Basically it is second (or subsequent) stage financing. The first stage is when you invite in your first outside investors: they are the ones who take the really hairy risks. By the time that you get to second-stage financing you should have an established track record and management team, and you should be able to get the money on easier terms. Mezzanine finance may come in the shape of equity, but is more normally debt, or a debt and equity package. Some banks specialise in arranging it. Take advice if you think you will need it.
Start talking. Venture capitalists and business angels know that some of their investments will give them problems. What they really do not like is being kept in the dark. So tell them what is happening, and what you propose to do about it. If they are not happy with your explanations and proposals, there will be very little that minority shareholders can actually do – apart from dumping the shares for the best price they can get, and passing the word around. (That could blight your attempts to raise new capital for years to come, so do not take it lightly.) If your outside investors hold debt, however, they may (depending on the terms), be able to force you to repay it. Whether they do it will depend, at least to some extent, on whether they think you are reliable and trustworthy, and are prepared to back your efforts to turn the situation around.
Venture capitalists will often expect to sell their shares – via the so-called ‘exit route’ of selling the company or arranging a flotation (a listing on a market such as the Stock Exchange) – after as little as three years. Business angels by contrast will probably be thinking longer-term – say five years, in the first instance. If things are going badly they may try and bail out sooner; if things are going well, they will probably be content to hold their investment for somewhat longer.
This is up for negotiation, too. As a minimum, however: assuming that they are buying ordinary shares — and most venture capitalists and business angels will be unwilling to accept anything less — then they will get the voting rights attributable to those shares. These usually include the right to vote on acceptance (or rejection) of the company’s annual accounts, the right to vote on the directors’ remuneration, and the right to vote on the appointment and dismissal of directors. Holders of at least 5 per cent of the voting also have the right to force the directors to call a general meeting (a meeting of the shareholders), or to call it themselves at the company’s expense if the directors refuse to do it within a reasonable time. Holders of at least 25 per cent of the ordinary shares can block special resolutions, and a special resolution is required to change the articles of association. Minority shareholders cannot of course block the majority in accepting the accounts, agreeing the directors’ remuneration or appointing new directors. Nevertheless, taking on outside shareholders is not a matter to be undertaken lightly. You, and the other directors of the company, have a fiduciary duty to act in good faith to promote the success of the company, and if you take on outside shareholders they will be checking to make sure you do it. Outside shareholders will also be entitled to their share of whatever dividends are being paid, and to their share of the assets left (if any), if the company has to be wound up. Many venture capitalists will ask for preference shares in addition to ordinary shares, which give them a guaranteed percentage of the amount they have invested, or of the company’s profits, as dividend each year – a “first call” on the profits before any dividend is paid to ordinary shareholders. This right is usually cumulative – that is, if the preferential dividend is not paid in one year it is carried forward and added to the dividend payable in subsequent years
In practice, assume a maximum of £50m, unless the circumstances are really exceptional – for example, where part of a large, established business is being sold off to its management.