Financial Myths: A Day Late and a Dollar Short, Part III

Michael McTague  |

Over the years, my colleagues and I have worked with many organizations that were not well prepared to raise capital. The fundamentals of how to present the company story are clear to those in the field of raising capital, but often unclear to those in industry who need capital for major enhancements. Able Global’s President, Peter O'Neill, has worked on transactions exceeding $100 million. We understand the challenges companies face. This third entry under “A Day Late and a Dollar Short” offers insight and advice on what to do when raising capital. Our clients and followers of the Myth Buster have asked for some practical advice in this critical domain.

The Default Approach

What happens when a company needs capital? Countless conversations about future plans and profits ensue. PowerPoint presentations show the ubiquitous hockey stick effect. The company is convinced that investors will be ready to loosen their purse strings. However, no conversation or slide presentation is enough. The company's business plan remains the vehicle that allows funding organizations to commit capital.

Despite its centrality, clients who seek funding often act surprised at a request for a definition of the project and its financial benefits. A common reaction is that the details will appear later in an offering statement. A second reaction is that due diligence is the vital step that presents a treasure chest key to the company seeking the funds. In fact, a complete offering statement and legal due diligence take place after the funds are committed.

Conversations and slide shows are effective inside the organization as the project takes shape and prior to Board approval. Due diligence firms up the commitment immediately prior to the final offering statement and closing. But, the critical element remains the business plan, or, more specifically, the strategic plan. Yet, many organizations enter the capital markets without an effective business plan.

The Successful Approach

Business plans are judged by three vital elements.

  • The corporation's strategic direction
  • Current financials
  • Projected financials (proforma)

Strategy comes first. Simply stated, this defines where the organization is going. Financing projects possess fluidity, infusing growth and profits. So, the funds provider needs to know the future. Tell the reader where the company is now and define the future. Tell where the company will be in three to five years. Three years is acceptable, but five years shows that company management is really looking at its future. State the market share, revenue and profit based on clear projections of how each year will play out. A good rule of thumb is that even if the company is not running in the black now, it may be in several years. That scenario is acceptable to most investors.

The plan should provide a brief description of the products and services offered. State why the products are attractive. Keep the discussion simple and straightforward. Also, remember that technology frequently has a short life. And, based on years of experience, avoid hyperbole. Give the facts; focus on financial results rather than technological superiority.

Current financials make up the second critical element. Of course, they should be audited, preferably by a major accounting firm and the opinion should be unqualified. Company executives who will be giving presentations need to be familiar with the numbers and the details of the notes in the statement. Be ready with an honest explanation of financial issues that might trouble investors. For example, how much debt does the company carry? What are the form and the term of the debt? Prior to seeking new funds, the company may be able to restructure debt to lower its costs. If the company does not take action, investors may lose confidence in company management.

The Devil is in the Details

The final element is the proforma, which shows how an infusion of capital will help the company reach new heights. From our experience, companies seeking capital often have the most difficulty with this element of a successful capital raise. We have worked with executives who think that they can achieve this part of the capital raise by talking about the future. Don’t sink into hyperbole. Show how much capital is needed each year and how much new revenue it will generate. As a simple illustration, if a company were looking for funds for rental property, show the cost of construction, the time frame to build and the annual increase in revenue.

We have encountered a few devils over the years, but in generating funds the details make the difference. Sharp investors know the danger of construction delays and of companies that assume a massive influx of profit will begin on the first day of a new project or product. So, be conservative in making projections. We had recent success negotiating the sale of oil and gas assets in Texas and Oklahoma, funding $20 million in equity for Redbud Exploration & Production to acquire these assets. The elements discussed here proved critical.

This myth has shown itself as an intriguing and robust test of strategic prowess. Poor planning hurt Obamacare. Weak execution damages Airbus’ (AIR) previous financial trajectory. Volkswagen’s quick action appears to be slowing the downward spiral thanks to strategic opportunities. And for all who need to raise capital, please make sure that all three elements of a successful raise – discussed in this entry – are complete before seeking funds. Next month, we will look at more absorbing tales that make us think about our strongest-held assumptions.

**********************

Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.


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