so, you will need to conduct a securities offering by producing and marketing a securities offering document in compliance with federal and state(s) securities laws. Rule #3. What constitutes a securities offering? First, we need to define what constitutes a security. The courts have generally interpreted the statutory definition of a security to include traditional, as well as non-traditional forms of investment. Section 2(1) of the Securities Act of 1933, as amended defines the term “Security” to mean: Any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest, or participation in any profit sharing agreement, collateral trust certificate, pre-organization certificate or subscription, transferable share, investment contract, voting trust certificate, certificate of deposit for a security, fractional undivided interests in oil, gas, or other mineral rights, any put, call, straddle, option, or privileges (including convertible rights) on any security and any interest or instrument commonly known as a “security” or certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. In Landreth Timber Co. v. Landreth, 4712 U.S. 681 (1985), the Supreme Court adopted a two-tier analysis that basically further interpreted as follows: “For purposes of the securities laws, a security is an investment of money, property or other valuable consideration made in expectation of receiving a financial return from the efforts of others.” Also, see SEC v. W.J. Howey & Co. 328 U.S. 293 (1946). If you think about it, that covers just about everything except bank loans or issuing Charter Membership contracts.

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I’ve read some opinions on a few capital raising strategies, such as a royalty financing contractual arrangements and personal loan guarantees with carried interests, as not being a securities offering and therefore these strategies sidestep all the compliance requirements, procedures, and the costs associated with and necessary to conduct a legal securities offering. We, as a company, do not agree with these opinions. We strongly believe that all such “contractual arrangements,” because they meet the statutory definition of “valuable consideration made in expectation of receiving a financial return from the efforts of others,” do indeed constitute securities and that one should proceed as if they do. Therefore, because such royalty financing arrangements certainly fall into this category, royalty-financing contracts constitute a security. We would caution you to approach these arrangements as if they constituted a security and the capital raising effort a securities offering. Even when dealing with accredited investors only, where technically no documentation is required for conducting a securities offering, your offering is still subject to the anti-fraud provisions of the Securities Act of 1933 and amendments thereof, irrespective of the degree of disclosure your documentation contains or lack thereof. If your company fails financially and you had inadvertently violated a securities law because of improper documentation, lack of registration (if needed), or other compliance deficiencies an opposing legal counsel in a lawsuit could tear you and your company apart. The opposing attorney may contact the appropriate regulatory authorities and wait for a criminal conviction or a declaratory ruling from the regulatory authority, first. Such a criminal conviction or declaratory ruling would make a summary judgment in a civil suit against you personally and your company a walk in the park. That is why we always approach everything involved with a capitalization effort, except obtaining bank loans or pre-construction real estate sales, as a securities offering and comply accordingly. It’s far better to be safe than sorry when you’re in the business of dealing with other people’s money. Now that we have defined what constitutes a security, we need to define what constitutes an offer or offering of a security. Presenting a business plan to a venture capitalist or a wealthy individual for obtaining capital will not constitute a securities offering, as long as the terms of financing are offered from the investor’s side of the table. The offer must come from the source of capital to avoid your company inadvertently making an offering of securities. Be careful, simply making presentations to a few wealthy people may constitute a securities offering. If you make the comment at a cocktail party that you would be willing to sell 20% of your company for $1,000,000, you just valuated your company at $5,000,000, ($1,000,000 is 20% of $5,000,000), priced its securities (20% of the total authorized shares can be purchased for $1,000,000) and you made the offer. With those elements in place, you have just conducted an offering of securities.

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Even before the issuing entity is formed, the regulatory authorities may still consider the distribution of equity or debt before, at, or shortly after the original meeting of incorporators, in the case of a corporate entity being formed, or a meeting of organizers, in the case where an LLC or a Partnership is the entity to be formed, as an offering of securities. One could conclude that, technically, there can be no offering of securities by the sheer nature of the non-existence of any issuing entity. Some regulatory authorities do view the issuance of equity or debt as a securities offering, even if the issuing entity is just being formed. When the regulatory authorities consider the distribution of equity or debt a securities offering (even before the entity actually exists), there are Intra-state exemptions from registration of the securities available. That is the reason why most start-ups do not necessarily violate securities laws. Some states allow for as little as 6 and up to 15 entities, individuals, or organizations (Founders or Principals), which reside in that state to form an organization and distribute securities to the founders, without the need to register the securities or qualify for the exemptions from registration. Every state has its own Uniform Offering Exemption(s) and the stipulations to qualify for claiming those exemptions must be complied with accordingly. However, if one Founder is from another state, the intrastate exemption cannot be relied upon. Therefore, the issuing entity must qualify for federal exemptions from registration under Regulation D. You may be thinking…“But my brother-in-law didn’t need to go through all this when he raised capital for his company.” Think of it this way: “You don’t need to comply with any laws, rules or regulations...just don’t get caught.” When raising capital, you must comply with Federal and State securities laws or face the consequences. What are the consequences? They vary from state to state, but for the most part the SEC and/or state securities administrators have the ability to issue a rescission order, which means that your company has to give the investors back 100% of their investment within a certain period-of-time. If the company does not have ample cash to pay back the investors, then the order will most likely include a liquidation of assets provision, much like the liquidation of assets in the case of bankruptcy. If the liquation of assets is insufficient to pay back the investors’ capital, then the company’s Principals’ personal assets may be attached and liquidated to satisfy any deficiency. The Principals will also most likely be barred from issuing any form of securities in any company for 5 years. The regulatory thought here is that should be a sufficient punishment to deter securities violations. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities laws, rules and regulations can change at any time. Rule #4. Prior to structuring the deal, producing the proper securities offering documentation, or conducting a full blown securities offering effort, one should “Test the Waters” by researching the local geographical area for Angel Investor interest, as well as their own personal market of private capital contacts, with a few prototype offering

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structures to obtain “Indications of Interest.” This process is known as a “Red Herring” test. A securities offering is very much like a new product launch and one should view the effort as such. It is very much like a marketing research project for a new product or service line, except it is for a securities offering. The market should first be researched to determine the demand for a particular structure. Once the demand has been ascertained based on your “Research” (the Red Herring test), then the “Product” (a securities offering structure and document in this case) can be “Developed” or produced and sold to meet the demand. Rule #5. There are no guarantees when it comes to raising capital, only degrees of probability. The degrees of probability increase in direct correlation with the amount of seed capital available to promote the capital raising effort. You are simply selling an intangible asset in a highly competitive and regulated environment. When selling private placements internally or engaging in a NASD syndicate selling effort, you must have an ample amount of funds (Seed Capital) to support the sales and marketing efforts of those securities. Remember, even when selling through a securities brokerage firm, your securities offering is in direct competition with other securities offerings to get the brokerage firm’s management and their broker’s attention and motivation to sell your company’s securities. If your marketing efforts generate investor leads for the stockbrokerage firm(s), your securities have a relatively higher probability of being sold. As with a new product launch, to successfully launch and close a securities offering, it takes capital to accomplish the goal. The more “Seed” capital you have available, the higher the probability of a successful securities offering. If you do not have a sufficient amount of seed capital, then raise it through a seed capital securities offering. Depending on your company’s situation, $75,000 to $100,000 of seed capital should be sufficient to obtain the larger, $1,000,000 to $5,000,000, amounts of start-up, development, or expansion capital. To enter the real game of capital procurement you must have the funds to compete for capital. Would you attempt to launch a product without a sufficient marketing budget? In a publication called “Small Business Financing Insights” Richard Wulff, Chief of the Office of Small Business at the Securities and Exchange Commission in Washington, DC was quoted as saying “If you’re trying to raise $5,000,000 in a private offering you’ve got $100,000 in expenses, printing, lawyers, phone calls, etc….” (April 1998). That was then, this is now. The traditional and standard costs could be more. Rule #6. For start-up and early stage companies, your capitalization plan should request the minimum amount of equity capital needed to bring your firm to the $5,000,000 in annual sales to engage an investment bank to sell your company’s securities. If you need $1,000,000 in development or expansion capital to accomplish that goal, you should

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consider raising say $200,000 to $400,000 in equity capital, through a securities offering, and obtain the $800,000 to $600,000 balance with bank debt, if your company is considered bankable. Most high tech companies are generally not bankable until they have established a “proven economic model.” If your company is a raw start-up, meaning simply a concept company on paper, other than a real estate development or manufacturing operation, and you are looking for $2,000,000 to $10,000,000, please re-think your mode of operation. We see too many deals that are “concept only” seeking $2,000,000 to $10,000,000 in capital. Other than a real estate development or manufacturing operations, the probability of attracting the needed funding at those levels is so low it is almost incalculable. You need to crawl before you walk and walk before you run. Remember, in the early stages of your company’s existence, you may need to give up too much common stock equity and possibly voting control to raise large amounts of capital. You should limit the issuance of the common stock equity, or equivalent interests in a Limited Liability Company (LLC), as it is the most precious element of your company. One should wait until the common equity is worth much more before selling it. By re-thinking your mode of operation you may discover that you could get by with and raise $100,000 to $500,000 with relative ease with a royalty-financing contract, if your company will simply be licensing the technology or product for distribution through another company that already has the distribution channels in place and the firepower to get the product(s) sold. Most inventors should invent and license their technologies to companies that already have sales, marketing and distribution channels in place, as opposed to building and managing a company. The point being is that, the less equity capital you need to secure the balance in debt capital, if bankable, to complete the funding, the higher the probability you will have in obtaining the funds. Would you like to build a company to compete with Dow Chemical and slug it out toe to toe with them in the market place or would you like to license your technology to Dow Chemical and have them slug it out with Dupont? Rule #7. Most entrepreneurs are under the impression that their technologies, inventions, patents, processes or trade-secrets, that make up their company’s product or service line(s), offer investors the greatest opportunity ever because nothing like their situation has ever occurred before and they have a lock on the marketplace. No entrepreneur can predict, with any real accuracy, when or if a competitor will introduce superior products, services, or technologies into the marketplace and completely decimate the entrepreneur’s product or service line(s). Sophisticated investors know that this is a key risk element. You can eliminate some of the elements of risk through the proper structuring of a series of securities offerings, which are designed to continue the capitalization process. Illustrate that, through a series of capital raising efforts, you can provide the original seed or early stage investors a real exit strategy by paying off Notes, Bonds or Call a Preferred Stock offering with proceeds from retained earnings and/or subsequent securities offerings.

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This type of capitalization planning should increase the probability of being able to compete for capital in light of newly introduced competitive products or services. Rule #8. Most entrepreneurs are under the assumption that their technologies, inventions, patents, processes or trade-secrets; that make up their company’s product or service line(s), will allow for sufficient net operating margins to expand their firm’s growth with internally generated revenue after they have received their initial funding. In theory, only a true monopoly can achieve that feat. Any direct or indirect competition will eventually lower those margins and outside capital must be employed to keep up with the competition, especially if the competition is formidably capitalized, (i.e. publicly traded). Just look at Microsoft as an example of a pseudo monopoly that needed substantial amounts of outside capital and had to “go public” to achieve the goal of continued growth. In addition, most informed investors know that formidably capitalized competitors can crush a small under-capitalized firm. Investors want firms that are serious about adopting a continual capitalization plan. As one would have a Marketing Dept., one should also have a Finance or Capitalization Dept. dedicated to a series of well-orchestrated capitalization raising efforts. We know that this may seem incredibly obvious to some, but for most it is not. Rule #9. Most entrepreneurs believe that raising capital is like selling Real Estate. They believe that there are entities out there that will raise capital for them for a commission. There are, they are called SEC Registered Investment Banks/Broker Dealers, which must also be NASD Members. However, they do not fund Start-Ups or Early Stage Companies. Why? There is very little money in it for them, because the deals are too small. These start-up and early stage companies are also too risky. Think of yourself as an investment banker. Would you put the brokerage firm’s clients’ money at risk for a couple of thousand dollars? (History has shown that 85% of all start-up & early stage companies will fail within their first five years). Why take the risk with start-up and early stage companies? Venture Capital Firms also use “Other People’s Money.” They too stand to be sued for imprudent investments or breach of fiduciary duty. The vast majority of entrepreneurs, even those running seasoned companies, do not understand the way the securities industry works. Most think that once engaged with a SEC registered investment bank and NASD Member securities brokerage firm for a “best efforts” underwriting (the only type that your company will receive unless it becomes a Fortune 1000 Company), that the management of the stockbrokers will demand that the stockbrokers get on the phone and sell their company’s securities to their clients. Nothing is farther from the truth. The management of these SEC registered investment bank and securities brokerage firms cannot legally demand that their brokers do so. There are suitability issues that the broker’s must consider, as well as, a whole host of other considerations they can use to block management’s effort in the solicitation

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and sales of those securities. The brokers can use federal securities laws to tell the management to take a hike. That is only one problem with a NASD Member sales effort. Stockbrokers do not want to tie up their clients’ funds in illiquid investments because they like to move the money around to collect commissions and/or fees. Therefore, private placements, although not impossible, are rarely placed through a securities brokerage selling effort. Even companies that are publicly traded still have trouble with this type of selling effort. Most small publicly traded companies do not have enough liquidity in their stock due to low average daily trading volume. Therefore, even PIPEs (Private Investments in Public Entities) are rarely accomplished in a securities brokerage selling effort. If a company wants to pursue this route, the management team had better be very well aware that their company would need to spend an exceptional amount of up-front money ($100,000 to $250,000) for marketing support to get an engagement contract. That amount of money would cover just the marketing support. The expense associated with the Broker Dealer’s due diligence is separate. For instance, the company will need to compensate the Broker Dealers, from $10,000 to $50,000 (depending, of course, on the nature of the company and its product and service line(s)), for investigating the management team and the claims that are made about the company’s product and service line(s). The stockbrokers will need to be provided with fresh investor leads to promote a company’s securities selling effort. To maximize your company’s relative position of strength with the stockbrokers, your company must provide fresh investor leads. Stockbrokers always want new clients. For the most part, the stockbrokers are only willing to sell your company’s securities to those prospective investors who responded to an advertisement in a newspaper or direct mailing concerning the securities offered. Your company will have to pay for that marketing campaign. In addition, the securities must be registered, if general advertising media is engaged, which adds to the cost of such an offering. On top of those up front out-of-pocket expenses, you will need to give up a generous commission, generally 10% to 12%, and depending on the market environment, you also may need to give up some other goodies, like a chunk of the company, by issuing warrants to the Broker Dealer(s). This further motivates the brokers to sell your company’s securities. Yes, no matter how you slice it, it costs quite a bit of money to get your securities sold, no matter what route you take. If you choose the Broker Dealer route, you should view the relationship as hiring temporary personnel to fulfill a certain defined function, selling your company’s securities to raise capital, for a limited time. It is less expensive than hiring an in-house sales force, especially when considering the supervisor functions to comply with all the securities laws, rules, and regulations. WARNING!!! HIRING MONEY FINDERS CAN BE EXTREMELY DANGEROUS. SUCH ARRANGEMENTS COULD LEAD TO CRIMINAL PROSECUTION FOR THE PRINCIPALS OF THE ISSUING ENTITY. PAY NO UPFRONT OR BACK-END FINDERS FEES UNLESS THE ENTITY IS FULLY

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REGISTERED WITH THE PROPER REGULATORY AUTHORITIES (i.e. THE SEC, NASD, & EACH STATES’ SECURITIES ADMINISTRATORS). IT IS YOUR RESPONSIBILITY TO COMPLY WITH FEDERAL AND STATE SECURITIES LAWS, NOT THE MONEY FINDERS. Anytime any entity is compensated by the issuing entity for the direct or indirect solicitation and sales of securities, that entity MUST be a NASD Member and registered as a Broker Dealer/Investment Bank with the United States Securities and Exchange Commission. The entity must also be registered with each State’s Dept. of Banking and Finance or equivalent where the solicitation and sales of securities occur. Money finders may overtly or inadvertently be conducting a securities offering on your behalf even though you think they are not. They can find you commercial bank loans but that is about it. If the bank loan involves a mortgage on real estate or real property, then the money finders must be licensed mortgage brokers, as well. Just about every other method of raising capital is considered a securities offering and can only be legally sold by your management team members or SEC registered securities firms. However, if the Money finders are paid 100% by the investor side, then there’s no problem. If you contract with any entity to fulfill the solicitation and sales function of a securities offering and that entity is not properly registered with the appropriate regulatory authorities, it is an unlawful transaction and you, your company and management team, are liable not only for regulatory compliance violations, but for the unlawful transaction, which may constitute a criminal offense. The limited liability of corporations and LLCs does not extend to and protect you or your management team’s personal assets, when it comes to regulatory violations, as well as, civil suits, because of those regulatory violations. We think it is important that these issues be outlined and disclosed. (You will find a Selling Group Agreement for engaging an SEC Registered & NASD Member Investment Bank in the Commonwealth Capital Club). Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities laws, rules and regulations can change at any time. Rule #10. Sadly, most entrepreneurs go through the arduous task of attempting to raise capital, for about nine months, before they realize what has been disclosed here is brutally true. By then, they are out of money, patience, and have been “kicked in the teeth” with broken promises so often that they simply give up. This is your wake-up call. Do it right or don’t do it at all! Being forewarned is being forearmed!

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The Top 15 Reasons Why Entrepreneurs Fail to Raise Capital The following reasons are not rated in succession, all may be equal, but the first five may be the most important. The average entrepreneur fails to raise capital for their start-up or early stage company because … 1.) The Entrepreneur does not properly assess their personal capital contact environment in the beginning stages in order to tailor their securities offering to meet those demands. Remember, you should conduct research on a securities offering before you develop your deal structure and securities offering documents. This effort is known as “Testing the Waters” through what is known on Wall Street as a “Red Herring.” 2.) The Entrepreneur does not start the capital raising effort early enough in the beginning of the project. Most entrepreneurs think that they have sufficient capital in the beginning stages of their operation to properly grow their company. Most often, things take twice as long and cost twice as much as originally planned. It is better to raise capital in the beginning stages, when you have some of your initial capital to do it right, then waiting until you run out of capital and become desperate for more. Once you are desperate for capital, the probability factor decreases. 3.) The Entrepreneur spends too much time, money, and effort soliciting the wrong sources of capital. You should always deal from a “Relative Position of Strength”. In the beginning stages of a company, you have a relative position of strength when soliciting your personal and professional contacts because they already know you personally and have trust in you and your abilities to get the job done far more than any individual or organizational strangers, such as a venture capital, investment-banking firm, or even angel investors. 4.) The Entrepreneur seeks too much capital for the project or company. You should re-think your company’s mode of operation at the very beginning stage of your company’s existence or new project or product launch. Your operational plan should be geared towards raising the minimum amount of capital necessary. This will accomplish two things. First, it will increase the probability of obtaining the desired capital sought and second it will allow you to maintain the maximum amount of equity ownership in your company. Most projects do not require as much money as you think. We have had clients who run themselves ragged to raise $4,000,000, when $500,000 would have been a sufficient amount of capital with a different mode of operation. 5.) The Entrepreneur spends too much time putting the cart in front of the horse. More often than not we see entrepreneurs spending too much time building their company or developing their project with little or no capital when they should be concentrating on raising capital. For the lone entrepreneur, it is very hard to conduct both activities with any positive results. One activity 25

robs the other of needed attention. Hire some professional help by hiring a retired or unemployed stockbroker who knows how to solicit and sell securities. 6.) The Entrepreneur does not have enough of their own capital committed to the project. We have helped entrepreneurs raise capital even when they have had very little of their own funds committed to the project. One way to mitigate this problem is to arrange to have you and/or your management team members sign personal guarantees on the debt financing or bank loan, if the company or new project is bankable. Most investors want to hear that you have money in the deal, and that you’re not taking a huge salary or have the ability to change your salary without investor(s)’ approval. Most investors have the mindset that, if they lose money by investing in your company, you had better lose all of your money, your house, your car, your dog, and pony. 7.) The Entrepreneur does not have a clear picture on the use of proceeds. Most of the business or capitalization plans we have seen do not have a detailed analysis of the use of proceeds from the capital raised. You need to be very detailed in your use of proceeds statement, especially when conducting a securities offering. Simply stating that it is to be used for expansion purposes or working capital does not cut it. A detailed “Sources and Uses Statement” is required in a securities offering document. 8.) The Entrepreneur does not have an internal rate of return projected on the investment. Investors already know what the downside is, zip, zero, a 100% loss. Most investors want to know what their internal rate of return on investment will be if things work out as planned. It is their benchmark when deciding whether or not to invest. It seems obvious that a business plan or securities offering document should have some indication of an investor’s potential internal rate of return on investment, but we’ve yet to see a business plan or securities offering document that provides those figures. This program calculates it. 9.) The Entrepreneur does not provide a forward position on liquidation rights for investors, in case of business failure. This is sometimes the biggest mistake of a deal structure. You need to show investors that if the firm fails, they come first or at least ahead of you and your founders, on liquidation rights on the company’s assets. Most structures are designed for the issuance of common stock equity, which creates a dilution problem for the investors. 10.) The Entrepreneur does not provide a sufficient amount of information in the business plan, which is required for a securities offering. Many very important elements are left out of the average business plan. The plan does not need to be extremely detailed, but certain elements must be in it. Not to worry, the Templates will provide for any shortfall that your company might have in its business plan or current securities offering document. 11.) The Entrepreneur does not guarantee an exit strategy for the investor. Although an IPO or an outright sale of the company or its assets may be a nice approach to an exit strategy, it cannot be guaranteed. You need to put a structure in place that will allow the investors to get their principal back in a relatively short period-of-time with a strong probability of occurrence, while enjoying some upside potential over a longer period as well.

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12.) The Entrepreneur does not have a solid management team put together. Do what you can to put together at least a contingent Management team; if you have not done so already (i.e. you will hire certain individuals to fulfill certain functions of the company’s project operation when the capital is raised). Include the Bios for each management team member in the business plan or securities offering document. Make sure you have received signed letters of contingent commitments before you include their backgrounds. If some members do not join the team and you did not obtain written statements of commitment, it could be seen as a potential misrepresentation of material fact, which is a very dangerous position to be in when attempting to raise capital. 13.) The Entrepreneur requires too large of a minimum initial investment. One should allow many investors to get into the deal with small amounts of capital. It is better to have 50 investors in at $10,000 for a $500,000 equity raise than 5 investors at $100,000. Investors rarely sue over $10,000 amounts, in case of company failure, where as a $100,000 amount is generally worth the time and trouble to go after. Besides, most investors who commit large amounts of capital will want to kick the tires more than you would like them to. Yes, they may distract you from your core duties. 14.) The Entrepreneur does not allow for ample time for raising the capital. Like most things in business, it will take you longer and cost you more than you originally thought. We generally advise our clients to plan on a minimum of 6 months and sometimes as long as 12 months to raise the needed capital for only the first round of financing. 15.) The Entrepreneur does not have enough “Seed” capital dedicated to the capital raising effort. Like a product launch, it takes promotional dollars to effectively raise capital. You need seed capital to promote the attainment of your development capital. If you do not have it, then raise it through a seed capital securities offering first. Before you decide upon a seed capital offering structure, you should produce your company’s development capital offering structure prototype to be sure that each structure fits with the other. The seed capital is riskier by design, so the structure of a first or second lien debt position should mitigate some of that risk and attract the initial seed capital. Ninety-nine percent of the entrepreneurs who contact us either want us to invest or find investors for them. It is not going to happen unless they are ready to chunk down a load of cash to engage in an NASD Member syndicated selling group, which they most likely will not qualify for. The bottom line on these reasons why entrepreneurs fail to raise capital is that the vast majority of entrepreneurs do not have a clue on how the world of capital works. It’s the “other” golden rule. Those with the gold…rule. There is no “Mother Load” of capital available for start-up, early stage, or for most seasoned companies, just trickles here and there. You need the tools, included in this program, to collect those trickles or you are just wasting your time.

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The Four Professional Functions of a Securities Offering Before we begin examining the mechanics of deal structuring, you need to understand how the investment banks, the “Players,” in larger capital markets, work. Once you understand how the investment banking divisions of Wall Street firms work, you will be better able to relate their capital raising techniques to your company’s capital raising efforts. There are four (4) fundamental professional functions used by Wall Street firms in the process of raising capital in the United States: 1.) The first function is that of the Accountant in the production of pro forma financial projections. These projections analyze potential future sources of revenue, operational expenses, net income potential, tax liability, cash flow and capital budgets. The “Sources and Uses Statement” is also part of the projections. In the case of an existing company, the accountant would also produce compiled financial statements, audited if necessary. 2.) The second function is that of the Investment Banker. The Investment Banker analyzes the company’s future valuation, establishes the current price of the company’s securities based on estimated rate of return potential, and structures the capitalization plan or “deal structure” so that it is accepted by, or fits the demand of, the various private or public capital markets. Then the Investment Banker tailors the securities offerings to fit market demand. 3.) The third function is that of the Attorney in the production of the legal documentation of the securities offering to comply with the various federal and state securities laws, rules, and regulations. The attorney is generally hired to handle the administrative compliance follow-up after the sale of securities. 4.) The fourth function is that of the Stockbroker in the legal execution of the solicitation and sales of securities to raise capital for the client firm. All four functions are managed by the investment banking divisions of Wall Street firms. By the end of this program, you should have an in-depth understanding of all four professional functions, to the degree necessary to determine a proper deal structure for your company, price the securities, and complete a securities offering document for your company’s legal counsel’s review.

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Organizational Structures There are three basic types of organizational structures in which you can sell an ownership interest: A Partnership, an LLC (Limited Liability Company) or a Corporation. In a Partnership, (General or Limited), you can sell limited or general partnership interests. In an LLC, you can sell membership interests, or other securities such as preferred stocks or convertible notes. With Corporations, there are two basic types of corporate tax structures. One is an “S” election tax status structure; the other is a “C” election or a full corporate tax status. To avoid unnecessary double taxation for a corporation, we generally recommend filing as an “S” election corporate tax structure at the early stage of a company’s existence. If you have not already done so, or if you have not incorporated a company yourself in the past, you should hire an attorney to incorporate your business. Make sure that there are no more than 70 shareholders. Otherwise, your company will not qualify for the non-taxable status of an “S” corporation. If your company is a Start-Up: • • • •

Have your attorney file your company’s Articles of Incorporation with the state that you have chosen to incorporate in. When the State sends back a “Filed Date” copy of your Articles of Incorporation, then get a copy of the Form SS-4 from your accountant. In the early stages of a corporation, you must file form SS-4, Application for Employer Identification Number with the IRS as per those instructions. After you receive your employer identification number from the IRS, it is wise to file Form 2553, Election by a Small Business Corporation’ for “S” corporation tax status, with the IRS.

There is no corporate tax on “S” corporations. You will also need to register for a State tax number with your State’s Department of Treasury. Most states adopt the IRS’s tax ID number assigned to your company. (See “Links” for these forms in the Commonwealth Capital Club.) “S” corporations can sell class A or B common stock, notes, bonds, or royalty financing contracts. However, they cannot sell any other class of equity. If you wish to maintain your company’s “S” election tax status, then do not sell preferred stock or convertible securities, including warrants, rights, options, convertible Notes and subordinated debentures, as they constitute a third class of stock or equity. An “S” corporation is only allowed two classes of stock. Class “A” voting common stock and class “B” non-voting common stock. If your company issues any other type of equity security or a security convertible into equity, it will lose its non-taxable “S” corporation status. If you elect to conduct a preferred stock offering, then you will need to form a “C” corporation. If you plan on growing your company very quickly and are planning to conduct an Initial Public Offering (IPO) in the near future it’s best to form a “C” corporation (currently, LLCs cannot trade in the public markets). To establish a “C” corporation, simply do not file a Form 2553 with the IRS. An “S” corporation will 29

automatically become a “C” corporation once a security has been issued that constitutes a third class of stock or equity or when you exceed the 70-shareholder limit. Incidentally, the 70-shareholder limit may change from time-to-time, so be sure to check the current rules with your accountant or attorney. NOTE: Only individuals and qualified “S” Trusts can own common stock shares class A & B in an “S” corporation. You can sell royalty financing contracts, notes, or bonds of an “S” corporation to any entity. If any other entity, such as an LLC or other corporation, “S” or “C”, purchases stock in your “S” corporation, the corporation will automatically become a “C” corporation. Also, “S” corporations cannot be held in qualified retirement accounts, such as IRAs, SEPs, Keogh Plans, etc. Although attorneys and CPAs generally recommend setting up an LLC for most new small businesses, you will see later, why you will just have to change it later if your company’s plan is to grow quickly to go public, through either an IPO or a reverse merger into a public shell, within five years. However, there is value in setting up your organization as an LLC, Partnership or an“S” corporation due to the distribution of losses, which pass through to the individual investors. You’ll need to discuss this strategy with your accountant. It may be easier to attract capital by selling shares in a corporation than by selling membership interests in an LLC or partnership interests in a limited partnership because the term membership or limited partnership interests may remind most investors of the term limited partnership interests. The large stock-brokerage firms in the mid-1980s to the late 1990s sold vast amounts of limited partnership interests. Some of those limited partnerships were grossly mismanaged, some even committed fraud, lost tons of money, went bankrupt and the investors lost fortunes. Therefore, the term membership interests is closely associated with the term limited partnership interests, which is associated with a bad situation and we would recommend it not be used, if possible. One way to circumvent this issue is to amend you LLC’s Operating Agreement or Partnership’s Partnership Agreement denoting the term substitution of Interests or Units, to the term “Shares.” This one change should allow you to avoid any explanations in the future. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time.

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Deal Structuring The philosophy behind creating a marketable deal structure primarily has to do with putting the investors first, in regards to the return of principal and profit. Secondarily, it has to do with your “Dollar to Headache Ratio.” Please keep in mind that the following examples represent a philosophy of deal structuring, rather than the actual mechanics of the deal structuring process. The mechanics of deal structuring will come later in the “Instructions to Producing Pro Forma Financial Projections” chapter. You need to understand how different capitalization structures interact with each other when developing your company’s deal structure, which ultimately leads to the securities offering. You need to know how much leverage (debt) can be or should be used as part of the overall capitalization plan, as well as, the different rights and obligations that different types of securities hold. This too represents the mechanics of deal structuring will come later in the “Instructions to Producing Pro Forma Financial Projections” chapter. The deal structure that your company should use will be dependent on a few variables such as, how long your company has been in operation, the value of its assets, and the size and make-up of your company’s management team. These are just a few of the many possible variables that will determine your company’s relative position of strength, which will ultimately determine the amount of equity that must be relinquished, if any, relative to the capital obtained. To arrive at the first deal structure, the very first question I generally ask a new client is very much like asking your child, “What do you want to be when you grow up?” This is because the wrong course of action now will result in the wrong outcome later. Backing up and making changes to your organizational structure, mode of operation, and five-year capitalization plan is not only expensive, but most often it is cost prohibitive. I ask the client, “What do you want your life to be like in seven to ten years from now?” Do you want to own 100% of a $5,000,000 company or 5% or a $100,000,000 company or something in between? Taking your company public with an initial public offering (IPO) seems to be the way to get rich quick. Ask yourself one question, “is wealth or freedom more important to you?” They are not necessarily the same thing nor do they go hand in hand. You will lose freedom by taking your company public, but you may gain more wealth. (More Dollars, More Headaches). Going public also means that your competitors can review your audited financial statements with ease. They can tell where your last year’s capital expenditures went, what your company’s advertising and promotional budgets as a percentage of gross revenues are, and they may be able to decipher executive compensation to compete for your executive talent. Maybe remaining privately held will give you more freedom with a respectable amount of wealth. (Less Dollars, Less Headaches). Those are personal decisions that only you and your management team can make.

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After assessing what the client wants his or her life to be like, which generally determines the mode of operation, only then can we start formulating the deal structure. Once the mode of operation is decided upon, we then run the numbers to see what the entrepreneur can offer to prospective investors to achieve the goal of attracting the capital. In any event, we tend to eliminate or at least limit any common stock (equity) offering at the early stage in the game. We do so because the common stock equity is the most precious element of any company’s financial structure and we don’t want to “sell out” the company so cheaply. More often that not we’ll wait a few years before recommending that our clients offer any common stock. However, the entrepreneur’s private capital market contacts may demand a portion of equity as part of the capitalization plan. Therefore, we have provided three securities offering document Templates that include common stock or membership interest equity: one represents 100% equity, one represents 70% debt with 30% equity mix (2 to 1 debt to equity ratio), and one represents a 100% Note, (debt or Bond), with an equity kicker. The next step in the process of raising capital starts with designing the capitalization structure. We use common stock shares, as the common denominator for equity, in most illustrations for two reasons: First, it is easier to understand when calculating values and, secondly, reference to shares makes selling securities much easier because most people own stock that’s publicly traded and are used to hearing the term. If you have an LLC or partnership, simply adjust member or partner interests accordingly or amend your Operating or Partnership Agreements to reflect “shares” as being the term your company will use to identify ownership. You can simply amend your Operating Agreement to reflect that “Interests” are denoted and termed “Shares.” You will see that we have used the correct terminology of Membership Interests Units in the Templates for LLCs and Partnerships. So, if you change the term Interests or Units in your company’s Operating Agreement, you’ll need to search and replace “Units” with “Shares” in the Template. First, we will run the numbers on the 100% equity plan to discover a “Pure Vanilla” valuation. By using the 100% equity structure we can discover how much “wiggle” room we have in regards to introducing different structures. For instance, if we have discovered that the sale of 20% of the company’s common stock for $500,000 would produce a substantial internal rate of return on investment, we then know that there is enough room to introduce a royalty-financing contract, as opposed to the sale of common stock. We know this because the royalties given to the contract holders will only diminish the gross profit by a certain percentage, which in turn will only temporarily decrease the internal rate of return on the common stock because, at some point in time, the royalties will end and the common stock will benefit. If the internal rate of return on investment for the pure equity plan only produces a marginal percentage, say 12%, then we know that leverage through the use of debt will improve that internal rate of return on investment by a certain amount. Of course, we will only know by how much once we have run numbers on that scenario. We also know that the debt with an equity kicker structure should produce even a greater internal rate of

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return on investment because the issue price of the stock, with that deal structure, is virtually zero. Now that’s buying low! Once we have run the numbers on a 100% equity capitalization plan, we will run a couple of sets of numbers on different securities offerings other than that of common stock. These sets of numbers are the basis of forming your “Prototypes,” which will lead to the creation of your company’s Red Herring document. Running the numbers means producing realistic & conservative pro forma financial projections. Such projections will include Gross Revenue growth assumptions, Cost of Goods Sold assumptions, General and Administrative Expense assumptions, Interest and or Royalties Expense assumptions, and finally Capital Budget assumptions, which will ultimately calculate the Estimated Net Income, Cash Flow Analysis, Cash Distributions and Company and Stock Valuation in a Private, as well as, a Public (public for corporations only) market. The time horizon generally runs five years for those types of financial projections. Most accountants don’t like to produce pro forma financial projections past five years. That’s fine for operating entities that are already in the black, however for most start-ups there may be (but shouldn’t be), three years of operating losses before any profits are realized and one needs to analyze 4 to 7 years of earnings increases to get a handle on stock valuation. Your company’s situation is unique, so make time horizon adjustments as needed. Why do we value common stock when we attempt to limit its sale? Simply put, you need to know how your equity is affected by the various deal structures or capitalization plans. Additionally, you should not decide how much common stock you should give up, if any, until you have run the numbers. The ability to raise private equity capital provides a certain relative position of strength for you when you approach the bank for the balance of debt capital, if needed. Remember traditional debt capital is as cheap as cheap can get when it comes to funding for a start-up or an early stage company, if of course you assume success. You may want the debt portion to be the larger percentage of your total capitalization plan. Once again, your company’s equity capital component is your most precious element and you should hang on to as much of it as long as you can. Before I explain the advantages of different types of securities, which will constitute the initial components of your company’s deal structure, I should first quickly explain the concept of Investment Risk vs. Return.

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Investment Risk vs. Return You need to view your securities offering from the perspective of the investor. To do so, you need to know about investment risk vs. return. Every investment has some form of risk. Federally insured certificates of deposits and interest bearing bank savings accounts have risk. Not necessarily principal or interest risk, but inflationary risk. If you are receiving 3% on your money in a two-year CD at the bank and you are in a combined state and federal marginal tax bracket of 33%, then you are netting out about 2% after tax. If inflation starts to rise to 5%, you would actually be losing 3% on your money in the form of purchasing power. Swinging the pendulum back in the other direction, one may view lower priced publicly traded stocks on the OTC Bulletin Board (penny stocks) as a high-risk highreturn situation. These investments generally have a higher principal risk but also have higher potential return. In general, risk and return “potential” go hand-in-hand. The higher the risk one takes on in an investment the higher the return potential should be. Your new company or project will generally be viewed as very high risk by most investors; therefore, a very high return potential must accompany that risk, but not too high, otherwise it becomes unbelievable. The trick to attracting capital for start-up and early stage companies is using differing deal structures to reduce the risk components of the securities for the investor while maintaining the high return potential. The three most popular deal structures do just that. They slightly warp the risk return continuum. These deal structures allow for maximum upside while minimizing the downside. You can get creative with these structures by themselves or in combinations with each other. Simply think of yourself as an investor. How would you like to invest a $100,000 in a new company or project in the following manner: You purchase a $50,000 first mortgage note, with 10% interest rate, a first lien position on 100% of the assets of the company. You also invest $50,000 in a royalty-financing contract that returns 30% of gross revenue from the sale of all products until that $50,000 grows to $500,000. By selecting this combination as your company’s deal structure, you would have reduced risk, while maintaining a high potential return.

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The Three Most Popular Deal Structures for Private or (Limited) Public Placements 1. Notes with Equity Kickers: This structure works well for seed, as well as, 2nd development capital securities offerings, especially if your new company or project is not bankable, because the Notes replace the first lien position of bank debt. If your company or project is bankable (i.e. the plan includes the purchase of real estate and/or real property, machinery and equipment, or you have current receivables and marketable inventory) then you could use this structure for a seed capital offering, and use bank debt later to pay off your seed capital investors or to keep them in the deal if they do not mind taking a second or third position on liquidation rights. Typically, you will need to raise equity capital through the issuance of common or preferred stock first, and then you will have the equity required to secure the debt component through bank loans. Once you have run your numbers on the “100% Equity” Template, you can easily plug in the debt components of interest and principal payments. We’ve done that for you in the Templates, you just need to adjust the amounts. Let us say you need $200,000 in seed capital. You could plan on issuing 1 or 2 year Notes with Equity Kickers and plan on paying off those notes with the proceeds from subsequent securities. This kick starts a seed capital offering. Or let us say, for instance, that you have decided that your numbers support the issuance of $1,000,000 in 5-year First Mortgage Note @ 12% interest with an equity kicker. Because you will have already run the numbers on the “100% Equity” Template, you’ll know what the expected rate of return is on the 100% equity deal structure. Let us say that your plan includes an equity kicker for the Note holders that equates to an equity ownership stake of 20% of the company. Now let us say that the 20% stake grows to $2,000,000 by the end of the fifth year. The internal rate of return can be calculated by comparing the initial, $1,000,000 Note, investment against the total proceeds returned back to the investor. For instance, that 12% equates to $120,000 per year over 5 years, which totals $600,000. That figure, plus the principal payment of $1,000,000, plus the equity stake of $2,000,000, equates to a total return of $3,600,000 by the end of the fifth year. You can illustrate the internal rate of return to be 29.20%. This internal rate of return should be acceptable to your private capital market contacts, but you will not know until you have tested the waters with this prototype. 2. The Royalty Financing Contract: This structure works well for seed, as well as, 2nd stage development capital securities offerings, especially if your new company or project is not bankable because the Contracts replace the first lien position on receivables, which the bank will require to be held by the bank to issue a bank loan. For instance, let us say that your investors 35

invest $300,000 in your company through a Royalty Financing Contract offering, which you promise to give them a certain percentage of gross revenue from the company’s operations. Yes, as holders of royalty financing contracts, they are paid first and they are secured with accounts receivable, which is the benefit to the investor. Once paid off, you do not necessarily have to deal with them any longer, although, you may want to sell them a preferred stock or note to recycle the capital back into your company. The benefit to you and your company is they do not have any voting rights and they are temporary investors. By using this deal structure you should be dealing from a relative position of strength, which would allow you to continue to dictate the terms of the deal. Here’s a better example. Let us say that in year 1; there are no gross revenues projected. Year 2; $300,000 in gross revenues projected, year 3; $700,000 in gross revenues projected, Year 4; $1,500,000 in gross revenues projected, and Year 5; $3,000,000 in gross revenues projected. The total would be $5,500,000 in gross revenue by the end of year 5. Let us say that you decided to offer 10% of gross revenue to the royalty financing contract holders until their investment grew by 50% or $450,000, the “Contract Termination Amount.” That’s right, royalty financing contracts have Contract Termination Amounts not necessarily maturity dates, like Notes or Bonds. Under the preceding scenario, it would take only four and half years, producing an internal rate of return of only 9.43%. That’s not a very attractive rate of return relative to the risk involved in investing in your new start-up or early stage company. You may need to double that percentage to 20% of gross revenue so that the total amount to be received is $900,000 over the same time-period. That would illustrate a 27.65% internal rate of return. That rate of return is far more attractive, wouldn’t you agree? You can subjugate the gross revenue stream to a particular product or service line’s revenue only if you have an existing company but need funding to launch just one new particular product or service line. You can get very creative with this arrangement and investors love it. Most deal structures in the royalty-financing arena are much richer for the investor than we’ve illustrated above. Most that we’ve seen give between 20% and 30% of gross revenue to the investor until the original investment amount increases ten fold, sometimes that figure is projected to be achieved just over a 5 or 6 year period of time. Because the royalty financing contracts are secured by accounts receivable they are considered a debt security in the eyes of other lenders. 3. The Participating Preferred Stock: This structure works well for 2nd development capital or 3rd stage expansion securities offerings, especially if your new company or project is bankable because the Participating Preferred Stock serves as an equity component, which enables you to acquire bank debt. All preferred stockholders receive a forward position on liquidation rights over any type of common stock, but is subordinated to any debt. A preferred stock is generally considered a hybrid between common stock equity and debt in the form of notes or bonds. Preferred stock can have different components added to it. From an

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accounting perspective, preferred stock is considered equity and is nicely reflected that way on your company’s balance sheet if you need to go to the bank to borrow debt. A preferred stock not only has a forward lien position over your company’s common stock on assets, it generally has a stated dividend. What that means is that it may state a dividend of $7.00 per year on a par value preferred stock of $100.00 per share. That stated dividend represents a 7% annual yield or return and is due and payable whether the company has net earnings or not. A participating preferred stock has more return potential because it “Participates” in a small percentage, generally 10, 15, 20, 25% or possibly as high as 50%, of net earnings of the company. If your company’s capitalization plan requires that you raise a large amount of equity, say one to three million dollars, to secure a larger amount of debt, say two to five million dollars, we would run the numbers on a preferred stock offering, maybe two scenarios of two different types of the participating preferred stock. The first set of numbers would illustrate a high stated dividend with a low percentage of participation on net earnings. For the second scenario, we would illustrate selling a preferred stock with a lower stated dividend with a higher percentage of participation on earnings. For the first scenario, we might illustrate a stated dividend of 12% with a participation of 10% of the company’s net earnings. For the second scenario, we might illustrate a stated dividend of 7% with a participation rate on the company’s net earnings of 20%. The first example takes on less risk by putting out a higher stated dividend, an obligation regardless of realized earnings coupled with a lower total return potential because of the lesser percentage of participation on earnings. Under both scenarios, we would make the adjustments on the dividend rate or the participation percentage, or both, to reflect the risks involved. If the first scenario had a total return potential of 18% per year, the second scenario would need to produce a total return of 24% to 27%, due to its relatively higher risk by having the lower stated dividend. Why issue a preferred stock offering you may ask? In addition to the aforementioned characteristics, a preferred stock can include what is called a “Call” feature allowing you to call the preferred shares back from those preferred stock shareholders at a certain period-of-time and at a certain price, generally at a slight premium above its par value or issued price. Let us say that in year five your net ending cash balances are projected to be $400,000. You would then be able to formulate a buy back of your preferred stock shares to coincide with a “Call” date at the end of year four to be called at 110% of par or face value. Let us say you sold $300,000 worth of the preferred stock. You would now need to pay $330,000, (110% of par), to buy it back from those preferred stock shareholders, leaving you with a $70,000 net ending cash balance for that fifth year. ($400,000 in net ending cash balance, less the $330,000 preferred stock share buy back). Although considered equity on your balance sheet, which is attractive to the bank when seeking debt capital in the form of a bank loan, the capital obtained from the issuance of preferred

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stock, participating or not, is not necessarily permanent capital if a call feature is included as part of the preferred stock’s features. That is only one of the reasons why it is so important to be realistic and conservative in your financial projections. You will need to conservatively predict net ending cash balances, (Consolidate Statement of Cash Flows), before you set the call date and the call price for the issuance of those shares, so that your company can afford to exercise the call feature. Before issuing any preferred stock, you must amend your company’s Articles of Incorporation for corporations, Articles of Organization for an LLC or Partnership to reflect the total amount of preferred stock that you want authorized. Be sure to also conduct a shareholders or directors meeting to approve the issuance of any security before its issuance. Even if you own a controlling interest, 51%+ of the voting equity, you need to have a meeting with yourself and enter it in the minutes. Politically speaking, it may be wise to have a shareholder’s meeting and discuss the deal structure(s) you’re considering, for two reasons: 1.) To get feedback, which may be helpful as a preliminary “Testing of the Waters”, and 2.) To get political support, i.e. referrals from your current investors, if you have any, of other investor sources. There are different types of preferred stock. The preferred stock may come with a cumulative dividend. We suggest that the dividend in your participating preferred stock be cumulative. That means no dividends can be paid to the common stockholders until all dividends held in arrears (past dividends that are due but not yet paid) are paid to the preferred stockholders. The dividends accumulate if not paid on schedule. Some capitalization plans that we produce actually illustrate cumulating the dividend for one or two years before payments begin. This helps the company’s cash flow stay as positive as possible during the early years of its existence. Another benefit for issuing a preferred stock to the issuing company is that the preferred stockholders generally have no voting rights, so control of the company can further remain in the hands of the founding principals. In addition, unlike note or bondholders, preferred stockholders cannot force your company into bankruptcy for defaulting on dividend payments. Currently, 70% of any dividend payments made to “C” corporations are taxexempt. This tax advantage encourages larger companies to invest in smaller companies to help them get started. Both the stated and participating dividends should qualify for the tax exemption. Of course, tax law is always a moving target, so double check with your accountant before you make that claim, if at all. (Sometimes it is better to say it in a sales presentation than to put it into a securities offering document). Keep this in mind when seeking a strategic alliance (other corporations) to invest in your start-up or early stage company. Always be sure to check with your tax advisor before making any such claims in your securities offering documents. The preferred stock may be convertible into common class A voting or class B non-voting. The participating preferred stock may be convertible, but does not

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necessarily need to be. The participating preferred stock is generally attractive enough for investors when dealing with start-up, early stage, and seasoned companies, so we suggest you do not get too complicated with a host of complicated features, such as the conversion feature. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time.

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The R&D of Debt Capital Before they contact any potential equity investors, we advise our clients to contact a few banks, and/or leasing companies, if debt will be part of the company’s capitalization plan. Contact those institutions with a loan or lease proposal outlining your company’s basic business plan, which should include the pro forma financial projections that you will use for your prototypes. Obviously, you will need to present one of the deal structures that use debt as a main component of your company’s capitalization plan. What you are attempting to do here is to gain “Indications of Interest” from the debt side of the capital equation. Obtaining a conditional letter of commitment from a bank and adding that letter to your company’s Red Herring document will carry massive weight in your prototype proposal. A Red Herring document is used to “Test the Waters” for “Indications of Interest” of a proposed securities offering. It can consist of a simple letter stating your intentions and the proposed capitalization plan and potential securities offered. It generally includes an executive summary and a summary of the “proposed” securities to be offered. Make sure you include the following disclaimer on each page of your Red Herring document: “This correspondence does not include an offer or a solicitation of an offering to sell securities. An offering of securities is made by Private Placement Memorandum only.” (Font size: 10 pt. Minimum). Let us say the bank wants more equity as a percentage of total capital on the table. Fine, you simply re-work the numbers to accommodate the bank’s request and re-submit that proposal. Let us say that you’re looking for $1,000,000 in total capital. If you go to the bank and say, “If I raise $500,000 in equity capital will you loan me the balance?” The banker may say, “Your company or project would be considered generally unbankable, but if you raise $700,000 in equity we will loan you the $300,000 in debt.” Simply get the conditional letter of commitment in writing then re-work your pro forma financial projections to reflect that 30/70 debt to equity deal structure. Of course, you can use the 70/30 debt to equity deal structure Template for any debt and equity ratio you need. Simply determine the ratio, 80/20, 50/50 or even 30/70 and calculate accordingly within the 70/30 debt to equity ratio Excel Template. We cannot emphasize enough the importance of obtaining that written and signed letter of commitment. If bank debt will be a large part of your plan, we would not proceed without one. In an investor’s mind, a letter of commitment from a bank generally gives the equity proposal increased validity and further assurance of a successful project. This will greatly increase the response rate from your investor pool and ultimately increase the probability of obtaining the full capitalization amount. Remember, we did not say you could not move forward without a conditional letter of commitment. If you cannot get one, you may want to raise the equity capital first, deposit into an escrow account held at the bank, then when you have cash on deposit at the bank, and ask for the loan. Remember, banks want to lend money to those who do

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not need it. By having a rather large deposit in the bank, you may be perceived by the bank as not needing any large amounts of additional debt capital. That is when you can start to negotiate from a relative position of strength. The key here is that most banks want to help you in your quest for debt, especially if you are successful in raising equity capital. Ask a commercial loan officer to forward an application for an SBA loan to you. Once your Red Herring document is complete, you could use the existing information from your financial projections to accommodate the information needed for the loan application. Be sure to fill out the application and supplement it with your Red Herring document. Why send along your Red Herring? It may carry some major weight in the bank’s decision-making process. If, for some reason, you are unable to get any interest from any bank on your capitalization proposal, you may want to add a Note offering in a marketing research letter to “Test the Waters.” Maybe a 4-year First Mortgage Note @ 12% interest with a small equity kicker would be attractive. If you register the offering at the state or federal level, you can advertise the interest rate in the local newspaper. If the bank sees that you are advertising and competing for lenders (the bank’s depositors), they may lend you the money, especially if you are viewed as a threat to banker’s efforts in raising deposits for the bank. I would use this tactic as a last resort though, as you will want your banker to support all your efforts. Commercial bankers are your friends, especially when you can raise equity capital or garner heavy weight co-signers. You have probably heard the saying that states “banks will only lend money to you if you don’t need it.” In a perfect world, a banker would lend money only to the very wealthy or those who don’t need a loan. By doing so, they eliminate any repayment risk. However, in the real world, banks must lend money to those who need it. Generally, those who need it need it for a reason; because they don’t have enough of it to build their company. What if you could convince your banker to introduce or refer you to a few wealthy customers of the bank to obtain a co-signer on a loan to receive some carried interest and/or an equity kicker for their co-signature? The banker gets what he or she wants, they get to loan money to those who don’t need it and you get what you want, a loan. We have done a few deals that involved the bank in this manner and the bank inadvertently became the primary investor referral source. It is one of the most successful capital raising strategies available for start-up, early stage and seasoned companies. Remember, in this phase of the process, your job is to research the different local and national avenues of debt capital. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time.

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The R&D of Equity Capital This exercise should be considered the production and distribution of a Red Herring document to gain “Indications of Interest” from the equity side of the capital equation. Red Herrings is the Executive Summary to “Test the Waters” for “Indications of Interest” for a securities offering. The Executive Summary should explain: 1) The industry that your company will be engaging and competing in; 2) The problems or changes that exist within that industry that provide the opportunity to sell your company’s product and/or service line(s); 3) The solutions your company’s product and/or service line(s) shall provide to solve those problems or address those changes; 4) The opportunity to the investor in terms of rate of return projections by investing in the securities to be offered by your company; and 5) The Exit Strategy After securing a conditional letter of commitment from the bank, if appropriate, we would advise our clients to send the Red Herring document to your management team’s personal and professional prospective investor contacts that may have an interest in investing in your company. We would recommend that you use a limited number of securities offering scenarios, so as to limit any confusion. Be sure the scenarios are germane to the stage your company is in (i.e. Debt with Equity Kicker for seed capital). Include any officers’ and/or directors’ professional biographies with no more than thirty to forty words for each team member. If you can, add an advisory board to thicken up the experience factor of your project or company. You may find that most professionals will not want to actually be a member of you board of directors because that position carries fiduciary responsibilities to your shareholder base that could create a direct liability against their personal assets if the management’s actions breach that fiduciary duty. That is why an advisory board, that has no actual power to vote on any action of the company, relieves the members of the advisory board from that fiduciary duty and therefore would be more attractive to most professionals. Surrounding yourself with some bench weight here will elevate your relative position of strength. Be sure to get permission from each Advisory Board Member in writing before you add their bios to your document. Incidentally, only the officers and directors, (managers for an LLC), of your company can legally solicit and sell securities in the company in a private offering, if you do not engage an investment bank to sell your company’s securities. If so, both your officers and directors, (managers for an LLC), and the stockbrokers of the investment bank’s selling group can sell. However, be careful not to directly or indirectly compensate any officer or director for the sales of privately placed securities. In a private or public offering, it is against the law to do so. If you will be compensating them, make sure that the sale of securities is incidental to their compensation and that they have other duties to fulfill for that compensation. Do not get cute where compensation is concerned,

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the regulatory authorities have seen every trick in the book. Consulting fees are a major Red Flag. Request in the Red Herring “testing” letter, that if interested in a particular security offering scenario that the prospective investor simply return the letter with a check mark next to the security scenario. We also suggest that you ask for a potential investment level commitment or dollar amount of interest and have the investor return it to your company’s headquarters in the self addressed stamped envelope provided with that mailing. You may also want to mention to your prospective investors that you have mailed this same letter out to hundreds of your personal contacts, or whatever the correct figure is. Ask them to respond within thirty days, as you will be making your decision on “how,” not “if,” you will proceed. When approaching investors, always exude confidence and a subtle professional attitude that you are going to move forward and succeed, with or without them. You may also rent or purchase a mailing list of accredited investors in the county or surrounding counties where the company’s management team resides. You should contact the regulatory authority in your State, generally the Dept. of Banking and Finance under the Dept. of Commerce or the Secretary of State to obtain a copy of your company’s state’s blue-sky laws. Once you receive it, take a look under Exempt Transactions of securities to see if a solicitation of securities to accredited investors only by a private mailing is allowed. In most states it is. As a matter of fact, the North American State Administrators’ Association (NASAA, the State Regulators), has adopted a uniform offering exemption, allowing companies that are soliciting and selling securities to accredited investors only, to advertise in the general media to seek indications of interest of a securities offering. (See Compliance Folder in the Commonwealth Capital Club for detailed directions on how to proceed). However, you should realize that by contacting accredited investors in this manner, you are still starting cold. Just because you’re ready to sell them doesn’t mean they’re ready to buy. Your response rate is going to be between 1% and 2% if you’re lucky. Even then, it is still a long-term process of building the trust relationship, which is critical for attracting capital. Trust relationships are the only conduit to get an investor to cut a check and invest in your company. Patience is your most powerful weapon in this battle. Once again, an ample amount of seed capital will afford patience. Throughout all of your company’s present and future capital raising efforts, you must always deal from a relative position of strength if you are going to dictate the terms of the deal. Positioning yourself and your company from a relative position of strength begins with contacting your own personal and professional capital contacts in the early stages of the capital raising effort. You should already have a relative position of strength when dealing with those who know and trust you.

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If you researched any fortune 1000 company, you would find that the vast majority, over 95% of them, started raising capital from “Friends and Family” before they were able to raise capital from an institutional source. You may be thinking that it is too politically sensitive to ask friends and family for capital. As an investor, I would ask myself the question, “If you don’t have enough confidence in your company’s ability to succeed, to raise capital from friends and family, then why should I invest my capital in your company?” By completing the production of your company’s securities offering documents you should increase your relative position of strength from your personal contact’s perspective. Once they see your securities offering document and realize that you wrote it, they should not only trust in your character but more importantly, they should further trust in your abilities to handle the task of building a profitable enterprise. When you have reached $5,000,000 or so in annual sales you can approach strategic alliances that would inherently benefit from your company’s expansion and receive a relatively warm reception. This does not necessarily work in the start-up phase though because, more often than not, they tend to take too long to make a decision and they will most likely want to dictate the terms of the deal. However, when you have $5,000,000 in annual sales you will be dealing from a relative position of strength with strategic alliances that are twice or three times the size of your company. Be mindful that when dealing with any larger strategic alliances you’ll start to lose your relative position of strength. (It’s all relative!). In addition, by letting these potential strategic alliances know that you are shopping their competitors, may increase your relative position of strength and they may move a lot quicker in their decision making process than they otherwise would. When searching for capital through strategic alliances (businesses or professions that understand what your company does to make money), look for an inherent benefit opportunity for the capital contact base. You should ask yourself the question “who or what company would inherently benefit from my project or company’s existence over and above the benefit of having an investment in the project or company?” Now I must digress here. This program is geared specifically to allow the entrepreneur to raise capital and maintain control of their company. Many times a strategic alliance will make a counter offer and bankroll the entire operation. However, they will most likely take control of the operation and give you some equity and cash, maybe 10%, and build the company on their own terms and conditions. Depending of course on your outlook on life and who the strategic alliance is, you may want to accept the deal. If I had a product with a certain chemical technology and Proctor and Gamble offered me 10% in cash and stock of the new subsidiary, I would take the money and run. If a company with worldwide distribution channels, production facilities and the marketing firepower to turn the company into a $2 billion dollar company within five years wants control of the company, it may be wiser for me to take that deal than for me to compete in the marketplace with Proctor and Gamble as a potential competitor. I would be worth more by accepting less, than I would be by going it alone.

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Now back to reality. This “Inherent Benefit” position goes further toward the “dealing with like minds” concept of solicitation and sales of securities. If you had a product or a service, like a real estate agent referral network system driven by a special software program that your company has produced, real estate agents may be interested in investing in your company because the product would directly influence their day-today sales volume. The agents can more easily relate to its value than other investors would. They may also give you a referral or two of some wealthy real estate investors they know and/or get their brokerage agency to invest or buy your company’s product. In other words, by positioning your company and your securities offering to those who would inherently benefit from your company’s existence you could build a network of investors and prospective customers with the sales effort, potentially with the same sales effort. This network may feed you leads of other investors. Trying to sell securities in a software company to a farmer is the opposite of the like mind concept, unless of course, the software increases milk production for a dairy farmer. The point being, approach and deal with those who at least understand and/or will directly benefit from your company’s new project or product line, in regards to prospecting for capital. What we’re doing at this stage of the game is conducting a private “testing of the waters” to find “indications of interest” for a private offering of equity or debt securities. Why a private offering you may ask? Because a private offering is easier, quicker, and less expensive than conducting a registered public offering. In the start-up or early stage phase of your company, if you can’t raise it privately you certainly will have a difficult time raising it publicly. This is the general rule. However, there are always exceptions to general rules. For instance, if you owned a company that had 5,000 subscribers to your product or service, like an Internet Service Provider, you could register your securities at the state or federal level and sell your company’s securities to your subscriber base. You could include a statement stuffer, explaining the offer, which allows them to request a securities offering document, which because the securities are registered can now be posted online. (Very little distribution cost). You could have them pay for their purchase of your company’s securities on their monthly service invoice. This is the very first step in the R&D of Equity section of capitalization planning. A securities offering is very much like a product offering, you’re researching your private capital market before finalizing your securities offering structure and document. Although, the concept of R&D for a securities offering is very much the same as R&D for a product or service launch, the approach and process of a securities offering is highly regulated. We’ve already streamlined the process with this program and the accompanying Templates. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time.

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Making Structural Changes Making structural changes means changing the deal structure. Let us say that you receive a positive indication of interest on one or more of the scenarios. If one scenario stands head and shoulders above the rest, then your plan of attack is pretty clear. Produce your securities offering documents to cater to those indications of interest and send it to those potential investors. Be sure to follow up with these investors at a later date. I will explain more on following up later in this program. If the responses for the prototypes are equal across the board, you may need to refine your Red Herring. You will need to figure out what securities scenario you want to sell to capitalize your company. You may need to call some of these potential investors and tell them that you are in a dilemma. Ask them if another scenario appealed to them as well. You may also want to ask them, “In a perfect world, what kind of investment would you be interested in?” As a matter of fact, in the very beginning of your research and development of the equity process in the capitalization plan you may want to tell a dozen or so wealthy individuals, who you know personally, about how you plan to proceed in your research and ask them for their sagely advice. Why? If you allow them to help map out the deal structure in the beginning stages, they most often will feel that they are the ones who will make your success happen. Be sure to ask them, “What elements would you be interested in seeing in an investment? What sparks your interest and why? What would spark the interest of your wealthy friends?” Of course, you may not hear what you want to hear, as most savvy investors may decide to bankroll your operation, but they’ll want control, first lien security on assets, and determination of your compensation levels. That’s why we generally take the position that by offering a security that gives them most of what they would want in an investment, through one of the three most popular deal structures, the prospective investors most likely would invest some money and give you a few referrals, which should be good enough, as opposed to bankrolling the entire project where they may seek control. Re-working your securities’ features and benefits will be relatively easy once you have produced your company’s original “100% Equity” pro forma financial projections. You simply run different “what if” scenarios. Maybe the Royalty Financing option at 20% of gross until the $300,000 hits $1,000,000 is more attractive to your investor community. Maybe a Participating Preferred Stock offering that has a dividend of 14% with 20% participation for a total annual return potential of 34% with a ten-year call at 130% of par value, as opposed to the 110% in the previous example, may be more palatable for the investors you and your management team know. That is the beauty of running the numbers in the first place; you will know what you can afford to give up and how to structure the deal so that it sells to your private market. Notice that with the three most popular deal structures for private or public placements, very little of the voting common stock equity was relinquished. The voting

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control of the company remained in the entrepreneur’s hands. Sometimes that is unrealistic especially if the entrepreneur has little or no money in the company. It does, however, depend on the entrepreneur’s personal and professional contacts and the wealth contact environment in which the entrepreneur exists, as well as, the industry in which the entrepreneur is engaged. A prudent investor’s biggest fear is losing their investment. One way to circumvent this fear to a potential investor base is to indicate in your research letter that you will escrow the money so that unless 100% of the funds are secured, including the bank loan, if appropriate, their entire investment will be returned to them. Indicate that the money will be safe and will only become an investment, “if and when,” all of the funds have been secured. If 100% of the capital cannot be secured then the funds will be returned to the investors with bank interest. That approach should calm or mitigate some fears. Once again, it really goes back to the entrepreneur’s personal and professional contacts. Maybe a minimum investment amount that you indicated in your research letter was $25,000 and no one in your circle of influence can obtain that amount of cash. Maybe a $5,000 minimum amount would have a greater acceptance rate. Maybe the annualized rate of return is too high and the plan is perceived as too aggressive because there is too much debt in the capitalization plan. You may need to simply increase the equity portion of the capitalization plan or stick with an all equity capitalization plan. Maybe you could get someone close to you to sign a personal guarantee with the bank so that you can obtain the line of credit, SBA backed or not. You might have to give the co-signer some carried interest plus some equity or royalty financing. There can be many capital plan combinations. There is an unlimited number of ways to structure a deal and formulate a securities offering, but try to keep it simple. Incidentally, carried interest is the interest you pay the co-signer, over and above the bank’s interest rate of 9% (for example), for taking on the risk. You may pay them 4% (for example) for a total interest rate of 13%. Once you get some cash flowing in on that avenue, your company may become bankable on its own merits for other product and/or service development. Remember, it is wiser to have many investors investing in your company with very small amounts of capital, as opposed to a few investors with large amounts of capital. This concept not only protects you and your company from potential civil litigation, but it also enables you to create a growing pool of private capital contacts that you can go back to with future securities offerings. The more investors you have, the higher the probability of actually raising the capital sought, round after round. By cultivating a large investor pool, you also increase the probability of getting additional investor referrals, as well. An alternative scenario may be that you get no response from your Red Herring test, even after you’ve re-worked the deal structure. If you have done a comprehensive job on listing all the folks that you know personally and professionally and sent them

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your company’s Red Herring document and your response was weak or non-existent, then you will need to consider registering your securities offering to conduct what is known as a “Direct Public Offering.” Under Regulation D 504, also known as a SCOR (Small Company Offering Registration) offering, you can sell securities to raise capital up to $1,000,000 in one year in the state where the offering is registered (State Registration). Under Regulation A, you can sell securities to raise capital up to $5,000,000 in one year in any state (Federal Registration). Such procedures are beyond the scope of this program. See the related links area in the Commonwealth Capital Club. The SCOR registration is at the state level and the Regulation A is at the federal level. Both cost quite a bit of money. A SCOR offering can cost between $25,000 to $50,000 and Regulation A offerings can run as high as $50,000 to $100,000. Many times, we recommend that our clients raise seed capital in their first round and then engage in a registered offering in a second round, so they can advertise the securities in the local newspaper or any other form of general media. Once again: you need sufficient seed capital to go after larger amounts of development or expansion capital. If you need close to or over one million dollars in development capital, raise a couple hundred thousand from friends and family. Use the money to register the offering at the state level, advertise a registered offering, and start the process all over again. The sad fact is if you want to raise substantial amounts of capital, you have to pay to play. After you have “Tested the Waters” in a public forum and you’re still unsuccessful in garnering sufficient “Indications of Interest” for your proposed securities offering, then you’ll need to either re-work your offering structure (i.e. your securities’ features & benefits that were offered) and/or re-think your mode of operation. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time.

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Changing the Mode of Operation Maybe it is your company’s mode of operation that is the real problem. It could be time to re-think your company’s entire mode of operation, which inherently determines its capitalization needs. Let us say the current mode of operation requires $1,000,000 in total capitalization, that amount may simply be too much money in the eyes of your potential investor base. Far too many times our clients have grandiose plans in the beginning of their company’s existence that requires millions and millions of dollars. After testing their private market they soon discover that re-thinking their mode of operation to a lesser degree of capital needed, greatly increased their probability of being funded. Most often, they actually do receive the funding after this conclusion has been reached because they have adapted and reduced their capitalization plan to meet the demand of their private capital market. Let us say that the $1,000,000 was to buy land, building, and equipment to produce your product or service. Could you lease the plant or equipment? Would that bring your capital needs to a total of $200,000? If so, maybe you need to raise only $100,000 in equity and obtain a SBA backed “fast track” loan from the bank for another $100,000. Can you rely on independent manufacturer representatives to sell your product or service line(s), as opposed to hiring an in-house sales force, at least for the first few years? Can you adjust your marketing and sales strategy to be primarily commission oriented? Read up on your industry’s trends and figure out where you can gain strategic marketing alliances. Think thin! If you can raise equity capital, raising debt capital is a snap. The point being is, you can easily increase the probability of raising equity by minimizing your overall capital needs in the beginning and then raise more capital as time goes by. More often than not, most start-up companies require very little capital to get up and running. Once your company is up and running and you prove that there is in fact a market for your product and/or service lines(s), you will further assure a successful placement of equity and/or debt related securities for further development and expansion. More often than not, investors want to see a “proven economic model,” before they commit their cash. Before you do anything else, I want you to re-think your mode of operation as best you can. For the next week, ask yourself, “How can I pull this off with very little money, no employees and no headaches?” If you have only obtained this instruction manual and are now ready to move forward, then you will need to purchase the entire Financial Architect® 4.0 program. Go to our website: www.commonwealthcapital.com and purchase Financial Architect® 4.0. Don’t forget to use the promotional code that you were provided to download this Ebook. The promotional code will provide for a large discount from the retail price.

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Instructions to Producing Pro Forma Financial Projections Due to the changing nature of the securities markets, financial reporting, and disclosure requirements, we have provided you with a set of pro forma financial projections and securities offering document Templates that are designed to be timeless in nature. These are the fundamental elements of deal structuring and securities offering document production, which probably will not change much. However, the Templates will be updated from time-to-time, as changes occur in regards to federal and state securities laws, rules, and regulations. Such updates will be available to the current Members of the Commonwealth Capital Club in the form of updated editions of the “Financial Architect®” programs. However, it’s up to your attorney and CPA to review the final document to ensure it will be current, in light of such regulations. Some projects may require 7 to 10 years to realize their maximum net operating margins, especially true for real estate or oil & gas projects. The pro forma financial projections Template files are illustrated over a 5-year time horizon. If you need to extend your time horizon, simply copy the formulations contained in the fifth year column and paste the formulations into additional columns as necessary. The pro forma financial projections and securities offering document Templates illustrate a manufacturing operation. However, they can be easily adapted to any type of operating or project development company. It really does not matter if your company is or will be producing products or services as an operating company. Simply adapt the right terminology to coincide with the dollar amounts in your projections. The next few chapters will walk you through each step of the process. We had to pick a name for a prototype company for these Templates. As you can see, we used “XYZ Company, Inc.” as the name. The model shown here is for corporations. Because more companies are choosing a Limited Liability Company (“LLC”) as their organizational form, we have included Templates for LLCs as well as for corporations. If you have or want to form a Partnership, (General or Limited) simply substitute the terms Member and Membership for Partner and Partnership within the LLC Templates. The company and the names of any personnel used throughout the Templates are fictitious in nature and shall be considered to bear no resemblance to any actual company or personnel. If any similar names should arise, the information contained herein shall not be construed as in any way a reference to those names. Generally, there are only a few changes one needs to make to transform a corporation securities offering document into a securities offering document for LLCs or Partnerships, therefore you may start with either form and change it if you like. However, we strongly recommend that you start with the Templates that are relevant to your company’s organizational structure. For example, open and use only the folder entitled “Corporation Templates” if your company is a corporation and open and use only the folder entitled “LLC & Partnership Templates” if your company is a Limited Liability Company or a Partnership.

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For your information, an LLC differs in form from a corporation in that it is technically a partnership that is managed either by Manager(s) or Member(s). (Limited Partnerships are managed by the General Partner and General Partnerships are managed by the General Manager). In general, if the LLC is managed by Managers, the majority of Members must vote for the Manager(s) according to the LLC’s Operating Agreement. Operating Agreements can allow each Member to have one vote per Member or many votes based on their capital contribution to the LLC. If a Member has one vote, irrespective of that Member’s capital contribution, it will differ substantially from the organizational structure of a corporation. Corporations must allow one vote per share of its class A voting common stock. Therefore, those investors who contribute the most amount of capital technically control the corporation. It is extremely difficult to raise capital for LLCs that do not allow voting control to be established by the majority of those who contributed the capital. So we strongly recommend that if you have yet to establish an LLC, make sure the LLC’s Operating Agreement allows for a majority of ownership interest to control the company. If you already have an LLC that allows each Member to have one vote per Member, irrespective of that Member’s capital contribution to the LLC, we recommend that you amend the LLC’s Operating Agreement to reflect ownership control is constituted by a majority of ownership percentage interest in the company. In addition, some LLCs are managed by its Members, which are like class A voting common stock shareholders in a corporation. If you will have many Members, (after the sale of securities), more than 5 or 7, you should amend the LLC’s Operating Agreement to allow the company to be managed by Managers as opposed to the Members, because you do not want “too many cooks in the kitchen.” Corporations are controlled by its officers and directors, who are elected by majority vote of its class A voting common stock shareholders. That is why LLCs should be set up, through the Operating Agreement, to be controlled by Managers elected by Members, based on a percentage of their capital contribution. The following is for your information only and does not require your immediate attention, as the Templates are already formatted with the correct terminology germane to your company’s organization form. However, this body of knowledge is still important for you to understand. The terminology changes are as follows: • •

Corporations have “Articles of Incorporation.” Limited Liability Companies have “Articles of Organization.”

• •

Corporations have “By-Laws.” Limited Liability Companies have an Operating Agreement.”

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Corporations have “Officers & Directors.” Limited Liability Companies have “Managers.”

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Corporations have “Shareholders,” which own shares of stock. 51

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Limited Liability Companies have “Members,” which own Ownership Interests.

• •

Corporations have unlimited life spans. Limited Liability Companies, like partnerships, have a pre-determined life span.

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Limited Liability Companies, have Admissions Agreements, like Partnerships, which have Partnership Agreements.

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Both have Subscription Agreements for the purchase of securities.

To convert a corporation’s securities offering document into a LLC’s securities offering document, you simply need to change the above terminology throughout the document and the Exhibit section. You may need to add an Exhibit entitled “Admissions Agreement” and copy and paste that agreement, which will be a part of your LLC’s Operating Agreement, into that Exhibit. When it comes to LLCs, the ownership interests are denoted as Membership Interests. Membership Interests can be broken into differing percentages of the company’s total ownership, which could be confusing to some investors and may make it difficult for you to calculate the estimated annualized rate of return on a particular security. Also, those Membership Interests are usually expressed as Units so, as with Partnership Interests, that term will become confusing if you decide to use one of the most popular deal structures; Debt with Equity Kicker. The Debt with Equity Kicker deal structure includes a security that is a combination of Notes with Equity (Membership Interests for LLCs or Stock for Corporations), and that security is expressed as a Unit. Therefore, we strongly recommend that if your company is an LLC or a Partnership, that you amend your LLC’s Operating Agreement or your Partnership’s Partnership Agreement to express Membership & Partnership Interests or Units as “Shares.” Making this one change will make developing your securities offering documents far simpler and potentially less confusing. In our examples, we have used 100,000 class A voting common stock shares as the common denominator for the total authorized class A voting common stock shares in a corporation. One share therefore represents 1/1000th or 1%. One would need to own 1,000 shares of class A voting common stock to own one percent (1%) of the company. We suggest that you amend your company’s Operating Agreement to reflect that percentage as well (i.e. One Membership Interest Share represents 1/1000th or 1%). We do not reference any class B non-voting common stock in the illustration or in the Templates. You could use class B non-voting common stock, but just realize that it is treated, for dilution purposes, the same as the class A voting common stock. For ease of illustration in regards to this instruction manual, and not because we are lazy, the terms: common stock, stock and shares, shall mean class A voting common stock and membership or partnership interests, as well.

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We realize that for early or later stage companies that already have investors and established total authorized shares, these changes may not be possible without obtaining a majority of ownership vote, which could be difficult as it may produce dilution. Simply keep in mind that we’ve used a simple way to calculate the percentage of ownership one would own by purchasing a certain amount of shares. If you feel that making changes to the total authorized shares or interests would cause you political problems throughout your company’s current investor base, then simply use your current total authorized shares or interests as the base point of your calculations. You will simply need to plug that number into the various areas within the worksheets and the notes to pro formas to arrive at the proper calculations. If you are using a Partnership as your organizational form, then use the LLC Templates and make terminology adjustments that coincide with your Partnership Agreement and state filings. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time. Financial Projections You are about to access a set of pro forma financial projection worksheets, which are advanced to the level of Generally Accepted Accounting Procedures (GAAP) standards. The examples include sets of worksheets for companies that are to be privately held. The publicly held scenarios are to be part of another Financial Architect® program. We have put together an example of a $5,500,000, 5-year, capitalization plan using a series of securities offerings and bank debt, as one would put together for a privately held start-up company. This example illustrates that we practice what we preach. The pro forma example begins with a seed capital offering, using the Debt with Equity Kicker structure, a development capital offering to begin operations, using a Royalty Financing Contract structure, a 1st stage expansion offering to build plant and equipment and to pay off the Debt with Equity Kicker investors and to provide sufficient equity to qualify for bank debt financing (and or lease financing), using the Participating Preferred Stock structure and finally a 2nd stage expansion offering to reduce bank debt and eventually “Call” or pay off the Participating Preferred Stock, using the permanent Equity (Common Stock) structure. Your company may not need all these structures in a capitalization plan. If not, simply omit one or more of the deal structures by leaving the capital amounts at a Zero Basis, by entering zeros in those cells. Do not leave them blank or delete those Rows, as it will skew the IRR and Balance Sheet calculations). If your capitalization plan calls for a traditional equity securities and a debt securities offering, simply use the Debt with Equity Kicker deal structure and increase the price of the Equity Kicker to the appropriate amount. If traditional bank debt is to be the used, then use the 70% Debt and 30% Equity deal structure and adjust that 70/30 ratio as necessary.

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We have not included the IPO plan as it is beyond the scope of this program. However, because we feel that someday, someone, somewhere will need to add the IPO structure to their company’s capitalization plan, we are planning to produce an additional Financial Architect® program that will address that plan. The Templates were done in Microsoft Word and Excel 2000. You need to make sure that whichever operating system you are using is compatible with that software. If not, you may need to purchase and install both of these programs before you will be able to operate the Templates. Before you can effectively and professionally conduct your research by approaching any source of capital at any stage in the capital raising effort, you must first produce pro forma financial projections with the corresponding notes to pro forma. These will illustrate gross revenue assumptions, cost of goods sold, general and administrative expenses, estimated net income, cash flows, capital budgets, stock, and company valuation. In this section of the program, we will show you how to value your company and price its securities using a systematic process. Your company’s pro forma financial projections should be realistic and conservative. Do not project pie in the sky estimations. You need to project future reality as best you can. As you will soon realize, you can increase the rate of return to investors through the deal structure, so remain conservative in your company’s revenue growth and expense component assumptions. In addition, to further your success in all of your capital raising efforts, you should underestimate your company’s performance and deliver more. If you can get the money back into the initial investors’ hands ahead of schedule, by under estimating and over producing, you will gain maximum credibility with the angel investor community and should receive many investor referrals for more capital raising efforts. You may think that this exercise is too arduous and detailed for you to produce. We, however, believe it is important for you to do this exercise for a handful of good reasons. Your pro forma financial projections serve as the heart of your overall deal structure and securities offering. You are actually mapping out how much money you are going to make. This process gets your dream closer to reality. Now I am not saying this exercise will be easy. Although we believe that we’ve created the worksheets to be as easy as possible to complete, this exercise may be one of the most difficult projects that you ever complete. However, we believe that most will agree that any learning process that is relatively difficult is generally worth doing for many reasons. If you are going to run a successful enterprise, you had better know how all the pieces of the complicated puzzle fit together. The production of the pro forma financial projections not only reveals how all the pieces fit together, they will greatly increase your probability of successfully raising capital. You could consider having your accountant perform these pro forma financial projections for you; however, you will need to instruct your accountant on how to price and value your company’s securities based on these formulas, because these are the only

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recognized and acceptable forms of company valuation and securities pricing in the private and public securities markets. You should at least complete your company’s pro forma financial projections as best you can, then allow your accountant to “clean them up,” which should save you a lot of money in accounting fees. In addition, by doing this exercise yourself, you will develop a clearer understanding on where your cost savings can occur, plus you will have a better overall understanding of your company’s capitalization and operational plan. I would say most CEO’s of our client firms have read, in detail, their pro forma financial projections, which we produced for them. Nevertheless, the problem is the CEOs did not produce them. Reading them is one thing, producing them is another. CEO’s who produce their own pro forma financial projections and write their own securities offering documents can rarely be tripped up from the unsuspecting question from an investor prospect. The production of your company’s pro forma financial projections and creation of the deal structures represents approximately 30% of the actual work involved in the entire capital raising process. The production of the text body of the securities offering document constitutes about 10% (assuming of course you have a written business plan), the solicitation and sales of securities constitutes about 50%, and the compliance followup requirements constitute about 10% of the actual work involved. If your prospective investors know that you produced the deal structure and wrote your company’s securities offering document, it should greatly increase their confidence in you and your ability to build a company that will produce a solid return on their investment. Preparing your Workplace Exercise 1. Before you can effective produce your company’s capitalization plan, we need to walk you through a fictitious company’s capitalization plan so you get a feel of how the process works. By doing this exercise, you don’t need to be concerned about revenue, cost of goods sold, or expense items, as you would when constructing your company’s capitalization plan. We will, however, point out how you would make changes to the calculations in various sections and categories, so that when you’re ready to develop your company’s capitalization plan you’ll be prepared. 1.

Open the “Financial Architect 4.0 Folder,” then open the folder entitled “Corporation Templates,” then open the folder entitled “Master – Corps,” Then Open the Excel file entitled “Master Pro Formas - Corps or (LLCs) - Exercise.” From here forward for ease of illustration, and not because we are lazy, we will assume that the organizational form of your company is a corporation. (Substitute LLC for Corps. if your company is a Limited Liability Company or a Partnership by opening the folder entitled “LLC & Partnership Templates,” then the folder entitled “Master Pro Formas for LLCs - Exercise.”)

2.

Once you have opened the Excel file, you will need to open the Word file entitled “Master Notes to Pro Formas - or (LLCs).” Now you should be running MS

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Word and MS Excel programs simultaneously. The Excel workbook should open to the Income Statement & Co. Valuation section, which is the far left tab at the bottom of the workbook. This is the main, or primary worksheet, as the numbers flow from this worksheet to the other linked worksheets, also known as “The Other Pro Forma Statements.”

For the following exercises, we recommend that you only use the workbook entitled “Master Pro Formas – Corps (or LLCs) - Exercise.” 3.

It is not necessary for the exercise that you’re about to go through, but when you begin to formulate your company’s capitalization plan, every time you make a change on the main worksheet entitled “Income Statement & Co. Valuation,” you should also make the related adjustments and changes to the “(Your Company’s) Notes to Pro Formas” in the Word document. Make sure that you make the changes to every single line in “(Your Company’s) Notes to Pro Formas” before you make any other changes to any other rows or columns on the Excel worksheets. This will enable you to proceed methodically, thereby reducing the possibility of making mistakes, in your illustrations.

Running the Numbers 4.

5. 6.

7.

Look at the panels at the bottom of the workbook. Start with the far left tab at the bottom of the worksheet entitled: “Income Statement & Co. Valuation.” Fill in the appropriate numbers in this section of the worksheet by following the instructions below. The numbers will flow to the other Pro Forma Statements identified by the tabs located at the bottom of the worksheet. The “Total” row of each section on the “Income Statement & Co. Valuation” are linked to those other worksheets so feel free to add or delete rows, also known as “categories” within those sections, which will automatically tie the “Total” rows into the links to the other worksheets. Make sure you do not change the order of the “Total” rows for each Section. The Revenue area is considered a “Section,” The Cost of Goods Sold is considered a section, and so on. The title of and each individual row within each section is considered a “Category.” As you will soon notice, we used an Excel workbook for a corporation that has 100,000 shares authorized to be issued. We used this figure because it is relatively easy to calculate rates of return, as well as, dilution. 100,000 shares represent 100% of the company on a fully diluted basis. Look to the Master Notes to Pro Formas and to the formula row under the top tool bar for explanation of how these pro forma financial projections were calculated.

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Formula Row

Most categories start off with a simple base figure and then formulas are used to increase or decrease those base figures. You need to look at either the notes or formulas to see the calculate. For instance, the payroll related taxes and benefits are driven by the payroll for the respective sections. You can change the deduction percentage by simply following the instructions below. You do not need to change the formula in the first row. To make changes to formulas on this Main Worksheet, entitled “Income Statement and Co. Valuation” we suggest, unless of course you’re really good a excel worksheet manipulation, that you simply change the rate of increase or other percentage assumptions, as defined in the Master Notes to Pro Formas to formulate your financial projections. For instance, the above formula indicates that it is adding $70,000 to an already established budget amount from the previous year and all previous years budgets are increasing at a rate of 3% (*1.03,0). If you wish to add or reduce the stated dollar amounts to this year’s budget simply increase or decrease the number 70,000. If you wish to increase or decrease the rates of increase for all previous years’ budgets, simply change the .03 in the (*1.03,0) formula to *1.10,0 for a 10% increase or *.95,0 for a 5% decrease. 1 is a neutral denominator. 1.2 represents a 20% increase as .90 represents a 10% decrease. Get it? WAIT! Don’t mess with these Sections or Categories during this exercise, as it will throw off the numbers in this example making the following illustration confusing. (WHEN YOU SEE THE TERM “MAKE THAT (THESE) CHANGE(S) NOW!” IN BOLD BLACK TEXT, THEN MAKE THE CHANGES.) Only make the changes, during this exercise, as we direct you. Make any changes using these instructions as necessarily when building your company’s capitalization plan. When in doubt, look to the Master Notes to Pro Formas and to the formula row under the top tool bar for an explanation of how these projections were calculated. We have illustrated sales based on the number of Units sold each year. This allows you to change the price of your company’s Units or the number of Units sold each year to easily run “What if” sales scenarios. When in doubt, look to the Master Notes to Pro Formas.

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When making changes to formulas in these rows for your company’s capitalization plan, be sure to look at every cell, as the formulas may change, as indicated in the Master Notes to Pro Formas. Section One: Revenue Assumptions. We have listed each category of projected revenue streams separately. Simply change the name of each one of those categories to reflect the categories that your company will be producing to generate sales revenue. Section

Category

You’ll see the formula for growth is calculated as follows: =C4*1.3. This indicates that the annual increase in sales for this Sales Category is 30%. If you wish to increase it to 40% for your company’s assumptions, simply the change the number three to 4 (=C4*1.3 to =C4*1.4). The illustration shows a company with one product selling into different markets over time. Your company could start out with any number of product or service lines and/or roll out more product or service lines selling into the same or multiple markets over time. You can keep the worksheet format the same and refer to the situation in the Notes or add rows to illustrate differing products entering differing markets over time. Make sure that you budget R & D expenditures for those new product or service line(s) rollouts in the year(s) before the actual rollout of each product or service line(s) occur. By doing so, you will illustrate comprehensive operational, as well as, financial planning. Be conservative in your estimated revenue and net earnings growth, especially with respect to the gross and net operating margins. You should keep the net operating margins low, (in line with your industry’s historical standards), to reflect a realistic scenario. You can adjust the deal structure and the securities offering to produce the desired estimated internal rate of return for the securities your company will be offering to your prospective investor base. *Good Advice. One consideration about revenue projections, when dealing with start-up companies, is that revenues are not generally produced within the first year or two. Annual revenue growth may increase greatly for the next few years thereafter, and then the growth rate should start to soften. You should show, over your company’s projected period of time, the revenues growing at an accelerated rate in the beginning years and

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then slowing in the later years. This is used to illustrate the business cycle of the average start-up or early stage company. Section Two: Cost of Goods Sold. The Cost of Goods Sold (“COGS”) section includes the direct cost components or categories of actually producing the product or providing the service that generates your company’s revenues. The individual categories included in your COGS section are generally considered direct variable costs and are calculated as a percentage of actual revenue for each revenue category. See the Notes for examples. The COGS section would include such categories as direct labor costs, sublabor costs, materials, packaging, warranty coverage, and freight (both in and out). Other expense categories in this section could include manufacturing expense, maintenance, and utilities associated with the direct production of your company’s goods and services. You will also notice that the payroll related tax and benefits package for the direct labor is also included in the COGS section. This is illustrated here because those costs are directly related to the labor component of your COGS. Look to the Master Notes to Pro Formas and to the formula row under the top tool bar for an explanation of how these projections were calculated.

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Section Three: General and Administrative Expense. These costs are considered fixed costs or expenses, although in a growing business no expense category is really fixed. In general, these are the costs that are relatively fixed and increase incrementally with the growth of the business, as opposed to being calculated as a percentage of the revenues produced. However, some of these categories may be expressed as a percentage of the total gross revenue or separate revenue streams, such as the advertising budget. Look to the Notes and to the formula row under the top tool bar for an explanation of how these projections were calculated.

Section Four: Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) to Net Cash Flow From Operations. Look to the Notes and to the formula row under the top tool bar for an explanation of how these projections were calculated.

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Interest Expense: You can see here that you will need to make an interest rate assumption on any debt that you may be requiring as part of your capitalization plan. For instance the formula: =ROUND((+'Bal. Sheets'!B36+'Bal. Sheets'!B37)*0.1,0) represents a 10% interest on all debt acquired. Only change *0.1,0) area of the formula to increase to 11% *0.11,0) or to decrease to 9% *0.09,0). Get it? Good. FOR NOW USE MUST CHANGE ALL OF THESE FORMULAS TO A ZERO BASIS i.e. from =ROUND((+'Bal. Sheets'!C36+'Bal. Sheets'!C37)*0.1,0) to =ROUND((+'Bal. Sheets'!C36+'Bal. Sheets'!C37)*0,0) IN EACH CELL FOR THIS ROW SO YOU CAN RUN A CAPITALIZATION NEEDS ANALYSIS. MAKE THESE CHANGES NOW!

Royalty Financing Expense: You can see here that you will need to make a royalty financing assumption on any royalty financing contracts you may be issuing as part of your capitalization plan. For instance the formula: =ROUND(C11*0.04,0) represents a 4% of gross sales to be distributed to royalty contract holders. Only change *0.04,0) area of the formula to increase to 10% *0.10,0) or to decrease to 2% *0.02,0). Get it? Good. FOR NOW USE MUST CHANGE ALL OF THESE FORMULAS TO A ZERO BASIS i.e. from =ROUND(C11*0.00,0) IN EACH CELL FOR THIS ROW SO YOU CAN RUN A CAPITALIZATION NEEDS ANALYSIS. MAKE THAT CHANGE NOW! Now these rows should look like this:

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Depreciation and Amortization: Only after you have completed the last section of this main sheet; Capitalized Assets, you need to go to the Depr. Schedule Tab and make sure that your Capitalized Assets are being depreciated and amortized over a proper period of time. You can see that there is another manual calculation required to determine the Number of Years an asset is to be depreciated or amortized. We have illustrated general assets with the correct periods; however, you should give your accountant a call and discuss any unusual asset category your company may have and then adjust the depreciation and amortization schedules accordingly.

Profit Sharing Allowance: You will need to determine the percentage of Net Income you will be dedicating to a company Profit Sharing Plan, under the Profit Sharing Allowance category. Once again simply make the formula of: =ROUND(+D72*0.1,0) to =ROUND(+D72*0.05,0) if you wish to only contribute 5% of the Net Income to the plan or =ROUND(+D72*0.00,0) if you will not establish a Profit Sharing Plan. State Tax: Under the category of State Tax, we generally assume that the corporation is an “S” corporation for privately held corporations, which means there is no direct corporate taxation on the federal level. However, we do assume, the highest of 4% for state tax, (even on “S” Corps, LLCs and Partnerships), which is one of the highest in the Nation. However, you should check with your state or accountant to add in the correct state tax bracket. Net Operating Margins: What you are trying to illustrate here is that you can run the company and maintain healthy net operating margins with your assumptions of revenue growth; cost of goods sold, and fixed costs. Net operating margins of 10% - 15% are healthy. Net operating margins of 20% - 30%, even for high-tech companies, may be too healthy. In any event, the net operating margins must be realistic, healthy, and reasonably obtainable. If you will be approaching a bank for debt financing and you are showing 20% - 30% net operating margins, they may be skeptical of your ability to produce and sustain such high net operating margins. It is better to be conservative and 62

predict lower net operating margins because the structure of your securities offering to the investors generally is not dependent on the net operating margins unless, of course, common stock equity is your primary vehicle for capitalization. As you will soon see, these Net Operating Margins make the Internal Rates of Returns on the various securities to be offered very high, possibly too high. We did this purposely, so you could see that what we say is true. The deal structures can stand alone in regards to their rates of return, so be conservative and get those Net Operating Margins down lower than this.

The Net Operating Margins will decrease once the Interest Expense and or Royalty Financing Expense is added “If ” those deal structures will be used for a securities offering. Just keep your eye on that important variable. Cash Distributions to Common Shareholders: Under this category, we have illustrated dividends being paid out on the common and stock. If your company remains privately held it is generally wise to provide dividends to all of your investors so they can recoup some of their investment and/or realize an actual return. If you plan on taking your company public, then the dividend is not necessary, as the free trading of the stock will allow your investors to sell some of their stock holdings to realize a return on their investment. If your investor prospects see the probability of having a decent dividend check coming in, they are more likely to invest. You are not going to be tied to issuing any dividends, there are plenty of disclaimers within the securities offering document Templates that allow you to do anything you want concerning dividend distributions, but you may want to illustrate your plan in this fashion because it furthers an exit strategy for the investor. Because it is wise to provide a minimum cash distribution to your company’s shareholders, to at least cover tax obligations created by the company’s profits, this is the one area you will need to determine a distribution percentage and plug that percentage into this schedule. You have determined, at least for now and to serve as a base reference amount, that the cash distributions shall be 50% =ROUND(0.5*C77,0) in all the cells in that row. This schedule should now appear as follows:

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You will also need to make sure that the per share amounts coincide with the actual amount of the shares outstanding in the respective years, ONCE YOU HAVE DECIDED ON YOUR DEAL STRUCTURES, WHICH WILL DETERMINE HOW MANY SHARES YOU WILL HAVE OUTSTANDING. In this example, the formula represents 100,000 shares outstanding. (See Formula Bar =D83/100000). If you need to change the amount simply do so by changing the 100000 figure in the formula. DO NOT CHANGE THIS FORMULA TO A ZERO BASIS. Cash Distributions to Preferred Shareholders: Under these categories, we have illustrated dividends being paid out on the common and preferred stock.

As you can see, you can change the dividend amounts by simply changing the percentage figure within each formula. For instance, the Cash Distr. to Common Shareholders formula of =ROUND(0.5*C77,0) represents 50% of net Income to be distributed to shareholders. If you want to increase that amount to 60% then change the formula to =ROUND(0.6*C77,0). You should at least distribute the maximum individual tax bracket amount of X (currently around 40%, with federal and state tax combined, check with your accountant on this figure, as it will always be a moving target). FOR NOW USE MUST CHANGE ALL OF THESE PREFERRED SHARE DISTRIBUTIONS FORMULAS TO A ZERO BASIS i.e. =ROUND(0.0*$B97,0) & =ROUND(0.0*D77,0) IN EACH CELL FOR THIS ROW SO YOU CAN RUN A CAPITALIZATION NEEDS ANALYSIS. MAKE THAT CHANGE NOW! After which the schedule should appear as below:

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Section Five: Capitalized Assets. WHEN RUNNING YOUR COMPANY’S PROJECTIONS, YOU’LL YOU NEED TO SKIP AND COMPLETE THIS CAPITALIZED ASSETS SECTION BEFORE PLUGGING CAPITALIZATION AMOUNT INTO THE “CAPITALIZATION SECTION.” This section lists the company’s assets that cannot be immediately written off in the year that they were acquired. These assets must be depreciated or amortized over a certain period-of-time. You will notice that these assets are further listed on the worksheet entitled “Depr. Schedule,” which is the tab at the bottom of the workbook. We included quite a few assets, so you might not need to add to the amount of categories in this section. Simply list each category and make sure that the depreciation and amortization schedule contain each category listed. The Total row on the “Depr. Schedule” worksheet will flow back to the Depreciation and Amortization row on the Income Stmnt. & Co. Valuation sheet worksheet.

Section Six: Capitalization. When running your company’s projections and for this exercise you should convert all of the Amounts in this Capitalization Section to a ZERO BASIS, until you finish running the Capitalized Assets section. MAKE THAT CHANGE NOW! BY SIMPLY ENTERING ZERO IN THESE CELLS. Once you have completed your Capitalized Assets section, which will adjust your Depreciation and Amortization Schedule you need to look at your Consolidated Statement of Cash Flows (See Tab at bottom of worksheet), to see how much capital you need at the end of the first year. Make sure the depreciation and amortization schedules are correct by adding those years of depreciation and amortization.

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You should have negative balances in one or more columns, which seems representative of your capitalization deficit, which will determine the minimum amount of capital required to build your company. Although the total accumulated deficit is close to $7,000,000 that is not how much capital you need. Test the amounts needed by inserting a figure in the Common Stock Share Sales category on the Income Stmnt. & Co. Valuation sheet ONLY. Do not insert the figure into the Consolidated Statement of Cash Flows or you will damage the calculation structure. By completing this exercise you can get an indication of your company’s capitalization needs plus a “pure vanilla” valuation. Go to the Capitalization area on the Income Stmnt. & Co. Valuation sheet now and plug in $5,000,000 in the Common Stock Share Sales category now.

Then go back to the Consolidated Statement of Cash Flows to see what happened.

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Due to the positive year-end cash balances, the $5,000,000 seems to provide ample capital based on the other operating assumptions. Oh no, here we go gain with that word “seems.” It only seems to represent your capitalization deficit. In reality, you may need to provide a series of differing deal structures and securities offerings to succeed in actually raising capital. (We will do that soon enough). In addition, the $5,000,000 assumes that you issued all available shares to raise that capital. If little or no founders’ capital was provided to raise that amount and out of 100,000 shares, for example, you sold 50,000 at a per share price of $100.00 (50,000 shares held by founders) you just determined your company’s post-money valuation. However, just because you think it has a post money valuation of $5,000,000 doesn’t mean an investor will. (We will discuss this later). As a side note, if your company does have $2,000,000 in founders’ capital and or retained earnings and or beginning equity on the balance sheet (retained earnings), then the company’s post money valuation would be $7,000,000. ($2,000,000 founders’ shares (pre-money valuation)+ $5,000,000 in new capital from the sale of shares). In any event, the $5,000,000 is a good starting point. Actually, you could raise $4,000,000 and still have ample cash at the LOWEST ENDING CASH BALANCE FIGURE, in year 2. Can you tell what the ending cash balance would be in year 2, with $4,000,000 in equity capital? One could just deduct the $1,000,000 difference from year 2’s ending cash balance, in one’s head. But you should get into the habit of running the numbers by going back to the Income Stmnt. & Co. Valuation sheet and enter $4,000,000 into the Common Stock Share Sales category for year 1.

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You can see that with the $4,000,000 figure, the year-end cash balance for the lowest year, in year 2, is the previous figure, less the $1,000,000 difference, of $723,910. That figure would be considered a relatively healthy year-end cash balance, as you do not want to run out of capital at the end of the year because you will need sufficient working capital after year-end. Increase that number to provide for sufficient working capital. Sometimes, after you have determined your capital needs and have plugged that figure under your Capitalization section, you may have a deficit in years two or three. If so, you’ll either need to increase the amount of capital to be raised in your first round of financing, or plan on a series of capital raising rounds in the years that you are running into negative Net Ending Cash Balances on your Consolidated Statement of Cash Flows. You could also decrease capitalized asset expenditures in the Capitalized Assets Section to increase the Net Ending Cash Balances for those years. Section Seven: Stock Valuation. First, be sure to check the PE (Price Earnings) Ratio average for your industry for publicly traded stock. In regards to the publicly traded scenario, if your industry average has a PE Ratio of 15, then use that ratio for arriving at the stock valuations for your company. In general, the PE Ratio of a publicly traded stock is based on its estimated future average earnings growth rate over the next five years. If the average estimated earnings growth rate is expected to be 15% per year, then the PE Ratio would be 15. Every industry has slight variations on this theme, but this assumption is used as a fundamental valuation tool when analyzing stocks within the same industry. If the banking industry’s average PE Ratio or multiple is 7 and you find a stock within that industry trading at a PE Ratio of 10 it may be overvalued, depending on other factors such as relative debt load, special niche services, take-over rumors and so on. (See “Links” in the Commonwealth Capital Club for stock quote and securities industry research for PE Ratio information). Once that PE Ratio for the publicly traded scenario has been determined, then the stock valuation of the privately held scenario can be estimated by reducing the PE Ratio. Generally, to arrive at a PE Ratio for a privately held stock, one would reduce the PE Ratio for a publicly held scenario by 80% or to a PE Ratio of 5 (20% of 15= a PE Ratio of 3). Look to the Notes and to the formula row under the top tool bar for explanation of

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how these projections were calculated. Yes, the sheer liquidity of a stock (publicly traded) can increase the PE Ratio by a factor of 4 to 5 times its privately held value.

To change the PE Ratio, simply change the formula in that row. To increase the share price you need to increase the PE Ratio. To double the stock price per share, you need to double the PE Ratio by changing the formula of =C119*3, to =C119*6. Please remember, you are attempting to valuate the common equity security, not necessarily the whole company, because you should be selling the securities, even if you decide to sell the whole company someday. Some CPAs may take the position that a buyer of the whole company will not want to buy the stock of the company, they will want to buy the assets of the company so they can depreciate those assets. In many ways, they are correct for small transactions. Nevertheless, on Wall Street, mergers, acquisitions, tender offers and hostile takeovers are all based on the price and purchase of the controlling interest of the company’s class A voting common stock, which is generally priced to net out any perceived depreciation value of a total asset sale. Although the bids for that stock may be based on the underlying fundamentals of the assets and income streams of the company, the ownership of stock is the key to the door and that is why it comes into play. That is how Wall Street works, so if you want to play their game it may be wise to format your thoughts in this light. Section Eight: Company Valuation. Simply stated the Company Valuation is the valuation of each share multiplied by the total outstanding common stock shares. One does not account for the debt or preferred stock portion of the capitalization of a company with this type of analysis. You do not add up the total amount of equity and subtract the debt or preferred stock. The debt or preferred stock is already calculated into the common stock price, because debt or preferred stock is the capital component that is increasing the company’s degree of operating leverage, which ultimately determines the earnings growth rate and therefore the PE Ratio of the company’s common stock. Look to the Master Notes to Pro Formas and to the formula row under the top tool bar for explanation of how these projections were calculated.

The formula of =100000*C121 is based on 100,000 shares outstanding after the sale of common stock. Be sure to change that number and that number in the Est. Net Earnings Per Share formula if the amount of shares will be different for your company.

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Section Nine: Estimated Realized Internal Rate of Return. The standard internal rate of return calculations were used to arrive at the IRR figures for each scenario. Go to the IRR worksheet at the far right hand Tab. Because you have yet to run the different scenarios using the different deal structures, the IRR worksheet may look like this:

Because the Master Pro Forma Templates are drawn out to illustrate a five-year capitalization using a series of different deal structures, you will need to go to this worksheet and change the formula -'Income Stmnt. & Co. Valuation'!$C$95+('Income Stmnt. & Co. Valuation'!$C$84*40000) under IRR for Common Stock Share Sales FIRST. You need to put in the total amount of shares that your company currently has available, “Authorized by your Articles of Incorporation,” to be issued and outstanding to arrive at a fully diluted IRR. By doing so, you can discover what your company’s pure vanilla valuation is. Now this will change, if and when you decide to sell a certain amount of stock, because when you sell a certain amount of stock the IRR shall be calculated on those shares only to illustrate to an investor, the upside potential of stock ownership in your company. The above example illustrates selling 40,000 out of 100,000 authorized, so we’ll change the formula -'Income Stmnt. & Co. Valuation'!$C$95+('Income Stmnt. & Co. Valuation'!$C$84*40000) to formula -'Income Stmnt. & Co. Valuation'!$C$95+('Income Stmnt. & Co. Valuation'!$C$84*100000), IN ALL THE CELLS IN THIS ROW, because our examples illustrate 100,000 shares authorized. (*Note: you can see from above that the 40,000 share would have a low IRR relative to the risk involved with this type of security and the limited operating history of the company, (6.82%), because it assumes that the other 60,000 had no cost to the founders, which represents a IRR on a fully diluted basis).

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The above calculation illustrates that if you wanted to provide an IRR of 42.67% to your investors then you would have to sell 100% of the authorized shares. That’s a good IRR percentage, but there is one fundamental problem, you just sold 100% of the company, you and your management team have no equity in the deal and probably not a job, because who would keep on a management team that put this deal together? So let’s split the difference between 40,000 shares to be issued which produced that low IRR and the 100,000 shares (1/2*60,000) to be issued to raise the $4,000,000 in equity capital and plug in an additional 30,000 on top of the original 40,000 shares for a total of 70,000 shares. CHANGE IS MADE IN ALL THE CELLS IN THIS ROW.

The above illustrates that if you wanted to provide an IRR of 27.20% to your investors then you would have to sell 70% of the authorized shares or 70,000 shares. Now there are three fundamental problems: 1.) The 27.20% is not a bad IRR percentage, but I wouldn’t take on this much risk, (assuming your company is in its early stages), without at least a potential IRR of 35%, so I am saying it may not be enough to attract capital; 2.) You just sold 70% of the company, more than 51% required to control it, so you and your management team just lost voting control of the company and; 3.) The investors just had their investment diluted by 30%. 100,000 shares divided by 30,000 of founders’ shares. 100,000 shares would be outstanding after the 70,000 shares sold. (This dilution calculation assumes that the company has little liquid value, i.e. cash or marketable inventory. Let’s say the company did have $1,000,000 in cash in the bank, which would soften the dilution factor. You would calculate dilution as follows: $1,000,000 Founders’/Company’s Cash + $4,000,000 in new Investor equity capital=$5,000,000. The new investor own 70% of the total liquid value of the company’s assets or $3,500,000 (70% x $5,000,000). So the dilution factor would be a lot less, 14.28% ($4,000,000 - $3,500,000=$500,000 divided by $3,500,000). So now what are you going to do. The deal structure is not attractive to investors because of the dilution of share value and you just lost control of the company. That’s why it’s time to use a series of “Hybrid” deal structures and securities offerings to get the job done and maintain control of the company.

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We are about to walk you through a complete 5-year capitalization plan, that attracts investors, allows you to deal from a relative position of strength at every stage of the process, raise seed capital, raise development capital, raise 1st and 2nd stage expansion capital, using a series of securities offerings and bank debt. Then finally retiring securities through a systematic process. You can customize these fundamental processes to fit you company’s capitalization needs. Adjust capital amounts and deal structures as you formulate your company’s capitalization plan, based to fit the company’s revenue, expense, tax and capital budget needs. Calculating the Internal Rates of Return Before you can run multiple scenarios you need to adjust some parameters within the IRR worksheet. Open the original Master Pro Formas and go to the IRR worksheet located at the far right on the lower Tabs. You should have been working on your company’s pro formas workbook, not the Master copy. Leave your company’s workbook open as you will need to create you own IRR parameters.

Please realize the following figures a representative of the multiple deal structures that are the conclusion of this exercises, so don’t be confused about how we arrived at these figures, you will soon realize how. Under the Debt with Equity Kicker scenario, you will need to look at how we calculated the Estimated Internal Rate of Return by reviewing the formula row. The first cell in the Debt with Equity Kicker includes the cash outflow of -$500,000, expressed as a negative, as its cash outflow for the investor, + the Interest received by the Note-holders of $37,500, expressed as a positive because its cash inflow to the investor.

This is critical because it assumes that this deal structure was only issues in this year. If you will be issuing securities, based on this deal structure, in subsequent years then you need to re-create this formula as we have created it here. This is the only deal structure that needs to be adjusted. All other deals structure formulas are in each of the Cells and should flow no matter what year you want to illustrate issuing those securities.

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By the end of year two, the Notes are paid off so the calculation string includes the debt reduction =-('Income Stmnt. & Co. Valuation'!$C$99, plus the Interest Expense +'Income Stmnt. & Co. Valuation'!$B$67), plus the Cash Distributions on the Equity Kicker portion of the Units +(('Income Stmnt. & Co. Valuation'!$C$84)*10000)

Notice that the 10000 figure in the calculation +(('Income Stmnt. & Co. Valuation'!$C$84)*10000) represents 10,000 shares of common stock. That’s the Equity Kicker. If you will be issuing more or less shares as the Equity Kicker then you need to change this figure. Simply change the 10,000 number to the correct amount and the calculation will flow. Be sure to look at every cell, as the formulas may change. Notice the following calculations in the later years in this deal structure formula are fairly straightforward. Since there is no debt because it was paid off on year 2, the calculations include only the cash distribution per share multiplied by the amount of the Equity Kicker, or 10,000 shares of the common stock.

Under the Royalty Financing Contract area you will need to look at how we calculated the Estimated Internal Rate of Return by reviewing the formula row. You’ll see that we allowed for additional contracts to be issued over the years in the formulas. Be sure to look at every cell, as the formulas may change. The first year’s calculation includes the $1,000,000 in Royalty Financing Contract amount of financing, expressed as a negative, as its cash outflow for the investor, plus the Royalty Financing Expense, expressed as a positive because its cash inflow to the investor.

All subsequent years are calculated the same to easily enable you to run additional “what if” scenarios using this deal structure.

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Under the Participating Preferred Shares area you will need to look at how we calculated the Estimated Internal Rate of Return by reviewing the formula row. You’ll see that we allowed for additional shares to be issued over the years in the formulas. Be sure to look at every cell, as the formulas may change. The first year’s calculation includes the $2,000,000 in Participating Preferred stock amount of financing, (spread over 2 years), expressed as a negative, as its cash outflow for the investor, plus the Stated Dividend & the Participation amounts, expressed as a positive because its cash inflow to the investor.

All subsequent years are calculated the same to easily enable you to run additional “what if” scenarios using this deal structure. Under the Common Stock Shares area you will need to look at how we calculated the Estimated Internal Rate of Return by reviewing the formula row. You’ll see that we allowed for additional shares to be issued over the years in the formulas. Be sure to look at every cell, as the formulas may change. The first year’s calculation includes the $500.00 from the Debt with Equity Kicker Deal Structure in year one and the $1,000,000 in Common stock amount of financing, in year 2, expressed as a negative, as its cash outflow for the investor, plus the Cash Distribution amounts, expressed as a positive because its cash inflow to the investor, multiplied by the amount of shares, 40,000, that you will be selling to raise the $1,000,000.

All subsequent years are calculated the same to easily enable you to run additional “what if” scenarios using this deal structure. *NOTE: The estimated share and company value at the end of year 5 was not taken into account as we are calculating an Estimated Internal “Realized” Rate of Return for the common stock. The Estimated Internal Rate of Return would normally include realized and un-realized gains and losses, however, when dealing with illiquid securities, it is generally wise to not include unrealized profits from the sale of stock or the company’s assets. If the company was sold at the end of year 5 or the securities became liquid, then the net selling price would be added to the IRR calculation string in year 5. There are an unlimited number of ways to structure a capitalization plan. You can mix and match any number of deal structures contained within the Master Pro Forma 74

Templates. Although you can very creative in your capitalization planning, we would strongly advise that you keep it simple. Now that you understand how we calculated the IRR on the different deal structures and what changes you’ll need to make to accommodate your company’s capitalization plan, you should now open the original Master Pro Formas and Master Pro Forma Notes and go to the Capitalization Section on the Income Stmnt. & Co. Valuation worksheet. Although we reference the various documents as the “Master” documents throughout this portion of the program, you should consider the term “Master” as “Your Company’s Master” documents because, as soon as you open the Master documents, you should save the Master documents to Your Company’s Name and save it to a separate folder.

Here you can see that we started off with a Debt with Equity Kicker deal structure to raise $500,000 in Seed Capital, to afford the necessary requirements to raise an additional $5,000,000 in development, 1st and 2nd stage expansion capital. We illustrated selling 100 Units, which are comprised of 100 first mortgage notes priced at $5,000.00 per Note for $500,000 in debt capital with 10,000 shares of stock at $0.05 per share for $500 in equity capital, which will represent 10% of the company on a fully diluted basis after all share are sold. In the Master Notes to Pro Formas we explain the basic securities offering plan for all offerings, so please refer to that document as well. After the Seed Capital is raised we illustrate raising $1,000,000 Development Capital with the use of Royalty Financing Contracts, within the same year.

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After the Development Capital is raised we illustrate raising $2,000,000 1st Stage Expansion Capital with the use of Participating Preferred Stock, ½ within the same year and ½ the next year. The Participating Preferred stock is “Called” or bought back at the end of year 4.

After the 1st Stage Expansion Capital is raised we illustrate raising $1,000,000 in Equity and $1,000,000 in bank debt for 2nd Stage Expansion Capital, within the same year. You may notice that the original $500,000 in Notes with the Equity Kickers (seed capital investors) get paid off with the bank debt and the bank debt is paid off over the following two years. Now that is a well though out capitalization plan. The seed capital investors, who take on the most risk, get paid off the soonest, by paying off the Notes with the Equity Kickers and still enjoy the potential upside of stock ownership. The royalty financing contract holders enjoy substantial cash flow from 4% of the gross sales and a very attractive IRR. The Participating Preferred stockholders get paid off next but enjoy some decent returns, while they are in the investment. The common stockholders are taking on quite a bit of risk, by having some dilution and getting in early in the company’s history, but they do have a large upside potential. In the above example, one can easily see that the capitalization plan using the various deal structures is well thought out and the potential Internal Rates of Return on the securities to be offered seem commensurate with the risk an investor takes on. What’s wrong with this picture? The Debt with Equity Kicker deal structure gets the investors their money back quickly, through a 2-year maturity of the Notes, while providing an exceptional internal rate of return through stock ownership, (The Equity Kicker). The Royalty Financing deal structure gets the investors their money back quickly, through cash distributions based on gross sales, which provides an exceptional internal rate of return through immediate cash flow. The Participating Preferred Stock deal structure gets the investors their money back, cash distributions based on stated dividends and provides an exceptional internal rate of return by participating in the Net Profits of the company. The Common Stock deal structure gets the investors their money back, through cash distributions based on 50% of the Net Profits of the company, while providing an exceptional internal rate of return through stock ownership. The company is in its infancy, but the deal structures are designed to mitigate relative risk. So what’s wrong? Are these potential Internal Rates of Return too good to be true? Probably.

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To correct a scenario that is “Too Good To Be True,” the goal is to lower all the potential Internal Rates of Return by lowering those Net Operating Margins. (However, I would try to preserve the IRR of the Participating Preferred Stock. Once you make the changes as suggested below, you may want to increase the participation percentage rate on the Preferred Stock.) If you recall, the Net Operating Margins were too large in the above example. So one would start to lower those Net Operating Margins by: 1. First lowering the annual revenue growth percentage assumptions. 2. By increasing COGS percentage assumptions. 3. By increasing G&A Expense percentage assumptions, (i.e. Marketing Expenses.) You will need to decide what’s too good to be true, however as a “rule of thumb” the securities issued in the early stages should provide for the most IRR potential relative to the others. Seed Capital: 60 to70%, Development Capital: 50-60%, 1st Stage Expansion Capital: 40-50%, and 2nd Stage Expansion Capital:30-40%. What happens with the opposite scenario? What if one or more of the deal structures Internal Rates of Return are not adequate? Then you will need to make some opposite adjustments from the ones previously mentioned. The following examples are meant to explain the fundamentals of making structural changes within the pro forma financial projections, only and are not related to any of the deal structure exercises. Let’s examine the IRR figures for same capitalization plan with different revenue and expense assumptions and see if we can’t identify a potential problem with this plan. What’s wrong with this picture?

The Participating Preferred stockholders are not getting a high enough IRR for the amount of risk that they are taking on and compared with the IRR of the other securities. Due to the Notes and subsequent bank debt, they do not enjoy a first lien position on liquidation rights. The 21.75% IRR, although somewhat attractive as a stand alone, it is not attractive in light of the other securities being issued and therefore may not sell. If Seed Capital investors feel that the Participating Preferred stock may not sell, which indicated that they may not get paid off on schedule, may be reluctant to invest in the seed capital offering, which is needed to raise additional capital. So in theory, each offering may be interdependent upon previous, as well as, subsequent planned offerings. This is an interdependent capitalization plan.

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Let’s see if we can’t improve the IRR for the Participating Preferred stockholders. We will adjust the participation rate up from 10% to 15% by changing the formula =ROUND(0.1*D77,0) to =ROUND(0.15*D77,0) in all cells in this row.

Now the Participation is 15% of Net Income as opposed to 10% and the numbers improve for the Participating Preferred stockholders’ IRR and does not affect the royalty financing contract holders or the common stock shareholders’ IRR, because it only affects cash flow unless the participation limits the ability for common stockholders to get their dividends, which we should protect.

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Now we need to look at how that 5% increase in participation for those preferred stockholders’ affects cash flow:

We can see that we need to make some adjustments somewhere to beef up year 4’s negative ending cash balance. We don’t want to drag out the call date of the participating preferred stock, because of a handful of issues, but primarily because we want to retire it as soon as possible because it is a more expensive form of financing compared to bank debt. So let’s put off the final $500,000 in bank debt retirement off for one year. Go back to the Income Stmnt. & Co. Valuation sheet and move the debt reduction of $500,000 in year 4 to year 5.

Remember to check the Interest Expense section to make sure its picking up an additional year of debt. The calculation should automatically flow through.

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All right, now we have increased the Participating Preferred shareholders’ IRR, moved a portion, ($500,000), of the debt retirement out an additional year to provide positive ending cash balances. Remember to change all assumptions in the Master Notes to Pro Formas to fit with your company’s capitalization plan as you make them on the worksheets. Congratulations! You have just determined how much capital this fictitious company needs, valuated the company and priced its securities, as well as, produced its 5-year capitalization plan using a differing deal structures to produce a series of securities offerings. Once your company’s deal structures have been decided upon, they will serve as the heart of the company’s securities offering documents. Remember, in the beginning of this exercise, that selling 40,000 shares for $5,000,000 produced a very low IRR for investors due to dilution because of 60,000 shares held by founders. Then we introduced hybrid securities to build the company initial operations first, which allowed us to eventually sell that same 40,000 shares of stock for $1,000,000, with a substantial IRR. Did you notice that the company’s final deal structure example had 100,000 shares authorized to be issued, 10,000 of which was issued for the Debt with Equity Kicker deal structure and 40,000 shares was used for the Common Stock Equity deal structure, so this company’s founders, who had no cash in the deal, maintained a 50,000 shares or 50% ownership or voting control in the company. You may be asking yourself, why didn’t the Management team retain, at least a 51% control? Well, for deal structuring simplicity and illustrative purposes, we wanted to keep the example simple. One could hold back 1,000 shares of the common stock, only worth $25,000 in cash flow or issue the common stock stripped of its voting control, by taking back voting trust certificates, to maintain control of the company. Did you also notice the IRR for the issuance of 40,000 shares of common stock was very high after implementing those hybrid deal structures? Also, did you notice that, because that IRR was so high that you didn’t necessarily need to sell all 40,000 shares at $25.00 to raise $1,000,000? What if you held back 20,000 shares and sold 20,000 at $50.00 per share? Let’s take a look.

See the 20,000 shares? Since we didn’t change the $1,000,000 on the Income Stmnt. & Co. Valuation worksheet, the formula assumes that you will be issue 20,000 shares to raise the $1,000,000, so it automatically assumes you will be pricing those shares at $50.00 per share. The IRR of 42.00% isn’t bad at all. Now you may not need to decrease revenue assumptions or increase expense assumptions to adjust this IRR to a believable IRR. This IRR is very good especially considering that there are unrealized gains due to the fact the securities are not liquid or the company has not been sold. At

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this point, you can put in those unrealized gains, but you need to explain how it was calculated and that the difference is and will be un-realized gain. To calculate the unrealized gain, simply add the formula that contains the Estimate Private Market Value per share from the Formula Bar on Income Stmnt. & Co. Valuation worksheet by copying that cell.

Then paste it anywhere on the IRR worksheet, because we simply want to copy the formula in the formula bar.

Once that formula has been copied then we delete that cell entry so that it’s blank. We then go to the last cell in the IRR for Common Stock Shares Sales row, because that corresponds to the last cell on the Income Stmnt. & Co. Valuation worksheet and paste that formula behind the current formula with the amount of shares to be issued to raise the capital, 20,000. Make sure you add the plus sign and parentheses as shown to calculate the realized and un-realized IRR for the Common Stock.

Now that IRR of 114.72% is better than before, but is it unbelievable? Probably, but at least now you know how to calculate both the realized and un-realized IRR on a common stock. Now, we know you must be anxious to get started on your own company’s capitalization plan, but before you do, you may need to be further educated on how the different deal structures with the related securities (hybrid or otherwise) operate as stand alone structures and how they relate to each other in combinations. So read on and be patient as we’re almost through with this part.

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Company Valuation and Securities Pricing As previously mentioned, calculating the company’s current and future valuation based on a PE Ratio is very important when conducting a securities offering because it is the way Wall Street valuates companies. Although there are many ways to valuate a company, we believe that most would agree that the value of anything is what someone else will actually pay for it. That is why the auction market of publicly traded securities, which represents a liquid market, is the purest and most correct company valuation and securities pricing method available. Many valuation experts may disagree with the PE Ratio valuation model, but until they can convince the publicly traded securities markets (Wall Street) of a better way, it’s all academic. That is why we only use the Wall Street company valuation and securities pricing model, because for all practical purposes, its reality. The valuation of your company, using the Wall Street pricing model, utilizes the PE Ratio as its core-pricing component. That component is determined primarily by the estimated annual earnings growth rate. Once again, although a healthy annual earnings growth rate is important, it is more important that the growth rate be as realistic and conservative as possible. When calculating the revenue growth rate, which would ultimately lead to the net earnings growth rate, one should not be concerned about how a slow conservative growth rate may relate to the estimated internal rate of return of a particular security. We recommend using hybrid securities for start-up and early stage companies, as well as, seasoned companies for a number of reasons. One particular reason we use hybrid securities for most companies is that the estimated internal rate of return of a particular hybrid security will only be partially dependent on the estimated net earnings growth rate. For example, let us say that your company has a total of 100,000 shares authorized for issuance. 20,000 shares are available through a common stock offering and the value of common stock of the company should grow from its initial price of $50.00 per share to $100.00 per share over a 5-year period-of-time. That would constitute an estimated internal rate of return of 14.87%. Not bad, but if you were looking to sell 20% of your company for $1,000,000 through a common stock offering, you may run into the dilution problem, from an investor’s perspective, unless there are substantial liquid assets already owned by the company. The value of the investor’s investment will be diluted by 80%. For example, let us say that there are no other tangible liquid assets in the company, including the entrepreneur’s cash. A sophisticated investor would realize that, by investing, he or she would immediately lose 80% of their $1,000,000 investment due to the outstanding stock’s total dilution factor. Once deposited, the $1,000,000 is now owned 80% by the other shareholders in the company and 20% by the investor by the design of that structure. Yes, the investor just lost $800,000. Obviously, this is not a safe situation for the investor and therefore this “Deal Structure” may deter some investors.

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As an alternative, let us say that you conducted and sold a Note offering, with a 10% coupon that has a 5-year maturity with an Equity Kicker that represented 20% common stock equity in your company. Your investors put up the $1,000,000 and in five years, they receive $500,000 in total interest, their original $1,000,000 in principal, plus the value of their equity kicker of $2,000,000. That deal structure would return an estimated internal rate of return of 28.47%, almost double the original common stock offering rate of return. This type of deal structure would put the investors in a first or at least forward lien position ahead of common stock holders, thereby eliminating the original problem of too much dilution. The moral of the story is: Be conservative in your estimated revenue and net earnings growth rates, especially in regards to the gross and net operating margins. You should keep the net operating margins low to reflect a realistic scenario. As you may have just realized, you can create and use hybrid securities to formulate the deal structure and the securities offering to produce the desired estimated internal rate of return on the actual securities for your investor base. The Fundamentals of Pricing Securities Although the dynamics of the various publicly traded securities markets are far more complicated than the examples given in this program, we are pricing privately held securities, and these pricing models are acceptable from the private and public market’s standpoint. In the venture capital industry, annual sales volume is an indication of the company’s value. For example, if your company is grossing $5,000,000 in annual revenue, it is assumed that the company is worth $5,000,000. However, that pricing model is a little too simplistic for the purposes of pricing a securities offering. This section is specifically intended to divert from the examples of the pro forma financial projection Templates. It is conceptual in nature and is dedicated to helping you further develop a clear understanding of the nature of company capitalization and how the issuance of different types of securities relate to that effort. As you may recall, the first exercise of company valuation and the pricing of common stock included selling 40% of the company (40,000 shares from the 100,000 total authorized shares). Actually, conducting an offering of that nature may not be wise, unless your capitalization effort is project specific. In other words, you may be developing a real estate or oil & gas project, which may only need a one-time capitalization effort. However, if you are building an operating company, you should consider giving up as little common stock equity in the first couple of rounds, as you’ll need that equity for further rounds and possibly for an IPO. Simply keep that in mind as you develop you capitalization efforts. Remember, it is not only all right to illustrate additional rounds of capitalization throughout the remaining years in your pro forma financial projections, it is highly recommended.

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Let us now review some different types of securities that can be used for capitalizing start-up, early stage, or seasoned companies. The Common Stock: Common Stock is the only security that is priced based primarily on its future potential value. For instance, let us say that you are using a PE Ratio or what is also called a “Multiple” in a private market of 5. Let us say that your company is estimated to be earning $20.00 per share at the end of the fifth year. With a multiple of 5, the common stock would be priced at $100.00 per share at the end of fifth year. You would then price the common stock, currently, to reflect a reasonable return for the risk involved in owning that security over that period. If you priced the common stock at $10.00 per share now and it is conservatively and reasonably estimated to be worth $100.00 per share at the end of the fifth year, you could illustrate a 58.49% internal rate of return for an investment in the common stock. If you established the current price of the stock at $20.00 per share, as opposed to the $10.00, the internal rate of return would be reflected to be 37.97%. If that price and that rate of return were acceptable to your private capital market, then that would constitute the current value of the stock. If you established the current price of the stock at $30.00 per share, as opposed to the $10.00, the internal rate of return would be reflected to be 27.23%. If that price and that rate of return were acceptable to your private capital market, then that would constitute the current value of the stock. If you established the current price of the stock at $40.00 per share, as opposed to the $10.00, the internal rate of return would be reflected to be 20.11%. If that price and that rate of return were acceptable to your private capital market, then that would constitute the current value of the stock. If you established the current price of the stock at $50.00 per share, as opposed to the $10.00, the internal rate of return would be reflected to be 14.87%. If that price and that rate of return were acceptable to your private capital market, then that would constitute the current value of the stock. Are you beginning to understand the fundamentals of pricing the common stock? Its current value is based on its potential future value. After you have conservatively estimated the future value of your common stock shares at the end of a period, you simply adjust the current price to reflect an acceptable rate of return to your private capital contacts. This is the basis of a common stock offering prototype. Remember, the value of anything is based on what someone else is willing to pay for it. How would you know what someone else would be willing to pay for it? You test the waters for an indication of interest. You could test the price of the common stock at any one of the estimated internal rate of return scenarios as described above. Certainly,

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in this example, an investor would rather pay $10.00 per share than $50.00 per share. So, you should consider an offering of common stock at maybe $30.00 per share, along with two other deal structures, that would provide a similar or greater estimated internal rate of return along with no dilution, a maturity date, a forward lien position on assets, plus current cash flow as with a Note with equity Kicker structure. The Preferred Stock: The Preferred Stock is priced somewhat like a Bond or Note. It has a par or face value upon its issuance, which matters very little when the rate of return is analyzed. There is not much difference between a par value of $10.00, $100.00, or $1000.00 when it comes down to pricing this type of security. What matters most is the stated dividend and in the case of a participating preferred stock, the stated dividend plus the percentage of net earnings that the preferred stock will participate in. Let us just stick with a regular preferred stock for now. You simply price the stated dividend as an annual yield or rate of return component. If you decide that 14% is the annual yield or rate of return that is acceptable to your private capital market, then that would establish the stated dividend of the preferred stock. A stated annual dividend of $1.40 on a preferred stock with a $10.00 par value and issuance price, represents a 14% annual yield or rate of return, as is a stated annual dividend of $14.00 on a preferred stock with a $100.00 par and issuance price. The 14% annual yield is the same. Most preferred stock is priced at $1,000 per share or par value. In this case, you would need to establish a stated dividend of $140.00 per share to arrive at the 14% annual yield. That is why the par value has very little meaning because you price the stated dividend not necessarily the par or face value of the preferred stock shares. It is very much the same way when pricing a Bond or Note. The difference between the preferred stock and the Bond or Note is generally the function of the safety of owning a debt instrument with a Security Agreement (See the Template) and predefined maturity date as opposed to owning a security that represents a permanent form of equity capital, which could be a preferred stock. In any event, with both types of securities you price the annual return, or in the case of a preferred stock, the stated dividend, and in the case of a debt instrument, such as a Note or Bond, the coupon or annual interest rate. Incidentally, the difference between a Bond and a Note is the length of its maturity date from the date of its issuance. Corporate Notes are generally issued with maturity dates ranging from 90 days to 5 years and Corporate Bonds from 5 to 30 years. The Participating Preferred Stock: When pricing the Participating Preferred Stock, one would analyze the stated dividends and the participation cash flows over a specified period, say at the end of the

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fifth year, to arrive at a total accumulated cash flow. That total accumulated cash flow plus the par value of the Participating Preferred Stock would produce an “Aggregate End Value.” That aggregate end value compared with the beginning value, the original issue price, will determine the internal rate of return. If you priced and issued the preferred stock at a $10.00 par value per share and the aggregate end value per share was $100.00, which included the principal paid back to the investors, by the exercise of a “Call” feature at the end of five years, the estimated internal rate of return would be 58.49%. If that rate of return is acceptable to your management team’s private capital contacts for the risk involved in holding that illiquid security over that period-of-time, then that would constitute the price. Since there is less risk with the ownership of a preferred stock than a common stock maybe a price of $20.00 per share with an estimated internal rate of return of 37.97% would be acceptable. You can only estimate the internal rate of return using the above formula if the Participating Preferred Stock has a Call Date at the end of the period-of-time and your pro forma financial projections illustrate buying back those shares by exercising the Call feature. You need to disclose that the exercise of the “Call” is planned by the company, because the Call of the preferred stock is at the pleasure of the issuer, not the shareholder, so the preferred shareholder cannot assume that the principal will be returned. If the Call feature will not be exercised, then you would only use the total accumulated cash flow, leaving out the return of principal amount, to arrive at the aggregate end value. Debt or Notes with an Equity Kicker: When pricing the Debt or Notes with an Equity Kicker, one would analyze three components. You would add the coupon or annual interest rate as the accumulated cash flow over a specified period, say at the end of the five years; the principal of the Note to be received at maturity; and the value of the equity kicker at the end of that period, to arrive at a total accumulated aggregate end value. That total accumulated aggregate end value compared with the beginning value or face of that Note will determine the estimated internal rate of return. If you priced and issued the Notes at $1,000.00 face value and the aggregate value per Note, with its accompanying equity kicker component and accumulated interest, was estimated to be worth $10,000.00 at the end of the fifth year, the estimated internal rate of return would be 58.49%. If that is acceptable to your private capital contacts for the risk involved in holding that type of security over that period, then that would constitute the price. Since there is less risk with owning a Note than even a preferred stock, maybe a price of $2,000.00 per Note with a rate of return of 37.97% would be acceptable. You may want to do your calculations as an aggregate of the total amount that you plan on issuing. In other words, if you plan on issuing $1,000,000 in five-year Notes, calculate your estimated rate of return using that total principal figure along with total interest paid and the total percentage of equity given up as the kicker. You can cut

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the aggregate amount into equal pieces later when deciding on the price of each Note. You may want to issue 1000 Notes at $1,000 or 100 Notes at $10,000. The Royalty Financing Contract: The Royalty Financing Contract is considered temporary debt because it holds accounts receivables as its collateral but is priced somewhat like a common stock, with a few slight twists. When pricing The Royalty Financing Contract, one would analyze the royalties as cash flows to arrive at an aggregate end value amount over an estimated period-of-time, say at the end of five years. The total accumulated cash flows from royalty payments would produce an aggregate end value. There is no principal payback, as with a Note, Bond, or a Called Preferred Stock. That aggregate end value, compared with the beginning value over the period-of-time, will determine the internal rate of return. For instance, let us say you priced and issued The Royalty Financing Contracts at $10,000.00 each with a contracted delivery of 20% of the annual gross revenues and you estimated a total accumulated cash flow produced for an aggregate end value of $100,000.00, per contact. At the end of five years, you could illustrate an estimated internal rate of return of 58.49%. We have assumed that the contract terminates at the end of the five-year period because it reached its Contract Termination Amount of $100,000.00. If that rate of return is acceptable to your private capital contacts for the risk involved in holding that illiquid security over that period, then that would constitute the price. Since there is less risk with The Royalty Financing Contract than a preferred stock, maybe a price of $20,000.00 per contract with the same 20% of gross revenues to be delivered over the same period to produce a rate of return of 37.97% would be acceptable. To increase or decrease the annual rate of return, you would change one of three structural components, individually or in various combinations. To increase the rate of return, you could keep the contract’s face value the same but increase the gross revenue percentage to speed up the time for the total accumulated cash on cash flow from royalty payments to be realized; (the Contract Termination Amount); you could increase the total aggregate dollar amount, by extending the time period; or you could decrease the contract’s price. Slight combinational moves would have a magnified effect on the rate of return. Now you could go through the following steps or reacquaint yourself with the previous exercise; make changes to the Categories with each Section; make a series of or one deal structure model(s); run what if scenarios; make the corresponding changes to the Notes to Pro Formas (as you make the changes to the numbers) to create your company’s prototypes or securities offering deal structure and then proceed to build the Private Placement Memorandum(s).

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Using the Master Templates 1. Open the “Financial Architect 4.0 Folder,” then open the folder entitled “Corporation Templates,” then open the folder entitled “Master – Corps,” Then Open the Excel file entitled “Master Pro Formas - Corps or (LLCs) – Existing Co.” or “Master Pro Formas - Corps or (LLCs) – Start-Up Co.” From here forward for ease of illustration, and not because we are lazy, we will assume that the organizational form of your company is a corporation. (Substitute LLC for Corps. if your company is a Limited Liability Company or a Partnership by opening the folder entitled “LLC & Partnership Templates,” then the folder entitled “Master Pro Formas for LLCs.” ) 2. Once you have opened the Excel file, you will need to open the Word file entitled “Master Notes to Pro Formas – Corps or (LLCs).” Now you should be running MS Word and MS Excel programs simultaneously. The Excel workbook should open to the Income Statement & Co. Valuation section, which is the far left tab at the bottom of the workbook. This is the main, or primary worksheet, as the numbers flow from this worksheet to the other linked worksheets, also known as “The Other Pro Forma Statements.”

3. Change the Company Name to Your Company’s Name by clicking the View button on the tool bar, then Header and Footer button, and then Customize Header. Change to your Company’s Name on each worksheet. Once you have made that change to the Master set, representing your company’s capitalization plan to another file representing your company’s name save to a separate folder, (“Your Companies Securities Offering” folder, for example), then start making the actual changes to the worksheets. By doing so, you will maintain the integrity of the original Template folders and files. In addition, you should make sure that the years and dates at the top of the worksheet coincide with your company’s capitalization plan. 4. Now open the Master Notes to Pro Formas, change the Name on the first page and save to another file representing your company’s name, save to Your Company’s separate folder and then start making the actual changes to the worksheets. 5. When you begin to formulate your company’s capitalization plan, every time you make a change on the main worksheet entitled “Income Statement & Co. Valuation,” you should also make the related adjustments and changes to the “(Your Company’s) Notes to Pro Formas” in the Word document. Make sure that you make the changes to every single line in “(Your Company’s) Notes to Pro Formas” before you make any other changes to any other rows or columns on the Excel worksheets. This will enable you to proceed methodically, thereby reducing the possibility of making mistakes, in your illustrations. 6. Change the numbers and rates of growth for each Category within the Revenue Assumptions Section. In the Revenue Assumptions Section we have illustrated the use of Units being sold at increasing prices over the years, for one product line. You can add product lines with different prices or if your company is a 88

service company then you can simply enter the Revenue Assumptions as dollar amounts and delete the calculation that multiplies the Units and the price per Unit. You can arrange any Section the way you want to, simply make sure that the Total rows calculate correctly. For example, for a service company entering only dollar amounts (without the illustration of the number of “Units” being sold. simply highlight the Total row and click the Summation button on the tool bar and make sure all the category rows in that Section are included in the calculation. *NOTE: Fill in the appropriate Terms and Numbers for each Category in each Section as it relates to your company’s future financial plan. The numbers will flow to the other Pro Forma Statements identified by the tabs located at the bottom of the worksheet. Remember the Revenue area is considered a “Section,” The Cost of Goods Sold is considered a “Section,” and so on. The title of and the numbers of each individual row within each Section is considered a “Category.” The “Total” row at the bottom of each Section on the “Income Statement & Co. Valuation” are linked to those other worksheets so feel free to add or delete Category rows within each Section, which will automatically tie the “Total” rows into the links to the other worksheets. Make sure you do not change the order of the “Total” rows for each Section. 7. Change the numbers and the percentage of revenues for each Category within the Cost of Goods Section. 8. Change the numbers and rates of growth for each Category within the General and Administrative Expense Section. 9. Establish a percentage of cash distributions to the Cash Distributions Common Shareholders row. We recommend not less that the combined highest federal and state tax brackets (35%?). We used 50%. The higher the better, without damaging your year-end cash flow balances. 10. Now you must establish a ZERO BASIS in the • Interest Expense, • Royalty Financing Expense, • Participating Preferred Stock Stated Dividend and the • Participating Preferred Stock Participation rows as indicated in the previous exercise.

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11. As you will soon notice, we used an Excel workbook for a corporation that has 100,000 shares authorized to be issued. We used this figure because it is relatively easy to calculate rates of return, as well as, dilution. 100,000 shares represent 100% of the company on a fully diluted basis.

The formula of =100000*C121 is based on 100,000 shares outstanding after the sale of common stock. Be sure to change that number and that number in the Est. Net Earnings Per Share formula if the amount of shares will be different for your company. 12. Look to the Master Notes to Pro Formas and to the formula row under the top tool bar for explanation of how these pro forma financial projections were calculated. 13. You may need to go back through each step of the previous exercise to make sure that you are setting up your workbook to easily run multiple “What if” scenarios. *Don’t forget to change the dates on this Income Statement & Co. Valuation sheet before you start formulating your company’s capitalization plan. The date changes should flow through to the other worksheets.

NOTE! We strongly suggest that you only make formula changes to the Income Stmnt. & Co. Valuation & IRR worksheets, so as not to damage the calculation flow. However, if your company is a Service Company or one that does not hold inventory, then you will also need to establish a ZERO BASIS for capturing an inventory assumption on the Balance Sheets, as well because service companies do not typically hold inventory.

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For instance, the formula that pulls the inventory figure from the Income Stmnt. & Co. Valuation page, =ROUND(('Income Stmnt. & Co. Valuation'!B22*0.15),0), which represents 15% of Total Cost of Goods Sold, will need to be changed to =ROUND(('Income Stmnt. & Co. Valuation'!B22*0.0),0) IN EVERY CELL IN THAT ROW to establish a ZERO BASIS.

Make that change before you start formulating your company’s capitalization plan if your company will not be holding inventory at year-end. Also, if your company is a Service Company or one that does not have a direct Cost of Goods Sold category within that Section, then you will also need to establish a ZERO BASIS for the Categories within that Section or you can simply delete all category rows within that section. Just make sure that the Total Row has a sum of Zero.

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We deleted all of the Rows through the Edit Menu and received error message “#REF.”

We simply put zeros in those cells and those errors were corrected.

There is one other area on the Income Statement & Co. Valuation worksheet that you will most likely change. The Capitalized Assets area. If you contract the section by deleting the category rows then you will trigger #REF errors throughout a handful of the Other Pro Forma Statements. This too can be easily fixed with a few adjustments as follows. We highlighted a range of cells to delete the entire rows of 104 through 110.

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The #REF error messages are derived from the depreciation and amortization schedule, which flows back to this Income Statement & Co. Valuation worksheet because of the elimination of those capitalized assets. To make the correction simply go to the Depr. Schedule Tab at the bottom of the workbook and highlight all of the Sections on the left which have the #REF error message.

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Then go to the Edit command and delete the entire row(s).

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After you have made this correction the Total row on the Depr. Schedule should total just fine.

This will solve all the #REF Errors on the Income Statement & Co. Valuation worksheet, however, the Balance Sheets need to be corrected as well.

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You simply go to the Balance Sheets Tab at the bottom of the workbook and highlight all the rows with the #REF error message for deletion.

After the deletion of those #REF error rows the Total Assets row on the Balance Sheets, total correctly and the Balance Sheets, Balance.

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If you need to expand the Capitalized Assets Section by adding more rows, then you’ll need to make the following adjustments to the Depr. Schedule and Balance Sheets as follows:

As you can see we added Fork Lifts and a Conveyor Line system to our Capitalized Assets Section on the on The Income Statement & Co. Valuation worksheet. We used some assumptive budget figures as illustrated. These categories must be added to the Depr. Schedule worksheet by inserting enough rows to accommodate these new items. If we assume that these assets will be depreciated at the same rate as the asset just above the row insertions, or the Case Machine row, then it is easy to quickly make the necessary additions to the Depr. Schedule worksheet. First, you must insert the proper amount of rows under the Case Machine section on the Depr. Schedule worksheet. To save time we’ve added seven rows for each asset plus a row to provide for spacing.

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After that we simply need to highlight a copy the formula rows for the Asset with the same Depr. Allowance and paste below that asset in the additional rows. When we do so though, there’s a small problem because Excel thinks we want to copy and paste rows that are equal in distance from each other that’s why it looks like this:

To correct this we simply look at the cell calculation in the Case Machine Section and since we know that the pother assets were added below that asset on the Income Statement and Co. Valuation worksheet, we know that these new sections need to reflect the formula for the Case Machine plus 1 and 2 respectively. The formula +'Income Stmnt. & Co. Valuation'!B112 simple need to be +'Income Stmnt. & Co. Valuation'!B113 & +'Income Stmnt. & Co. Valuation'!B114 for those new Sections.

Of course you need to change that formula for the five adjacent columns as well. From there the worksheet will calculate throughout all the worksheets. 98

Now you need to make one more adjustment to the Balance Sheets. You need to insert two new rows and add those new asset categories under Case Machines. Simply copy the Case Machines row and paste in the new rows.

You will need to adjust the formula in Column A from +'Income Stmnt. & Co. Valuation'!$A$112 to +'Income Stmnt. & Co. Valuation'!$A$113 & +'Income Stmnt. & Co. Valuation'!$A$114 so that the category name will flow through.

The formulas for these two new rows should coincide with the formulas for other the rows. For instance, the +'Income Stmnt. & Co. Valuation'!B113 formula should be shown in this cell.

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The illustrations and exercises above were designed for a Start-Up with no operating history and henceforth No Existing Current Balance Sheet. However, most companies that need capital current exist and have current balance sheets. Therefore, we have produced two sets of Master Pro Forma Templates, one for “Start-Ups” and one for “Existing Companies.” The Master Pro Forma Templates for Existing Companies contains an extra column in the pro forma balance sheet worksheet entitled: Last Year’s Ending Balance Sheet. Fictitious amounts were added for illustrated purposes.

You simply take your companies last year’ balance sheet and plug in the numbers into this column. Remember, this is the only column or row (other than explained above) on the pro forma balance sheets worksheets that you should manually insert a figure otherwise you will skew the calculations for all the worksheets within the workbook. (You can manually insert accounts receivable, accounts payable, and accrued expenses as force points if necessary to balance the balance sheets. However, we recommend that you simply adjust the formulas as per the Notes to Pro Formas. Those formulas should be close for most operating companies.) Remember, you should add your balance sheet information here after you have established your revenue and cost assumptions on the Income Statement & Company valuation worksheet. This is done in this order, so as not to mentally limit your expansive plans for your company by being constrained by your current “Chart of Accounts.” Once you have a plan of expansion, you should have additional sources of revenue and cost categories to accommodate those expansion plans. So just stick with the exercise protocol and dream on!

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Securities Offering Document Production It is assumed that your company has already produced a written business plan in MS Word format or at least convertible into the MS Word format. If not, the following information should serve as a guideline for the basic outline of what you will need to produce a complete business plan to be copied and pasted into the Templates, which is the first step in the production of your company’s securities offering document. If you do have a business plan, please review the following to make sure that you will have the information necessary to convert it into a securities offering document. Other areas needed for compliance are already embedded into the Templates. For most entrepreneurs, the Red Herring document will be the first document to be produced to seek indications of interests. A Red Herring document is a summary of a securities offering document, as explained in a previous chapter. Remember, you will need to convert the existing text in your company’s business plan to be represented in the third party prose, if you have not already done so. If not, wait, as we will instruct you on how to do that in the Document Production section of this chapter. When producing your documentation, keep in mind that most investors want answers to, among other things, seven basic questions about your company and its capitalization plan or the securities offering deal structure. If you cannot answer these questions, in a believable and professionally written manner within the proper securities offering documentation, the probability of you and your management team raising capital for your company will be very low. Some of this information is being repeated and some of it is new. 1. What does your Company do and why is it different from the competition? The answer to this question should be easily answered by inserting the correct components of your company’s business plan into the Templates or by developing the correct response from your company’s product and/or service line(s) marketing materials. 2. Who are you? This question refers to who the members of the management team are, which is easily answered by including your management team’s background in the business plan or securities offering document. Obviously, the more experienced management teams have a greater probability of raising the needed capital, due to the nature of their personal and professional capital contacts. Do what you can to form an experienced board of directors, executive officer staff, and an advisory board. Choose a well “Networked” team. Be careful not to compensate them for directly selling securities though, because it is illegal to do so. They can be compensated for other duties and responsibilities, but the function of soliciting and selling securities must be incidental to their other duties, unless your CFO’s primary job is raising capital. If that is the case, the CFO cannot be compensated as a percentage of capital raised otherwise the compensation is considered a

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commission, which is illegal unless the sales effort is run through the books of an SEC registered broker dealer/securities firm. Even then, the CFO would need to be licensed with that firm and working for your company as a CFO, which for all practical purposes will not be allowed because the broker dealer/securities firm must make sure that the CFO’s compensation does not violate NASD rules of fair practice. In other words, it is not going to be allowed by the NASD Member firm, because from a NASD Compliance standpoint it is too cumbersome. 3. What will you do with my investment? To answer the question, a detailed “Sources and Uses Statement” should be included in the business plan and must be included in a securities offering document. The Sources and Uses Statement serves as your Use of Proceeds Statement, which is a required disclosure in a securities offering document. A statement that the money will be used for “General Working Capital” does not cut it. You must give details. The more detailed the better. The pro forma financial projections that you have produced contain that “Sources and Uses” statement. You will also need a detailed “Sources and Uses” statement to complete the “Notice of Sales” federal and state filings requirement after each sale of your company’s securities. 4. How safe is my investment? This question is generally difficult to answer. More often than not, entrepreneurs will attempt to sell less than a controlling interest in their firm for a substantial amount of equity capital. For instance, Management may attempt to sell 20% of the equity interest in a Start-Up or Early Stage Company for a certain amount of capital, for illustrative purposes, let us say $1,000,000. Generally, there are no other tangible assets in the company, including the entrepreneur’s cash. A sophisticated investor would realize that, by investing, he or she would immediately lose 80% of their $1,000,000 investment due to the outstanding stock’s total dilution factor. The three most popular deal structures, illustrated herein and included in the Templates, provide for additional elements of safety. Remember, the quicker you can return your investors’ capital contribution(s) the safer the illiquid investment becomes. Also, the quicker the company’s product and/or service line(s) are accepted into the market place, (the degree of actual sales revenues growth), the quicker a “proven economic model” has been established, which leads to higher degrees of safety in an investment. 5. How do I get my investment back? Exit strategies generally need to be rather quick. Although IPOs or out right sales of the entire company may seem attractive for exit strategies, those strategies cannot be guaranteed or further assured, therefore those exit strategies are not taken too seriously by a savvy investor.

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The three most popular deal structures provide for realistic exit strategies for potential investors. You may be able to attract the interest of strategic alliances, other businesses in your industry that would inherently benefit from your company’s existence, which may provide the equity and/or debt capital sought. A favorable exit strategy with a non-diluted equity position would be attractive to most strategic alliance candidates. 6. If the firm fails, what are my liquidation rights and lien position on assets? The deal structure of your company’s securities offering should provide a forward position on assets for investors and subordinate you and your management team’s equity in case of liquidation. In the mind of an investor, this type of deal structure further justifies taking on the risk of an investment in an illiquid security. All start-up and early stage companies are risky in the mind of the informed investor. They know that, on average, 85% of all start-up & early stage companies will fail within the first five years of their existence and 60% of the remaining firms will simply survive providing little or no return. Therefore, you need to mitigate an investor’s risk through the issuance of nonsubordinated securities and proper capitalization structuring. 7. If things go as planned, what will be my rate-of-return on investment? Most business plans and securities offering documents do not include rate of return projections for the purchase of securities and/or a current company valuation based on reasonable future financial projections. You should have already determined your company’s current value based on realistic future financial projections along with the internal rate of return potential for an investment in your company’s securities. Once you have run the numbers, you may find that the percentage of equity you are willing to relinquish may be too much or too little for the capital sought. Most securities attorneys would prefer that you not project a rate of return on the securities that your company is offering primarily because they fear that it would increase the probability of you and your company being sued if the company does not meet its financial projections. That is a legitimate concern; however, the securities offering documents, which the Templates are based on, are hallmarked by the internal rate of return projections because in most investor’s minds that is the bottom line. The securities offering document Templates have disclaimers that should warrant sufficient protection against litigation for not meeting those financial projections. In reality, if you do not provide those internal rate of return estimations, the likelihood of attracting funds is very low, which makes the increased probability of being sued a moot point. Document Production The securities offering document that you are about to create will be comprised of four different documents, which are to be combined at the printers to form one securities offering document. Each completed securities offering document will include: 1) the Cover & Table of Contents, which will not have page numbers at the bottom of the page; 2) the PPM, which will include the main text body and the Exhibits Section with page numbers at the bottom of each page; 3) the Excel worksheets, which make up your Pro

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Forma Financial Projections, which are to be copied and pasted in Exhibit A.; and 4) the Notes to Pro Forma Financial Projections, which are also to be copied and pasted in Exhibit A. At this point in the process, you should have produced the deal structure(s) that you would like to offer to prospective investors with your completed “Pro Forma Financial Projections” in an Excel document and the “Notes to Pro Forma Financial Projections” in a Word document. You will use only one Master set of these pro forma financial projections and notes thereof, throughout all the securities offering documents that you will be producing. Open both Word documents inside the Template folder that you have chosen that are entitled “Cover & Table for…(The deal structure(s) that you have chosen)” & “PPM for…(The deal structure(s) that you have chosen).” Filling out these Template(s) of Private Placement Memorandums (PPM), which will be your company’s securities offering documents, should be relatively simple. Simply copy and paste the appropriate portions of your written business plan into the PPM Templates. We suggest that you complete all the securities offering documents now because even the deal structures may change before the actual securities offering(s) occur. It’s easier to complete them now when this information is fresh in your head. Start with the Cover & Table(s) first. Change the company name, deal structure, quantity, and price of the securities. The areas that are highlighted in Blue are the areas that will need to be changed to reflect your deal structure, quantity and price of securities offered. (FOR THE SECTIONS THAT ARE IN BLUE AND IN CAPS WE ARE SPEAKING DIRECTLY TO YOU, SO YOU WILL NEED TO DELETE THESE COMMENTS WHEN YOU HAVE COMPLETED THAT SECTION.) *NOTE: The numbers, according to the deal structure chosen, that are to be inserted into the Cover & Table and PPM text body are derived directly from the capitalization section in the Notes to Pro Formas that you just completed, so open that file to gather those numbers. Under the Securities Act disclaimer section, you will not need to decide on what sub-section of Regulation D, you are claiming an exemption for because you can claim multiple exemptions and the PPM Templates were designed to blanket all of the available exemptions from registration. Although, you should know that Regulation D §504 allows $1,000,000 to be raised in a 12 month period and does not need to have an audited balance sheet. Regulation D §505 allows $5,000,000 to be raised in a 12 month period and does need to have an audited balance sheet, if your company has any operating history. Regulation D §506 allows unlimited dollar amounts to be raised in a 12-month period and does need to have an audited balance sheet, if your company has any operating history. You will need to make the same changes in different areas throughout the PPM that reference these Regulations. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time

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Be sure to change the offering date(s) and the termination(s) date on the front cover(s). *Hint: It is better to have an offering date that will be a few weeks after the anticipated completion of the printed finished document and mailing dates. These documents have a shelf life and will seem old after three months. Investors like to see deals early, before they are available to anyone else, so it is better to date the document later rather than earlier. Leave the Table of Contents (TOC) alone for now. You will need to develop the TOC after you have formatted the main body text portion of your PPM. Finishing the TOC is the last thing you’ll do in the production of your PPM. Now go to the PPM Template(s) and develop each one in order of the capitalization plan. In our example, you would start with the Debt to Equity Kicker deal structure, then the Royalty Financing deal structure, the Participating Preferred stock deal structure and finally with the 100% Equity deal structure. See that very first paragraph, where it says XYZ Company, Inc.” (or LLC depending on Template chosen). Go into the edit menu and find ‘replace’ to change “XYZ Company, Inc.” with your company’s name. Use the ‘replace’ command under the edit menu whenever you can to save time. As illustrated at the end of the Executive Summary, we took a company that had only a total of 60,000 shares authorized and increased the amount by 40,000 shares, by amending the Articles of Incorporation at the state level, so that we had 100,000 as the total authorized amount. Remember the 100,000-share amount makes it relatively easy to express percentages of ownership and calculate the estimated compounded rate of return. If you’ve chosen the 70% Debt with 30% Equity deal structure, you may want to assume that the debt will be obtained through traditional commercial bank sources of debt. We have made that assumption in the PPM Template denoted 70% Debt & 30% Equity. However, you could obtain debt through a Note offering. If so, simply use the Debt with Equity Kicker Template for a straight debt offering of Notes and remove reference to the Equity Kicker, throughout entire document, including the Exhibits section. If you do so, you must also change the term “Units” to “Notes” throughout the entire document Template. Units are a “combination security” comprised of the Note and the Stock as the Equity Kicker. You can combine an offering of debt (Notes) and equity (Stock) in one PPM. To do so, you should use the Debt with Equity Kicker deal structure and simply increase the cost of the Equity portion of the security known as the “Unit.” This is the easiest way to complete a combination securities offering. An alternative way to do so, is that you simply insert your refined business plan into the PPM for 100% Equity and insert the various sections within the 70% Debt with 30% Equity offering that describe the Notes and the Terms of that Note offering, as well. If you decide to go this route, you will need to produce two separate Subscription Agreements though, one for the Stock-offering and one for the Notes-offering. Your Exhibit Section will need to have additional Exhibits adjusted to reflect the Subscription Agreements for both, plus the Security Agreement

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that accompanies the Note offering in the Debt with Equity Kicker Template. Whether you have one combined offering or two separate offerings, it will still be considered one offering in regards to the dollar limitations over a 12-month period because it will be considered part of the same capitalization plan. In other words, under Regulation D 504, where the dollar limitation is $1,000,000 over a 12-month period, an offering of $700,000 in Notes and $300,000 in stock would maintain that exemption (See Regulation D in the Compliance Folder.) If you have chosen a Preferred Stock offering that will not include any net income participation, simply put a zero as the participation percentage, because you may decide to change it later and you shouldn’t delete the calculation. Also, you will need to eliminate any reference to the “Participation” feature throughout the PPM & the Cover & Table. Even though we have attempted to make this process as simple as possible by establishing a format in which you may copy and paste your business plan into these documents, you will need to read every single line and every single word to make sure it is true and representative of your company’s situation. Do not misrepresent or omit a material fact in your securities offering document. If you do, you could face criminal prosecution. Remember, before you copy and paste your business plan into the Templates, adjust the text of your business plan once inside this document to reflect it being written or said by the third or outside party. Instead of referring to management in the first party prose, “we want to do this,” say, “management expects to do this.” Also, in your wording, never say that you will do anything. Always hedge yourself with phrases such as; Management expects, Management believes, Management shall attempt and Management feels. In addition, use phrases like “intends to,” “is to be,” “shall attempt,” etc. Do not ever refer to anything as a definite fact because you could be sued based on that type of wording in a securities offering document, if in fact the intentions are not fulfilled, which they never really are to any accurate degree. Once again, you are to produce this document to save 90 to 95% of the legal, investment banking, and accounting fees associated with securities offering document production. An attorney must review the final document so that the Company will have further direction in the area of complying with any changes in federal or state securities laws. Be sure you have completely exhausted your effort in the production of your securities offering documentation, so that you are further assured of receiving the lowest final securities offering document production “clean up” bid from your attorney and CPA. Obviously, you will need to adjust the line spacing and centering sentences and paragraphs to coincide with the exampled text headings once you have completed your first draft. Once your first draft is complete, print off a hard copy for “red line review” (i.e. read the entire document with a red pen and mark it up). We wait 48 hours between the first draft completion and red line review. The reason is that you need to get away from the document for a while to gain perspective. You will be amazed at the amount of

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mistakes you will make and the additional changes that you will want to include, after that 48-hour period. You might be anxious, but remember you only get one chance to make a first impression, so take your time. Once the entire Word document sections have been completed, simply print them for camera-ready copy. You should copy and paste your company’s other documents into the other Exhibits as indicated on each Exhibit page. If those other documents are not available in MS Word form, simply print them and insert them into those sections before you take your master copy to the printer. The Excel worksheets will also need to be copied and pasted or printed and inserted into your master PPM document before you take the document to the printers or have it burnt into a CD Rom (see next Chapter for more information). If you can put all the documents together digitally, you can convert the PPM into an Adobe “pdf” file for electronic transmission. If you do so, be sure allow the document to be printed because an investor will need to print off and sign the Subscription Agreement. Inside the Private Placement Memorandum, you will have an Exhibit for your Subscription Agreement for both Corporations and LLCs (Partnership can be substituted for an LLC). You will also include an Admissions Agreement only if your organization is an LLC or a Partnership Agreement if your organization is a Partnership. Your LLC or Partnership records should contain a copy of your LLC’s Operating Agreement or Partnership’s Partnership Agreement. If not, then you’ll need to contact your attorney who set up your LLC and/or Partnership and ask the attorney to forward those agreements to you, preferably in MS Word format so you can easily copy and paste it into your securities offering document. Each LLC has a different form of Operating Agreement according to and in conjunction with that LLC’s state law. If you will be sending out hard copy printed securities offering documents, one of the things you will need to do is copy that Subscription Agreement for corporations, a Subscription Agreement and Admissions Agreement in the case of an LLC, and a Subscription Agreement and a Partnership Agreement in the case of a Partnership, then paste it to another blank document so that you can send that agreement document separately bound in addition to those documents that are inside the Private Placement Memorandum as Exhibits. The Subscription Agreement is an agreement subscribing to the securities that your company is offering. The investor signs the agreement acknowledging all the provisions that are inside that Subscription Agreement and in the Private Placement Memorandum. For hard copy distribution, you’ll send out the two documents under the same cover letter. You need a Private Placement Memorandum that is wholly bound together meaning that any pages that are taken out of that Memorandum destroys the document. You can simply staple the Subscription and/or Admissions (Partnership) Agreement(s) that are to be included as separate documents with the wholly bound PPM.

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If you will be issuing Royalty Financing Contracts, you will need to do the same with the Royalty Financing Contract in the Exhibit section. You’ll need to copy and print out two exhibits. You will have a separate Subscription Agreement and a Royalty Financing Contract Agreement. These documents are in addition to those same agreements inside that PPM as Exhibits. Make copies of those agreements and send them with the Private Placement Memorandum. It is the same process with the Debt with Equity Kicker structure. You’ll need to copy and print out the contents of those two Exhibit sections. You’ll have a separate Subscription Agreement and a Security Agreement. The Note indenture is actually the wording that goes on the certificate of the Note, so you will not send that along with the PPM and Agreements. You will have to produce or actually copy and paste it to another MS Word file so you can produce that language on the face of the Note certificate once you’re ready to actually produce the physical certificate. IMPORTANT!! You should copy and paste all agreements to separate word documents, which should be named specifically to each Agreement. Once each agreement has been segregated to its own file, you will need to paginate those agreements before you print them off and send them with your PPM. All agreements that are sent in addition to the PPM should be paginated to reflect page (i.e. 1 of 6). On the Word tool bar, go to the View button and click on Headers and Footers. Click to Footer and then click “Insert Auto Text.” There you will see the term “X of Y.” Click on it and the proper pagination should be completed automatically. Before you print off your final master copy for the printers, decide how you will have it bound. Under the current format, there is no “gutter” to allow for spiral or thermal binding. The current format is used to copy onto 11 by 17 inch paper, double sided, center stapled, also known as “stitch binding.” Keep this in mind, as you may want to add a gutter of ½ inch under the Page Set-Up command under the File menu if you will be spiral or thermal binding your PPM. Do not expect a legal opinion from your attorney on the accuracy or completeness of the document itself, or its ability to claim exemption from registration. Many times the attorney will only issue a legal opinion on the legality of the business entity’s existence, (i.e. the same information that is made in the PPM under “Representations and Warranties of the Company”). Legal and tax opinions are not required to qualify for an exemption from registration of your company’s securities under Regulation D. (See “Regulation D” in the Compliance folder). We know this may be difficult on the first go around, but if you do this once, you’ll be able to continue to do this many times, if needed. Many clients have to go through 2, 3, 4, or 5 rounds of financing before they are in a position to go to an investment bank or a venture capital firm and still be able to dictate the terms of the deal. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time.

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Soliciting & Selling Securities to Raise Capital Have you really made it this far into this program? Have you completed your exercises and produced your pro forma financial projections, valuated your company, priced its securities and produced your prototype securities offerings? Have you tested your private capital market with those prototype securities offerings? Have you made a decision on the deal structure that you’ll pursue? Have you produced your company’s final securities offering documentation and had it reviewed by your attorney? Are you now ready to raise capital? (If not, please go back and complete those exercises so this portion of this program has maximum value for you). If you have completed the above exercises, then you may be one of a very few individuals who will succeed in raising capital for your company! You have come a long way, but you are only half way through. You need to actually sell the securities, in a highly regulated environment, to raise capital. “The journey of a thousand miles starts with one step.” Well, you need to pick up the pace now, because its crunch time. Everyone sells all the time. You’ve been selling yourself and your abilities all your life. You sold your dad on giving you the car keys or buying that new computer for your room. You attempted to sell your brothers and sisters on letting you borrow their stuff. You sold your first boss on hiring you, etc. Most investors like to be sold. Most savvy investors know that a CEO and his or her management team better be able to sell everything in sight. You and your management team need to be able to sell the products and/or services that your company produces into distribution channels and to sell the company’s corporate culture to potential talented employees to work for your company and not your competitors. In addition, you and your management team need to be able to sell the banker on providing the bank loan after the equity is raised, sell the FDA, FCC, OSHA, the IRS or any other regulatory authority that the company must deal with, that it does in fact comply with the various regulations. More importantly, you and your management team need to be able to sell securities to raise capital for your company. You and your management team need to be able to sell, sell, sell! Obviously, some folks are more successful at selling because of their inherent personalities. If you have a real problem with the concept of selling intangible assets; such as securities to capitalize your company, then you may want to re-think your mode of operation one more time and attempt to raise enough capital to license and place your inventions, products, or services with a potential strategic alliance. Most inventors should invent. They shouldn’t attempt to build a company, especially if they have no formal education or experience in that area. This is not a course on selling. Although we have outlined the techniques of selling securities in a highly regulated environment, one must understand the fundamentals of basic selling first. There are quite a few selling courses at your disposal.

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Zig Zigler and Dale Carnegie come to mind. Og Mandino’s book entitled “The Greatest Salesman in the World” is a must for those who want to perfect their selling skills. I’m sure that there are many more fabulous programs and books available, I suggest that you learn from them if you’re not used to selling. If you are the selling type, you may want to review those selling courses to get yourself refreshed and pumped up because this is the big show. Arm yourself with basic selling abilities and skills. Once you feel confident with the basic selling skills, employ these following techniques to sell securities. Other advanced selling techniques are available to you in the Commonwealth Capital Club as well. The Key Points to Selling a Private Placement of Securities 1.) In the beginning of this program I recommended that you “Test the Waters” of your private capital market for “Indications of Interest.” This means finding out what others want in an investment and tailoring your securities offering to meet that demand. Your success in your capital raising efforts will be in direct relation to how well you have attempted to serve the needs of others. Remember that I suggested that you ask a few wealthy folks that you may know to help you in your quest to formulate your investment or securities offering? If you had put together your prototypes and asked these folks for their honest opinion on the deal structure, you would have gotten back a feeling for where your private market is, as far as their desire for a particular deal structure. It is as if you went to them, with hat in hand, and asked them for their wisdom, sagely advice, and help. By finding out their level of interest, you were able to customize a securities offering that fit that demand. Many times, when an investor says he or she will like this or that, they are giving you their honest opinion. They are investors. They invest money all the time. There are many folks out there with lots of money to invest. I’ve read estimates that over 60 billion was invested in start-up and early stage companies in the year 2000, even after the dot-com bust. It is simply up to you to tap into it. Do you realize that 1/10th of that is 6 billion, 1/100th of that is 600 million, 1/1000th of that is 60 million, 1/10,000th of that amount is 6 million and 1/100,000th of that is $600,000? All you have to do is tap into 1/100,000th of that amount for $600,000 in start-up equity capital! Use that amount of equity capital to entice the bank for a $400,000 loan. Now you have $1,000,000 in capital. 2.) You are selling an intangible asset. Attempt to make the buying experience for the investor as tangible as possible. If you have developed a prototype product, make sure the prospective investor(s) get their hands on it. If you provide a service, make sure the prospective investor(s) can somehow experience the value of that service. 3.) You are selling a high risk/return potential security. Sell it for what it is. Tell the prospective investor that you’ve attempted to take as much risk out of the security as possible through the structure that you’ve formulated. You’ve put them first and yourself behind them in all manners of safety and return. (Of course you have done this, haven’t you? If not back up and rework your structure to accommodate this effect).

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4.) Soliciting and selling securities is a numbers game that is highly regulated. You can solicit and sell securities to up to 35 non-accredited investors and an unlimited amount of accredited investors under Regulation D. If you can, I suggest that you solicit and sell to accredited investors only. By doing so, you will further remove yourself and your company from inadvertently violating any rules of the Regulation D exemptions from registration. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time. 5.) The key to successfully raising any and all forms of capital is to start building trust relationships with potential investors. You must meet four key elements for a prospective investor to actually invest in your company: • • • •

They must believe in you and your business opportunity; They must understand what your company does; They must trust you and your ability to make them a profit; and More than anything else…they must like you. (I know that sounds a bit corny, but if they don’t like you, do you think they’re going to cut you a check?)

How Stockbrokers Sell Stock Who is the only professional that can legally raise capital for companies in the United States? The stockbroker. Most stockbrokers are now called Financial Advisors. You can call them whatever you want to, but they still broker securities and raise capital. Let us review a day in the life of a NEW stockbroker: Why am I exposing a day in the life of a new stockbroker to you? Because you and your management team need to temporarily act like new stockbrokers in order to raise capital for your start-up or early stage company. A new stockbroker must raise or attract a minimum of $100,000 in new investment capital, on average, every week if he or she plans on being in that career for any length of time. In their second year, they should be raising at least $250,000 per week to keep their job. You may be thinking that it sounds incredibly difficult. It is incredibly difficult, especially with the onslaught of discount brokerage firms out there, along with many other problems that the industry constantly goes through. It would seem that most stockbrokers would have a few advantages of selling stock over you. They should have a distinct advantage over you, as it is their chosen profession and they have been trained to engage in the process. Some do have an advantage over you… most do not. Let us examine each area to see if you may have any advantages over them. Let us also see if we cannot transfer their advantages to you, to increase your probability of success.

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Most new stockbrokers have what is known as “administrative support.” They generally share a sales assistant with a few other brokers who handles the day to day nuisances that are associated with opening accounts, transferring financial assets and so on. You do not really need this support, as your administrative activities will be limited to a few filings with the SEC and the state securities administrators after the sale of company’s securities. (See the Commonwealth Capital Club.) Most stockbrokers have tons of market and company research at their fingertips, which they are able to provide their clients at no cost. Many use this research as their “Value Added” component to establish the broker/client relationship. You really don’t need all this research, as your company’s securities are offered through your securities offering document, also known as, your company’s Private Placement Memorandum, and this is the only security that you can legally sell. Most stockbrokers have all day to prospect for new clients and thus have a perceived luxury of time. If you have already raised or can raise sufficient seed capital to take a half-year or a full year off from your day job to raise capital, you will also have the luxury of time, at least to some degree. Remember, if the stockbrokers do not start bringing in the capital they lose their jobs, so the perceived luxury of time can be elusive because they are under heavy pressure to attract and raise capital. Most stockbrokers have managers that insist that the stockbroker cold call on the phone all day long for investors. This task, in my opinion, is as wasteful and demeaning as any attempt that I could imagine in the effort of raising capital. However, for some it works. You have the advantage of prospecting anyway you choose. Although most stockbrokers have all day to prospect for new clients, most of their time is wasted by cold calling on the phone. Therefore, their perceived luxury of time becomes limited due to the unproductive activities required of them by their management. You have the ability to be as productive as you want to be. All stockbrokers have restrictions in the way they prospect for new clients. They are highly regulated by a number of regulatory authorities. Actually, over sixty regulatory authorities in the U.S. regulate how they operate. However, they can sell investments to just about anyone, as long as the investment is suitable. If the investment is not suitable, the stockbrokers can get fined heavily and even lose their licenses. They may advertise pretty much anywhere and everywhere. You have restrictions in the way you can prospect for new investors when engaged in a private placement. You may not use a general form of advertising, unless you have registered your company’s securities at the state and/or federal levels. You must keep the solicitation and sales effort private or directed to accredited investors only. This may seem like a disadvantage, but it is a blessing in disguise. General advertising doesn’t work for most start-up and early stage companies, unless you can advertise a relatively safe security like a Note with a high yield in the newspaper to generate investor leads. A private deal has the element of secrecy. You have absolute exclusivity to your securities offering, unless of course, you are engaged with a NASD Member syndicated selling group. Even then you still have relative exclusivity. You are different and should command an investor’s attention if your approach is done correctly.

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Accredited Investors are bombarded by stockbrokers’ everyday. These stockbrokers are selling the same old stuff. Any broker can get a municipal bond or a publicly traded stock. Basically, they’re all fishing from the same public pond. Even new municipal bonds are priced to the market so the exclusivity one broker has over the other, for all intent and purpose, is meaningless, because all bonds are priced the same according to coupon rate, maturity and safety. That becomes a bit boring. Accredited Investors like to review special and exclusive deals with exit strategies and real upside potential. Most stockbrokers sell securities that are publicly traded and therefore liquid. Investors can buy and sell them all day long. This seems to be an advantage if you look at it that way. First, the stock, being liquid, has already gone through its initial public offering (IPO). It is already priced to the publicly traded market, or where it should be priced. The entire bang for the investment buck is gone! The greatest amount of upside potential in most stocks is getting in BEFORE the IPO. Hot IPOs can go up ten times their original offering price since going public. Some have done it in less than a year. But what about the original investors that got in at maybe one-tenth or one-twentieth that original offering price? Those returns are huge. Now that is upside potential and that is what you are offering investors, if your company’s plan is to go public someday. Incidentally, there’s a little unwritten rule about IPOs, which you should know about since you’ll be competing with liquid securities. Most large institutional buyers of IPOs, such as mutual funds, insurance companies and pension funds, take positions or buy stock in just about all the IPOs that come to market, including the less impressive ones. This entitles them to the majority of shares of the very best IPOs. Generally, what this means to the average investor is that if your broker can get stock in an IPO, it may not be worth the paper it is printed on. As stockbrokers back at the old brokerage firms used to joke that, “If you can get your hands on an IPO stock for your retail client, then we’ll short it.” In Bull Markets, investors can make this argument: “Why should I take on the risk of a start-up or early stage venture when my mutual fund has been returning 32% a year for the past few years.” Your come back should be, “Do you think that’ll last forever?” “Why don’t you start paring back by selling some of those shares to raise some cash to take advantage of the next market downturn?” “Why don’t you take 10 or 20% of that cash and invest it in our company?” In Bear Markets, investors want to hold on to the ever-fleeting hope that their stocks will rebound and they will regain their lost profit or at least break even on their principal amount. More often than not, the likelihood of that happening anytime soon is slim to none. In bear markets, even after suffering paper losses, investors will eventually become inpatient and will look for high yielding cash flow producing investments. This is where your company’s hybrid securities can compete. Overall, I believe that you have a distinct advantage over the average stockbroker. You do not need administrative support, research or the costs associated with it. You can

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prospect actively in person, which is the most effective way. You have an exclusive offer that is pre-IPO with huge upside potential. My goodness, you have it all! *Good Advice: If you plan on a series of capital raising rounds, as most companies should, consider placing an advertisement in the employment section of your local newspaper seeking to hire a stockbroker away from his or her firm, to work for your company internally and exclusively. Provide them with a base salary, profit sharing plan, benefits, and bonuses. The turnover rate in the securities industry is very high. Many quality individuals who have the prospecting and selling skills, with compliance knowledge required for an effective and legal offering of securities, are available at a relatively inexpensive price. Just make sure that they are not paid as a percentage of the capital raised. Success fees must not be tied directly or indirectly to capital raising performance. Make sure that there are many other duties, which they can perform during periods when capital is not being raised. The capital raising function can be a primary duty, but not an exclusive duty, otherwise the SEC and or state regulator(s), may consider the capital raising effort as being unlawful, because they may view your company as operating as an un-registered broker dealer. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time. Productive Prospecting Okay, now you know what your competition is all about. It is time to make contact with investors. You have your current private personal and professional contacts. These are your most valuable contacts and they shouldn’t be approached until later. You can’t afford to blow it with these folks. You should adopt an old stockbroker’s trick. The trick goes something like this, when we as stockbrokers, back at the large securities firms, had a special bond issue or stock opportunity we were encouraged to do the following: (I will give you the actual example of a new municipal bond issue. You should adjust the pitch to be relevant to your securities offering). First, I would make a list of those prospective clients that I have already introduced myself to (warm call) and a list of existing clients that probably would not or could not buy at least $10,000 worth of the issue. I’d then develop a quick 30-second to 1-minute sales pitch. Also known as the “Elevator Pitch.” That pitch would include a brief explanation of why I was calling. The pitch would start with the phrase “I thought you’d appreciate hearing about a new Municipal Bond issue that just became available.” With the prospect’s or client’s positive indication of interest, I would continue; “It’s a Tampa airport revenue bond that pays a 10% tax-free yield. (Yeah, that was many years ago.) It is AAA rated and insured. Although it has a 30-year maturity, it does have a 10-year call protection. What that

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means is that if interest rates continue to fall they can’t buy the bond back from you for at least ten years. If they do buy it back from you, at the end of the ten-year period, they’ll give you a 5% premium over the par value or the price you’ll pay.” As stockbrokers most of us would “Take Down” (reserve) a certain dollar amount to sell, so that we wouldn’t work on an issue for a few weeks, just to find that it had been sold out from under us. I’d be able to say; “The bonds are offered in denominations of $10,000 each and I only have 25 of them or $250,000 left. Would you be interested in purchasing any of those bonds for investment?” If the answer was no, as it most often was with this type of prospect, it didn’t bother me one bit. I wasn’t mentally dependent on selling any of these prospects or clients any of this Bond issue. I was, however, mentally engaged in developing and refining the perfect sales pitch for the issue. As I “practiced” on these folks, I gained more confidence and my sales pitch became very fluid and relaxed. When I was ready to approach my more valuable clients and prospects, the ones that I thought really would be interested in purchasing some of those Bonds, I was very relaxed, and my sales pitch was smooth. That relaxed, confident feeling was felt by my valuable clients and prospects and most often the sales effort was a success. Sometimes, to my pleasant surprise, the less valuable prospects and client base, that I was just practicing on, would actually buy some Bonds. Sometimes I’d have to call my valuable clients and apologize that I only had $100,000 left and I’d ask for forgiveness. That humility put them in a position of importance and out of the need to feel magnanimous they would say, "No problem, Tim, put me down for $25,000 of that issue.” Alternatively, even better “I’ll take it all.” “Can you get a hold of anymore of those Bonds?” Music to my ears as I would reply, “I doubt it, but I’ll try.” I usually could get more, but if I could not get anymore of that issue there was always another similar one coming down the pipe. Getting the Message Through You need to get the message of your securities offering through to all of your prospects in the most productive manner possible. Productivity here means spending your time efficiently and not wasting theirs. I have found that when talking to investors about a particular securities offering, the average attention span is limited to about 10 to 35 seconds max, unless of course they expressed real interest. Believe me, you’ll know. If they are not interested they’ll most likely change the subject or ignore you all together. Don’t bore people with your deal. If they do not indicate interest simply move on. Getting the message out is where one would spend the majority of their “Seed” capital. Later I will give you a few ideas on where to spend it. The Seminar Approach The seminar approach is a leveraged way to get your message out.

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For Private Offerings: We prefer mailing a seminar presentation invitation to all of the Management team’s personal and professional contacts. If you use Regulation A, a limited federal registration you can “Test the Waters” through general solicitation, like mass mailing a letter to accredited investors in and around your geographical area. Also for some limited private offerings you should check with your State’s Securities Regulatory office, as some States allows you to “Test the Waters” “Intrastate,” (within the state only). If so you may rent a mailing list of those accredited investors in your area and invite them to a very exclusive and private seminar. (See Regulation A in the Commonwealth Capital Club). Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time. Most marketing or mailing list companies have access to mailing lists for Accredited Investors. If you’d like to know what an accredited investor is, the definition is located in the Subscription Agreements contained in the Private Placement Memorandum section within the Templates. You will need to give the marketing company or the mailing list company your criteria for selection. The accredited investors must have annual income levels to a certain degree and/or a total minimum net worth. Simply look up a few marketing companies in the yellow pages. You will have costs associated for renting the mailing list, mailing to accredited investor prospects, and for the hotel conference room to hold the seminar. Remember, with a private placement you cannot advertise the seminar using the general media. To get more bang for your invitation dollar, offer a series of dates and times. Maybe 10:00-11:00 a.m. and 1:00-2:00 p.m. each on Friday and Saturday for the next two weeks. You do not want to open the window of opportunity too wide with additional weeks. If you decide on an evening seminar format, these seminars should be scheduled 5:30-6:15 Cocktails, 6:15-7:00 p.m. presenation. In any event, the presentation should last only 10 minutes and the time limits should be highlighted in the invitation. 10 minutes for Q&As. Cut it off at that point, make them want to know more on a private basis. Arrange for appoinments to meet with these prospects in the near future. Be brief and to the point on each section of your seminar. Pitch The Story: In 4 Short, 5 minute Steps. 1. Explain the “World” as it exists within the industry, in which your company has or will engage. Example: One of the fastest growing business segments of the Internet is on-line securities trading and investing. 2. Explain the “Problems” that exist in that world. Example: Most research and discount on-line brokerage companies have been giving their research to the on-line

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investor for no cost simply to attract their trading business. The problem for the on-line investor is that there is simply too much free research and information. It is becoming increasingly difficult for these on-line investors to make correct decisions because of all the data available. It truly a problem of “Information Overload.” 3. Explain the “Solution(s)” to those “Problem(s)” and how the solution(s) relate to your company making money. Example: We have developed a Web site that filters all this data down to meaningful decision-making tools. As former stockbrokers, we know how to minimize the data flow into a workable decision-making model. For a low monthly fee of $9.95, the on-line investor can utilize this system to make clearer, more precise decisions (The Niche Products and/or Services, which you’ve identified, that will properly serve the Market). 4. Explain the “Investment Opportunity” that now exists by purchasing securities in your company. Example: If we are able to tap into just 3% of this growing market over the next five years and if our financial projections prove to be correct, a $10,000 investment now should turn into $163,985.61 at the end of the seventh year, if we go public. That is internal rate of return of 49.12%. If not, the$10,000 should produce X amount of cash flow through dividend distributions, for an internal rate of return of 29.82%. Those four sections make up the introduction, the body, and the conclusion of your seminar and your sales pitch to be used over the phone or on the golf course. The first problem that you’ll probably run into when attempting to conduct seminars is that everyone has an excuse why they can’t attend the seminar. The holidays, tax time, kids are out of school, etc. It is now time to start spending some of that Seed Capital. I’d only invite the elite of your management team’s contacts or selected accredited investors to the following events. Consider a golf outing for attracting your best personal contacts and accredited investors. Make it on a weekday. Preferably in the mid-morning on a Thursday or Friday. Ask the golf course professional if you can have a 10:00-10:30 a.m. “shotgun start” with an hour lunch scheduled for 12:00 Noon or 12:30 p.m. (“Shotgun Starts” are where everyone goes out to different tees around the course and all start at the sound of a shotgun going off at the clubhouse, thereby everyone starts at the same time and everyone finishes at the same time). Make sure your invitations are golf oriented. For instance, “You are invited to The XYZ Widget Co. 1st Annual Golf Classic.” Make sure that your guests know that there is No Charge for them and that their green and cart fees have be taken care of, compliments of XYZ Widget Co. In addition, be sure to inform your guests of the special investment presentation to be held at lunch. Be upfront about your intentions to conduct an investment opportunity presentation during lunch. If you are not upfront about your motives, you’ll be wasting your money. Investors do not like to be tricked into a sales pitch and they may resent you for it. In all aspects of business, but especially when raising capital, honesty in not the best policy, it is the ONLY policy.

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Nine holes should take about two hours to play. After the first nine holes are played, you’ll want everyone in the clubhouse at the same time for lunch so that you and your management team can give the sales presentation. You want another “shotgun start” after lunch so that people won’t start going out of the clubhouse after they’ve eaten. In different parts of the country the golf courses have seasonal and non-seasonal rates. I’ve seen entrepreneurs drop $5,000 to close the course to the public for the day. I think that is one of the most professional ways to attract seminar prospects. Make sure there are complimentary cocktails and hors devours, as well as, door prizes and skins or “cash prizes,” after the outing. All compliments of your company. You’ll want a little shmooze time with your guests after the outing. You can have 18 foursomes, which equates to 72 potential investors, participate in an eighteen-hole shotgun start. However, husbands and wives sometimes play golf together, (although rarely in an outing), so they would be considered one buying or investing unit. The actual amount of buying or investing units should be between 36 and 72. If it ends up that your turnout represents an average of 54 investors, actual buying units, that is a rather productive way to spend your day. If your cost is $5,000 for the outing and you conduct 5 outings you should attract 270 buying units, on average, for $25,000. If you have your act together, you should be able to get half or 135 of them to invest at least $10,000 each. That’s $1,350,000. If you’re conducting an equity offering, you may be able to secure an additional $1,650,000 in debt for a total capitalization amount of $3,000,000. You also may want to consider a day or weekend cruise. It is the same basic invitation as the golf outing; however, it is a cruise with gambling or some other type of activity. One of our clients spent almost $12,000 on an afternoon cruise for about 50 doctors and their wives. The company raised just over $600,000 over the next six weeks primarily from that cruise. If you can present your presentation with multimedia, we STRONGLY suggest you do so. With a pre-edited electronic presentation burnt to a CD Rom, you can perfect your securities sales presentation. You will want your presentation to be absolutely perfect. You can’t afford to make any mistakes because you’re dropping big bucks for this sales effort and you won’t get a second chance to make a first impression. Besides, you could have your presentation running again in a more private room, off the main clubroom, after the outing and during the cocktail time. Give out the CD Roms that contain the multi-media presentation to everyone who attends, as part of a door prize package if you like. Allow those prospective investors to get a securities offering document during the event. Most multi-media pieces that we have had produced for our clients, contain the Private Placement Memorandum (PPM) embedded in the CD. This not only is a very simple and productive way to deliver the “sizzle” with the steak, but it will cut down on hard copy document printing costs as well. Also, remember to allow those prospective investors to get a securities offering document if they cannot attend your function.

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Depending on your company’s story, the length of the presentation and other considerations, the multi-media presentation, burnt onto 1,000 to 5,000 CD ROMs could cost $10,000 to $25,000. Expensive? Not really when you consider the productive impact that you can make on many different avenues with a multi-media presentation burnt onto a CD Rom. Once again “Seed” capital makes it happen. Make sure that the production of the multi-media presentation is orchestrated correctly. There are many more ways to do it wrong than right. You want the multi-media presentation to primarily sell securities and summarily be able to be inexpensively edited to sell your companies product(s) and/or service(s), as well as, to attract quality employees. Do it right the first time and you will be able to benefit from the production costs from many different angles. This is the first step in re-establishing a trust relationship with your personal and professional contacts, as well as establishing new trust relationships with newly acquainted accredited investors in your community. These are simply examples of how you can “capture” your seminar audience. You should tailor your creative ideas for a seminar to your particular region and/or situation. Proactive Prospecting For most forms of solicitation, the least expensive contact method usually results in the least effective process of producing qualified prospects, which in turn, lead to a lower sales closing ratio. E-mail Spam is the least expensive way to reach a mass audience and is, basically, a waste of time along with being a nuisance. Next, is newspaper advertising that is another avenue to reach a mass audience and generally results in a less than impressive response rate. Direct mail is probably the next least expensive and the response rate starts to improve, followed by telemarketing. In regards to a securities offering, if the securities are not registered, the above techniques will violate securities laws. Face-to-Face is the most expensive form of solicitation and the response rate starts to improve greatly. The Face-to-Face cold call can be used for the solicitation and sales of registered or securities that are exempt from registration, i.e. the private placement. Now stick with me here, as the following will relate to your prospecting process, I’m not just patting myself on the back. I started my securities industry career with Merrill Lynch in the early 1980’s, which was the largest securities firm in the U.S. at the time. There was also no question that they had the very best training program “On the Street” for new stockbrokers. Yes, back then we called ourselves stockbrokers. Even mother Merrill, or military Merrill as some referred to the company, placed a great deal of emphasis on cold calling over the phone to gain investor contacts and open accounts. Back then telemarketing was in its infancy, and the acceptance and response rate was far better than it is in today’s environment. Due to reluctance to engage in a telemarketing sales effort, I decided that I wasn’t going to cold call over the phone. Instead, I decided to cold call face-to-face. To improve my ability to actually make the face-to-face investor contact, I needed to design

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my life and my securities practice in such a way that would maximize my efficiency. I decided that my “Specialization” would be covered call writing. Covered call writing means buying a common stock and hedging the position by selling options against the stock for a premium, which would provide an immediate, although small, net profit for the client. If the stock went up far enough in the allotted time of the option, the client realized a greater profit through a short-term capital gain, as well. The stock would automatically be sold, thereby creating an automatic commission to me. Yeah! It would also create cash throughout my clientele and therefore I would have additional funds available to do it repeatedly. Yeah! Since options expire one day each month, I only needed to be in the office a few days just before and just after the expiration date(s). Yeah! This freed up my time greatly and the clients loved the idea that they would only trade automatically if an additional profit would be realized. This represented a clear win-win situation for the client and for me. Yeah! With my professional specialization in place, I could now use it as my “door opener” on the face-to-face cold calls. Back then, and even more so today, the average stockbroker would not know how to pick a decent covered write, (buy a stock and sell a call option, that has a very high probability of being called away or sold at an additional profit), if it stood up and bit them in the face. Therefore, for all intent and purpose, I had very little, if any, competition in my specialized field. That was my relative position of strength. Now that I had designed my professional specialization, I needed to further design my personal work habits, to fit nicely into that professional specialization. I needed clients that: 1.) Had more risk capital than the average retiree; 2.) Had the intelligence to understand what a covered write was; and 3.) Had a previous stockbrokerage relationship established. This last factor was one of the greatest advantages, because I needed to compete with all stockbrokers. I did not want to compete with bankers for CD deposits by selling bonds, because there was no money in it. The criteria provided me with a clear indication of the model client. A successful businessperson, who was used to taking on risk in many areas of their own profession or enterprise, therefore, I concentrated on cold calling, face-to-face, to business people as opposed to retirees, which seemed like every other stockbroker was going after. My prospecting process was developed as follows. I would get up early in the morning, drive to industrial parks, commercial office buildings, strip malls, construction sites and other areas where these types of prospective investors would be located. I would arrive at these various places between 6:00 and 9:00 AM, to avoid the secretaries who would perform the task of “gatekeeper.” I would simply introduce myself, with business card in hand, and comment that I was simply on my way to work and that I just wanted to stop by and introduce myself. Most where shocked at seeing this young, welldressed professional, knocking on their door at such an early time in the morning. The overwhelming response was “I get cold called on the phone all day by stockbrokers, but I never really met one.” Of course, my response would be along the lines of “they’re probably just rookies trying to beat out a living.” Of course, I was as green as a rookie could get.

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I would collect about 15 to 20 business cards before the day began and add them to my rolodex. Because this effort was so successful I would continue throughout most of the day and collect even more business cards. On average I personally introduced myself to at least 100 qualified investors every week. I was done prospecting, each day, before the other brokers were finished with their first cup of coffee. I opened many accounts from this effort and my manager left me alone, which is THE goal of every stockbroker, because it means that you are making money for the management and yourself. How many phone calls do you think it would take, every week, to establish that many personal introductions. Today, you would be lucky to receive a 2% response rate. That would equate to 5,000 phone calls per week, a 1,000 a day, 125 calls an hour or 2.08 calls per minute. Now that is exhausting hard work. Work smart, not hard. The very first Face-to-Face cold call is obviously the most difficult, because you are dealing with the unknown. Dealing with the unknown creates fear as a normal human reaction. You need to ask yourself, “What’s the worst that could happen?” Probably the worst that could happen is that some jerk would say, “Get out of my office and don’t come back.” When you think about it, would you really want this person as your client or investor? Not likely. Moreover, that person didn’t waste my time. I would much rather be told something like “I don’t have any money” or “I hate stockbrokers” rather than have someone lead me on and waste my time, by leading me to believe that they are very interested and have lots of money to invest, when in fact they do not. So, if you get a nasty rejection, be thankful that your time is not being wasted and just move on. As a quick side note, there are some really strange birds out there. There are those who have nothing better to do but waste your time, there are those who are simply dreamers or thinkers and will never be “doers,” and there are those that are just bold faced liars. (Sorry, sometimes the truth is brutal). Here are a few techniques to clear through the proverbial clutter that is out there. First, if the prospective investor has a securities brokerage account, ask them about what they like or dislike about some of their investments. Listen carefully to how they respond. You should be able to pick up an indication if they are full of it or not, just from this portion of the conversation. Make the general assumption that they may be at least exaggerating. On the follow up process (its three strikes and you are out), if they cannot commit to your company’s securities offering by the third contact then move on and never look back. By doing so, you will avoid passing up investor prospects that will commit their funds to your company. Real investors make decisions rather quickly. You may be wondering if I am expecting you to actually cold call in this way. Not necessarily, but if cold calling needs to be done to increase the probability of your company’s capital raising effort, I am relating to you what has been most effective for me as a former stockbroker. After establishing that the prospective investor is “real” and has interest in your company’s securities offering, simply give them your sales pitch and hand them a PPM. Remember, the distribution of a PPM is a legal requirement and not necessarily the

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ultimate sales tool. Although our securities offering document Templates are written in the fashion of a sales tool, ultimately you and your management team must sell the deal. Prospecting in Every Day Life In every day life, you are going to want to be able to give your “Elevator Pitch” as quickly as possible, to create curiosity first. Develop a 20 to 30 second sales pitch that can be followed up with a 5 to 7 minute sales pitch (something that you can use on the phone or on the golf course). Pitch it and drop it. Create some mystery here. Remember, you’re offering an exclusive opportunity. Keep the mind set that you’ll choose whom you will let in the deal and not the other way around. Example: Tim: “Hey Tom, did you know our company is serving an untapped niche segment of the investment banking industry?” Tom: “Oh?” Tim: “Yeah, after being in the industry this long, we finally realized that the vast majority of entrepreneurs need help in raising capital, so we put together the first in a series of transactional tools, called Financial Architect® 4.0. It’s a software template program that enables any entrepreneur at any stage in the capitalization process to, legally and effectively, raise capital in the United States?” Now the 20 or 30 seconds is up and the prospect either has an interest in hearing more or not. If you’ve sparked their curiosity continue. If not, move on. Tom: “Wow! How does it work?” Tim: “Its comprised of three interdependent components: 1.) The Ebook, which informs the entrepreneur on how the world of capitalization works, from an investment banker’s standpoint, serves as the instruction manual for the second component; 2.) The securities offering document production Templates, which enables them to produce their own securities offering documents in record time at a small fraction of the standard cost; and 3.) The Commonwealth Capital Club, which is a password protected area on the website that houses the critical compliance component and the links to accredited investors around the world.” Tom: “How are you marketing the program?” Tim: “Through a network of affiliated professionals, such as attorneys, accountants, business incubators, trade associations, investment banks, venture capitalists, and other organizations that are involved in promoting entrepreneurship in the U.S.” Tom: “Why did you choose that route?”

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Tim: “Because the product line and affiliation network naturally expands and enhances the business of those entities. Although, everyone gets a fee for the sale of the programs, the most important aspect is that the attorneys and CPAs get the document completion and review work from a whole new market segment that could not normally afford the standard costs associated with the process. And what happens when the entrepreneur actually raises the required capital? The attorneys and CPAs have new client with funds available for other services, which they will invariably need. As far as the venture capitalists, investment and commercial banks are concerned the process allows them to build a “farm club” of potential quality deal flow, which is always in demand. It’s a win/win situation for everyone.” Tom: “What about non-profit organizations like University Incubators, Economic Development Centers, Trade Associations and Chambers of Commerce?” Tim: “Good question. These organizations are tasked with the responsibility to promote economic development, geographically or by industry, and therefore the affiliation network is perfect for them, because all affiliates can provide this instruction manual to any entrepreneur for a free complimentary review, so the entrepreneur can make a qualified decision on whether or not the program is right for them. The worse case in this scenario would be that every entrepreneur receives a valuable education, in regards to raising capital, for free.” Tom: “Is there any liability in becoming an affiliate?” Tim: “According to our attorneys, very little because of the programs are simply preparation tools that one completes for legal and tax counsel review. The programs are simply designed to save the average entrepreneur a vast majority of the costs involved with these processes by completing the majority of work themselves.” Tom: “It sounds like you really have thought this through. Have you got a business plan?” Tim: “As a matter of fact, we our conducting our own securities offering now and we do have a Private Placement Memorandum, if you are interested in learning more about possibly investing in the company”…(FOR EXAMPLE ONLY. DOES NOT CONSTITUTE A SOLICITATION FOR THE SALE OF SECURITIES). Remember, there is a ton of money out there looking for good opportunities. Sometimes people want what they cannot have, keep that concept in mind as well. Productive prospecting and good selling techniques are based on asking questions and listening. You have one mouth and two ears, so let the ears do twice the work. The questions you should ask should relate to your efforts in seeking an indication of interest of your company’s securities offering.

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The Follow Up The deal structure that you have created should sell itself, as it should serve as the sizzle, as well as, the steak. If your sales pitch can include an indication that you are also at risk, like “If this project fails I lose not only my money, but my house as well,” Investors will feel much better about cutting a check or signing a personal guarantee on a bank loan. *Ask for the money: There are many closing techniques for this. However, remember you’re not selling used cars here. Your approach should be soft and slow. “What level of financial commitment do you feel most comfortable with? $25,000 or $50,000? No…would $10,000 be more comfortable?” If your prospect’s response is a flat NO, don’t say “Why Not?” Just say in an inquiring tone...“Oh?” You want to ask questions that are more open-ended. You want to find out what the real objection is. You will not know unless you persist. Don’t say, “When can I come buy to pick up the check?” This makes you seem too eager and is likely to make the prospect reluctant to invest. Rephrase it in a softer, sophisticated tone. “Would you like me to stop by this afternoon to pick up your investment?” Don’t say, “Why don’t we have lunch next Tuesday and we’ll complete the transaction then.” Start it off with, “Would you like….” “Would you like to have lunch next Tuesday and we’ll complete the transaction then?” By taking this stance you’re at his or her service in a very professional manner. “Would you like to put this investment in your self-directed IRA to avoid a potentially large capital gains tax?” Incidentally, some people do not think of their IRA as money, they think of its assets, as a long-term investment because, more often than not, they were sold the investments within the IRA as such. Sometimes they don’t know that those investments can be sold to produce the cash available for an investment in your company’s securities. (See the Commonwealth Capital Club on techniques and procedures to attract qualified plan funds, such as IRAs, SEPs & Keoghs, to capitalize your company.) In the follow-up call you need a reason to call. Don’t just say, “I’m calling to just follow up and see if you have any questions about our securities offering?” That is an incredibly unprofessional call. Don’t call until there’s a reason. Reasons would constitute reaching certain milestones in your project or in the capital raising effort itself. Let us say that you were raising $300,000 in equity and there’s only $150,000 left. That would constitute a reason to call. Let us say that you’re prototype product has a newly developed technology or application added to the product. That would also constitute a reason to call. You want to keep your very best prospective investor(s) informed. You should call every 60 or 90 days just on a friendly, “Thought I’d let you know where we are at” kind of call. Investors appreciate this. You are letting them know that you are still around plugging at it and that you are truly committed to the process and moving in a positive direction. Only create a sense of urgency and a call to action or commitment, if it feels right.

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Electronic Posting on Various Websites The Commonwealth Capital Club has links to various websites where you can post your completed securities offering document electronically or digitally. We provide this as a valuable tool to enable you to access many accredited investors inexpensively. However, as with most things in the business world, you get what you pay for. Posting your completed securities offering document electronically or digitally while very inexpensive, the results are mixed at best. But, sales is a numbers game and you never know, you may find a nest of angel investors that are familiar with your company’s business through electronic posting. However, this may be considered general solicitation and therefore depending on your company’s circumstances, your company may not qualify for an exemption from registration. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time. More often than not, you are better off buying a list, from a direct mailing list company, of accredited investors who are geographically close to your company so that a personal meeting can be made easy. There’s nothing like a face-to-face meeting to get the trust relationship started.

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Compliance with Federal and State Securities Laws The Critical Compliance Component is included only in the Commonwealth Capital Club. Do not attempt to issue securities without reviewing that critical information. Review the “Compliance” area inside the Commonwealth Capital Club at our website www.commonwealthcapital.com, using you User ID and Password you established when you purchased this program, for information concerning Compliance with Federal and State Securities Laws. There you’ll find instructions on filing Form D “Notice of Sales” with the SEC, which you must do within 15 calendar days of the first sale, and each subsequent sale of securities, thereafter. Peruse the links to the various regulatory authorities to keep updated on any changes in Federal and State Securities Laws, which may change from time to time. We decided to keep the Compliance section of this program separate from this instruction manual, so that we may send out notifications or new Compliance files to the members of the Commonwealth Capital Club, when necessary. Once again, be sure to check with your attorney before conducting the actual offering of securities, as securities, organizational structures, tax, and procedural laws, rules and regulations can change at any time.

In Conclusion… The bottom line in successfully raising capital for start-up, early stage, and seasoned companies, while maintaining control of the company and retaining the maximum equity for yourself and/or your management team is by using the Wall Street process of raising capital, as disclosed throughout this program. This often takes time, money, and a concerted sales effort. Plan on it and be patient. I know I keep bugging you about this, but I strongly encourage you to develop and conduct a Seed Capital Securities Offering before conducting a larger development capital offering, especially if your larger development capital offering is going to be in the neighborhood of 1 to 5 million dollars. This strategy will afford you with the patience it will take to complete your company’s capital raising effort. Remember, throughout the entire process you must analyze the deal and remove as much risk from the investor’s side of the equation as possible. If you do this, you should be successful in funding your start-up, early stage, or seasoned company. We hope to hear of your successes soon in the Commonwealth Capital Club. We envision the Commonwealth Capital Club to not only be a depository of other links to other related sites, but also providing good concrete information concerning all aspects of raising capital and growing your business. We want to make the Commonwealth Capital Club a private and exclusive club where “Tricks of the Trade” can be disclosed in a confidential manner. Be sure to check it out and give us your comments.

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Our goal is to make the Commonwealth Capital Club a very valuable club for our members. Maybe someday, you can contribute your wisdom and experiences to the Commonwealth Capital Club to help others just starting out. Good Karma. I know that if you follow the steps in this program, you should raise some if not all of the capital you seek and with practice, you will raise as much as your company needs. It is now up to you. You can do this. I know you can, because you have committed yourself to this program and by completing it, you are they type of person with the guts to get the job done. You are one of the very elite in the world of entrepreneurship. Don’t forget it and don’t let anyone discourage you from accomplishing your goals. Remember, there are talkers and there are doers. Talkers will drain your energy and doers will inspire and energize you. Hang out with the Doers and tell the Talkers, well… to find someone else to talk to! Take Care, Good Luck, and God Speed.

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Exhibit A Sample Private Placement Memorandum

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Offeree_________________________________________________ No. ______

PRIVATE PLACEMENT MEMORANDUM

XYZ Company, Inc. Third Round: 1st Stage Development Capital

EQUITY CAPITALIZATION Common Stock - Class A Voting

No. of Shares

Price Per Share

Discounts & Commissions Percentage

50,000

$100.00

00.00%

Aggregate Discounts & Commissions $00.00

Proceeds To Issuer $5,000,000

The Securities offered by this Memorandum are offered only to a limited amount of non-accredited investors (35) and an unlimited amount to accredited investors who meet the Accreditation Requirements, as set forth under the Securities Act of 1933 Sub-Section 4(2), Regulation D, 504, 505 or 506, and 4(6) the “Accredited Investor Exemption” as denoted within the “Subscription Agreement” contained herein. Only such person(s) or entities are authorized to receive this Private Placement Memorandum and participate in the offering. The Securities offered hereby have not been approved or disapproved by the Securities Exchange Commission, or any State’s Securities Bureau, nor have the forgoing authorities passed on the accuracy or adequacy of the Memorandum. Any representation to the contrary is a criminal offense. These securities may not be sold, transferred, or otherwise disposed of by an investor in the absence of an effective registration statement or an opinion of legal counsel that registration is not required. The securities are to be considered illiquid. No public market exists for these securities. The Management cannot guarantee, warrant, or further assure that any type of liquid market will develop. The securities offered herein are to be considered high risk in nature. Private Placement Memorandum Dated 04/15/0?. Offering expires 12/31/0?.

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TABLE OF CONTENTS Headings

Page

INTRODUCTORY STATEMENT STATE RESTRICTIVE LEGENDS EXECUTIVE SUMMARY Tax Structure Exit Strategy Estimated Earnings per Share Company Valuation Estimated Annualized Compounded Rate of Return in a Private Market Estimated Annualized Compounded Rate of Return in a Public Market

5 6 7 7 7 7 7

SUMMARY OF THE OFFERING Securities Offered Capitalization

8 8 9

THE COMPANY History Current Status Future Goals

9 9 9 9

THE PRODUCTS XXYYZZ AABBCC Patent Status Testing & Prototyping Product Benefits Fuel Savings Research Product Validation Research Marketing the Products Distribution Strategy

9 9 10 10 10 10 10 10 10 11

MANAGEMENT THE INDUSTRY TERMS OF THE OFFERING General Investor Representations Representations, Warranties and Covenants of the Company Capitalization Plan Minimum Purchase Requirement The Offering Period Availability of Information

11 13 13 13 13

3

7 8

14 14 14 14 14

Escrow Agent Registrar and Transfer Agent Shareholder Right of Inspection of Corporate Books and Records Plan of Distribution Size of Offering Estimated Use of Proceeds Statement Prior Offerings Documents Incorporated by Reference Description of Common Stock Voting Control Voting Rights Preemptive Rights Company’s First Right of Refusal To Purchase Class A Common Stock Shares

14 14 14 14 15 15 15 15 15 15 15 16 16 16

RISKS AND OTHER IMPORTANT FACTORS Best Efforts Offering Limited or No Substantial Operating History No Guarantee of Profitability No Guaranteed Return of Investor’s Capital Contributions Dividends on the Common Stock Shares Capital Requirements Arbitrary Determination of Offering Price Competition Reliance upon Management Reliance of Market Research Governmental Regulation Financial Projections Restriction on Transfer Private Offering Exemption No Litigation Dilution

16 17 17 17 17 17 17 17 17 18 18 18 18

INVESTOR SUITABILITY STANDARDS

18

List of Exhibits: Exhibit A - Pro Forma Financial Projections Exhibit B - Articles of Incorporation Exhibit C - By-Laws Exhibit D - Subscription Agreement Exhibit E - Current Financial Statements Exhibit F - Industry Articles and Supporting Documents

19 31 32 33 35

4

16 16 16 16

(YOU MAY HAVE ADDITIONAL HEADINGS AND SUB-HEADING IN THE TABLE OF CONTENTS. THE FOLLOWING ARE THE MINIMUM REQUIRED DISCLOSURES THAT MUST BE INCLUDED TO CLAIM EXEMPTION FROM REGISTRATION AND THEREFORE SHOULD NOT BE ELIMINATED) (THE PAGE NUMBERS SHOULD BE CHANGED ONCE 100% OF THE CHANGES ARE MADE TO THE MAIN TEXT BODY OF THE PPM)

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INTRODUCTORY STATEMENT (REMEMBER, EVERYTHING IN BLUE NEEDS TO BE ALTERED TO FIT YOUR COMPANY’S INDIVIDUAL SECURITIES OFFERING. ONCE THE CHANGES HAVE BEEN MADE, RETURN THE COLOR TO BLACK. THE UPPER CASE WORDS IN BLUE ARE DIRECTIONS FOR YOU. ONCE THE CHANGES HAVE BEEN MADE DELETE THESE BLUE PARAGRAPHS.) (AREAS DENOTED WITH RED TEXT WERE PURPOSEFULLY LEFT INCOMPLETE. THESE AREAS ARE INCLUDED IN THE FINANCIAL ARCHITECT® 4.0 PROGRAM). XYZ Company, Inc., “The Company”, or “The Firm”, is offering the Common Stock Shares in the form of “Class A Common Stock Shares” or “Shares” only to a limited number of investors who meet certain qualifications necessary for the offer and sale of the Class A Common Stock Shares to be exempt from registration under state and federal securities laws This area is incomplete in this example. This area will describe the nature of the offering, the amount being offered, to whom it is being offered and describe the type of offering the company is making and disclaimers about the contents of the Memorandum. The company’s obligations to the investor will also be listed. NOTE: This area is included in the Financial Architect® 4.0 program. This investment involves a high degree of risk. The Company is in the early stages of development and expansion with a limited history of proven record of business operations in these products and service applications as described throughout this Memorandum. An investor could lose his/her or its entire investment in the Shares offered hereby. Among the risks and other factors to be considered carefully by potential investors are those set forth below under the heading “Risks and Other Important Factors.” This Memorandum has been prepared solely for informational purposes and is for distribution to a limited number of investors. The Company anticipates that this offering may continue through (OFFERING TERMINATION DATE) unless the Company, in its sole discretion, sooner terminates or extends the offering. Management shall use the proceeds from this offering as received. The Balance of This Page Was Intentionally Left Blank (THE PRECEDING STATEMENT NEEDS TO BE INCLUDED ON ANY PAGE WHICH IS NOT FULLY COMPLETE)

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STATE RESTRICTIVE LEGENDS THE INCLUSION OF RESTRICTIVE LEGENDS FOR EACH STATE IN THIS MEMORANDUM IS NOT INTENDED TO IMPLY THAT THE SECURITIES COVERED BY THIS MEMORANDUM ARE TO BE OFFERED FOR SALE IN EVERY STATE, BUT IS MERELY A PRECAUTION IN THE EVENT THIS MEMORANDUM MAY BE TRANSMITTED INTO ANY STATE OTHER THAN AS MAY BE DELIVERED BY THE COMPANY. Individual State Restrictive Legends are listed in this area, 12 pages in total. NOTE: The State Restrictive Legends are included in the Financial Architect® 4.0 program. The Balance of This Page Was Intentionally Left Blank

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EXECUTIVE SUMMARY (THESE ARE EXAMPLES ON HOW TO START YOUR EXECUTIVE SUMMARY, MAKE ADJUSTMENTS AS NECESSARY) In this area you will give a brief description of your company. NOTE: an example for this area is included in the Financial Architect® 4.0 program. Tax Structure. XYZ Company, Inc. has elected to be tax as a C Corporation. Therefore, the Company will be subject to federal and state corporate taxation and shareholders will only realize a taxable obligation in the event of dividend distributions. (THIS STATEMENT IS ONLY ACCEPTABLE IF TRUE. IF NOT THEN YOU MUST AMEND THIS STATEMENT ACCORDINGLY). (IF YOUR COMPANY IS AN S CORP, LLC, OR PARTNERSHIP YOU SHOULD REPRESENT THAT THESE TAX OBLIGATIONS ARE TO BE PAID TO EACH SHARE HOLDER, PRO RATA, TO COVER ANY TAX OBLIGATIONS CREATED BY THE COMPANY. BY DOING SO, THE ESTIMATED NET INCOME FIGURES YOU WILL ILLUSTRATE ARE “AFTER TAX” RETURNS. YOU MAY DENOTE THAT FACT IN THE ESTIMATED COMPOUNDED RATE OF RETURN ILLUSTRATION.) Exit Strategy. The exit strategy for the Stockholders in the Company is planned to be in the form of annual cash distributions to be issued in the form of “Dividends” starting at the end of year 3, 200?. Management has expressed a desire to take the company public by executing an Initial Public Offering after the fifth year, assuming that it is prudent to do so. (DELETE THIS STATEMENT IF IT IS UNTRUE). Estimated Earnings Per Share. The outstanding common stock shares divided by estimated net income. Out of the total authorized shares of 100,000, it is assumed that 100,000 shares are outstanding by the end of year 1 through the end of year 5. Estimated Dividend Distributions Per Share. 1. Year 2005: $5.88 2. Year 2006: $9.25 3. Year 2007: $11.44 Company Valuation. The valuation of a share of common stock of the Company was calculated by multiplying the current outstanding shares in each year by the estimated share price based a simple Price Earnings (P/E) Ratio of 5 for the Privately Held Scenario and a PE Ratio of 25 for the Publicly Held Scenario. *Estimated Internal “Realized” Rate of Return in a Private Market for the Common Stock Shares The Estimated Private Market Value per Share was calculated by multiplying the P/E Ratio times the estimated net earnings per outstanding Share to arrive at the per Share

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figure at the end of the fifth year. The accumulated dividends are also added to the estimated share price to arrive at the total aggregate figure. The Standard Internal Rate of Return formula was use to calculate the percentage of . *NOTE: The estimated share and company value at the end of year 5 was not taken into account as we are calculating an Estimated Internal “Realized” Rate of Return for the common stock. The Estimated Internal Rate of Return, would normally include realized and un-realized gains and losses, however, when dealing with illiquid securities, it is generally wise to not include unrealized profits from the sale of stock or the company’s assets. If the company was sold at the end of year 5 or the securities became liquid, then the net selling price would be added to the IRR calculation string in year 5. (ALL MONETARY AMOUNTS WILL NEED TO BE ADJUSTED ACCORDINGLY TO FIT YOUR SPECIFIC COMPANY’S FINANCIAL STRUCTURE). SUMMARY OF THE OFFERING Securities Offered. The securities offered, are herby made available to the prospective investor(s) who are named on the cover page of this Private Placement Memorandum. The $5,000,000 in this initial first round of financing of Common Stock, “Stock”, “Shares”, sought through this securities offering, is to be used as general working capital to provide the initial capital to execute the business plans contained herein. (See “Sources and Uses Statement” included in the “Pro forma Financial Projections” in Exhibit A). Fifty Thousand (50,000) Common Stock Shares are hereby made available to the prospective investor(s) who are named on the cover page of this private placement memorandum. The securities are offered at a per share price of $100.00. The minimum purchase amount is 100 shares for an aggregate dollar amount of $10,000. Pro Forma Financial Projections in Exhibit A illustrate selling 50,000 shares of common stock at a per share price of $100.00. The shares offered herein are offered on a first come first served basis. The Company currently has 60,000 Class A Common Stock shares authorized. The Company shall amend its Articles of Incorporation to provide for an additional authorization of 40,000 shares, before the end of this year 200?, for a total of 100,000 shares authorized for distribution. Therefore, 50,000 shares were used as a fully diluted base reference point representing 50% ownership in the Company. (THIS STATEMENT IS ONLY ACCEPTABLE IF TRUE. IF NOT THEN YOU MUST AMEND THIS STATEMENT ACCORDINGLY). Capitalization. Management has formulated XYZ Company, Inc. capitalization and organizational structure to provide for maximum rate of return potential to all investors.

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Management may elect to suspend, discontinue, or cease this offering at any time for any reason or for no reason. Management reserves the right to formulate the firm’s capitalization strategy on an “as needed” basis. THE COMPANY (THE SECTIONS FROM HERE TO “TERMS OF THE OFFERING” SHOULD CONTAIN MOST OF YOUR BUSINESS PLAN AND SHOULD BE CHANGED IN ACCORDANCE. REMEMBER, YOU NEED TO CHANGE THE GRAMMATICAL STRUCTURE TO THE THIRD PERSON. THIS SECTION INCLUDES THE STORY OF THE COMPANY’S HISTORY, ITS CURRENT OPERATING STATUS, AND PLANS FOR THE FUTURE. ORGANIZATIONAL CHARTS MAY BE USED AS WELL AS REFERENCE TO PATENTS, ETC. PATENT DOCUMENTS SHOULD BE ADDED AS ADDITIONAL EXHIBITS.) History. You should include a basic rundown of your company’s existence and operations. NOTE: an example for this area is included in the Financial Architect® 4.0 program. Current Status. You should include a basic rundown of your current operations. NOTE: an example for this area is included in the Financial Architect® 4.0 program. Future Goals. You should include a basic rundown of your future operations. NOTE: an example for this area is included in the Financial Architect® 4.0 program. THE PRODUCTS The XXYYZZ. To understand how the XYZ technology works, it is necessary to understand the combustion process first and then look at how this works in the diesel engine. This is how the technology works…. In this area you should briefly describe the product, what it is used for and what role it will play in the marketplace. NOTE: an example for this area is included in the Financial Architect® 4.0 program. The AABBCC. This breakthrough device is a specially developed system that controls the fuel injection in diesel engines and direct injection gasoline engines. This is done in

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such a way that all the fuel injected into the combustion chamber will be almost completely burned. More Products using this technology are to be produced using the R&D budget. Patent Status. A patent search for the “XXYYZZ” has been conducted by corporate patent council, Our Company’s Law Offices, Ltd., Patent Law Building, 3717 Columbia Pike, Arlington, Virginia 22204. Phone number, 1-800-4PATENT. The results were that there are no existing patents for these inventions and it is the opinion of the firm’s attorney, John Doe (the contact at Doe Law Offices who can express opinions on any patent questions) an engineer with 28 years of service working in the United States Patent and Trademark Office, that the devices submitted are patentable and that process is presently underway. The “AABBCC” is undergoing a patent search with Doe Law Offices. No results are available at this time. Testing and Prototyping. The operation of the XXYYZZ results in has major enhancements to the diesel engine: 1. List your product benefits in this area. 2. 3. NOTE: an example for this area is included in the Financial Architect® 4.0 program. Fuel Savings Research. List all market research projects in this area with their results. NOTE: an example for this area is included in the Financial Architect® 4.0 program. Product Validation Research. The following is collaborative evidence from Engine Research Laboratory that the AABBCC is a proven technology. Independent verification of the scientific soundness of Dr. Zchevago’s inventions has been provided by Professor Jane Doe, of the Engine Research Laboratory. This Laboratory is a privately run research operation funded in large part by large corporations conducting R & D projects on engines and combustion. Professor Doe and members of her staff reviewed Dr. Zchevago’s work carefully during a special presentation arranged for the laboratory. They judged the scientific theory and evidence presented on the AABBCC compelling enough to offer to help set up the development and testing of working models at her laboratory in preparation for introduction of the products to leading injector and diesel engine manufacturers. Marketing the Products. The Company plans to take advantage of its technological supremacy to launch the XXYYZZ & its extensions. XYZ will pursue a segmentation strategy focusing initially on the aftermarket followed by diesel engine manufacturers (OEMs) as its priority targets. XYZ will then expand its marketing drive to encompass the mass consumer automobile market, first domestically, then in Europe, South America, then in Asia and finally to other areas around the world. To amplify the impact of this plan, all the strategies, tactics, and programs devised for this launch will be

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analyzed and adapted in the context of the proven marketing disciplines of the packaged goods and commercial and consumer automotive industries. Distribution Strategy. XYZ Company, Inc.’s distribution strategy is to take place through a series of licensed dealers/distributors. The licensees are to have distribution responsibilities for all non-house accounts in their respective territories. This dealer network is similar in financial and production planning and cash flow to typical auto dealers. Export sales goals are also to be met through the licensed dealers/distributors. The Company will target national trucking fleets and parts suppliers such as Auto Parts (6,000 stores), Advanced Auto (2,400 stores) and Car Auto Parts (4,000 stores). MANAGEMENT (BY LAW THE COMPANY MUST HAVE A PRESIDENT, TREASURER AND A SECRETARY, WHICH ONE OR MORE PERSONS MAY SERVE IN ALL CAPACITIES. PLEASE DETERMINE WHO IS TO SERVE IN THESE CAPACITIES AND LIST NAMES AND CVS). Chairman & CEO: (Name) Mr. (Name) has worked in the trucking industry for the past 39 years in various functions. Mr. (Name) shall be responsible for developing and maintaining the vision of the Company along with identifying and overseeing new strategic directions, identifying funding sources and maintaining key financial relationships, spearheading the corporate acquisitions drive and seeking business opportunities and strategic alliances with other companies and organizations. Vice President: (Name) Mr. (Name) earned his degree from ABC University and has worked for Smith & Smith Company as a Senior V.P. of Operations responsible for…. Mr. (Name’s) responsibilities shall include supervising all domestic and international operations, organizing a highly professional management team, guiding the Company through the key startup and expansion phases, overseeing all daily operations and communications, supervising all strategic planning, and managing all relations with strategic partners. Director of Research & Development: Dr. Mumar Zchevago. Dr. Zchevago is a graduate of the Technical University. He earned his Bachelor of

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Science in Mechanical Engineering and his Ph.D. in Molecular Physics. Dr Zchevago was an Associate Professor for Engines, at Technical University. He worked in the Space Program’s Engine project and Liquid Oxygen Engine project. Dr. Zchevago has also published papers for the Society of Automotive Engineers. Dr. Zchevago’s responsibilities shall include supervising the research, development and testing operations of the Company, supervising the design of the manufacturing process for the technology, supervising all production quality control systems, evaluating competitive technologies and furthering product development and expansion. Vice President of Production and Quality Control Manager: (Name) Ms. (Name) is a graduate of State University where she studied business management. Ms. (Name) has worked extensively in the automotive parts production industry. At Moore Industries, she worked on planning and production for automotive clients. Other responsibilities included managing the complete manufacturing and shipping process. Ms. (Name) is a member of an Organization. Ms. (Name)’s responsibilities shall include managing all XYZ production facilities and relations with sub-contracted manufacturers, managing all raw material purchasing and maintaining inventory, managing all aspects of quality control, supervising all production scheduling, supervising the in-house project management staff. Vice President of Sales & Marketing: (Name) Mrs. (Name) completed his undergraduate studies at State University. She then obtained a master’s degree in Marketing from College. Mrs. (Name) has extensive engineering and sales management knowledge. She has taught classes on chemical instrumentation technology for Institute of Technology. Mrs. (Name’s) Responsibilities shall include managing market planning, sales forecasting and US sales/marketing operations with primary emphasis on major trucking firms, supervising all relations with industry affinity & trade groups, organizing a highly professional sales team and managing all relations with support groups such as Advertising and PR Agencies. Treasurer &Controller: (Name) Mr. (Name) received his degree in Accounting from College. He opened his own firm in 1992. Mr. Name’s Responsibilities shall include managing all working capital including receivables, inventory, cash and marketable securities, performing financial forecasting including capital budget, cash budget, pro forma financial statements, managing all external financing requirements and financial condition requirements, directing preparation of budgets, assisting the Executive Vice President in all aspects of financial planning, establishing and managing the Company's management information systems.

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(ADD MORE OFFICERS AND DIRECTORS IF NEEDED). THE INDUSTRY The American Freight Carrier Industry breaks down into four key segments: • •

• •

Air: Commercial or private aircraft and all air service for shipments that typically weigh more than 100 pounds. Includes airfreight and air express. Rail: This industry segment comprises establishments primarily engaged in operating railroads (except street railroads, commuter rail, urban rapid transit, and scenic and sightseeing trains). Line-haul railroads and short line railroads are included in this industry. Truck: Private Trucks and For-Hire Trucks. Water: Shallow Draft Vessels and Deep Draft Vessels.

In this area you will give a brief synopsis of your industry’s current status. NOTE: an example for this area is included in the Financial Architect® 4.0 program. TERMS OF THE OFFERING General. The $5,000,000 in this initial first round of financing of Common Stock, “Stock”, “Shares”, sought through this securities offering, is to be used as general working capital to provide the initial capital to execute the business plans contained herein. (See “Sources and Uses Statement” included in the “Pro Forma Financial Projections” in Exhibit A). Fifty Thousand (50,000) common stock shares are hereby made available to the prospective investor(s) who are named on the cover page of this private placement memorandum. The securities are offered at a per share price of $100.00. The minimum purchase amount is 100 shares for an aggregate dollar amount of $10,000. The Pro Forma Financial Projections in Exhibit A illustrate selling 50,000 shares of common stock at a per share price of $100.00. The shares offered herein are offered on a first come first served basis. Investor Representations. The securities will be offered to… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Representations, Warranties and Covenants of the Company. 14

The Company

represents, warrants, and covenants for the benefit of purchasers of the securities that: NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Capitalization Plan. Management believes… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Minimum Purchase Requirement. Each qualified investor will be subject to… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. The Offering Period. The offering extends from… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Availability of Information. Prospective investors and their investment advisors are invited to communicate with… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Escrow Agent. There is no minimum aggregate offering amount… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Registrar & Transfer Agent. As with most private placement offerings, the Company shall act as…. NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Shareholder Right of Inspection of Corporate Books and Records. In compliance with… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Plan of Distribution. The Common Class -A- Voting Stock will… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program.

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Size of Offering. Amount of Shares Offered Price Per Share Commissions Net Proceeds to Firm 50,000 $100.00 $0.00 $5,000,000 NOTE: Proceeds to the Company are computed before deducting… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Estimated Use of Proceeds Statement. The $5,000,000 in cash shall be allocated in conjunction with… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Prior Offerings . There has been no other prior execution of a securities offering… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Documents Incorporated by Reference. All of the information contained in this Memorandum and the enclosed Exhibits are hereby incorporated herein by… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Description of Common Stock. In this area you will describe the amount of stock available, whether dividends will be provided, transferability, and list owners of any stock (if applicable). NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Voting Control. The Class A common stock shareholders have… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Voting Rights. The Class A common stock shareholders have… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Preemptive Rights. Management, out of general courtesy to its existing shareholder base, shall…

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NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Company’s First Right of Refusal. XYZ Company, Inc. reserves the right as a “first right of refusal” to… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. To Purchase Class A Common Stock Shares. To purchase the Class A common stock shares offered herein, the… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. RISKS AND OTHER IMPORTANT FACTORS Any person contemplating an investment in the securities offered herein should be aware of the risk factors relevant to the offering and should consider, among other things, those factors set forth below. Best Efforts Offering. This offering is being conducted on a “best efforts” basis by the Company's Officers and Directors only. No other individual may solicit or sell the NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Limited or No Substantial Operating History. The Company is a development stage company recently formed, (200?), the purpose of… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. No Guarantee of Profitability. The Company anticipates that profit from aftermarket sales will be sufficient to… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. No Guaranteed Return of Investor’s Capital Contributions. The Common Stock shares offered hereby are… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program.

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Dividends on the Common Stock Shares. The Company intends to pay dividends on the Shares once… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Capital Requirements. Management believes that the capital raised from this offering will be sufficient to cover costs to… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Arbitrary Determination of Offering Price. Management believes it has priced the securities offered herein to provide for NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Competition. Management believes that… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Reliance upon Management. The success of the Company depends to a large degree upon… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Reliance on Market Research. A substantial portion of the market research conducted for this project is… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Governmental Regulation. (ADD ANY STATEMENT CONCERNING THE OVERSIGHT OF ANY FEDERAL AND STATE AGENCIES, WHICH REGULATE OR COULD REGULATE THE INDUSTRY THAT YOUR COMPANY WILL ENGAGE IN.) Financial Projections. The Management of the Company, based on information and assumptions Management believes to be reasonable, prepared the financial projections… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program.

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Restrictions on Transfer. The securities have restrictions and limited transferability. There is currently no public trading market for the securities and… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Private Offering Exemption. These securities are being offered in reliance upon the non-public offering exemption as provided in… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. No Litigation. There are no actions, investigations, lawsuits or… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. Dilution. The Estimated Rate of Return projections contained in the Executive Summary and the notes to pro forma financial projections contained in Exhibit A take into account… NOTE: The complete disclosure and disclaimers for this area are included in the Financial Architect® 4.0 program. INVESTOR SUITABILITY STANDARDS See Subscription Agreement

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EXHIBIT A PRO FORMA FINANCIAL PROJECTIONS SOURCES AND USES STATEMENT (CENTER THE TITLE)

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Notes to Pro Forma Financial Projections for

XYZ Company, Inc. GENERAL ECONOMIC & FINANCIAL ASSUMPTIONS Income Statement & Company Valuation (OBVIOUSLY, YOU WILL NEED TO CHANGE ALL OF THESE ASSUMPTIONS TO COINCIDE WITH YOUR COMPANY’S SITUATION.) (WE PURPOSELY LEFT THESE NOTE ILLUSTRATIONS IN BLACK, SO YOU COULD SEE HOW TO DISPLAY THE NOTES.) (HOWEVER, TEXT AND NUMBERS IN BLUE NEED TO BE MANUALLY INPUT INTO YOUR SECURITIES OFFERING DOCUMENTS, SO SPECIAL ATTENTION SHOULD BE PAID TO THESE AS THE WILL BE REPRESENTING YOUR COMPANY’S DEAL STRUCTURE.) (THE REFERENCE TO YEARS (DATES) AND THE ACTUAL YEARS THAT YOU WILL USE NEED TO BE CHANGES THROUGHOUT ALL THE WORKSHEETS.) REVENUE ASSUMPTIONS: • • • • •

U.S. Domestic Sales: Sales start in the third quarter of the Year 1, 200x. The 30% annual increases based on Management’s estimates for the U. S. Domestic after market sales only. European Sales: Sales start in the first quarter of the Year 2, 200x. The 30% annual increases based on Management’s estimates for the European after market sales only. South American Sales: Sales start in the first quarter of the Year 3, 200x. The 30% annual increases based on Management’s estimates for the South American after market sales only. Asian Sales: Sales start in the first quarter of the Year 3, 200x. The 30% Annual increases based on Management’s estimates for the Asian after market sales only. All Other Country Sales: Sales start in the first quarter of the Year 4, 200x. The 30% annual increases based on Management’s estimates for the All Other Country after market sales only.

Total Unit Sales: Summation of above figures. Average Sales Price Per Unit: Units sell at a $199.95 wholesale price the first year, with annual sales price net decreases of 2% to account for inflationary increases of 3% countered by 5% volume discount purchases. TOTAL GROSS SALES: Summation of above figures.

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COST OF GOODS SOLD: •

Labor Costs: Includes Vice President of Production salary of $70,000; supervision, direct labor, indirect labor, and over-time wages represents $10.00 per unit, due to the ease of the assembly process. Quality Control staff wages are included in this figure. Annual cost increases of 3%. • Payroll Tax & Employer Related Insurance: Represents Workmen’s Compensation, State & Federal Unemployment Insurance, etc.: Represents 11.50% of direct assembly labor employees’ wages and salaries. • Benefits: Includes Health, Life & Disability Insurance. Represents 4% of all pay-rolled employees’ wages and salaries, rising at an annual rate of 15%. • Packaging: Represents 5% of Sales. • Materials: Represents an average cost of $50.00 per Unit. Annual cost decreases of 5% due to economies of scale volume purchases by the Company. • Warranty Coverage: Represents 0.5% of Gross Sales. • Freight In: Represents 2% of Materials Cost. • Freight Out: Represents 0.35% of Materials Cost. (For returned materials). *Note: Freight charges to be billed to the sales invoices. TOTAL COST OF GOODS SOLD: Summation of above figures. GROSS PROFIT: Equals Total Gross Sales Less Total Cost of Goods Sold. GROSS MARGIN PERCENT: Equals Total Gross Profit Divided by Gross Sales and is Expressed as a Percentage. GENERAL AND ADMINISTRATIVE EXPENSE: •

•

•

Management Salaries: Represents a standard total management annual salary budget $100,000 for a CEO, $70,000 for a CFO (whose primary responsibility will be to sell the Company’s securities for capitalization), and $70,000 for a COO, as well as, Director Fees of $25,000 for each of five Directors. Annual increases of 30% to accommodate for additional Management as well as current Management salary increases. Engineering Dept. Staff Wages: Represents a standard budget for two engineers at $85,000 salaries each and one assistant engineer at a $50,000 annual salary, with scalable annual increases of 20% to attract the needed personnel for current operations quality improvement and continued R&D. Sales & Marketing Dept Salaries: Represents a standard budget, which includes a $75,000 salary for a Vice President of Sales and Marketing and $90,000 for two in house marketing and sales personnel at $45,000 annual salaries each, prorated to 50% for year one, with scalable annual increases of 30% to attract additional in house marketing and sales personnel.

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• • • • • • • • •

•

• • • •

Maintenance Staff Wages: Represents a standard budget with scalable annual increases of 5%, prorated to 50% of an annual budget for year one, with additions in years three and five as the facilities expand. Shipping and Receiving Dept. Staff Wages: Represents a standard budget with scalable annual increases of 5%, prorated to 50% of an annual budget for year one, with additions in years three and five as the facilities expand. Administrative Dept. Staff Wages: Represents a standard budget with scalable annual increases of 5%, prorated to 50% of an annual budget for year one, with additions in years three and five as the facilities expand. Human Resources Dept Staff Wages: Represents a standard budget with scalable annual increases of 5%, prorated to 50% of an annual budget for year one, with additions in years three and five as the facilities expand. Investor/Public Relations Dept. Staff Wages: Represents a standard budget with scalable annual increases of 5%, prorated to 50% of an annual budget for year one, with additions in years three and five as the facilities expand. Customer Support Dept. Staff Wages: Represents a standard budget with scalable annual increases of 5%, prorated to 50% of an annual budget for year one, with additions in years three and five as the facilities expand. Payroll Tax & Employer Related Insurance: Represents Workmen’s Compensation, State & Federal Unemployment Insurance, etc.: Represents 11.50% of general and administrative employees’ wages and salaries. Benefits: Includes Health, Life & Disability Insurance. Represents 4% of all payrolled employees’ wages and salaries, rising at an annual rate of 15%. Commissions to Independent Manufacturer Representatives: Represents 15% of Gross Sales for both divisions. Management estimates that a large portion, but not all sales will come from Independent Manufacturer Representatives. The percentage of all sales by Independent Manufacturer Representatives is 90% for years 1& 2, 80% for year 3, 70% for year 4, and 60% for year 5. Sales & Marketing Expense: Represents 10% of Gross Sales in year 1, dropping by 2% each year until it has settled at 4%, as a standard budget to support the Sales and Marketing Dept. Includes general advertising and promotion, brochures, order forms, trade magazine, trade show presentation booths and personnel attendance, advertising, point of sale displays and web site e-commerce development. Travel, Lodging, and Entertainment Expense: Represents 1% of Gross Sales, for both divisions, as a standard budget to support the Sales and Marketing Dept. Automobile Leases: Provides for four vehicles for the first two years then 8 in year three and 12 in year five, with annual price increase of 5%. Automobile Insurance: Represents 25% of Auto Lease Value. Provides full coverage for four vehicles during the first two years then 8 in year three and 12 in year five, with annual price increase of 5%. General Liability Insurance: Represents a standard budget, which includes Officers and Directors errors and omissions insurance with annual increase tied 0.75% of Gross Sales for both divisions.

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• • • • • • •

• • • • • • • • • •

Key Man Life Insurance: Represents 5% of Management and Engineering Dept. Salaries. Personal Property Taxes: Represents a standard budget of 2% of accumulated equipment. Real Property Taxes: Represents a standard budget with annual increases of 2%. Pro rated to ¼ for the first year. Equipment Lease: Represents a standard budget, primarily for computer and telecommunications equipment with annual increases of 30%. Office & Computer Supplies: Represents a standard budget with scalable annual increases of 30%. Accounting: Represents a standard budget with scalable annual increases of 30%. Legal: Represents a standard budget with scalable annual increases of 30%. This line item does not include the securities documentation production or other legal work performed for the organization of the Company. Organizational expenses are included under Capitalized Assets and are amortized over five years. Building Lease Main Facilities: Represents standard budget for Mfg. Plant for years one and two, while main facilities are under construction. Sales Offices in Metropolitan Areas: Represents a standard budget with additions in years three and five as of the facilities expansion plan, with scalable annual increases of 5%. Utilities: Represents 20% of building lease and sales office expenses with scalable annual increases of 5%. The building lease value is used for all years. Software Purchases: Represents a standard budget with scalable annual decreases of 10%. Telephones & Internet Access: Represents a standard budget with scalable annual increases of 30%. Trade Subscriptions & Dues: Represents a standard budget with scalable annual increases of 30%. Moving Expense: Represents a standard budget with scalable annual increases of 30% to move personnel from different parts of the country to the Company headquarters. Outside R&D Consultants: Represents a standard budget with scalable annual increases of 30%. Diagnostics Machinery & Mfg. Maintenance: Represents a standard budget with scalable annual increases of 30%. Miscellaneous Expenses: Represents standard budget with scalable annual increases of 30%.

TOTAL GENERAL AND ADMINISTRATIVE EXPENSES: Summation of Above. Net Operating Profit (Loss) EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization • Depreciation & Amortization: Capital expenditures for Fixed Assets depreciated over 7 to 39 years. Organizational costs amortized over five years. IRC 179 not taken due to the amount of equipment purchased each year. (See Depreciation and Amortization Schedule). (WE USED THE STRAIGHT LINE

24

• • • • • •

METHOD FOR ILLUSTRATIVE PURPOSES ONLY. CONSULT WITH YOUR COMPANY’S TAX ADVISOR FOR THE APPROPRIATE DEPRECIATION METHOD FOR YOUR COMPANY). Interest Expense: 10% on Notes sale and Bank Debt, pro rated the first year to 75%, as it is assumed that it will take six months to raise the full amount. Royalty Financing Expense: Represents 4% of Total Gross Sales Royalty Distribution per Contract: Represents Total Royalty Distributions divided by the outstanding contracts for the respective years as illustrated. Net Income Before Profit Sharing and Taxes: Represents EBITDA less Depreciation & Amortization, Interest Expense, and Royalty Financing. Profit Sharing Allowance: Represents 10% of Net Income before Profit Sharing and Taxes. This amount is to be part of a qualified employee profit sharing plan. State Corp. Tax: No Federal tax. Company is an “S” Corporation and Federal Tax is passed through to individual Shareholders. Some states impose additional taxes on the LLC, which is an expense of the company (check with the tax authority in the state of business). Assuming a State business tax bracket of 4%.

ESTIMATED NET INCOME: Net Income after deducting Profit Sharing Allowance and State Taxes. • •

• • • • •

Net Operating Margins: Estimated After Tax Net Income divided by Total Gross Sales. Cash Distributions to Shareholders: Represents 50% of net income for years 2 through 4, the 60% for year five, due to the retirement of the preferred stock. Management has used this illustration to plan for annual cash distributions to the Shareholders of the Company. The amount was pro rated (IT IS WISE TO DISTRIBUTE MORE THAN THE ESTIMATED HIGHEST TAX BRACKET AMOUNT, CURRENTLY 35%, TO INVESTORS IN ORDER TO COVER THEIR TAX OBLIGATIONS CREATED BY THE COMPANY’S PROFITABILITY). Cash Distributions Per Common Stock Share: Represents Total Cash Distributions divided by the outstanding shares for the respective years as illustrated. Preferred Shares Stated Dividends: Represents 10% on $1,000,000 until the end of year 4, when the preferred stock is called. Pro Rated to 25% for year one and 75% for year 2. Stated Dividends per Preferred Share: Represents Preferred Shares Stated Dividends divided by the total outstanding shares in the respective years. Preferred Shares Participation: Represents 10% of Estimated Net Income until the end of year 4, when the preferred stock is called. Pro Rated to 25% for year one and 75% for year 2. Participation per Preferred Share: Represents the Preferred Shares Participation amounts of 10% of net income divided by the total outstanding shares in the respective years.

25

CAPITALIZATION: •

Debt with Equity Kicker: These securities are expressed as Units to be sold in year 1. Units include 10,000 shares of Common Stock priced at $0.05 per share. Units also include 100 Notes priced at $5,000 per Note for $500,000, with a 10% interest rate and a maturity date of 12/31/0? The Debt with Equity Units are assumed sold over the first six months of the year, therefore the interest rate is pro rated to 75% of the annual rate. • Common Stock Shares Sales: 40,000 shares are to be sold at $25.00 per share for $1,000,000 in year 2 as permanent equity capital. • Royalty Financing Contract Sales: 100 Contracts are to be sold at $10,000 per Contract $1,000,000 to be sold by the end of year 1. Contracts to receive 4% of total Gross Sales until the Contract Termination Amount of $3,500,000 has been achieved, which is estimated to be reached by the end of year 5. • Participating Preferred Share Sales: 50,000 shares at $40.00 per share for $2,000,000 to be sold by the middle of year 2. Dividends pro rated to ¼ of the annual obligation, as Management assumes that the preferred stock will be sold in the 3rd and 4th quarters of the first year and in the 1st and 2nd quarters of the second year. Preferred stock called at 100% of par at the end of year 4, as the ending cash balances should be sufficient for such retirement of these securities. The 10% participation is shifted into distributions to Shareholders for year 5. • Bank Debt or Note Sales: $1,000,000 acquired in the middle of year 2 as Bank Debt which replaces 100% of the $500,000 Notes issued in year 1. (PAY SPECIAL ATTENTION TO THE CALCULATION HERE AS IT IS PRO RATED FOR ½ OF THE 2ND YEAR) • Debt Reduction: $500,000 at the end of year 2 as part of the $500,000 Debt with Equity Kicker Units sold in year 1. $500,000 at the end of year 3 as part of the $500,000 Bank Debt acquired in year 2. $500,000 at the end of year 4 as part of the $500,000 Bank Debt acquired in year 2. (SOME ILLUSTRATIONS ASSUME THAT YOU BEGIN EACH RESPECTIVE YEAR WITH THE AMOUNT OF CAPITAL INDICATED. YOU MAY NEED A YEAR TO RAISE EACH ROUND OF CAPITAL, SO ADJUST ACCORDINGLY AND USE PRO RATA ASSUMPTIONS, IF NECESSARY). • Working Capital Increase: Summation of above working capital figure.

CAPITALIZED ASSETS: Includes assets that either must be depreciated or amortized.

•

•

Organizational Costs: Represents a standard budget with scalable annual increases of 10%. Includes legal work for U.S. and International patent applications; incorporation of main company and subsidiaries; application for import export licenses, costs associated with setting up assembly plants in different geographic locations, QS 9000 Certification and for the production of securities offering documentation, printing and distribution. Includes property and equipment move to new building in year 2. Land Purchase: Represents standard budget to be incurred in year one for the collateral used to secure $1,000,000 bank loan for building construction in year 2.

26

• • • • • • • • • • • •

Parking Lot & Landscaping: Represents standard budget to be incurred in year 2. Water & Sewer Hook-Up: Represents standard budget to be incurred in year 2. Building Construction: 20,000 square feet at $50.00 per sq. ft. cost for the total of $1,000,000 to be incurred in year two. Leasehold Improvements: Represents standard budget for year one while main facilities are under construction. Furniture & Fixtures: Represents standard budget with annual increases of 50% in facility build out. Coil Winding Machines: Represents a standard budget with scalable annual increases of 30%. Include purchases and replacement parts. Storage Racks: Represents standard budgets. Case Machine: Represents standard budget. Automatic Packaging Machine: Represents standard budget. Diagnostics Equip. Machinery: Represents standard budgets. Misc. Equipment: Represents a standard budget with scalable annual increases of 30%. Includes worktables, carts, bins, fire protection system, and quality control equipment. Misc. Tools: Represents a standard budget with no scalable annual increases. Includes maintenance and other tools.

Total Capitalized Assets Outlay: Summation of above items. Earnings Per Share: The outstanding Shareholders units divided by estimated net income. Out of the total authorized shares of 100,000, it is assumed that 100,000 shares are outstanding by the end of year 2 through the end of year 5. Company Valuation: The valuation of the Company was calculated by multiplying the current outstanding shares in each year by the estimated share price based a simple Price Earnings (P/E) Ratio of 3 for a privately held scenario.

*Estimated Internal “Realized” Rate of Return in a Private Market For the Debt with an Equity Kicker Units. The Estimated Private Market Value per Common Stock Share was calculated by multiplying the estimated net earnings per outstanding share by a P/E Ratio, to arrive at the per Share figure at the end of the 5-year period. The accumulated Dividends and Interest figures are also added to the estimated Unit price to arrive at the total aggregate figure. The IRR calculation, takes into account a two-year maturity on the Notes and a five-year holding period on the shares. The Standard Internal Rate of Return formula was use to calculate the percentage. *Estimated Internal “Realized” Rate of Return for the Royalty Financing Contract The Estimated Internal Rate of Return for the Royalty Financing Contract was calculated by comparing the Royalty Financing Contract original face value of against the

27

accumulated gross royalties over a 5-year period. The Standard Internal Rate of Return formula was use to calculate the percentage. *Estimated Internal “Realized” Rate of Return in a Private Market for the Participating Preferred Shares The Estimated Internal Rate of Return for the Participating Preferred Shares was calculated by comparing the Participating Preferred Share original Par value per Share against the accumulated stated dividends per share, plus the participating cash distributions per Share, plus the Par value of the stock, in anticipation of a call or retirement at the end of a 4-year period. The Standard Internal Rate of Return formula was use to calculate the percentage. *Estimated Internal “Realized” Rate of Return in a Private Market for the Common Stock Shares The Estimated Private Market Value per Share was calculated by multiplying the P/E Ratio times the estimated net earnings per outstanding Share to arrive at the per Share figure at the end of the fifth year. The accumulated dividends are also added to the estimated share price to arrive at the total aggregate figure. The Standard Internal Rate of Return formula was use to calculate the percentage. *NOTE: The estimated share and company value at the end of year 5 was not taken into account as we are calculating an Estimated Internal “Realized” Rate of Return for the common stock. The Estimated Internal Rate of Return, would normally include realized and un-realized gains and losses, however, when dealing with illiquid securities, it is generally wise to not include unrealized profits from the sale of stock or the company’s assets. If the company was sold at the end of year 5 or the securities became liquid, then the net selling price would be added to the IRR calculation string in year 5.

Balance Sheets TOTAL ASSETS: • •

•

• •

Cash: Drawn directly from the Pro Forma Statement of Cash Flows. Accounts Receivable: Represents 5% of Accumulated Gross Sales drawn directly from the Income Statement and Company Valuation worksheet. (THIS ROW CAN BE AUTOMATICALLY CALCULATED OR MANUALLY INSERTED AS A FORCE POINT.) Inventory: Represents 15% of Accumulated COGS, drawn directly from the Income Statement and Company Valuation worksheet. (THIS ROW CAN BE AUTOMATICALLY CALCULATED OR MANUALLY INSERTED AS A FORCE POINT.) Property & Equipment: Represents 100% of Accumulated Capitalized Assets, drawn directly from the Income Statement and Company Valuation worksheet. Less Accumulated Depreciation: Represents 100% of Accumulated Depreciation drawn directly from the Depreciation Schedule. 28

Net Fixed Assets: Summation of Property & Equipment less Depreciation. Other Assets: Represents Net Accumulated Organization Costs drawn directly from the Income Statement and Company Valuation worksheet less Accumulated Amortization drawn directly from the Depreciation Schedule. Total Assets: Summation of above. TOTAL LIABILITIES: Current Liabilities: • Accounts Payable: Represents 1/12 of Total General and Admin. Expenses and 1/12 of Total Cost of Goods Sold, drawn directly from Income Statement and Company Valuation worksheet. (Or) Represents Management’s best estimates. (THIS ROW CAN BE AUTOMATICALLY CALCULATED OR MANUALLY INSERTED AS A FORCE POINT.) • Accrued Expenses: Represents 1/12 of Interest and Royalty Financing; 100% of Profit Sharing and 25% of State taxes, drawn directly from Income Statement and Company Valuation worksheet. (Or) Represents Management’s best estimates. (THIS ROW CAN BE AUTOMATICALLY CALCULATED OR MANUALLY INSERTED AS A FORCE POINT.) Long Term Liabilities: • • •

Royalty Financing Contracts: Represents 100% of Royalty Financing Contracts, drawn directly from the Income Statement and Company Valuation worksheet. This liability ends after the fifth year. Bank Debt or Note Sales: Represents 100% of Bank Debt or Note Sales, drawn directly from the Income Statement and Company Valuation worksheet. Debt Reduction: Represents 100% of Bank Debt or Note Pay Down, drawn directly from the Income Statement and Company Valuation worksheet. *NOTE: Under GAAP standards debt reduction does not go on a balance sheet. This was done to allow for a free flow of data between the worksheets and is for illustrative purposes only.

Total Liabilities: Summation of above.

• •

Common Stock Shares: Represents paid in capital from Common Stock Share Sales. Participating Preferred Shares: Represents paid in capital from Participating Preferred Share Sales.

Total Shareholders’ Capital: Summation of above. •

Beginning Shareholders’ Equity: Shareholders’ Equity.

29

Represents previous year’s Ending

•

Ending Shareholders’ Equity: Calculation of Beginning Shareholders’ Equity, plus 100% of Net Income less Cash Distributions to Shareholders, drawn directly from the Income Statement and Company Valuation worksheet.

Total Equity: Represents summation of Founders’ Capital, Shareholders’ Paid-In Capital, and Ending Shareholders’ Equity. Total Liabilities & Shareholders' Equity: Summation of Shareholders’ Equity plus Total Liabilities.

Pro Forma Income Statement and Company Valuation Year 1 -200x

Year 2-200x

Year 3-200x

Year 4-200x

Year 5-200x

20,000

26,000

33,800

43,940

20,000

26,000

33,800

43,940

20,000

26,000

33,800

Revenue Assumptions: Unit Sales - U.S. Domestic Sales

11,000

Unit Sales - European Sales Unit Sales - South American Sales Unit Sales - Asian Sales

30

20,000 Unit Sales - All Other Country Sales

26,000

33,800

20,000

26,000

Total Unit Sales Average Sales Price per Unit

$

11,000 199.95

$

40,000 195.95

$

92,000 192.03

$

139,600 188.19

$

181,480 184.43

Total Gross Sales

$

2,199,450

$

7,838,040

$

17,666,942

$

26,271,511

$

33,469,905

Labor

$

180,000

278,100

545,900

791,040

1,006,722

Payroll Taxes & Relating Insurance

$

20,700

31,982

62,779

90,970

115,773

Benefits

$

7,200

12,793

25,111

36,388

46,309

Packaging

$

109,973

391,902

883,347

1,313,576

1,673,495

Materials

$

550,000

1,900,000

4,370,000

6,631,000

8,620,300

Warranty Coverage

$

10,997

39,190

88,335

131,358

167,350

Freight In

$

11,000

38,000

87,400

132,620

172,406

Cost Of Goods Sold:

Freight Out

$

1,925

Total Cost of Goods Sold

$

891,795

$

6,650 2,698,617

$

15,295 6,078,167

$

23,209 9,150,161

$

30,171 11,832,526

Gross Profit Gross Margin Percent

$

1,307,655 59.45%

$

5,139,423 65.57%

$

11,588,775 65.60%

$

17,121,350 65.17%

$

21,637,379 64.65%

Management Salaries

$

365,000

474,500

616,850

801,905

1,042,477

Engineering Dept. Staff Salaries

$

220,000

264,000

316,800

380,160

456,192

Sales & Marketing Dept. Salaries

$

82,500

214,500

278,850

362,505

471,257

Maintenance Staff Wages

$

12,500

26,250

45,563

47,841

68,233

Shipping and Receiving Wages

$

22,500

47,250

78,613

82,543

115,670

Administration Dept. Staff Wages

$

22,500

47,250

78,613

82,543

115,670

Human Resource Dept. Wages

$

22,500

47,250

78,613

82,543

115,670

Investor/Public Relations Dept. Wages

$

22,500

47,250

78,613

82,543

115,670

Customer Support Dept. Staff Wages

$

22,500

47,250

78,613

82,543

115,670

Payroll Taxes & Relating Insurance

$

91,138

139,783

189,879

230,590

300,899

Benefits Package

$

31,700

55,913

75,952

92,236

120,359

Sales Commissions to Ind. Mfg. Reps.

$

329,918

1,175,706

2,650,041

3,940,727

5,020,486

Sales & Marketing Materials Expenses Travel, Lodging and Entertainment Expense

$

87,978

313,522

706,678

1,050,860

1,338,796

$

21,995

78,380

176,669

262,715

334,699

Automobile Leases

$

24,000

24,000

52,800

52,800

87,120

Automobile Insurance

$

6,000

6,300

13,860

14,553

22,869

General Liability Insurance

$

16,496

58,785

132,502

197,036

251,024

Key Man Life Insurance Personal Property Taxes

$ $

29,250 18,100

36,925

46,683

59,103

74,933

General and Administrative Expense:

31

27,710

39,663

47,687

57,146

Real Property Taxes

$

12,500

51,000

52,020

53,060

54,121

Equipment Lease

$

10,000

13,000

31,900

41,470

68,911

Office and Computer Supplies

$

35,000

45,500

59,150

76,895

99,964

Accounting

$

20,000

26,000

33,800

43,940

57,122

Legal

$

20,000

26,000

33,800

43,940

57,122

Building Lease - Main Facilities

$

80,000

-

-

Sales Offices

$

11,000

11,550

34,128

35,834

48,626

Utilities

$

18,200

19,226

23,967

24,325

27,011

Software Purchases

$

15,000

13,500

12,150

10,935

9,842

Telephones & High Speed Internet Access

$

20,000

26,000

33,800

43,940

57,122

Trade Subscriptions & Dues

$

5,000

6,500

8,450

10,985

14,281

Moving Expense

$

20,000

26,000

33,800

43,940

57,122

R&D Consultants

$

50,000

65,000

84,500

109,850

142,805

Diagnostics Mach. & Mfg. Maintenance

$

35,000

45,500

59,150

76,895

99,964

-

-

Miscellaneous Other Expenses

$

15,000

Total General and Admin. Expense

$

1,815,775

$

3,526,800

$

6,261,818

$

8,602,398

$

11,061,695

Net Operating Profit (Loss) EBITDA

$

(508,120)

$

1,612,623

$

5,326,958

$

8,518,952

$

10,575,684

Depreciation & Amortization Interest Expense Royalty Financing Cash Distributions per Contract

$ $ $ $

168,142 -

$ $ $ $

318,691 -

$ $ $ $

447,630 -

$ $ $ $

556,192 -

$ $ $ $

676,460 -

Net Income Before Profit Sharing and Taxes Less:

$

(676,262)

$

1,293,932

$

4,879,328

$

7,962,760

$

9,899,224

Profit Sharing Allowance 10%

$

-

Federal & State Corp. Tax

19,500

129,393

-

Net Operating Margins Cash Flow From Operations

796,276

1,888,300

(676,262) $

(676,262)

$

NM

$

12.18%

989,922

3,081,588 -

954,580

42,842

2,503,095

3,831,000

$

14.17%

-

4,084,896

$

15.55%

5,078,302 15.17%

(508,120)

$

1,273,271

$

2,950,725

$

4,641,088

$

5,754,762

Cash Distributions to Shareholders

-

$

190,916

$

500,619

$

816,979

$

1,015,660

Cash Distributions Per Share

-

Net Cash Flow From Operations

$

32,955

487,933

209,959

Loss Carryover (Information Only) Estimated Net Income

25,350

$

(508,120)

$

5,000,000

1.91 $

5.01

1,082,355

$

8.17

2,450,106

$

3,824,109

10.16 $

4,739,102

CAPITALIZATION: First Round: Common Class A Share Sales

32

-

-

-

-

Founders' Capital Stock

$

500

First Round: Bank Debt or Note Sales

$

-

-

-

-

-

(Debt Reduction)

$

-

-

-

-

-

$

5,000,500

-

-

-

-

Organizational Costs

$

180,000

239,580

263,538

Land Purchase

$

250,000

-

-

-

-

Parking Lot and Landscaping

$

200,000

-

-

50,000

-

Water & Sewer Hook-Up

$

50,000

-

-

-

Building Construction

$

1,000,000

-

-

-

-

Leasehold Improvements

$

20,000

-

-

-

-

Furniture & Fixtures

$

25,000

37,500

56,250

84,375

126,563

Coil Winding Machine

$

40,000

52,000

67,600

87,880

114,244

Storage Racks

$

30,000

-

45,000

-

60,000

Case Machine

$

65,000

-

70,000

-

90,000

Automatic Packaging Machine

$

-

140,000

160,000

-

Diagnostics Equip. Machinery

$

700,000

200,000

300,000

-

-

Misc. Equipment

$

20,000

26,000

33,800

43,940

57,122

Working Capital Increase Capitalized Assets:

198,000

217,800

-

Misc. Tools

$

25,000

Total Capitalized Assets:

$

2,605,000

$

678,500

$

815,450

$

690,775

$

736,467

Est. Net Earnings Per Share

$

(6.76)

$

9.55

$

25.03

$

40.85

$

50.78

Estimated Private Market Value per Share: PE Ratio of 5 Private Company Valuation

$

(33.81) NM

$ $

47.73 4,772,900

$ $

125.15 12,515,473

$ $

204.24 20,424,482

$ $

253.92 25,391,510

NM NM

$ $

238.65 23,864,500

$ $

625.77 62,577,363

$ $

1,021.22 102,122,409

$ $

1,269.58 126,957,550

Estimated Public Market Value per Share: PE Ratio of 25 Company Valuation

33

25,000

25,000

25,000

25,000

Pro Forma Consolidated Statement of Operations Revenues Cost of revenues Gross Profit

$ $ $

Year 1 -200x 2,199,450 891,795 1,307,655

Operating expenses: General and administrative Depreciation and amortization Total operating expenses Operating profit (loss)

$ $ $ $

1,815,775 168,142 1,983,917 (676,262)

$ $ $

(676,262)

Net profit (loss)

$ $

(676,262)

Net profit (loss) per Share

$

(6.76)

Other income (expense): Interest Expense Profit Sharing Allowance 10% Profit (loss) before income taxes Federal & State Corp. Tax

$

Year 2-200x 7,838,040 2,698,617 5,139,423

$

3,526,800 318,691 3,845,491 1,293,932

$

$

129,393 1,164,539

$ $

209,959 954,580 9.55

Year 3-200x 17,666,942 6,078,167 11,588,775

6,261,818 447,630 6,709,448 4,879,328

$

$

487,933 4,391,395

$ $

1,888,300 2,503,095 25.03

Year 4-200x 26,271,511 9,150,161 17,121,350

8,602,398 556,192 9,158,590 7,962,760

$

$

796,276 7,166,484

$ $

3,081,588 4,084,896 40.85

Year 5-200x 33,469,905 11,832,526 21,637,379

11,061,695 676,460 11,738,155 9,899,224

989,922 8,909,302

$

3,831,000 5,078,302

$

Note: The Pro Forma Statement Of Cash Flows, Balance Sheets, Depreciation And Amortization Schedule And The Sources And Uses Statement are included with the Financial Architect®4.0 program.

34

50.78

EXHIBIT B ARTICLES OF INCORPORATION (CENTER THE TITLE)

(Copy and Paste your articles of incorporation)

35

EXHIBIT C BY-LAWS (CENTER THE TITLE)

(Copy and Paste your BY-LAWS)

36

EXHIBIT D SUBSCRIPTION AGREEMENT (CENTER THE TITLE)

37

ROUND 1 Name of Investor(s) SUBSCRIPTION AGREEMENT FOR CLASS A COMMON STOCK SHARES XYZ COMPANY, INC. Pursuant to a Private Placement Memorandum dated April 15, 200? (the “Memorandum”), on the terms and conditions set forth below, I hereby agree to become a Class A Shareholder of XYZ COMPANY, INC., a (State) “C” Corporation (the "Company") and to make a capital contribution to the Company in the amount of $________________for which I shall receive voting Share(s), of Common Stock Share (the “Class A Share(s)) in the Company. The minimum purchase amount is 400 shares for $10,000.00. The capital contribution for each Class A Share is Twenty Five U.S. Dollars ($25.00). Such capital contribution for the subscribed shares is to be tendered herewith. I understand that the Company will not escrow such moneys. (THIS STATEMENT IS ONLY ACCEPTABLE IF TRUE. IF NOT THEN YOU MUST AMEND THIS STATEMENT ACCORDINGLY.) The offer to become a Class A Shareholder hereby made shall be deemed to be accepted by the Company only upon the Company's execution of the acceptance set forth below. A. Representations and Warranties. I represent and warrant to the Company as follows: I declare that I am at least 21 years of age and am a bona fide RESIDENT of the United States of America or foreign government recognized as such by United States of America and I am not an accredited investor as defined by the definitions below. ____________Initials

OR I am or represent an organization, which meets or exceeds at least one of the accreditation requirements contained within this subscription agreement. (1)

Initial all of the following that apply:

NOTE: this area is included in the Financial Architect® 4.0 program

EXHIBIT E CURRENT FINANCIAL STATEMENTS (CENTER THE TITLE)

(Copy and paste your Current Financial Statements, if any)

Copyright: Commonwealth Capital Advisors, LLC-2003

39

EXHIBIT F INDUSTRY ARTICLES AND SUPPORTING DOCUMENTS (CENTER THE TITLE)

(This Exhibit is Optional) (COPY AND INSERT ANY OTHER DOCUMENTS RELATED TO THE INDUSTRY OR YOUR COMPANY THAT YOU FEEL ARE IMPORTANT TO HELP SELL THE SECURITIES AND DISCLOSE ANY OTHER MATERIAL INFORMATION TO INVESTORS.)

Copyright: Commonwealth Capital Advisors, LLC-2003

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