03 Feb Investment Dollars are Not Created Equal
No two capital sources are created equal. Like the deals they fund, capital types and capital providers have very different incentives, motives and structures. As any good financier knows, debt behaves very differently from equity and other mixed-bag securities (e.g. mezzanine funding). Furthermore, the stage and type of the business will attract different capital providers. The spectrum ranges from early stage venture capital through very late stage private equity. The company stage and investment need can sometimes create desperate situations for entrepreneurs. Unfortunately, when companies get desperate for capital, they will often submit to usurious rates or other forms of extremely toxic financing. In such cases, the financing tail can wag the corporate dog.
Solid companies that create a true market through running an investment banking process will ultimately have their pick of various quantitative terms important to closing a quality transaction. But, what of the other soft metrics? Capital is much more than just a senior debt rate, a note or a sliver of equity. Every legally-binding investor contract includes investors (which in this case means people and personalities) behind the paper.
Playing Culture-Matching Craps
While most larger, institutional investment firms operate at a level of sophistication and professionalism that creates a somewhat predictable culture, culture wildcards exist nonetheless. Avoiding a round at the culture craps table is nearly impossible if you attempt to source capital from alternative means (crowdfunding is especially egregious here). Having a trusted capital advisor with direct experience with a particular lender or investor, can help issuers and entrepreneurs avoid the pitfalls inherent in yoking oneself into an undesirable situation. Some bad situations are unavoidable without the hard-knock lessons of hindsight.
Here are a few questions to ask yourself when weighing the extremely varied financing options that exist:
- Are you seeking debt or equity? Both behave very differently. Equity holders are likely to be much more hands-on. They participate in the upside, but can also get burned on the down-side. Three “D’s”: debt doesn’t dilute.
- If equity, is it minority or majority. The amount of control you sacrifice can significantly alter future options. The decision-tree scenarios for debt vs. equity and minority vs. majority are nearly unlimited. Weighing those options could be the subject of an entire book, let alone a short article.
- How quickly do you need the funding? Many entrepreneurs seeking capital need it yesterday. There are plenty of lenders that provide less-than-desirable rates for things like factor financing, but that is rarely the best route. Desparation often excludes the most highly-professional lenders and investors. If you can avoid desparation and–perhaps more importantly–avoid appearing desparate when on the money-raising trail, it will reflect much better on investors that are the higher caliber. In addition, if you hire an investment banker, s/he will be more confident they can assist in your capital transaction needs. Desparation breeds fear and failure in finance. Furthermore, it is reflective of a lack of confidence on the part of the issuer, which is a terrible sign.
- What are the use of funds? This question may also help paint the picture for the overall capital stack, but it can also be a determining factor in solidifying the financing parties in the deal.
- What do you know about the lender? If you can connect with a third party that knows them personally, it can help avoid later headaches of unknown investor risk to the deal. Easiest path here is connecting on Linkedin and finding where connections exist and references can be checked.
- Where are you in the life cycle of the business? Are you early/late stage? Are you more of a VC deal or a PE deal?
- Are there assets that can back up any claims against the company in the event of potential default on any debt? Are you willing to put a personal guarantee against any instrument?
As in many cases, the key to obtaining the best terms on your capital transaction–regardless of the deal structure or deal type–is creating a market. Doing so requires access to a large data-set of potential acquirers, buyers and investors. It also requires a great deal of hustle on the part of the dealmaker, whether internal to the company or hired as a buy-side investment banker. Creating a market for the deal in question can create multiple options for the issuer which breeds an environment that puts the power back in the hands of the business owner–which is where it always should be.