Source: David Gilroy, Managing Director, Scale Finance LLC
Owners/CEOs of growing entrepreneurial companies often underestimate the difficulties, nuances, and complexities involved in the process of successfully raising equity capital. The challenge is made even more difficult as the company’s development stage is earlier rather than later, where investors can depend less on substantial trailing revenues, profitability, and growing cash flow, but rather must fundamentally believe the equity “story”.
An effective process is systematic, targets the addressable capital market comprehensively, is professionally managed, and thus can also be time-intensive. Critically, management teams must balance the importance of running the business and “putting points on the board”, in order to maintain momentum, with the week-to-week demands of the capital raise process. If not managed properly, a capital raise can take too much time away from day-to-day operations and negatively impact the business. There is enormous risk around this common problem since stalling momentum in the business can quickly translate into investor “wait and see” thereby extending or defeating the capital raise process – a double whammy at the worst time potentially.
The critical keys to success with an equity raise process are as follows:
- Clarifying the optimal growth financing (amount of capital, type of capital, cost of capital, mix of capital) the company really needs in the immediate term
- Preparing the business (and entire senior management team) for evaluation by professional investors, e.g. setting expectations and tuning message and emphasis
- Developing a quality marketing package to showcase the company – detailed, fact-based, structured information which comprehensively “documents” the business, clearly communicates the story, builds investor confidence from Day 1, and provides an enormous head-start on smooth diligence
- Identifying and accurately targeting potential equity investors – alone or in syndicates
- Coordinating efficient information exchange – adroitly balancing disclosure with confidentiality concerns over time
- Tailoring deal structure and terms to bridge gaps and find common ground for a transaction
- Managing due diligence activities on a critical path
- Assisting the legal process problem-solving/ “debugging” toward a successful final closing.
We know that careful scrutiny of a company in the context of a capital raise can be a stressful and emotional experience for any owner/CEO. Having a game-plan for a professionally managed process is critical to maintaining control, minimizing distractions from running the business day-today, and maximizing the probability of closing the desired financing on the best terms the market will bear.
In raising private venture capital, a company must nail the addressable market from the outset, striking the balance between targeted/prioritized and comprehensive. Companies do not want to “drift” lazily and opportunistically from one potential investor to the next getting relevance half-right, making the process protracted and “hit or miss”, and ultimately reaching out to only a small fraction of the several hundred institutional venture capital firms who are actively investing in growth companies today.
Nailing the addressable market means segmentation of these several hundred VC firms by:
- Industry sector or segment focus as precisely as the firm itself defines their niche (i.e. medical devices, healthcare services, enterprise software, semiconductors, consumer products, financial services, cleantech, etc)
- Target stage of investing (e.g. Seed, Early, Mid, Late/Expansion, Change of Control)
- Geographic requirements or preferences
- Size of commitment – minimum or maximums (e.g. $2M initial equity, minimum $20M initial equity)
- Current activity level and appetite for brand new commitments.
An effectively managed capital raise process typically involves the following scope of work in four phases with a timeline that can range from 8 to 16 weeks:
Phase I – Preparation (Week 1 – 2):
- Establish clear transaction objectives, i.e. the optimal growth financing (amount of capital, type of capital, cost of capital, mix of capital), roles in the process, and timing
- Prepare and maintain/update primary marketing materials – Executive Summary, Corporate Overview Presentation, Email Cover Intro, and Financial Model
- Create Target Investor list – review with client and establish a prioritized (Tier 1, Tier 2) final list to contact based on match between investor’s charter and client’s profile.
Phase II – Marketing (Week 3 – 9):
- Maintain confidentiality to maximum allowable level throughout process
- Contact prospective investors per the targeting and prioritization
- Do initial calls with investors to explain Company and outline investment thesis
- Supply additional follow up information and manage conference calls & meetings with selected investors as necessary
- Receive preliminary Term Sheets – review, analyze and discuss with client
- Negotiate select/final Term Sheet with client’s input.
Phase III – Due Diligence (Week 6 – 12):
- Select lead investor – client signs Term Sheet or LOI
- Organize syndicate of other investors if applicable
- Outline due diligence timetable, events, deliverables & hold meetings
- Manage data repository – provide detailed financial & operational Information
- Assemble deal team – legal & tax accounting
- Receive draft legal agreements from investor’s counsel.
Phase IV – Consummation (Week 8 – 16):
- Manage ongoing negotiations
- Support the legal process – negotiate and finalize Stock or Unit Purchase Agreement, Investor Rights Agreement, Amended Articles of Incorporation
- Wire funds and close transaction.
About Scale Finance
Scale Finance LLC (www.scalefinance.com) provides contract CFO services, Controller solutions, and support in raising capital, or executing M&A transactions, to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, business valuations, and other financial management, and provides strategic help for companies raising growth capital or considering M&A/recapitalization opportunities. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. Scale Finance LLC has offices throughout the southeast including Charlotte, Raleigh/Durham, Greensboro, Wilmington, Washington D.C. and South Florida with a team of more than 40 professionals serving more than 100 companies throughout the region.