Capital Acquisition The Third Way

Jim Blasingame What is capital? Well, obviously, cash is capital. But while a company that has all of it's capital in cash may be rich, as we've discussed before, cash only has value in exchange, and no value in use. Here are a few of the many examples of non-cash capital in a business:

A well maintained fleet of vehicles
A functioning marketing strategy
Adequate and well-maintained facilities
A well-trained staff
Adequate inventory
Up-to-date technology

A business's capital comes from three primary sources, and the challenge for management is to know how much of each to blend into its capitalization process:

1. Profits left in the business as retained earnings
2. Debt
3. Investment

All businesses, large or small, have to deal with capitalization questions. Here is one for each of the above:

Profits: "How much of our growth can be funded from profits?"

Debt: "Do we lease our new vehicles, pay for them from profits, or borrow the money to purchase them?"

Investment: "We can't make this new acquisition if we have to borrow the money because the debt service would create negative cash flow. The only alternative is investment. Are we willing to give up a piece of the company to an investor?"

It's safe to say that making sure the company has enough capital to operate effectively and grow is the most important issue that faces any CEO. Furthermore, capital acquisition is one of the most difficult management activities to delegate. Indeed, for a small business, delegating capital acquisition is virtually impossible because often there simply isn't anyone to delegate this level of activity to.

The Third Way
In the future, I believe we are going to see more small businesses consider the investment alternative to capital acquisition. With the growth of entrepreneurialism has come an increased opportunity to invest in entrepreneurial plans. And while small business owners may have gotten pretty good at approaching banks for loans, unfortunately, many of us do not possess the same acumen when it comes to acquiring investment capital.

Consequently, I believe that there needs to be more discussion and instruction on how small businesses can become proficient in what I call The Third Way of capitalization, investment capital.

Common Mistakes
Someone who is raising the level of discussion and instruction for small businesses seeking investment capital is Andrew Sherman, one of our most valuable members of The Small Business Advocate Brain Trust. In his new book, Raising Capital, Andrew says you have to get inside the head of the typical investor, and deliver a plan and business model that meets his or her interests, concerns, and investment profile.

Sometimes, the best way to instruct is to discuss mistakes. The reason I want to use this approach is because often mistakes result from misconceptions arising from intuition and marketplace folk lore, rather than experience and research. In Andrew's book I found a list of common mistakes entrepreneurs make in their search for investment capital, and I am going to use it as a guide for our discussion. Here's Andrew's list of mistakes, followed by my thoughts.

Mistake: Using An Investor Search That is Too Broad.
Fish where the fish are. Every investor or investment group has an investment strategy that focuses on a profile of opportunity. You must qualify investor prospects enough to be able to identify the ones who are likely to even consider your type of investment opportunity. Qualify your investor prospects the way you qualify customer prospects.

Mistake: Misjudging The Time.
Murphy's Law states that everything will take longer than it seems. Murphy is alive and well in the investment marketplace. It can take months, not weeks, to find, approach, and get an answer. And remember, like the answer to your prayers, sometimes the answer is "no".

Mistake: Falling In Love With Your Business Plan
Every mother's baby is beautiful. But your baby is not your investor prospect's baby. Andrew says falling in love with your plan can lead to stubbornness, inflexibility, and defensiveness, all of which are deal killers. Realize that your business and your plan may have to be, let's say, adjusted, before you get your investment. The challenge is to know when to change and when to stick to your own vision.

Mistake: Taking Your Projections Too Seriously.
It is possible to rationalize anything if you want it badly enough. But rationalizing doesn't make it the right thing to do. You can manipulate projections, consciously or otherwise, so that they make you very excited. Never forget this absolute truth: All projections are wrong.

Mistake: Confusing Product Development With Sales Development.
It's true, you must have something to sell, and developing just the right project or service is critical. But remember another great truism: Nothing happens until someone sells something. And nothing makes an investor prospect's eyes light up like customers and sales.

Mistake: Failing To Recognize The Importance Of The Management Team.
The greatest plans, products, and projections are like the ingredients of a fancy meal, sitting on the counter before they are blended together. Investors know that plans, products, and projections, like ingredients, are commodities, and that the management team is the chef who must put the ingredients together to create the successful result.

Mistake: Providing A Four Inch Thick Business Plan.
Andrew says you actually should have more than one length. I think you need a two or three page plan, a 12 page plan, and the one with all of the details. You will use each one at different stages. I recommend only providing the detail when asked. These days, most experts like
Andrew, say less is better.

Mistake: Not Understanding How Busy Investors Are.
Get to the point when you are making a projection. I know you are excited about your baby. If you're not, you won't get any investment capital. But try to net it out for your investor prospect. If you have something they are interested in, they will ask you to elaborate.

Mistake: Too Little Analysis In The Business Plan.
You must have research to back up your assumptions. Investors are not likely to give you money based on your instincts. Even though I told you not to show your research until asked, you must be able to produce when that question occurs.

Mistake: Not Recognizing That Timing Is Everything.
One of the most frustrating things you will experience in the capital acquisition process is when you find out that your time-frame and that of your investor prospect are not in synch. Guess who makes the adjustment? Be sure to build some timing wiggle-room into your capital chronology.

Mistake: Being Afraid To Share Your Idea.
Andrew says you can't sell something you can't tell. Get your hands on a confidentiality agreement that suits your project, understand it, and get comfortable with using it. Investors appreciate you protecting your intellectual property, but they don't like squirrelly entrepreneurs.

Mistake: Being Price Wise And Investor Foolish.
Which would you rather have: a) $1 million from an investor who knows nothing about your industry; or b) $500,000 from an investor who brings lots of contacts, background, etc. to the table? Well, believe it or not, "b" will be the correct answer most of the time. Be sure to take all things into consideration before turning down an offer of capital that is less than you wanted. Remember, capital is much more than just cash. Here's a good place for another truism: There's more than one way to skin a cat.

Mistake: Thinking You Are An Expert At Valuing Your Small Business.
When you get to the "haggling over the price" stage, be prepared to make concessions. Sure, investors will try to cut the best deal. You will to, but remember who has the gold. Also remember that your prospects look at a lot of deals, and they probably know what the market will bear for a deal like yours. The best way to keep them honest is to do your homework so you can discuss this issue intelligently, not passionately.

Mistake: Believing That Ownership Equals Control.
This is where many deals that could have been put together fall apart. Ownership and control are not necessarily the same thing. Ownership can be more about distributions than control. Also, if you structure the deal properly, you can have control and own less than 51%. Keep an open mind to creative structuring, and focus on your investor's exit plan more than the initial split.

Write this on a rock... As the CEO of your small business, get smart about the opportunities and fundamentals of acquiring capital The Third Way. It's your job.

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