Make Your Company Attractive to Capital: Build a Mosaic

by Stefania Aulicino, President of Capital Link, Inc.

Step 1: Build a Mosaic

A mosaic is simply a picture composed of lots of small colorful pieces. Individually, each piece is of little value .... until they are methodically assembled by a skilled craftsman to create a unique piece of art. The concept of a mosaic, applied to finance, helps focus attention to a financial fact of life; there is no single financing solution. The right solution will be unique to your company. (There is an art to financing growth so it helps to have a skilled advisor to create the greatest value and achieve the lowest cost.)

A Mosaic Approach builds on the principal of divide and conquer because different capital sources have different risk appetites. Young companies learn quickly that equity is prepared to bet on the future because equity investors want to share in any upside. Debt, on the other hand, will not take an equity risk because a lender has a cap on its return; debt only receives interest.

A savvy entrepreneur named Jack discovered the power of a mosaic when he wanted to introduce a new product. Jack learned that a mosaic is most valuable when it is built upon sources which stand to benefit from his success. He defined a mosaic as cashing in" on customer and vendor relationships. That is insightful because more than just credit, those are the kind of sources able to lend a credibility factor to reduce the uncertainty of your future. And, predictability lowers risk, which lowers your cost of capital. 

"Cashing in" on customer and vendor relationships!

First, Jack checked in with several key customers. But not just any customers; the most highly respected industry players. By demonstrating the compelling economics of his new product, Jack created several willing buyers. But that was not all he wanted - Jack was after credit. So, he skillfully negotiated a very lucrative first time purchase price, based on 50% cash with order. The customers were delighted, Jack earned a little cash and borrowed a lot of credibility!

Next he went off to his key vendors. Frankly, with orders in hand, it didn't take much of a sales effort. Jack focused the vendors' attention on the awesome size of the market he was addressing and the rate of growth he projected. Based on Jack's success with such impressive customers, his vendors didn't want to risk losing the opportunity to link up with a rising star. They agreed to defer payments for 3 month -- way in excess of conventional selling terms. 

Convert Expenses into cash-attracting assets

Now for a really aggressive twist. Rather than delaying the expenses associated with a top flight lawyer, accountant and investment banker, Jack cleverly sought out the best candidates and engaged several highly visible professional advisors. Jack was counting on the power of perception to convert those expenses into cash-attracting assets. With the help of his advisors, Jack assembled a package which made his future tangible enough for outsiders to see. Now he was ready for the banks.

Jack selected several banks and showed them his projections. One of the banks did business with several of Jack's customers and was happy to advance against such quality receivables. As you might guess, Jack negotiated a higher than normal advance rate. But, the real coup came when the bank noticed that Jack had created economic alliances with many of the constituents that could assure his success. The bank began to look at Jack in a very different light. Here was a company with credit from major customers and vendors, auditors the bank knew and trusted and several impressive professional advisors. The bank began to feel confident that Jack's projections were solid. So, they offered him an over-advance line. After all, it's hard to find quality borrowers and the bank ~ in the business of lending money. The bank would like nothing more than to ride the coat tails of Jack's success.

Based on the enthusiastic support Jack got from his customers and vendors, he got very creative. Jack became quite sophisticated about dividing his financial needs into small pieces so that each piece he put in place lowered the cost of the next. As a result, Jack conquered more and more credit because he was attractive to a wider range of financing alternatives. Now a days, Jack's business strategy dictates his actions, not scarce financing options. 

Growth financing is a 2 Step Process

Based on Jack's revenue projections, it was easy for him to calculate the labor, cost of materials, advertising and other expenses needed to support this planned market penetration. Using his well honed mosaic approach, Jack financed them all. But, for a growing company, that is not sufficient.

Whenever you introduce a new product, or expand into a new market, expenses precede revenues. Assuming that prudent business people price their products to generate a profit, losses are simply a "timing gap " before expenses and revenues synchronize. The most difficult thing about a Timing Gap is how to finance it because it is an unknown. Some might say the Timing Gap is the greatest unknown facing any growing company: just how long will it take for revenues to cover expenses? While the Mosaic offers a lot of ways to finance known expenses, there is only one way to finance the unknown: with equity.

If it's so simple, then why do growing companies undercapitalize themselves? Because equity is not just cash; it's control. That is why a 2 step process works best. Financing the known expenses first allows the equity component to be the smallest piece, with the greatest value, because it is leveraged by all those mosaic pieces! The Mosaic Approach ideally positions management to preserve control because you are not dependent upon any single source of funding. So equity can not hold you hostage! Now that you are willing to consider equity, where will you go to find it? 

Not all equity is the same

Not all equity is the same. That is why it pays to have a skilled craftsman to assist in selecting just the right pieces. In finance, this is the role of an investment banker. Serious growth equity wants YOU in control because they realize the investor's upside is not assured unless management makes it happen. After all, they are investing based on the fact that your future is worth more than your past.

Growth capital must be committed capital. It is a mismatch to undertake a multi-year growth program with uncommitted dollars. Committed investors have committed investment dollars. Discretionary investors, on the other hand, are hard to get a commitment from because their investment dollars are here today, gone tomorrow. Discretionary dollars are subject to a prior call to fix a leaky roof or satisfy an urge for a last minute vacation.

There are plenty of committed dollars around, if you know where to look. The institutional private equity market exists for the specific purpose of funneling committed dollars into growth driven opportunities. Funded by insurance companies and pension funds, this money is committed for 10 years and managed by professional growth investors. Today, more than $36 billion is committed to more than 600 partnerships, each with different risk and investment parameters. While it might take an experienced investment banker to find the right pieces, the bucks are there. In fact, today there is more growth capital, for more industries, at more stages of growth, than ever before. 

Make the capital markets work for you

When growth is your dilemma, there are not many alternative capital sources where you can get credit for your future. Most creditors, like your banker, extrapolate from past performance. Most investors, as evident in the stock market, put their emphasis on the last buy/sell order. In contrast, the private equity market invests based on your future. Getting credit for your future today, is a matter of negotiation.

Where an investor looks for value is critical if you are earning $1 million today but could be earning $5 million in 3 years. Using a Price/Earnings market multiple of 17x, an investor who gives consideration only to your past sees $17 million, while an investor willing to give you credit for your future sees $85 million. The difference between an $85 million valuation and a $17 million valuation is a matter of negotiation based on management's ability to convince an investor of your capacity to create value. If it will take $1.7 million to achieve that growth9 the difference is a 2% equity give-up to an investor who believes in your future, versus 10% to the one who focuses only on your past.

The power of negotiated value is derived from a basic tenet of the capital markets: VALUE IS NOT OBJECTIVE. There is no such thing as intrinsic value. If there were, you would not have both a buyer and seller exchanging stock at the same price in the market daily.

Value is a matter of perception, a concept the mosaic approach takes advantage of' but not to its full potential. Perception is so powerful it has been known to change objective facts. Did you ever see an accident? Honest bystanders offer facts, but the cop reporting the incident is overwhelmed with conflicting data. So it is with the equity market. Perception is management's secret weapon.

Management is what converts projections into reality. It is up to you to have an investor see a $85 million company, not a $17 million one. Value creation is management's job. Fortunately, the private equity market is prepared to pay up for value creators. Selecting the most knowledgeable capital source lets the capital markets work for YOU! Investors who understand your business are in the best position to appreciate the risks you have managed which supports their confidence in your financial projections and results in the highest valuation. It is a misuse of your company's unique currency and your management talent to seek growth capital any place else. 

NOW is the ideal time to grow

If resources were not a constraint, how big could you be? No one said times are easy, but then for growing companies, times never are. You are always navigating in uncharted waters so why stop now? Interestingly enough, today it is easier to get attention for your growth plans than to finance your status quo. Why? In part because the business atmosphere is charged with uncertainty and everyone is searching for a solution. If you have growth in your marketplace, now is the ideal time to share your ambitions with those who could benefit. Besides, given the quality of your product/service, shouldn't your company be the market leader? Considering the size of your market, should your company be a lot bigger than it is? Changing the upside your company is targeting can entice a wide range of resources, because growth itself is a valued currency.

Fortunately, for the company committed to growth, we are in an environment of surplus resources. Companies are laying off some of their best people. Very seasoned managers who took advantage of early retirement or received golden parachutes are even willing to bring in some cash for the privilege of joining your team. Those with the talent to build value as part of your team will want to share in the upside they help create - which is the good news! They are willing to be accountable for their contributions, not look to you as a salary machine. Even the most conservative growth entrepreneur should be excited to share equity with the right management team if it means the difference between owning 100% of a $2 million company or control of a $200 million company.

In addition to human resources, landlords of prime real estate are offering unbelievable deals. Advertising space is available at a discount. Your competitors have reduced their new product development to a trickle and are exposing their jugular. While every one is battening down the hatches, you have the opportunity to leap frog 5 giant steps ahead. 

Building teams to grow

Within the entrepreneurial world, there are 2 kinds of entrepreneurs. Those who are part of the solution and those who are part of the problem. You, the entrepreneur, are your company's most valuable asset, on or off the balance sheet. Conversely, you dilute your company's value every time you divert your attention from what you do best. Successful entrepreneurs learn to leverage themselves by focusing exclusively on what they do best, and surrounding themselves with other experts who share their vision and goals. That means enrolling customers and vendors who support your ambitions, selecting advisors who can offer perspective, and attracting managers who will make it all happen. Growth only flourishes where there are believers. The challenge of growth is to build a team, inside and out, dedicated to what your company could be! The next step is YOURS!

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