Preparation for equity or bank finance ahead of time is key

1. No Man’s land | 4ms | The money
by Peter duff
Money issues
1.
2.
3.
4.
Sufficient capital and allocation
Know your speed limit
Financial metrics - e.g. ROI
Exit strategy valuation
In earlier articles we discussed issues confronting early stage
and middle market companies in relation to markets and
model. Let us now tackle our next “No Man’s Land” issue of
money. In Austin I am finding early stage companies I have
been working with have tapped family and friends and other
incubators for start-up money However what might not
have been contemplated was the early arrival of the need for
additional funds. Ironically the very success the business has
achieved drives the need for additional finance. Not only does
the growth of the net funding of (receivables and inventory
net of payables) drive funding demand but the businesses
generally need to step up capacity well in advance of revenue.
That creates the need for additional finance and likely to
require longer term finance and is shown.
Growth
in sales
Growth in
profitability
Generates
<
About Peter Duff
Peter is a partner in the
Newport Board Group A CEO
and Board Advisory firm of 70
Partners. The partnership
advises middle market and
early stage companies to
transition to higher levels of
profitability. Reach Peter at
Peter.Duff@NewportBoardgroup.com.
Growth in
profitability
Is less than Net
(Growth in receivables
+ inventory – payables)

2. The financial model that shows how the growth in sales and profitability drives cash demand is demonstrated
ably in Doug Tatum’s best selling book on No Man’s Land, Where Growing Companies Fail. Doug has kindly
let me borrow the relevant diagram which is shown below.
Growth in profitability
These illustrations were built from an economic
model that accounts for the typical asset growth
characteristic of a rapidly expanding business on
accrual accounting and transition through No
Man’s Land.
Preparation will be key for a successful funding
event. Let me give you some findings of
companies that went for equity events and I was
on the buyer’s side of the table. What I found
was a mis-match between the Founder/CEO’s
team and the Buyer’s team. It was not the quality
of the transaction advisors on the Founder/
CEO team but if the company was not prepared
substantial value was lost on the sale price.
Here is an analogous situation when you have to
go to court on a serious law suit. You meet one
morning with the best lawyer in Texas and his
team. After a challenging discussion he and his
team say they think on balance they can win the
case. They ask when is the case to be heard. You
say 2pm this afternoon. Nobody would expect
that timetable to work and you shouldn’t expect a
hurried transaction timetable to work either.
Preparation Time
Ideally preparation for a funding event should be
an 18 months plus timetable with the help of an
advisor. You want to present a company that has
not only maximized current opportunities but
presents to the buyer a view that demonstrates a
continuing path to a higher level of profitability.
Let us take a look at what are the basic building
blocks for that.
You will need to develop a strategic plan,
block by block that looks out 3 to 5 years
and your key staff need to be involved in its
development. If you have key staff position
missing that needs to be addressed quickly.
Next year’s operating plan for a fiscal year
needs to seamlessly flow from it. Again key staff
have to be involved and aligned with the goals
which they participate in developing. Initiate, if
not already doing so monthly, financial results
for Income Statement, Balance Sheet and Cash
flow. Most importantly have an operational
narrative that takes the key performance
statistics of the business and relates them to
the operating plan targets. The operating plan
needs to be reported on monthly in terms of
the month and the year to date.

3. Performance
Performance statistics can come out of the
strategic plan but you probably need an
operational and financial audit to be sure
what your base line is. It is difficult to put in
performance improvement statistics on say
“lean manufacturing” if you do not know your
base line labor and material usage and the
same for say the cost of acquisition of a new
customer.
Additionally what products need to be
eliminated and which ones need to be
performance improved need to be considered?
Performance
improvement
Improvement in operating performance and
indeed asset management should be carried
out outside of the fiscal year which determines
the valuation of the company. Cleaning up
usually involves minuses to EBITDA. You
want those minuses out of the valuation year
(year when trailing 12 month EBITDA and the
multiple are used ) so that is why you work on
it early. Elimination of products usually takes
time and creates old and obsolete product.
Aged inventory should be an early target
and so should old receivables. When we get
to an equity event we want to demonstrate
a solid team of professionals managing the
company for higher levels of profitability and
aged inventory, aged receivables and yes aged
payables detract from that view.
We started this discussion on the basis that
we did not know what level of demand for
financing we required. We also need to consider
the supply of financing. Again we do not know
the state of the economy, future credit markets
in terms of financing rate nor whether the credit
market is for all practical purposes shut down.
Remember September 2008, and with the
financial market ruptured, the credit markets
seized up for a couple of years. If we think that
was a one off remember the challenges of
borrowing after 9/11/ 2001!
Preparation complete
So you have now completed the preparation for
a financing event. Take a look at your current
and projected performance and determine if
you need additional funding and where it will
come from. If it is an investor meeting you
are prepared and if it is bank finance you are
prepared. There are lots of things left for you
to do but you have the basis for “selling your
company” to gain bank finance or equity from
prospective investors.
More next time on the 4
M’s when we address the
challenges of management.
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