Capital Raise Blog Series - Vol 9 Strategies to Raise Capital

As investment bankers, RKJ Partners possesses a breadth of knowledge and experience in advising clients that seek growth capital.  In our latest blog installment, we define and outline the key elements involved in the process of raising capital.

Given their title and job description, private company chief financial officers (CFOs) are expected to be able to raise capital for their company, yet many often feel unprepared or under qualified for this challenging task.  By leveraging and utilizing some sound and fundamental guidelines, CFOs from all levels of experience can become efficient and successful at sourcing needed capital that serve the best interests of their company while potentially creating more wealth for owners, shareholders, management as well as themselves.

Strategy 1: Create a Quality Business Plan

In order to secure the best possible financial terms, capital requirements need to be clearly and thoroughly articulated. This is not likely to happen without some detailed projections of income statements, cash flows and balance sheets. Ideally, projections should be completed for a five-year period with the first two to three years projected on a monthly or quarterly basis. Projections should outline how much capital the company will need both now and in the future. The ideal goal is to obtain financing that will work for the company over the next five years. The projections should be optimistic yet achievable. It’s also important to provide a concise description of the business (products/services), growth strategies, company history, industry dynamics and management team.

Strategy 2: Play the Numbers: Solicit Numerous Funding Sources

Bankers typically do not like to compete, but competition can dramatically reduce the overall cost of capital.  Traditional banks tout the value of relationships, yet relationships rarely drive pricing or creativity as much as competition. Professional investors such as buyout firms and equity players know the importance of competition. 

Strategy 3: Consider Financing Sources Beyond the Bank

Beyond the traditional banks there are pension funds, specialty lenders, BDOs and other financial institutions that provide capital.  These groups can offer very innovative rates and structures.  Often these structures have appealing aspects such as fewer covenants and limited or no personal guarantees from the owners.  Given the uniqueness and possible benefits, it’s important to include these institutions in the search for capital.

Strategy 4: Know the Primary Financing Products

With so many potential funding sources and alternative strategies, CFOs can become overwhelmed by the different financing products.  Financial institutions, particularly specialty finance companies, will often combine several products to make them appealing to established businesses.  To be fair, the terms from the bundled product need to be compared against comparable financing for individual/single products from at least two separate sources. 

Strategy 5: Consider Subordinated Debt as an Alternative to Equity

Most CFOs are familiar with the two financing products: senior debt and equity. Probably the most exotic of the instruments is subordinated debt. While not a household name, subordinated debt has been around for over 25 years. Entrepreneurs often shy away from these types of instruments because of the higher interest rates and increased complexity.  The pros, however, use these financial instruments extensively to finance buyouts, growth or acquisitions.  These products are popular with buyout firms because they significantly reduce the amount of equity the buyout firm has to put up in order to buy a company. By buying companies on a predominately debt basis, buyout firms are able to make spectacular returns on their equity. Private companies have the same opportunity.

Strategy 6: Anticipate a Wide Range of Pricing

The main reason for all this effort is because the differences in the cost of capital and financing terms can be dramatic particularly when institutions bid in a competitive situation.  The decision to choose one institution over the other is not always solely dependent on the cost.  The discussion should also include an analysis of the different costs of capital including any added costs for increased asset monitoring or compliance.  While it is true that pricing can vary substantially between the same types of institutions, the structure and covenants differences can be more significant. By shopping all available types and sources of capital, the CFO and entrepreneur are armed with the information necessary to make the best possible decision.

Strategy 7: Address Any Conflicts with Advisors

The benefits of using an advisor or consultant can often far outweigh the costs.  However several common conflicts which buyers should be aware of include:

• Investment bankers and advisors are often paid a variable amount based on the amount and type of capital raised. The most common approach to investment banking is for an advisor to be paid more to raise equity than debt.  This compensation structure can encourage advisors to lead clients toward equity rather than debt and needlessly giving away too much ownership because the advisor wanted to maximize his or her fee.
• Advisors often take additional compensation in the form of stock or warrants. For those that do, the amount of stock or warrant received is based on the valuation of the company at the time of the investment.  
• When working with an advisor, use common sense and make sure that advisor is willing to help the company seek a variety of financing alternatives and ensure that their compensation is not in conflict with the best interests of the company.

Strategy 8: Proactively Seek Ownership Opportunities for Management

Management team members and CFOs are often promised ownership in their company when they join but many owners never formalizes this offer. For companies where the owner has set such an expectation, a major financing event provides the opportunity for management to seek a stake in the business either through options or a small management buy‐in. For companies with strong growth prospects, an option plan can be good for the owner because it can motivate the management team, increase retention, and minimize equity dilution. For a company where the owner may sell the company in the next five years, a partial management buy‐in may be attractive. In the case of a buy‐in, management invests personal capital that is combined with outside capital to allow management to purchase a small stake in the business (say 5% to 20%). For the owner, this can provide some real liquidity and personal financial diversification while locking in management to stay committed to the business.

Strategy 9: Focus on the Long Term Goals

Financing can be time consuming and everyone should celebrate when one is complete.  However, long term success is driven by ensuring management stays focused on the ultimate goal of trying to hit their five year projections.  Unfortunately, companies will often work hard to make a great financing happen only go shelve the business plan and miss their numbers.

Summary

Despite some inherent challenges for private company CFOs, most are in an ideal position to make a strong positive impact on the success and value of their company.  By implementing these 10 Strategies to Raise Capital Effectively, CFOs will have the opportunity to grow their skill set and expertise while serving the best interests of their company.