THE NITTY-GRITTY OF ALTERNATIVE EQUITY: A DEEP DIVE ON ORGANICALLY GROWN COMPANY’S SERIES A TERM SHEET
Raising money is always hard, no matter the situation.
For companies that are committed to perpetual independence, the challenge is even more daunting.
Why?
Because independent companies have two distinctions that set them apart, in the eyes of investors:
a) They don’t want to sacrifice control
b) They never want to sell the company
Conventional investors are known for their love of control and liquidity.
So how can companies that are committed to independence and/or steward ownership raise money without sacrificing control and/or without the promise of a big liquidity event down the road?
Last year, Organically Grown Company (OGC), the nation’s largest independent distributor fully committed to organic produce, did just that - successfully completing an $11M Series A fundraise that was 100% compatible with steward ownership and perpetual independence.
I helped lead the equity raise for OGC, and today I am going to do a deep dive into the key terms we used to complete what is arguably the most successful steward ownership fundraise that has ever happened in the United States.
In each section below I will describe not just the key terms of the Series A Preferred Stock, but also the thinking and context behind each term in order to give you a behind-the-scenes look at how we made these decisions.
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Summary
OGC’s Series A preferred equity offering allowed the company to transition to 100% perpetual trust ownership. Trust Ownership makes it possible for the company to focus on purpose over profit into perpetuity, create long-term returns for mission-aligned investors, and share profits with all stakeholders including employees, farmers, customers, and community.
Non-Voting Preferred Stock
Because OGC was committed to 100% steward ownership, the plan going into the Series A raise was for all of the company’s common voting stock to eventually be held by the Sustainable Food and Agriculture Perpetual Purpose Trust, which was specifically created for the purpose of stewarding OGC (and potentially other mission-aligned companies) into perpetuity.
With this parameter in place, the only sort of stock OGC could sell to outside investors was non-voting stock. So, using examples from companies like Equal Exchange and Organic Valley as inspiration, OGC designed non-voting preferred stock with terms that I will describe below.
Base Dividend
The non-voting preferred shares included a 5% cumulative annual base dividend. This means that if you invested $100,000 in the Series A, then OGC would pay you $5,000 per year. If the company couldn’t pay for some reason in any given year (i.e. a downturn), then that amount would accrue.
Share Price Appreciation
By committing to trust ownership and perpetual independence, OGC was declaring to the world that they were no longer on the market. They were no longer a commodity that could be bought and sold.
Once you make that commitment, the concept of share price appreciation becomes much less relevant. There will never be an exit or an IPO or a private equity partner looking to flip the company. So we took it off the table. The shares are a set price, and rather than accruing value to unleash on a select few shareholders at a future date, OGC committed to sharing current year rewards with current year stakeholders.
How does the company do that? In two ways:
First, by operating the company in a way that provides a good base “return” to all stakeholders.
a) For shareholders, this means a good base dividend, as previously described.
b) For employees, this means good base pay and benefits.
c) For suppliers and customers this means great service and fair pricing.
d) For community partners, this means steady support - both financial and logistical.
Second, by committing to sharing the rewards of growth in a balanced and transparent with an Upside Dividend.
Upside Dividend + Cash Flow Waterfall
Non-voting preferred shares with a base dividend operate a lot like debt.
That may be fine depending on the sorts of investors you want to attract and the amount you need to raise, but in OGC’s case, we knew we needed to make the shares look more like equity in order to attract institutional investors and optimize our chances of fundraising success.
So we created what we called an Upside Dividend and a Cash Flow Waterfall.
This may have been the most interesting part of the entire term sheet, and it took multiple work sessions collaborating with our lead investors, lender, and other stakeholders to land on the right framework that everyone felt good about.
The image below was copied from the OGC Term Sheet. It directs the company to “pay an Upside Dividend on outstanding shares based on company performance and obligations in that year. Specifically, each year, OGC will use cash according to the following Cash Flow Waterfall:”
The concept of the Upside Dividend is simple: If, in any given year, the company does well, so should investors and other stakeholders (employees, suppliers, customers, community partners).
Why?
Because all of those groups provide valuable inputs:
Employees provide labor
Suppliers (farmers in OGC’s case) provide fresh, organic produce
Customers (retailers in OGC’s case) provide a market for the produce
Investors provide capital
Community Partners provide the leadership and capacity to help the entire organic and regenerative agriculture movement and industry survive and thrive.
OGC’s philosophy is straightforward, but novel: in return for providing these valuable inputs, all of the stakeholder groups, not just the capital providers, should be entitled to share in the success of the company. And because cash must be used according to the Cash Flow Waterfall, anytime there is enough cash to get to Tier 7 in the waterfall, it must be broadly shared. It is not discretionary.
During our negotiations with our lead investors, we realized that because investors get no voting power at the company level, it was especially important to prioritize and practice transparency. investors would never be able to change how OGC uses its cash (due to having no voting rights or board seats), so we all agreed that it was only fair for them to fully understand how those spending decisions will be made before they make their investment. That’s why we co-created this Cash Flow Waterfall together.
In addition to giving investors transparency, OGC sent a clear message to employees and other stakeholders that for them, the era of shareholder primacy was over. All stakeholders will be respected and rewarded. The better the company does, the better everyone does, not just the select few capital providers.
And it’s working! In 2019, which was the first full year governed by the Cash Flow Waterfall, OGC returned $406K to stakeholders as part of the Upside Dividend (Tier 7). Over the next decade, millions of dollars will flow to all of these stakeholder groups - dollars that in a conventional setup would likely accrue primarily to shareholders.
Investor Redemption Rights
Because OGC never intends to sell the company, go public, or have any sort of big liquidity event, we needed to design a way for investors to get their principal back.
Our goal was always to attract long term investors, so it was important to signal that in the term sheet. To that end, while investors had the right to request redemption of their principal at any time, OGC has no obligation to grant a redemption during the first 5 years of the investment.
After 5 years, the company must fulfill redemption requests if there is cash available per the Cash Flow Waterfall (see above). However, in order to prevent large, unexpected cash obligations, we designed the redemption so that it is spread out over three years - one third per year.
So if you invested $100,000 and you request redemption in year 7, you could expect to get paid $33.3K per year for three years (in addition to any accrued but unpaid dividends).
Company Call Rights
The thing about attracting long term investors is that you attract long term investors. Some of them may never want to sell their stock. Philosophically, having mission-aligned investors who never want to redeem their principle is a pretty sweet deal for the company, but you also have to consider the other side of the coin: investors create an ongoing financial obligation on the company (a 5% base dividend + X% upside dividend each year in OGC’s case).
There may come a point, in the future when it no longer makes strategic sense for OGC to keep that preferred equity on the balance sheet. That’s where the company call right comes in.
This was another term that took us a while to get right. We wanted to recognize and reward long term investors for their investment at this critical juncture to help the company become steward owned AND we also wanted to preserve the long term flexibility of the company and future management teams to do the right thing.
Collectively, we landed on 10 years as the time frame that seemed fair to everybody. So after 10 years, the Company has the right to redeem preferred stock at the original issue price plus any unpaid cumulative dividends (base + upside). Further, to ensure fairness, redemptions by the company need to be pro rata across all Series A Shareholders.
During years 1 through 10, the Company still has the right to redeem shares, but this is subject to a prepayment penalty to ensure that investors get reasonably compensated for being forced to prematurely liquidate their position. In OGC’s case, if the company forces any Series A Shareholder to sell their shares (without mutual consent) within 10 years of their principal investment, the Company will be subject to a prepayment penalty equal to the amount that would give said Series A Shareholder an aggregate effective IRR of 6.5%.
Shout Outs
I’d be remiss in writing this post if I didn’t mention some of the key players who made this fundraise possible: The entire OGC leadership team, RSF Social Finance, Purpose, Candide Group, Natural Investments, OGC’s founding farmers and owners, Dan Fireside at Equal Exchange, and dozens of others along the way.
What To Do Next
We believe that one important part we can play in growing the steward ownership and alternative ownership movement is sharing the nitty-gritty details of how things are done with other business leaders, entrepreneurs, lawyers, and advisors who can use these templates for their own companies. We encourage you to adapt these terms to your own stock offering.
Nonetheless, no matter how much we share, designing a successful steward ownership transition and recapitalization strategy – and then executing that plan and actually raising money – is definitely hard work. If you are interested in steward ownership for your company, we can help make this process easier and faster so that you can focus on running your business. Please reach out for a free 30-minute consultation, or read more of our articles on our blog.