In today’s turbulent economic environment, many companies are finding their cash flows temporarily reduced due to difficult business conditions. Less cash flow generated from operations can cause a working capital squeeze or make existing lenders uncomfortable and/or uncooperative, particularly if the company has violated a loan covenant or agreement. In the past year, we have witnessed a dramatic pullback on the part of all lenders, especially banks. If a bank has the power in its relationship with a borrower due to a broken agreement or covenant, a company could find itself in real trouble unless it is able to raise capital from another source.
What types of capital are currently available?
The answers vary based on the company’s size (revenue, profits, assets, etc.), history of financial results, strength of its management team, and industry.
In general, there is debt and equity (i.e., stock), but capital should be considered on a spectrum from senior to junior. The most senior capital is typically a bank loan secured by a first lien on all the assets of a company, followed by second lien debt and then unsecured debt. As a general rule, the more junior the capital, the riskier and more expensive it is.
No matter the interest rate, senior debt will be cheaper than other capital. In the current market, cash flow-based senior lending has all but dried up. It seems that cash flow senior loans are available only to those companies with strong cash flows — in other words, those that don’t really need the money. On the other hand, if a company has significant assets and is not already leveraged, the owners should check with their bankers; interest rates may be higher and advance rates lower, but senior debt may be available.
Let’s assume bank debt is not available — that leaves equity (common and preferred stock) and subordinated debt (sometimes called mezzanine debt because it comes between senior debt and equity in the capital structure). It will be least expensive if owners are able to access friends and family as investors. That said, many entrepreneurs prefer to keep business and family separate, so that leaves high net worth individuals (angel investors) and institutional investors.
How can business owners prepare to raise capital?
Regardless of the type and source of capital a company chooses to pursue, there are several steps to take to ensure the capital-raising process runs smoothly and, more importantly, maximizes the chances for success.
Prepare an executive summary of the business. Describe the company and how it makes money, be sure to discuss products and services and talk about the company’s challenges and opportunities. Also provide biographies of key members of the management team. Use charts and graphs to make strong points about financial performance and industry dynamics.
Assemble a historical financial information package. Include at least three full years of historical financial statements. Audited financial statements are best, but statements reviewed or compiled by a recognized accounting firm likely will suffice. Also, include monthly financial statements for the last fiscal year and the year-to-date period. It is helpful to include information such as sales and gross margin by customer and/or product to help investors consider concentration risk. In addition, provide a detailed breakdown of costs and expenses, including information regarding capital expenditures. Try to break down capex by expenses required to maintain the business and those that contributed to growth.
Assemble a financial planning package. Include the current-year budget and a forecast for the coming year. A detailed bottom-up analysis is essential to creating credibility with investors. Future growth will be the decisive factor for equity investors. Include projections for the next five years if possible, even if they are just a best guess driven by top-line growth rates and margin assumptions; they will be helpful for investors who want to understand the potential of the business.
Select an online data room provider and begin uploading documents for investors to review. Be sure to include all key contracts, credit agreements, charter documents, board minutes, tax returns, etc. An online data room will streamline the due diligence process significantly, requiring less of the management team’s time and shortening the overall time to close.
Prepare a PowerPoint presentation that walks investors through the business, its historical results, challenges, opportunities and projections. Include details regarding the use of proceeds. Invite the most interested investors to visit the company and use this presentation as a basis for discussion.
Where do business owners go to find capital?
The best advice for owners and management teams is: Do not underestimate the time required and the complexities involved with undertaking a capital raise. Never be afraid to admit that you are in over your head and need the help of professional advisers. Investors, particularly institutional investors, are currently at an advantage. In today’s business environment, capital is scarce and at a premium. To get the best deal for your company you need to bring your A-Game and your A-Team. A variety of corporate and/or business advisers such as attorneys and accountants may be able to help business owners determine the best sources of capital and recommend an investment bank to assist with a more comprehensive review of capital-raising alternatives, as well as sources of potential capital. It could be the difference between using a watering can versus an industrial sprinkler when combating your company’s capital drought.