Most entrepreneurs do a great job of buying the products, services and raw materials needed to run their operating companies. But they don't do such a good job when it comes to purchasing capital investment products. This White Paper sets out six guiding principles that will help you to locate the ideal financing package to help you to grow your business.
Principle 1: Match the financing product to your specific needs
Most entrepreneurs, when they think about financing, immediately go to bankers or venture capitalists. But in today's capital markets, those are only two of a wide variety of lending alternatives. To sustain your company's growth, make sure you get the right financing product(s) for your specific capital needs.
For example, if you go to a bank or commercial lender when you require mezzanine financing, you won't get the loan because you won't have the collateral to support it. If you borrow from a venture capitalist when you could have used mezzanine financing, you'll probably give away far more of your company than is necessary.
To pick the financing products that truly meet your needs, take the steps below.
- Do the research. Take the time to learn about the many different types of financing available in today's capital markets. Identify the type of lender that fits your industry, your type of company and your financing needs, and focus your efforts in that area.
- Clarify your needs. Talk with your CFO, your accounting firm, your lawyer and anyone else who plays a key role in planning the growth of your business. Be crystal clear about your financing needs before you approach the capital markets.
- Get professional help. Raising growth capital could be the most important decision you ever make in your company. Hiring an experienced professional who can help you to craft your business plan and find the right type of financing will pay for itself many times over. If you insist on doing the plan yourself, at least have an outside party review and challenge your assumptions. The key to successful financing is to select your financing products with the same care and precision with which you hire employees or buy raw materials for your operating business.
Principle 2: Minimise your risk
Entrepreneurs often think they have to bet the house in order to obtain financing. But we believe that funding your growth should involve less risk, not more.
Before signing any agreement, ask yourself this question: "Am I taking more risk to finance this growth than before I decided to grow the company?" If the answer is yes, don't sign the paper. Rapid growth carries enough risk on its own without you adding to it by obtaining the wrong kind of financing. The faster you want to grow, the less risk you should take.
To minimise risk:
- Look for lenders willing to structure flexible agreements. Avoid agreements filled with restrictive covenants and warrants.
- Build in a cushion in case things go wrong.
- Don't take out a second mortgage on your house, give any kind of personal guarantee or give up control of your company.
- Never give away opportunities to protect yourself.
Principle 3: Adjust your agreement for performance
When you present your business plan to lending institutions, they will automatically discount it. Why? Because they have no assurance that you will achieve all the goals in your plan. Accordingly, they will discount your performance projections and take more compensation in the form of fees or equity.
Negotiate a reward
You can't do much about this discounting, because lenders must have some way to protect themselves. What you can do, however, is negotiate a clause that adjusts the terms should you hit all the objectives set out in the agreement.
So when lenders discount your business plan, don't argue. Simply accept it as part of the process and get the best deal you can. However, don't hesitate to ask for a clause that will adjust the terms back to what they would have been had the lender believed in your plan in the first place. Most lenders will agree to something like this. If not, you have the wrong lender for your capital needs.
Principle 4: Cast your net wide
When looking for growth capital, start with around 100 lenders and work your way down to a final shortlist.
In particular, look for lenders that specialise in your industry, size and type of company. For example, if you run a carpet company, don't approach lenders that specialise in high-tech medical device manufacturers.
Time your delivery
Once you have a small group of finalists, deliver your business plan to all of them at the same time.
There are a lot of lenders out there, and they all have different ways of analysing and structuring deals. The more lenders you approach, the better the odds of finding one that fits your specific financing needs. By creating competition among several lenders, you greatly increase the chances of getting the best deal for your company.
Principle 5: Never give up control
Many financing transactions require you to give up some equity in exchange for the money. Some equity is all right, but if you have to give up control to grow your company, don't do the deal.
We have seen far too many entrepreneurs give up more than 50% of their company and then get thrown out or bogged down by people who don't accept their ideas for growth. If you have to give up control in order to grow, don't grow!
Get lenders to compete
The best way to avoid giving up control is to create competition for your transaction. Put together a business plan that describes everything you will do in the next five years. Make it clear and compelling so that lenders can understand it, react to it in a short period of time and make a proposal to you.
Never include a term sheet. If you do, lenders will take it and work backwards from there. Instead, send out your plan and let the lenders propose their best deal.
Principle 6: Write a world-class business plan
Your business plan's quality and credibility has a huge impact on the quantity and quality of the financing you get. In order to get the most money and the best possible deal, create a business plan that lenders can't resist.
A well-documented business plan contains narrative description as well as hard numbers. The key is making sure that one supports the other. We believe that every line item should have some narrative that describes the assumptions behind the numbers. However, the narrative must be credible or the lender won't buy your plan.
For example, suppose your business plan projects a 3% increase in gross profit margin and your explanation for the increase says: "We will have less scrap." No lender will buy that explanation because you can't prove it. To build credibility, you need to say something like: "We have signed a contract to have X part made by Y company, who will guarantee us a lower price." Now you have a valid reason why your gross margins will go up by 3%.
Above all, don't make the mistake of thinking that a two-page summary will capture the attention of lenders. Most financial institutions won't even look at that kind of plan because they know it has no substance. It takes more than a few pages to provide the raw data to support your projections and conclusions. Without that data, your plan has no credibility whatsoever.
Plan your growth based on your potential, not on your current capital position. Most companies prioritise their needs based on their existing capital, which is wrong. Instead, project the company to grow to its full potential and strive to get the best financing with the least risk, the least dilution and the fairest transaction terms.
Get to know the people
Make sure you like the people you will be working with, because you will have to deal with them for the life of the agreement. You may have a great transaction, but if you aren't comfortable with the people, pay a little more and get someone you like.
How to find the right lender
Once you have taken these six principles on board, how do you go about finding the right lender for you?
The internet offers a quick and reliable way to conduct research. Simply load your favourite search engine and search under key words such as:
- venture capitalists
- high growth
- mezzanine financing.
Use a consultant
Hiring a consultant is often a good option for finding lenders. For those new to the ways of today's sophisticated financial markets, the investment required to hire a consulting firm can pay huge dividends over the long term.
Firms such as TCii offer a complete package of services to help you to:
- craft the business plan
- present the plan to a variety of lenders
- select the best deal
- negotiate the terms of the deal.
If you decide to use a consultant, keep the following in mind.
- In return for negotiating the deal, most consultants will want the option to obtain a certain amount of equity in your company at the price the lender pays for it. Be aware that the price your consultant negotiates for your equity may be influenced by their interest in obtaining it.
- Most consultants will also want you to include a term sheet with your business plan. Don't let them talk you into it. If they insist, find another consultant.
- Ask your consultant whether they are receiving a finder's fee from the lending institution. If they are, it doesn't necessarily mean you shouldn't do the deal. But you need to know who is getting paid for what.
In summary . . .
Finding lenders is easy. The hard part is identifying the one that's right for you. Look for someone who has done deals in your industry and with your type of company. Check references carefully. Get to know the people who will play a large role in the future of your company. Whether you do it on your own or use a consultant or consulting firm, invest the time and energy to do it right.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.