Raising Money in a Tough Economy

Dec 13, 2012

Photographer: David Paul Morris/Bloomberg

Raising money for any business in this tough economy isn’t easy. More owners are scrambling to attract new capital, and investors are holding tighter to their money, causing a major disconnect. Successful VCs and private equity funds are only investing in 1 out of every 500 or so deals they see. Banks have cut back lending. Angel investors hammered in the 2008 market meltdown, lost their appetite for new deals while focusing on salvaging existing investments.   However, you can raise the funds you need. You won’t get the very best terms and it will take you much longer than you thought. You may even have to retain an outside firm to help; but if it makes sense and you are fundable, you can get the deal done.   

Get real   

One of the benefits of raising capital from outside investors and lenders is they are a litmus test for your business model. Their decisions will help you get a better—and more objective—perspective on the prospects for your business. Many owners fall deeply in love with their business and continue to plow through their own capital hoping, wishing, and expecting it to be a home run. They do this up to the point where they have exhausted their own financial resources and taken on debt, but haven’t taken the business to the promised land. Be realistic. Don’t bleed yourself and your family, dry funding an idea that is not working. I see this all the time—entrepreneurs are optimists. To have a shot at raising serious capital to support growth, your company needs to have a business plan that makes sense.

Five things you should consider before sharing your business plan with potential investors include:   

  • Have you really thought through how much additional funding you need? Typically, companies overestimate their additional funding requirements because they are unwilling to make difficult internal changes to free up working capital. Or they have growth plans that are too ambitious.   
  • Can you present a plan that shows logical profit growth? Forget presenting “hockey stick” revenue and profit forecasts. Error on the side of being too conservative with your numbers.   
  • Do you own, totally understand, and have the ability to defend the numbers in your plan?
  • Is your plan concise? Sophisticated investors say they form their initial opinion and judgment within the first 30 seconds of skimming a submitted plan. If you can’t present a compelling argument on a maximum of one or two pages, then you probably have no shot at raising new money.   
  • Are you raising money to achieve profitable growth? Investors and lenders are unwilling to put in funds to pay off problem accounts, payables or to pay off loans from previous investors or back salaries to the founders.   

Target the right investor or lender   

Investors are not created equally. Some can be more of a strategic asset than others. For example, my firm is helping develop a new fund to invest in new medical technologies developed in Europe and Israel. We are approaching leading U.S. healthcare companies as potential investors, since they obviously can bring a lot of expertise and talent to this project.

Learn as much as you can about the potential lender/investor you are pursuing. If you are desperate and casting a big net for investors, you can wind up going down the wrong road. One company owner I know wound up talking with the Mob because he had not done his homework. He was tipped off when a major bank that had been interested in the deal backed out when the owner’s poor choice of possible equity investors surfaced. It’s a small world out there, so take time to know your potential investors.    

Constantly work to build your network    

 The quality of your network will heavily dictate how successful you will be in your money-raising effort. As a business owner, stretched for capital or not, you can never stop growing your network of solid people. Your network is very much a big part of your personal net worth.    

Structure the deal to work for both parties

Be realistic in what you are willing to give up in exchange for new funding. Investors walk away immediately from business owners with unrealistic valuations of their businesses. A better approach, particularly with equity investors, is to suggest a deal in which the investor’s return can vary based on whether or not you successfully reach certain benchmarks. If you miss your key targets, the investor gets a bigger chunk of the company. If you exceed the targets, the investor’s share of the equity might be trimmed back. That’s a smart way to propose a deal and it is fair. It puts the onus on you and your team to perform. Another approach would be to give new investors a piece of the business’s top-line revenue until a certain return has been achieved. There are huge advantages to this approach for both the business owner and investor. Obviously, this does not work for early stage companies with uncertain or low revenue flows and it won’t work for companies with tight gross margins.   

Decide whether or not to raise money yourself  

Successfully raising new capital can be a full-time job. Can you afford to take yourself away from running your business while you are raising money? Do you have skills to develop the right documentation and presentations needed in the fund-raising process? More importantly, do you have the right network of contacts to which you can turn for the additional money your business needs? Do you speak the language of bankers or investors? In most cases the answer to all of these questions is “no.”  

A possible solution is finding a firm that can take on a large part of the money-raising task. Many business owners are willing to do this, provided they don’t have to pay a retainer fee plus a success fee based on assets raised. This is an unrealistic expectation.   

Any company in the business of helping clients raise capital needs first to really develop an understanding of your business, your market, your competitive edge, your financial situation, your organization, and more. This requires work before money-raising can start. These firms expect to be paid to do their due diligence. The risk, of course, is that at the end of this factfinding stage, the outside firm will fail to raise the new funding because your business turns out to be a poor investment opportunity or because they lack the right connections themselves. If you are totally realistic you will avoid bringing an outside firm into an almost impossible situation.   

Don’t run directly to traditional lenders or equity investors    

Focus first on increasing internally generated cash flow by trimming costs and finding new ways to boost revenue. If that means eliminating people, then do this all at once. Don’t cut staff in stages. It rips the morale out of an organization.   There is often a real advantage to being in financial difficulties, although it is not fun. Many suppliers working with struggling companies would rather extend more favorable terms rather than lose the business entirely. As long as you are totally up-front with suppliers they will usually work with you. If you duck their calls, avoid their notices, and lie to them, you are just making your situation almost unsolvable. In some cases, it makes sense to jump the gun and tell your suppliers to put you on C.O.D. while you implement a plan for cleaning up old balances.  

One example of creative fundraising was a New England family-owned and -managed manufacturing company that was looking to be acquired. When we evaluated the business, we found they were within days of running out of cash without realizing it. We convinced the owner to take his wife off the payroll, but continue to have her work; fire his youngest son, who was a non-factor; get rid of four company cars; renegotiate his lease (the building owner preferred to take 50 percent less rent rather than have the space sit empty); and renegotiate all insurance policies and have employees pay more for their health benefits. The freed-up cash gave him badly needed breathing room to make other positive changes.   

No two businesses are alike. It is almost always possible to find creative ways to generate needed funding by making internal operating changes, developing different types of strategic alliances, and tweaking the basic business model.

Jack Killion is managing partner of the Eagle Rock Diversified Fund, an 11-year-old fund of hedge funds. He is also the co-founder of Bluestone+Killion, a firm dedicated to helping professionals and their organizations sharpen and develop their networking and client development skills. Killion's 35 years of business experience includes consulting with leaders of Fortune 500 and emerging companies as well as owning and managing successful businesses in venture capital, publishing, manufacturing, and real estate development. He can be reached at jack@bluestonekillion.com.

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