For ambitious businesses seeking investment dollars for expansion, the high seas of capital raising are as turbulent as they are vast. With so many ‘X ’s marking so many spots, can a business builder walk the plank without getting wet? Jana Matthews charts a course for companies at all stages of development.
Why do so many entrepreneurs seem obsessed with money? Because they need a lot of it to achieve their dreams. But few entrepreneurs know when to approach different sources of funds, or what each source is looking for when it reviews a business plan or balance sheet.
In the beginning, you work long hours. You bootstrap. You might use your own money to get the company going, tap into your savings, borrow against credit cards, use your house as collateral for a line of credit. You may even dip into your retirement funds or convince your spouse, parents, relatives and friends to provide long-term loans or buy equity in the company.
If the company begins to grow, you may want to approach angel investors for equity financing or long-term loans. And then, if your company has tremendous growth potential and needs an infusion of capital to “hit the window” of opportunity, you may wish to seek venture capital financing.
It’s a long haul and the stakes are high. Nine of out ten new businesses fail in their first year. Fewer than one percent of all companies who seek venture capital are successful, and a much smaller percentage of these ever go public.
So what does a business builder need to know to raise capital without walking the plank.
CHECK YOUR RIGGING BEFORE YOU HOIST THE MAIN SAIL
Having money is not always the answer to a business owner’s problems.
If you don’t have a strong strategic plan, you will probably fail to spend your newly acquired capital on the right things. Also, if you haven’t built a company with systems in place to monitor your cash flow and address slow cash collection or cost over-runs, you will simply burn new money just as you have exhausted current resources.
While insufficient capitalisation is often cited as a key reason for business failure, poor financial management can lead to the same end.
Importantly, growth for growth’s sake is never as important as profitability and sustainability. Disasters can occur when an entrepreneur does not understand the rules of the game of debt or equity financing. These types of funding become available at different points in a company’s development cycle. Newer companies may find many of these doors closed, while established companies will find that some sources simply cannot fuel the level of growth they’ve reached.
But never forget, making a bad deal for the wrong kind of money from the wrong source (such as high-interest debt, or giving up a significant share in your company) can be more damaging to your business than not having growth capital at all. A really bad deal can cause you loss of ownership before you’ve even set sail.
Get your ship in shape before leaving the harbour. That way, you will be prepared for whatever obstacles and opportunities the wind blows your way.
PIECES OF EIGHT
Debt financing is possibly the most common tool for new and established businesses. This occurs when a business or business owner obtains a loan or a line of credit with interest from a bank, individuals and sometimes even from customers. With debt financing, the borrower takes on the burden of paying interest and repaying the principal at some future point in time. Banks are usually willing to loan money for assets such as land, buildings or equipment. If the borrower defaults on the loan, the bank has something to recover. However, when it comes to less tangible things such as cash flow, banks will generally require personal assets, such as stocks or even property as collateral. You owe it to yourself to be certain that you are not gambling with your personal stake just to obtain debt financing.
Banks and bankers always try to minimise risk. The minute your company looks like it is having fi nancial difficulties, the bank will intuitively know. It is not uncommon for a bank to pull their line of credit and demand repayment just when an entrepreneur needs financing the most.
To prevent this from happening, build a relationship with your banker and cultivate this relationship even when you don’t need the money. Meet with the bank frequently. Discuss your business plan. Show them your cash flow and balance sheet. Set up a line of credit as soon as is feasible and establish a good history early. If you have a good relationship with your banker, and have a solid, well-documented financial picture, it will be easier to deal with the bank in tough times.
If things do go wrong – if your bank officer moves on, your bank gets sold, the bank’s board of directors changes its lending strategy – always have a back-up plan. Make yourself known to other lenders and capital sources now, rather than the day after you need money. That way you won’t end up sunk in the face of unexpected bad weather.
WALKING THE PLANK (WITHOUT GETTING WET)
Equity finance is sometimes described as the ‘Holy Grail’ of growth finance – it is often sought but rarely found. Like debt financing it also has its own strengths and draw-backs.
Venture capitalists are possibly the best known source of equity capital, but there are alternatives. Employees, wealthy individuals (also known as angels), family members or corporations are all potential equity sources, who will exchange money for partial ownership and shares in a private company.
Venture capitalists provide financial and knowledge capital in exchange for equity in the company. Remember that venture capitalists are interested in the potential of the company with a view to making a profit on exit, such as a trade sale or an initial public offering (IPO) on a public stock exchange.
While the strengths of the management team will play a key role in the venture capitalists decision on whether or not to invest, their investment is ultimately in the potential of the business itself – not the entrepreneur.
In some cases, a venture capitalist may require the entrepreneur to stand aside as a condition of investment. They will not hesitate to replace key people (even founders), sell the company, or even close down the company if it does not perform as projected when the deal was struck.
Angels, unlike venture capitalists, often bet on the entrepreneur to achieve the dream. But with a stake in the company, they often choose to become engaged in the operations of the company. This can be a double-edged sword. While an angel can provide valuable contacts and expertise, they may wish to “meddle” in the business and may want the entrepreneur to manage things “their way”.
X MARKS THE SPOT … OR DOES IT?
Most companies should be planning to exit from day one. Whether this comes about in the form of a trade sale, merger, IPO or alternative route will depend on the type of company and the timing of the planned exit.
Some companies use a public listing as another way to obtain growth capital. Whether this option is right for your company will depend on its growth potential, the size of the company and the strength of the investment market (ie. The potential demand for share ownership in the enterprise). Capital obtained through a public offer has legal and fi nancial strings attached. However, a listing can also give a company exposure to a whole new world of potential investors (quite literally).
Your decision on whether or not to chart this course will depend on your choice of vessel. Public listings are generally best suited to your larger ship. In fact, all listing platforms, such as the Australian Stock Exchange (ASX), set their own minimum requirements, to ensure that companies don’t launch when they are not yet ready for the high seas of public equity trading.
There is one lesson that all entrepreneurs must learn when raising capital: raise more than you need and spend less than you have. Start with a strategic plan, not with a loan application, and you will reduce your chances of running aground.
Dr Jana Matthews is founder and CEO of Boulder Quantum Ventures and is special advisor and consultant to Solon House – a community of entrepreneurs.
Solon House will be running “Pennies From Heaven” workshops in Sydney, Melbourne and Brisbane in September 2005, which will focus on Angel Financing for potential investors and companies looking to fund their growth. For more information contact info [at] solonhouse.com This article was originally published at www.entreworld.org and adapted by australian anthill.
GRANTS FOR GROWTH
Not all sources of growth finance come from the private sector. AusIndustry is the Federal Government’s business program division. Every year it delivers a product range of 27 innovation grants, tax and duty concessions, industry support, and venture capital to more than 10,000 small and large businesses. Government support is one course worth charting. In 2001, the Federal Government announced its Backing Australia’s Ability initiative, a $3 billion set of measures to support science and innovation. Commercial Ready is AusIndustry’s newest innovation grants product.
Commercial Ready will provide up to $200 million a year until 2011 to businesses for research and development, proof-of-concept, technology diffusion and early-stage commercialisation activities. Grants range from $50,000 to $5 million for eligible projects of up to three years in duration. To help customers with product and eligibility information, AusIndustry has customer service managers located in 22 offices across Australia, a national hotline and website, plus more than 50 Small Business Answers Officers in regional areas. AusIndustry provides incentives to help Australian businesses:
- conduct research and development
- grow a small business
- take up new technology
- undertake industry-specific manufacturing and production
- commercialise a new technology or venture
- apply for a tax or duty concession
- gain access to science resources
AusIndustry offers both entitlement and competitive-based products. For an entitlement-based product, such as tax concession, a customer qualifies to receive the assistance. For a competitive or merit-based product, such as an innovation grant, successful customers are selected on merit, based on their application
Got a great business idea but don’t know how to get it started? Are you looking for advice on boosting your research and development? Or are you taking a new product through the commercialisation process? Help is only a mouse click or a phone call away through AusIndustry’s website (www.ausindustry.gov.au) and hotline (13 28 46).