Most of us in the entrepreneurial space, whether building, supporting or funding early-stage companies, assume attracting investor capital is just the normal course of business.
We have been conditioned to believe or accept that once an entrepreneur gets a business underway, raising investor capital is just part of the plan. Some entrepreneurs begin crafting their investor pitch before they even start up the company. And for a lot of companies, it is the reasonable route to start up the company, gain some traction and then turn to investor capital to fuel the growth. But there are occasions, particularly in the tech sector, where this course of action is entirely unnecessary and troublesome.
Sometimes there is a better way to finance company growth. Sometimes you just need to go out and sell. If you can sell, you can create your own cash to build the company on your own. If you can’t sell, you won’t be able to attract investment anyway. If you need to continue developing your products, there are options there too. The entrepreneur with the patented technology who needed to rebuild his product for another operating system didn’t seek investor capital to pay for this development. He, instead, went and found a large company that would be a good prospect if their product worked on that operating system. He worked out a contract that paid for the development at cost. The company got the resulting product at a reduced rate, and the entrepreneur got the product built so he could go off and sell to others.
When deciding between raising capital and selling your way through growth, there are several factors that should weigh into your decision. Organic growth may be slower, but your ownership value may be higher upon exit. The entrepreneur who didn’t sell any equity and sold his company for $1 million five years after startup is better off than the entrepreneur who sold 75 per cent of his company to investors and sold out for $3 million in the same period. There are also a lot of entrepreneurs who want to raise capital but can’t accept the notion of giving up any equity in the company, or they overvalue the company to such an extent that any sophisticated investor would never touch the deal.
It all depends upon the opportunity. Most tech entrepreneurs believe they are en route to building a company to a $500 million exit. Not all companies have a realistic shot at garnering a big exit. If yours does have that opportunity, it is highly likely that owning 25 per cent of something big is much better than owning 100 per cent of a company that can never achieve its potential because it is cash-starved.
Is it important that your company is first to market? Will you get run over by those better financed? What is your plan for the company? Are you building to sell? Building to sell will put you into better alignment with investors. If you want a modestly successful business that affords a comfortable lifestyle for management, you and investors will not be aligned.
To best serve the investor’s perspective, the best decision-making exercise will be to create two sets of forward-looking financial statements. Make one set that reflects what you think you can do on your own, and create another plan that reflects the results of what would occur if the company were to raise additional capital. The resulting company values of each scenario should provide a quantitative justification for one path over the other.
It is wrong to assume that the scenario with added investor capital will outpace the value of the other plan. Capital injection, whether by debt or equity, comes at a cost of capital. The cost of that capital needs to be outpaced by the value accretion of the company. If the cost of capital is higher than the rate of company value growth, trouble awaits.
It’s about creating an efficient capital model. As the company grows and debt options become available, there will be another need to balance organic growth against equity participation and debt load. The entrepreneur finds the sweet spot by keeping the cost of capital as low as possible while building the company at a significantly higher rate.
Entrepreneurs often throw a party after they have closed a round of financing to provide quick recognition of another milestone achievement within the company. Everybody is happy, thrilled, relieved and exhausted by the time a significant round of financing gets done.
There is, however, an unanticipated feeling that washes over the entrepreneur after the party. Pressure. Where previously the company was operating on your founder capital and business revenue, now there are others with money at stake, and they have expectations that you will take to your pillow each night.
An entrepreneur called me for assistance when growth had stalled and cash had run short. I asked him if he would invest in a company that was having trouble and had no real plan for a massive turnaround. He admitted that he would not. The answer was simply to sell his way out of trouble. He had become so distracted by the demands of leading a company that he had lost the most elemental foundation of any company.
Instead of pitching for investor money, he started to focus on pitching for revenue. Driving sales became the main focus of his every day. Sales went up, payables went down, and payroll was made on time for the first time in months. Employees stopped leaving the company and they started showing up again at company events. Employees regained pride in their company, customers regained faith in the less desperate vendor, and the owners finally had focus.
Selling is a gift that has been dramatically undervalued in the tech sector. We love to fawn over cutting-edge technology, but the truth is that the best technology in the world is completely worthless if the entrepreneur can’t sell. In some cases, investor capital may be what you want, but maybe selling is what you need.
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