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- Three decisions
need to be addressed prior to raising
capital: ownership, control and valuation.
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- Several rounds
of capital raising may be required
depending on the stages of company
development.
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- By introducing
external investors, you are implicitly
agreeing to step aside if the objectives,
funded by the capital raising, are
not met.
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- Prepare for
the investor meetings with a presentation
about the company, not just the technology.
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- Investors
don’t back businesses they don’t
understand.
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Capital raising can be a time consuming and costly process.
Before approaching investors, some key decisions need to
be made, along with much preparation.
The key decisions relate to issues concerning ownership,
control and valuation. Your company’s structure, governance
and direction will change with input from external professional
investors.
Preparation, on the other hand, relates to a number of activities,
with the key being the development of a clear and concise
business plan. The plan needs to outline the business model,
the company’s strategic position, and the competitive
advantage.
Key Decisions
There are three main decisions to consider prior to raising
capital: ownership, control and valuation.
Ownership relates to the sale of shares in your company.
Rather than retain full ownership with 100% of the shareholding,
shares are issued to raise capital to support the different
stages of the company’s development.
This implies several rounds of raising capital, rather than
the “one off” approach.
The VC managers usually say 10% to 20% of a very successful
company is far more valuable than 100% of a company struggling
to grow with limited internally generated funds.
Growth opportunities may come and go very quickly, and
timing is everything.
How many shares will you need to issue?
The answer to this question is explained in more detail
in the Valuing your Business and
the Valuation Assuming Future Dilution
articles. Check this Website for further information.
Essentially, the size of the share issue and the amount
raised will be dependent on the business opportunity and
the company’s stage of development.
Control is the next key decision that needs to be addressed.
As a company grows from early stage, through the period
of rapid growth, and eventually through to slower growth,
control of the company starts to change.
Initially, it is the founder/CEO who is the key decision
maker determining strategy, culture, governance and levels
of performance.
As the company grows, more and more complex decisions need
to be made. It is not unusual for the CEO to feel under
pressure to make decisions quickly and avoid the bottlenecks.
The CEO’s role starts to change from the visionary,
operational, “do everything” role to one of
direction setting and delegation. He or she needs to become
the team builder, coach and chief communicator.
The CEO also needs to be the driver of the organisation’s
culture, as well as the change catalyst.
It is very rare to find the founding CEO as the same CEO
of an established and listed company.
There are several key questions that most CEO’s need
to ask themselves:
- Do I have the ability to change and be part of the company’s
transition?
- Will I be prepared to step aside and let someone else
lead the company as CEO?
Research has shown that the ability to change is a key
attribute of successful entrepreneurs. Another critical
factor is their willingness to use mentors or coaches to
accelerate their learning and development.
This last question, “ Will you step aside?”
is a crucial one. By introducing external investors, you
have implicitly agreed to step aside if the objectives,
linked to the capital raising, are not met.
The other issue related to control is the change in the
governance structure, with the Board of Directors becoming
far more important as the company grows.
The board needs to expand to include non-executive directors
with industry and/or marketing experience.
The appointment of non-executive directors brings another
dimension to the company with access to independent, informed
and experienced individuals. The collective wisdom is generally
far greater than that of a small company driven by the founder/CEO.
The expansion of the board also signals the transfer of
some key decision making from the CEO to the board.
The expanded board will be focused on strategy, governance,
performance, and risk review, with the CEO will be more
focused on management, culture and operational effectiveness.
The last key decision for the founder/CEO is valuation.
See the Valuing your Business
article at this Website for further information.
Valuation generally arises as the key point of difference
between the company’s current shareholders and the
new external shareholders.
In some cases, the valuation gap will be too broad to achieve
any degree of consensus.
The valuation needs to be compared to the valuations of
similar companies to arrive at a realistic valuation range.
The key aim for the investors is to see the valuation increase
during the investment period. The investors are also seeking
increases in the valuation multiples during this period
as well.
Valuations are based on assumptions and financial projections.
If the projections are not achieved, the investor has paid
too much for the shares. However, if the projections are
exceeded, the investors have picked up the shares at what
they would say a “realistic” valuation.
The “buy low, sell high” is their mantra.
Mechanisms can be structured into the terms and conditions
to allow the upside, or downside, to be directed back to
the party responsible for the variation.
One key point is that, if the valuation goes up during the
investment period, all shareholders benefit.
Realistic valuations will also determine whether capital
is available to achieve your strategic objectives.
Preparation for Raising Capital
Having considered the high level decisions related to introducing
external investors, it is now important to prepare for the
meetings with investors or VC managers.
The key starting point is your business plan.
Your business plan needs to be clear, concise and fully
explain both the opportunity and describe the people who
will deliver that performance. Understanding execution risk
is a key area of focus for investors.
The business plan needs to address nine key questions about
the business:
- Who is the Customer?
- What is the Customer’s decision making process
when buying the product?
- Is this a compelling purchase for the Customer?
- How is your pricing determined?
- How will the customers be reached?
- How much does it cost to acquire a customer?
- How much does it cost to produce and deliver the product?
- How much does it cost to support the Customer?
- How easy is it to retain the Customer?
See “How to Write a Great Business Plan” by
William Sahlman, Harvard Business Review, July – August
1997 for more information.
The people providing the skill and experience need to be
clearly identified, along with any gaps in the management
team. As the future performance and investment returns will
be strongly influenced by the quality of the team, it is
critical to show that your company has the requisite skills,
or access to them, to execute the business plan.
Preparing yourself for the meetings with the investors or
VC managers is essential.
Since VC managers receive hundreds, if not thousands, of
plans each year, and listen to numerous presentations, it
is important to not only prepare for the process, but to
clearly identify who you can work with during the term of
the investment.
See the “How to Select a VC
Manager” article at this Website for further information.
The first meeting with the VC managers or investors needs
to arouse strong interest. You need to be fully prepared
with a short presentation of around 15 to 20 minutes on
the company.
It is not just about selling the technology, or some new
revolutionary products, it is all about selling the company.
This means it is necessary to:
- Establish your people credibility by describing prior
successes and execution skills
- Describe the market opportunity in terms of size and
growth of the market
- Describe your product or technology, especially focusing
on its uniqueness and differentiation from other offerings
- Identify your competitors, both existing and new, as
well as likely substitutes
- Identify your customers, in terms of their needs, potential
targets and access
- Show the opportunity in numbers, with the breakeven
point and the cash flow movements
- Request the capital, and identify the key milestones
to be achieved.
The presentation needs to be believable and clearly describe
your business model. It is really important to establish
this understanding very early on in the presentation.
Investors don’t back businesses they don’t
understand.
If you don’t present this type of information in
your first meeting, you are unlikely to get a second chance.
Selling the business opportunity is more than selling a
product.
There is a definite sales process and cycle you need to
go through. If interest is not aroused at the first meeting,
you need to have the “Plan B” strategy in place
to get back in the door at some later date.
This may involve some regular contact, say every 3 to 6
months to confirm that you are actually making progress
and achieving your milestones.
This communication process will also serve to reinforce
that you have the team to execute your plan.
Capital raising is a time consuming process that diverts
the CEO’s attention away from running a business.
Companies sometimes flounder and nearly go out of business
because too much time is focused on a poorly planned capital
raising process. Like all things, a little bit of planning
and some discipline goes a long way.
Peter T Gow is the Managing Director of Creative
Capital Pty Limited. He founded Creative Capital to accelerate
the learning skills of entrepreneurial CEO's and develop
their expertise in capital management, business and strategic
planning, cash flow management and market research and analysis.
Peter has over 12 years of experience in working with growth
companies and has been involved in the completion of over
30 financings in the software, manufacturing and medical
areas. His expertise covers company evaluation, strategy
and market analysis, capital raising, transaction structuring,
documentation and completion. Peter has also set up several
venture capital funds for a major financial institution
and appraised a range of venture capital managers.
Creative Capital Pty Limited
Peter T Gow
61 412 235 455
petergow@creativecapital.com.au
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