By: Patrick Ungashick
You believe your business would grow faster, if you had more cash. Or, perhaps you’d buy out that partner who’s not in sync with the direction the company is going in, if you had more cash. Or, perhaps you’d take some cash home to diversify your wealth and sleep better at night, if you had more cash. Whatever your specific need is, perhaps you’d do it—if you had more cash. That’s just the thing though. How do you get more cash to accomplish your business needs, without giving up too much in return, or taking on more risk than you should?
Most business owners at some point will struggle with this question, and some wrestle with it indefinitely. Many owners are unfamiliar with their options to raise capital, and often have negative impressions about this issue. Some owners avoid debt like it’s a disease, and like the idea of bringing in outside investors even less, usually for fear of losing control and autonomy. (Recently, we were speaking with one business owner about this issue and very quickly into the conversation he asked us if outside investors might force him to give up the company’s season tickets to his beloved professional football team.) Consequently, many privately held companies are undercapitalized, limiting their growth due to insufficient resources. Ironically, inadequate capital can increase the owners’ risk as they remain heavily concentrated in their business, with little liquidity and personal wealth outside the company
If a need for additional capital is identified, often owners understandably prefer to use debt to meet the need, if possible. This avoids dilution of equity and profits that comes with bringing in outside partners. Also, in many cases securing outside debt is easier than finding suitable investors. Finally, owners know that with debt they are not sharing leadership and decision-making control with outsiders.
Yet, there are situations where investigating the equity route, either as alternative to debt or as part of a combined debt and equity approach, may make sense. We see six common situations where raising outside equity may be a good fit for the owners’ needs:
- You can bring in outside equity without giving up control. It’s more myth than fact that if you bring in outside investors, you must give up control over your business. While some investors want control, many will consider minority investment situations, and some even prefer it. Most investors will require certain protections, often called “super-majority rights”, that require unanimous consent for the most important decisions, such as selling the entire company, raising additional debt, or bringing in additional investors. But the day-to-day operations and decisions can remain entirely yours in many situations.
- You have a proven business model with no serious limitations to scalability. If this is accurate, then the more fuel into your company engine, the faster and farther it may go.
- You have one or more co-owners who are not on the same page with regards your company plans and direction, and buying them out will remove this obstacle and source of friction. With outside capital, you may be able to put cash on the table and buy them out quickly and at an attractive price.
- You are racing against competition, and speed to market and/or rapidly gaining market share will define success or failure. If this is the case, then you may need to secure sufficient cash to win the race.
- Your equity partners bring more than just cash to the table. If your investors can bring you market experience, leadership skills, transaction knowledge, industry contacts, or growth opportunities, then you may be getting a bargain. For example, many investors will require a certain number of seats on the Board of Directors. You cannot underestimate the value of having a formal board to help with financing, recruiting, financial and market analysis, project feasibility analysis, legal issues, and exit timing.
- You desire to “take some chips off the table”, and outside money will allow you to diversify your personal net worth and gain liquidity outside the company. Many owners spend years and sometimes decades highly illiquid. Eventually, this causes most owners personal stress and anxiety—for good reason. Bringing in outside investors may create personal liquidity, which not only reduces risk but for some owners infuses them with a new excitement about taking the company to the next level, given their new financial security. Bringing in outside investors often eliminates the need for any personal guarantees, further reducing the owners’ risk.
- You have a strong leadership or management team, some of whom want an equity stake in the company. Usually these leaders and managers lack personal capital to buy into the business. Outside investors can help the management team to buy in, again without requiring taking control. Often we see this done with the current owner maintaining some ownership in the business, allowing him or her to gain liquidity while remaining involved in the company going forward.
There can be additional benefits to bringing in outside equity. One is potentially increased credibility at your exit. If after raising outside equity you later decide to sell the entire company, many buyers have a perception that the business is more “buttoned up” because outside equity investors have been involved.
Also, with outside investors in place you may secure more attractive debt financing. Many lenders like that there is new money coming into a deal behind them in the capital structure, and consequently will provide better terms. Also, if the investor is a private equity firm that has done multiple deals with the lender, that lender may be more willing to offer favorable pricing and terms to this “repeat customer”. Lenders also take peace-of-mind from having outside third-party investors involved in monitoring the company, another way outside equity can translate into more attractive debt financing.
While there are other reasons to consider bringing in outside equity, these seven are perhaps the most common situations where outside equity could be a game-changer for the company and its owners. When any of these situations are encountered, owners would benefit from a more objective, quantified approach to evaluating the company’s capital needs, and determining the most effective capital strategy—including outside equity where advantageous.