Question & Answer
How Do Investors Structure Deals to Mitigate Risks?
Every investment carries risk. Market conditions shift, companies underperform, and unforeseen crises emerge. Sophisticated investors don’t just hope for the best – they structure deals to protect their capital while preserving upside potential. A well-structured deal doesn’t just define the terms of investment, it strategically mitigates risks at multiple levels.
Balancing Risk with Reward
Investors must evaluate risks from several angles – financial stability, governance, operational execution, and exit potential. A common mistake is assuming equity is the only way to structure an investment. While equity offers high upside, it also exposes investors to dilution and a loss of influence over time.
Another option? Debt. Investors can structure deals using venture debt or secured loans, giving them downside protection while still participating in the company’s growth. Combining equity and debt – rather than relying solely on share purchases – can offer a stronger overall risk-adjusted return.
Key Strategies to Reduce Investment Risk
Whether investing through equity or debt, investors use specific structural mechanisms to protect their capital. These include:
- Liquidation Preferences – Ensures investors recover their investment before common shareholders see any returns. A 1x liquidation preference guarantees that an investor gets their money back before any profit is distributed.
- Anti-Dilution Protections – If the company raises future funding at a lower valuation, anti-dilution clauses adjust investor equity to minimize loss of value.
- Convertible Notes – Rather than buying equity immediately, investors lend capital that converts into shares at a later date, typically at a discount or with a valuation cap.
- Venture Debt – Instead of diluting ownership, investors can provide loans secured against company assets or future cash flow, offering a structured repayment plan.
- Secured Loans with Collateral – Investors can take securities in the company, such as intellectual property, inventory, or real estate, ensuring repayment even if the company struggles.
- Board Representation – A board seat provides visibility into decision-making and ensures investors have a voice in strategic moves.
- Veto Rights – Investors can structure agreements so they have final approval over major decisions like new funding rounds, executive hires, or acquisitions.
- Performance-Based Payouts – Instead of providing full capital upfront, investors can structure funding in stages, releasing additional funds only when the company meets certain milestones.
Example: Structuring Debt to Reduce Risk
Consider an investor who wants to put $2M into a startup. Instead of taking a full equity position, they structure the deal with a combination of debt and equity:
- $1M in equity for 15% ownership.
- $1M as a secured loan with 8% interest, collateralized against company assets.
If the company succeeds, the investor benefits from equity growth. If the company struggles, they still receive interest payments on the debt, and in a worst-case scenario, they have claim over assets before other stakeholders.
Why Equity-Only Deals Are Riskier
Many investors default to equity investments because they want exposure to high returns. However, pure equity deals come with significant risks:
- Founders may raise additional rounds, diluting early investors.
- There’s no guaranteed payout—returns depend entirely on a future exit.
- If a company fails, equity holders are paid last in liquidation.
By incorporating debt structures, investors can reduce exposure while still maintaining a strong position in the company.
Great investors don’t just focus on potential returns – they focus on minimizing downside risk too. Structuring deals with liquidation preferences, anti-dilution protections, convertible debt, and secured loans ensures that even in adverse scenarios, capital is preserved.
In Deal Structuring, I explore examples of how investors successfully de-risked investments while maintaining strong upside.
Deal Structuring
Buy the book today and dive into practical techniques that empower you to get started immediately, navigating transactions efficiently and maximizing your success in minimizing cash requirements.
In this book, you will:
- Be introduced to the fundamentals of deal structuring
- Learn 19 proven deal models for structuring deals
- Discover 39 key elements of deal nuances
- Access 32 actionable clauses for your term sheets
- Explore 9 specific deal structures
- Receive 257 pages of invaluable insights
- Gain the distilled expertise of 20 years