What is ROI?

ROI is also known as rate of profit but means Return on Investment. Return can also refer to the monetary amount of gain or loss. ROI is the return on a past or current investment, or the estimate d return on a future investment. ROI is usually given as a percent rather than decimal value.

ROI does not indicate how long an investment is held. However, ROI is most often stated as an annual or annualized rate of return, and it is most often stated for a calendar or fiscal year. In this article, "ROI" indicates an annual or annualized rate of return , unless otherwise noted.

ROI is used to compare returns on investments where the money gained or lost - or the money invested - are not easily compared using monetary va l ues. For instance, a $1,000 investment that earns $50 in interest obviously generates more cash than a $100 investment that earns $20 in interest, but the $100 investment earns a higher return on investment.

• $50/$1,000 = 5% ROI
• $20/$100 = 20% ROI

Since rates of return are percentages, negative rates cannot be averaged with positive rates for purposes of calculating monetary returns. However, it is common practice in finance to estimate monetary returns by averaging periodic rates of return; these es timations are most useful when the averaged periodic returns are all positive, all negative, or have low variances.

Cash Flow Income Stream

ROI is a measure of cash (or potential cash) generated by an investment, or the cash lost due to the investment. It measures the cash flow or income stream from the investment to the investor. Cash flow to the investor can be in the form of profit, interest, dividends, or capital gain/loss. Capital gain/loss occurs when the market value or resale value of the investment increases or decreases. Cash flow here does not include the return of invested capital.

Annual Returns

An Annual Rate of Return is the return on an investment over a one-year period, such as January 1st through December 31st, or June 3rd 2006 through June 2nd 2007. Each ROI in the cash flow example above is an annual rate of return. An Annualized Rate of Return is the return on an investment over a period other than one year (such as a month, or two years) multiplied or divided to give a comparable one-year return.

Private Placements Memorandums

A private placement is a direct private offering of securities to a limited number of sophisticated investors. It is the opposite of a public offering. Investors in privately placed securities include insurance companies, pension funds, mezzanine funds, stock funds and trusts. Securities issued as private placements include debt, equity, and hybrid securities. In the United States, private placements are exempt from public registration under the Securities Act of 1933. The exemption from registration for a private offering is contained in Regulation D of the Securities Act of 1933. While the procedure for conducting a private placement pursuant to the exemption is less stringent than for that of a public offering, the process requires a careful compliance with the terms and restrictions of Regulation D.

Those requirements typically require the use of a private placement memorandum, which, for all practical purposes, complies with the requirements of a prospectus which is required in public offerings. The important aspects of the offering are covered: a description of the terms of the offering, the company's business, risk factors, additional terms (i.e., antidilution protection, registration rights, control features), expenses of the transaction and summary financial information. The purpose of the summary is to make the offering easy to read and understand. As stated, suppliers of capital are inundated with business plans and private placement memoranda; the sales-conscious issuer must get all the salient facts in as conspicuous a position as possible if he hopes to have them noticed.

Private placements can only be sold to certain sophisticated investors. In the U.S. these are called accredited investors, and they are defined in the U.S. Securities and Exchange Commission's requirements for a Reg. D offering.

Issuers should approach offerings that have stated maximums and minimums with caution. The SEC has made its position clear. If the issuer elects to increase or decrease the size of the offering above the stated maximum/minimum, each of the investors who have signed subscription agreements must consent to the change in writing. It is not open to the issuer to send out a notice to the effect that "We are raising or lowering the minimum and, if we do not hear from you, we assume you consent."

Regulation D is a government program created under the Securities Act of 1933, instituted in 1982, that allows companies the ability to raise capital though the sale of equity or debt securities. The programs were designed to provide two main things - an exemption to sell securities in a private transaction without registering the securities (something that happens in any transaction involving investors) and the appropriate framework and documentation for doing so properly. Regulation D Offerings are the practical method companies use to raise capital from individual investors. Who should use a Regulation D Offering? Any company or entrepreneur that is seeking to raise equity or debt capital from investors.

There are 2 basic types of Regulation D Offerings that can be structured:

An "equity" offering is where the company sells partial ownership in the company (via the sale of stock or a membership unit) to raise capital. Equity offerings are preferred by early stage companies because there is no set repayment schedule or debt service payments - the investors profit when the company profits.

A "debt" offering is where the company raises debt financing by selling a note instrument to investors with a set annual rate of return and a maturity date that dictates when the funds will be paid back to investors in full. A debt offering functions much like a business loan except instead of a bank providing the financing it is a group of investors lending funds to the company.

Preparing a Regulation D Offering is very straightforward. It involves three primary steps:

1. Pre-Offering Structuring: Most entrepreneurs are not experts in raising capital - and thus typically have poorly structured transactions. An improper or non-existent transaction structure will portray a very unprofessional image of you to potential investors. Thus, the very first step in an offering is properly setting the transaction structure and, in equity transactions, company share structure.

>Pre-offering structuring typically includes such items as setting share price or note amount, determining how much of the company to sell (in equity situations), which Reg D program to use, setting the maturity date and annual rate of return for corporate notes (in debt situations), share allocations to principals so they maintain a set amount of control in the company, minimum and maximum offering amounts which set the effective range of the offering, minimum amount of investment per investor, etc.

2. Document Creation: Step two of preparing an offering involves the creation of the related Regulation D offering documents. These documents include:

Private Placement Memorandum: The Private Placement Memorandum, or "PPM", is the document that discloses all pertinent information to the investors about the company, proposed company operations, the transaction structure (whether you are selling equity ownership or raising debt financing from the investors), the terms of the investment (share price, note amounts, maturity dates, etc.), risks the investors may face, etc. Do not confuse the detailed disclosures and transaction structure in a PPM with the general information a business plan provides - they are not the same.

Promissory Note: In debt offerings you need to have a Promissory Note outlining the terms of the loan arrangement with the investors. The note is the actual "loan document" between the company and the investor.

Form D SEC Filing: The Form D is the notification filing that is sent to the SEC in Washington, DC. It notifies the SEC that you are using the Regulation D program and provides them basic information on the compan y and the offering. It is not an approval document or registration - it is merely a filing that notifies the SEC that you have a Regulation D Offering in place.

3. Marketing: The offering is now ready for marketing to investors.

A Regulation D Offering will solve all of the technical issues you will face when dealing with investors (investment structure, investment documentation, etc.) - these are issues that should be addressed before you interact with investors. Not addressing them ahead of time presents a very unprofessional image of you to the investor.

The Regulation D Programs can be used by domestic as well as foreign corporations. While the programs can be used by any corporation type - the preferred structure is a stock "C" Corporation or Limited Liability Corporation "LLC".

By Luiz Fernando Saife Salemi: In the US, rating agencies such as Moody's and S&P rate private placements, but they are not used to monitoring it, given that most of the buyers of a private placement are institutional investors.

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