Читать книгу Winning at Entrepreneurship - Rod Robertson - Страница 16

Chapter 6

Raising Cash

UNLESS YOU ARE IN THE ULTRA-MINORITY of the very wealthy, you will have to wrestle with how much you can allocate to this adventure. Again, funds needed are not just the cash upfront but also the ability to fund growth and carry yourself to profitability. Often poised is the question, “How much risk do I take? Do I bet the ranch and go down with the ship if the company tanks?” What is your threshold for loss and will it endanger the well-being of the family unit? Do you put in enough that if you lose your investment you will endanger the home front? You and your advisors must dispassionately look at this acquisition and find your level of commitment. If this needed level of commitment goes beyond what you are capable of putting up or, better yet, willing to put up yourself, a whole new and (mostly unfortunate) world must be explored of partnering up.

Understanding your risk threshold comes from evaluating your personal Balance Sheet. Where does your significant other play into this? He or she really should be on board for this roller-coaster ride. You should explain to this person the risks/rewards and how you are going to be absent many a day and night in this all-consuming passion to own a business. Coming home from grueling long days and facing a confused and angry spouse who does not understand the trial by fire you’re going through is a recipe for disaster. Studies show that the average entrepreneur oftentimes sacrifices personal relationships and even good health, especially during the launch cycle of a new business.

STEWARDSHIP OF OTHER PEOPLE’S MONEY

The responsibility of being the steward of other people’s investments and their almost blind trust in you are very serious responsibilities. Your conduct is held to high moral and legal standards as well. It is a mixed blessing to have partners/investors. Many sole proprietors without outside monies have the luxury of running their business like a frat house. A friend just told me that he bought a Rolls Royce and charged it off to the business, and he is not in the limo industry! I have heard legions of stories of cash under the table, home improvement charges run through the company, and multitudes of other questionable expenditures, all undertaken to beat the taxman. These owners are taking a BIG RISK and, in most every instance, have the capital to pay taxes but have decided to try to throw the slider by the government. They usually do not realize the double and triple jeopardy they are playing. If a miffed employee plays whistle-blower or ownership activities throw a wrinkle in their financials that leads to an IRS audit inquiry, the unraveling of their misdeeds can be catastrophic. Not only are they called on the carpet for their one-time sin, but the IRS auditors also will then have the ability to look back year over year for other suspicious activities. Besides the obvious costs and trepidation, IRS deep dives lead to paralysis and then a public censoring that will tarnish the business for years. Any such transgressions could lead to investor lawsuits as well.

Below are a number of ways to run afoul of the IRS.

1 Not having good record keeping from the beginning. It is essential to the financial well-being of your company that you start good bookkeeping from the very beginning and build a sound practice from there.

2 Make sure to separate personal financials from your business financials. Co-mingling funds could lead to a personal audit as well. You may “lend” money to your business, but it must be recorded and eventually paid back.

3 One must always set aside cash to pay for estimated personal income taxes. Cash flow is always tight up front, but one must be disciplined to set aside monies. Once a new owner falls behind and cash flow is restricted, this can lead to poor decision making at tax time.

4 Make sure not to take a convenient short cut by paying employees as “independent contractors.” Although keeping employees under thirty hours or outside of the company avoids health insurance costs and a multitude of other “tag along” issues, the IRS is becoming a stickler on giving workers more protection. They can look at back records and make an owner pay severe retro costs, so beware of this possible trap.

5 Do not ignore IRS calls or inquires. They will not go away. They will circle back, and eventually the owner will have to confront these issues. In recent years, stories of IRS employees browbeating citizens has actually made for a more friendly IRS. Avoiding the IRS is TAX EVASION.

6 When you own a business, speak with your accountant regularly, especially in the beginning of ownership.

7 Keep your business-related receipts, and take the time up front to log everything accordingly. Credit-card receipts without a record of who was entertained are not enough. If the IRS sees sloppy record keeping this year, they may start looking back several years …There is no need to be afraid of the IRS, but self-employed people do have to pay attention to IRS regulations that affect their business. The incredible freedom of owning your own business comes with some additional responsibilities.1

There is much operational good associated with taking on investors. Many operators have a tendency to slough off on operational procedures and slip into an operating mode that would be unacceptable to an outside entity. Most investors invest in companies where they have some industry-related experience or have been aware of the company’s performance for some time. This level of knowledge changes the landscape, and most sound operators will tighten up their procedures and reporting with other partners on board. Investors should request or be provided with periodic financials that show the course of the company and highlight management’s efforts on their behalf. This minimal oversight is extremely beneficial to ownership— no more Rolls-Royces!

“Smart money” that actually wants to assist the company is the best type of investor. This class of investor, usually with industry connections and expertise, will assist in driving revenues and have the owners running a tight ship. With industry experience, the investor can make recommendations on operations, as well as contacts and introductions, that will enhance the returns on their investment.

But what about the pain-in-the-ass, “know-it-all investors? This breed can be a scourge, especially when they think they know a better path and are ready to tell the owner/operator ad nauseam how to pilot the ship. Their clucking and hissing can be the proverbial nails on the chalkboard. Bringing in these “masters of the universe” could lead to a serpent in the nest. If the business goes sidewise and these unemployed know-it-alls believe they can do a better job or contribute on a full-time basis, watch your back for their unwanted intervention.

— CASE STUDY —

We had a client, Rich, an officer and a gentleman, who founded a business and grew it to over thirty million dollars in revenues while making it very profitable. Along the way, he took in two hundred thousand dollars from seemingly professional investors. After a good run, however, the company was hammered in the recession and was tottering on insolvency. Rich, like so many clear-thinking executives in his position, decided to go through a quick sale to a strategic player. He had the safety and well-being of his employees in the forefront of his thoughts and realized he could use the strategic horsepower of a major industry player to bring his products to market. We, as intermediaries, were moving briskly to a close with Rich’s company to an industry player when the “investors” reared their ugly heads and tried to step in and take over the company while disrupting the sale by every means possible. This included calling the bank that was holding the loan and other shareholders and even threatened us with a lawsuit if we continued with the selling process. They were after a hostile takeover, which was eventually quelled. These were sophisticated investors who simply were looking for a job and attacked the company like bull sharks. Rich held them off and sold the company to an industry leader where the company flourished once again. Post-sale, Rich stayed on as CEO and ramped up sales quickly, and all ended well.

Always understand the motives of your investors, as many can be angling for more than just a return on investment.

A FULL INVESTMENT CYCLE

This chart sets forth a classic example of an individual starting a company that is doing well and needs growth capital. It depicts the sums of cash going into the business (“Funds Invested”) by each group and the approximate valuation of the company after each investment. The “Founder’s %” column shows the diluting effect to the founder as more cash flows in through investors.

The sequence below of a sample transaction of forty million dollars shows the estimated cash or “waterfall” of cash that will trickle down to the final tally for the original founder.

FOUNDERS CONTRIBUTION: ($0–$100,000)

What can you afford to ante up? You certainly do not want to be known as the “mouse that roars.” No matter what path you are going to take—sole owner, partner, franchisee—you have to have skin in the game to be taken seriously. Financial players and backers will understand if you’re a person of modest means. I often find myself quoting Winston Churchill, “There goes a modest man with much to be modest about,” when I see a founder not putting in any cash. If the investors feel you are putting in half of your available cash and that contribution is only, say, 5 percent of the equity needed for the acquisition, they know you are risking your cash reserves. They want you to feel the pain!

Sweat equity: work and effort by an owner that results in an increase in value of his or her company; also the work by an employee that eventually gets stock in firm.

Contributing sweat equity is fine, but to maintain a reasonable stake in an enterprise, one must have equity (cash) in play. When one is cranking up a start-up and actually has created value in the enterprise, then the upcoming dilution and whittling away of a founder’s stock position only becomes an inevitable and painful process. One recurring and always painful theme is when a founder has developed a spreadsheet for world-conquering growth and is drinking the company Kool-Aid by the gallon. Their grandiose growth strategies can reach megalomania proportions. If the founder has a great product and position in a marketplace, the wolves are patient and will sit on their haunches until the time to swoop in is right.

Dilution: the reduction of the value of a company’s stock when new investor money comes into that company.

FAMILY AND FRIENDS ($100,000–$250,000)

This certainly is an investment option many would like to avoid! Entrepreneurs often don’t have any choice. When you take the money from family and friends, you are on the clock 24/7. You will be dragging yourself home, and there are your in-laws or your sister sitting on the couch, wound up with fresh ideas while you are ready to do a face plant in exhaustion. Their money once in the hopper is most often immediately spent on operations, as it was needed desperately in the first place. Now that they are on board, they own a piece of you.

Although family and friends will be omnipresent, the great point of family and friends is they will not hold you to strict operational procedures or oversee you day to day. They will let their money ride, as they know they are invested early and have other motives besides just seeking a cash-on-cash return. They supposedly are looking for the big return, and thus their money should be considered “patient money.” As they are in early and constantly are getting diluted and ignored through the business’s life cycle, they are a painful pay-off to be addressed at the end when the business is sold. Most times, they have been overly diluted (at least in their minds), and the founder is having to keep harmony at the home front or with friends and has to compensate them more from his equity than is required on the balance sheet. If the business is not sold and is running break even just paying the bills, some novice investors may eventually get impatient and ask to be cashed out. This is usually an issue unless you can give them a pay-off and financial haircut that benefits the company. This pay-off is often done through cash from the company’s line of credit.

The sums taken in from family and friends are usually in increments no lower than twenty-five thousand dollars and preferable in blocks of fifty thousand dollars. Some operators like to say the units are of one hundred thousand dollars, but they will “split” a unit if they can get two individuals ready to take fifty thousand dollars each. It is a bit of a sales tool to split a unit.

ANGEL FUNDING ($250,000–$1,000,000)

For the first time, you will be stepping into the world of professional investors. These are usually experienced players working in teams that will expect you to have a professional approach and know your business backwards and forwards. Typically the angels are far more interested in tech and software-related enterprises that need expertise in scaling. They are not interested in meat-and-potato operations growing at 10 percent per annum. They want the juggernaut, the land grab, the scaling machine that will give them a tenfold return. Their preference is not for a start-up but, rather, a company that has “proof in concept” and has a blue-chip client that has bought into the company’s services or products. This “beta” client of the company hopefully has bought repeatedly of its own volition and because it is locked into a first-time contract.

Virtually all research references state that Angels should get 5X to 20X return. Most seem to say that 10X is realistic and so that should probably be considered a reasonable “best practice” number.

On the one hand, everyone would like a 10-bagger (10X return on the investment (ROI)) plus, realized in three-to-five years. Many Angels have also argued for a 30 percent ROI, presumably over a shorter period.

A 30 percent per annum ROI over three years is only a 2.2X return, while 30 percent ROI over five years is a bit less than 4X. Conversely, if the Angels demand a 10X return over only three years that is a staggering 115 percent annualized ROI. Over five years that’s almost 60 percent.²

Angel groups abound, and they are usually retired (not by age), well-heeled, former operators trying to stay in the game and invest in sectors where they can bring their industry expertise to the firm to enhance operations. They usually pride themselves on being mentors and usually seek an active over-sight affiliation with the firm. Oftentimes, they bring in strategic thinking and have deep networks that, if harnessed correctly, could rapidly propel the company forward. They are seeking an organization that they understand how to grow rapidly.

Angels are all about rapid growth and time to market. They have virtually no interest in long technology gestation periods. They will ride the company for as long as the company is increasing in value. If the company plateaus out and sees no large expansion upside, they will seek an exit for their investment or, if locked in, try to manoeuver the company into a sale. The angels need to have their chips back in their hands for another investment opportunity that will give them the big 10X return.

The company shopping for angel money should be wary of the kindly big brother that, once on board, becomes more involved and dictatorial. The angels usually seek a board seat and will review financials and strategies to great extents. A good angel or angel group can be the key to success for a promising firm. Their wisdom, money, connections to bigger money, and group think-tank mentality are great tools for the entrepreneur.

Before you introduce yourself to these groups, undertake a rigorous dress rehearsal with your current team of advisors. Also do your homework on them. Many of these angels or angel groups can be notorious tire kickers who are just keeping themselves busy and not investing very often. They often throw out term sheets that, if carefully analyzed, can be seen as the actions of a pirate! Ask them what deals they have done in the sector and ask for references as well. Do not take their credentials at face value but really drill down to understand their accomplishments. Oftentimes, this due diligence can lead to new relationships with industry players that will continually expand your network.

TEN TIPS FOR FINDING AND WORKING WITH ANGEL INVESTORS

By David Gass

1 Network, network, network. Build your network and you’ll build your net worth. You don’t have to know an angel investor to get a meeting with one; you just need someone in your network that can connect you to an angel investor.

2 Have a Business Plan. Once an angel investor says they are interested in learning more they will want a business plan. The business plan should have all key areas mapped out such as a clear explanation of the product/service, the size of the market, the target demographic, return on investment for the investor, exit strategy, financials, pro forma, and organizational structure of the company.

3 Investors invest in people not the idea. Don’t pretend to be someone you’re not in order to solicit an investor. Investors want to work with people they like, they trust, and they believe can grow the business. If you pretend to be someone you’re not, the investor will find out over time and the deal will likely blow up.

4 Have your elevator pitch down. You never know when you will have the opportunity to get an investor interested in your deal. You could run into an investor who wants to hear about your deal at a cocktail party, walking down the street, by email, over the phone, in a meeting or just about any way you didn’t think would have been the traditional introduction. So be prepared to present a killer elevator pitch that clearly states your offer, your business, and what makes you and your company unique.

5 Put together a one–two page summary. In addition to the elevator pitch you need to have a one to two page executive summary on your business, similar to the elevator pitch, but on paper. This is something you can hand to an investor if they want to learn more without boring them with a 30-page business plan.

6 Know your numbers. Angel investors don’t want to invest in a business when the owner can’t articulate what the numbers in the business plan mean. The fastest way to lose confidence in an investor is when you can’t explain the numbers.

7 Learn basic presentation skills. Investors want to have confidence in their investment. You are their investment. If you have trouble speaking in front of people, you need to learn the skill. You don’t need to be the next Tony Robbins, but you do need to be able to provide a clear and interesting presentation that will attract the interest of those listening.

8 Know your strengths. Investors know that you aren’t going to be an expert at all aspects of running a business. They want to know the truth about what strengths you have and more importantly what you believe are your weaknesses. Then you need to explain how you are going to overcome those weaknesses by outsourcing, hiring experts, or another way.

9 Have a team. A team is important for investors to see. They need to know you understand a business isn’t built with just one person. You don’t have to have specific individuals in place right away and they don’t have to be employees. They can be mentors, board of advisors, board of directors, managers or independent contractors. At minimum have an organizational chart based on a time line for growing the business and what team members you will add over time.

10 Maintain focus. The last thing investors want is to invest in a business only to have the entrepreneur get sidetracked with other ideas. They also want to see focus when you are presenting your deal to them. Don’t have too many projects, product lines or ideas. Maintain focus on what you are offering and investors will find clarity in your offer. Clarity = Power.These tips can be very helpful but if no action is taken to implement them, you’ll remain in the same position you are today—little to no chance of getting funded by an Angel. So take the steps to put yourself in a position to get funded:

 Step #1 - Develop your elevator pitch and one page presentation.

 Step #2 - Write out your business plan.

 Step #3 - Join networking groups and attend conferences where investors are likely to be.3

B ROUND ($1,000,000–$3,000,000)

This amount of investment in an operating company is usually made only when the company has the platform ready for expansion and the roll-out of new products and services that require additional working capital. The baton is passed from family and friends or angel investors to the next-up round of funding. This raising of equity oftentimes falls into the venture capital arena. These formal financial institutions, besides infusing cash, also bring value-added subject expertise. They operate in a zone where they often have complementary investments, and they can create joint operating synergies. This could range from using existing sales forces to deploy another company’s products to creating licensing and marketing joint ventures.

Convertible debenture: a loan issued by a company that can be turned into stock at a given point in time; usually has a lower interest rate than otherwise because of the convertibility factor.

For a traditional operating company (non tech/software), this type of investment is more rare as business owners are loath to give up the equity in the firm to outsiders who will be seeking to recoup their investment in a three- to five-year window. Owners who want to hold their businesses indefinitely have a much more difficult time getting investors, as there is no exit. In these situations, the ownership may want to take on a convertible debenture, which is a loan against the company that can be converted into stock by the holder of the loan and, thus, has a lower interest rate than otherwise. Because the group lending the money has the right at certain junctures to turn the loan/note into equity, they obviously do this only if the company looks promising. Conversely, the owner is not always pleased to have the debt suddenly become equity, especially when it looks as if the company is about to make positive growth or increase in value. But this conversion also takes the debt off the balance sheet and converts it into stock that makes the company healthier with less debt. This conversion oftentimes allows the company to get traditional bank financing to continue growth that was previously withheld.

Note: a loan from a bank or private individual.

This round of financing often propels a company onto the playing field of industry giants that now can see this firm with its recent growth and enhanced offerings as a welcome player to the sector.

C ROUND ($5,000,000–$10,000,000)

This round of funding is often seen as the last step before a company is acquired and gives the firm enough cash to implement the strategies that were created and started in earlier rounds of funding. Many times, this round of funding combined with earlier investors has the founder losing majority interest in the company and thus operating control. This change of control is usually implemented at the board level where, by this time, the board should have five members, which could conceivably be the founder, a friend or family investor, an angel, a representative of the B Round, and one from the C Round. The professional investors whose interests are all aligned now would have three of the five seats so they could steer the company to a sale or other event over the objections of the original founder.

STRATEGIC INVESTMENT

Virtually all exits or sales of a growing or mature company are made to a larger industry player from the same sector. There are often a multitude of dialogues between a larger player and the smaller company (the entrepreneurs) about joint synergies, but the discussions most often evolve into an outright sale of the smaller company. It usually makes no sense for the smaller company to be partially owned by a bigger industry player as that would inhibit the growth of the smaller target business. Operational constraints put on a subsidiary company recently bought could hamstring the small firm’s value in the long term as well.

EBITDA: earnings before interest, taxes, depreciation, and amortization; most-used method of assessing a company’s profitability.

The vast majority of sales of companies with values over twenty million dollars (which is approximately the minimum size a company would be if it went through the full growth cycle of funding outlined above) are made to strategic buyers. Very rarely does an individual or entrepreneurial buyer have the cash and/or the sector experience to buy such a large organization. The price or multiples of EBITDA (earnings before interest, taxes, depreciation, and amortization) to buy bigger companies is much higher and oftentimes do not make financial sense to the individual buyer. The high price these larger professionally run firms demand make it almost essential that a buyer have the ability to merge the two companies and save operating expenses.

Multiple: a number used to multiply against revenues, profits, or EBITDA of a company to find its valuation. (See next chapter, “Valuation: What Is It Really Worth?” for more information and examples of multiples.)

Strategic sales are also preferred buyers as they are predominantly cash buyers or, at the very least, pay out over 80 percent in cash and the balance in shares of stock, or earn outs, over time. Post Great Recession, many strategic buyers have practiced much stricter financial controls and have fattened their war chests. This allows them to pay big premiums for smaller firms that on paper make no sense.

The strategic buyer is most times the preferred exit vehicle for entrepreneurs.

Earn out: part of the purchase price of a company, paid over time, that a seller must earn based upon the specified post-sale performance of the company.

THE MYTH OF GOING PUBLIC

When I hear a small business owner chattering about going IPO (initial public offering), I immediately understand this owner is not in tune with the marketplace. You have as much chance of seeing a white elephant on Main Street as a ground-zero ramp-up of a firm that drives to a successful IPO. If this IPO mirage were an actual possibility, the firm would already be surrounded by high-end handlers and most likely not be a play for the readers of this book. A firm with this much potential would have to have an unprecedented value proposition.

An IPO involves a huge time commitment that can potentially distract business owners from other strategic priorities …

The Small Business Administration (SBA) says the fees and expenses of going public can reach into the six or seven figures. U.S. investment banks managed to charge a 7 percent spread on IPOs in the past decade, about 3 percentage points higher than their European counterparts, according to researchers at Oxford University …

It is little wonder that fewer than 1,000 businesses a year are successful at IPOs, according to the SBA. Emerging companies have instead turned to other strategies to cash out investors, such as trying to get acquired.⁴

In the world of small public companies, it costs well over two hundred thousand dollars to stay public. It also takes approximately 30 percent of the top company officer’s time to deal with the issues of being a public company and staying a public company. Getting delisted or going “private” is a serious consideration for most underperforming small businesses that are publically traded on any exchange.

NOTES

¹ Veronica Robbins, “10 Ways Small Business Owners Get in Trouble with the IRS,” HubPages, April 2008.

² “Expect Return on Investment,” Indiana Angel Network

³ David Gass, “Ten Tips for Finding and Working with Angel Investors,” Fast Company, June 27, 2011.

⁴ “The Ins and Outs of IPOs,” Entrepreneur.