By Brian Boorstein
As we discussed in our last article, private equity has become an increasingly important and widespread source of funds for all types of businesses. Moreover, the velocity of capital being raised in private equity pools continues at a torrid pace as returns for private equity funds have far outstripped the returns that can be earned in the public markets. As such, greater numbers and types of investors are increasing their allocations to this asset class, leading to the perception that money is everywhere.
While that may be true in a global sense, the primary question on your mind – “How do I get some of that money?” – is more localized. In this article we will guide you through some of the steps that you should take to position your company to raise private equity capital and posit some issues you should consider before initiating the effort of fundraising.
There are many factors to weigh in raising capital, but the first is to determine the need for and use of the money. Determining the use of the money is not as simple as it initially may sound. There are myriad potential uses, including money for growth capital, debt reduction, buyout of a partner or family member, an acquisition, a dividend, etc., and your needs and desires may be to raise money for a specific single use or for multiple uses.
Regardless of the need, it is certain that adding an equity partner will influence your business, from operating procedures to the culture that evolves as a result of the priorities and values that a new partner brings to the organization. In addition to the discipline that preparing for fundraising brings to any organization, and promotion of the organization required to seal the deal, it is important to remember that you seek a “fit” with your funder in order to sustain and grow the business over time and create a good workplace for your employees.
The use or uses of the money will impact many of the activities that you need to perform to be successful in your fundraising. You will need to formulate the story, decide how much money you seek, build a business plan around the story, test and verify your financial assumptions, establish a capital structure and the pricing for the money and, ultimately, live for years with your new investor. The answers to each of these questions will affect how you position your company to access outside capital.
Once you feel comfortable with your reason for accessing outside capital, the next point to consider is when the right time is for you to raise money. There is a tried-and-true adage in fundraising that you should raise capital when you don’t need it. This axiom contemplates both the time element and the emotional element of raising money. Raising money can be a long and exhaustive process. It is critical that you start the effort well in advance of the time that you become cash constrained. If you reach that point before or during the fundraising process, you may be forced to cut corners operationally or take a deal that is less favorable than what you otherwise would have had to accept.
Generally, it is best to raise money when sales and profits are rising. While investors are committing capital for future profits, they still would like to use historical results as a barometer of the future. Recent strong results present easier stories for investors in terms of diligence and underwriting, and provide more cushion for them to fall back on.
The raising of outside capital is often as much art as it is science. To appeal to both of those characteristics, it is important to get prepared in advance of a fundraising process. Some small items of preparation can be done quickly and easily, but those that typically have a greater effect on the success of fundraising would likely need to be put in place well in advance of approaching capital providers. The areas to address in advance of a fundraising process involve your financial history and presentation, the management team, the operations of your business and the competitive landscape in which you operate.
Second only to having the operations of your business running at full speed, getting your financial house in order is the most important action that you should do in preparation of accessing outside capital. Your business is depicted in a number of ways, but certainly one of the most critical is through financial statements. As such, it is essential that you can present a clean, unadulterated story of how your business generates profits and cash flow.
You should be in a position to deliver to a potential investor a full set of financial statements, including a Profit & Loss Statement, a Balance Sheet and a Cash Flow Statement. At a minimum, the financial package should include annual statements, but quarterly or monthly statements would be preferable. It is also beneficial if your financial statements have been audited by a reputable accounting firm. However, in lieu of a full audit, having the statements reviewed or compiled by an accounting firm would help.
In addition to the standard financial accounting reports, a good practice would be for you to habitually provide a management discussion and analysis of the company’s performance along with each statement. An analysis of this type will help any reader of your financial statements understand the interplay between the operations and the financial results.
Last, but certainly not least, it is extremely important and beneficial for you to be able to present “clean” financial statements that portray only those expenses that are part of the business itself. Other expenses, generally those of a non-business nature like personal meals and entertainment, travel or life insurance, should either be paid for by you personally or well documented so that they can be added back to the profits of the business without any ambiguity.
Part 2 of this article, coming in September, will discuss some considerations that business leaders should address before opening their doors to investors-to-be, including suggestions to anticipate and alleviate employee concerns.