It is not uncommon for business owners to determine the introduction of equity partners or investors [such as venture capitalists or angel investors] through cash flow austerity to solve all their problems. Unfortunately, in my 28 years in the alternative business finance industry, I have seen many companies fail because of this idea.
Specifically, these owners are not aware of the differences between equity financing and working capital. I saw good, profitable companies that are self-proclaimed because of cash flow problems, and entrepreneurs lose ownership and control over the company before they have a chance to succeed. If the owner is open and takes time to take it seriously, then many of these griefs can be prevented. from
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The financing options they can get.
Often, what these companies really need is to increase or get more working capital. "There is a big difference between increasing liquidity and introducing equity partners," said Davis Vaitkunas, president of investment bankers and bond capital.
"Although owners who experience cash flow problems may think their only solution is to inject a lot of cash from equity investors, it is probably the worst thing," Vaitkunas said. "In fact, mathematics proves that owners who own 100% of their working capital can get a lower return on their equity."
Working capital and equity financing
At this point, clarifying some terms may help. For beginners, "working capital" is the money used to pay for your business bill until the actual cash [or receivables] is received. Terms of sale vary by industry, but companies typically wait between 30 and 60 days. Therefore, as a general rule, your business should retain twice its monthly sales in the form of working capital. You can increase the amount of working capital available by retaining profits, improving supplier credit or using other financing instruments.
At the same time, "equity financing" refers to funds obtained by an enterprise by selling part of its business ownership shares. In many cases, this may also involve abandoning control over some or all of the most important business decisions. It would be a good thing if investors brought some unique expertise or synergy to the relationship. However, the terms of equity investments can be complex, so it is important to fully understand them and have good legal advice. Think of it as a commercial marriage.
According to Vaitkunas, "companies should use equity to fund long-term assets and working capital to fund short-term assets. You want to apply matching principles and match the length of asset life to the length of life." Long-term asset needs More than one 12-month business cycle to repay, and short-term assets are usually repaid in less than 12 months.
When to dilute equity
"Fairness is a valuable commodity," Vaitkunas stressed. "Only if there is no other option to sell. Equity partners should bring experience and/or contact information that cannot be found elsewhere." The best strategy is to ensure equity financing when you can negotiate and prioritize certain terms. . Ideally, absolute control should be retained by the owner.
Vaitkunas goes on to say that time is everything about equity financing. "Sometimes it's best to just spend time waiting for the best value proposition. During the waiting period, you can use short-term debt to grow within your means."
When a business is new, trying to make a profit or suffer setbacks, finding equity is usually not a good idea. Unfortunately, this is the time when many business owners start to think they need to "find investors". This process can take a lot of time and consume a lot of energy, which will disappear from the business, which will aggravate and compound the existing problems.
As a rule of thumb, equity partners should only be sought when the company has a reliable track record of sales and profitability and has clear and specific funding needs. Then, it's important to explain how injecting capital will create greater profits and higher sales. Companies with reliable profitability, some historical sales growth and more potential for future sales growth are a more attractive investment for potential equity partners.
Financing working capital
Shortage of working capital is a short-term issue that can be financed through senior debt or mezzanine debt. In addition, short-term financing can be obtained from factoring or A/R financing providers who treat certain receivables and inventory assets as collateral. The combination of these types of alternative strategies can increase the available working capital to the extent that the equity partner's demand disappears.
So how do you decide which financing tool to use? Vaitkunas said: "If you want to consider injecting equity to solve the growing pain, then you must consider the possible partnership risks and the real cost of equity." The best working capital solution may be accounts receivable credit. The amount is lower than the equity and does not introduce partnership risk.
Bottom line:from
In addition to accepting partners or shareholders, there are many alternatives available to companies that require cash injection. Before making such an important decision, every business owner must understand and understand all the options. Knowing all the available options - and knowing which one is best to use - can prevent the grief and difficulty of many business owners.
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