Capital Link USA - Cash and Control

CASH AND CONTROL: YOU CAN HAVE BOTH

by Stefania Aulicino, President of Capital Link

Would you like to position your company
so YOU control the outcome
when seeking outside investment?

Here is the 5-step secret, from one entrepreneur to another!

1. The BACK DOOR APPROACH

See your company through investors' eyes before you formally enter the market.

2. The BRAIN TRUST^TM PROCESS

Generate solutions before finalizing.

3. The BUSINESS PLAN

Address investor concerns and build value.

4. The MOSAIC APPROACH

Divide your financing needs into equity and non-equity pieces.

5. NEGOTIATE FROM A POSITION OF STRENGTH

Be an informed decision maker.

This step-by-step approach puts you in control to get the best deal.

Let me tell you the story of 2 entirely different companies I took to market for growth capital.

Bob's Startup Company

The first was an exciting start-up. The company had invented a remote control robot to perform bridge inspections capable of detecting problems humans couldn't even get close enough to locate.

Bob, the inventor who founded the company, had done an impressive job of building his company. He had gotten friends to help finance the prototype; he bad won a demonstration contract with the Department of Transportation and bad earned quite a reputation nationwide for his innovative approach to bridge inspection. Now be was receiving requests to bid on major contracts.

Bob came to me to finance a business plan to introduce his bridge inspection service. Bob's company would own the robotic equipment, and municipal authorities would call upon him to perform the inspection, typically once a year. The benefit to the customer was that Bob's company would perform exactly the same robotic inspection each year which enabled the municipalities to predict rates of deterioration so as to prioritize the use of scarce maintenance dollars.

I helped my client design a financing strategy but, I warned Bob that his company lacked business management. He immediately concurred, realizing even if be were the engineer who could design a race car, he still needed a superb driver to win the race. But Bob was anxious to avoid any delay in going to the market. So, we agreed to simply state his intentions by adding another line to the use of proceeds; "hire a CEO".

Even though I knew a missing CEO was critical, I felt confident that I could find quality investors who would be willing to help find the CEO, attracted by this start-up's multi-billion dollar market and a service business approach capable of yielding a 75% pretax profit margin.

David's Established Company

The second company was at the opposite end of the spectrum with $15 million in sales. This company designed and manufactured motor controls to start and stop industrial production lines; but not just simple controls. For example, one of their customers was a paper mill where spinning wet pulp to become solid paper requires the coordination and control of hundreds of rollers. An uneven pull anywhere in the process could break the wet pulp and stop the entire production line at great expense.

David and his team had grown exclusively with internally generated funds to date. As experienced as they were, the team bad not realized the need for a business plan to support their request for growth capital. So they asked my help.

At first, David's team was having trouble writing their business plan because they did not think their business offered investors anything particularly distinctive. (I reminded them there are a lot of restaurants selling hamburgers, but McDonald's stands apart.) I shared my impression of a few distinctions which David's team seemed to be taking for granted.

stellar customer list with 95% repeat orders yearly
significant penetration in the Japanese market, based on excellent quality control
market ranking just below the leader in Canada.

As they drafted their business plan, management indulged me with text and a few charts. But, when it came to the financial projections, David was unshakable. My client reasoned he had experience preparing projections. Yes, I tried to explain, but those were the kind of projections provided to a banker for debt, not to a source of equity for growth capital.

Even though management's projection were very conservative, I felt confident investors would see through the numbers, as I did. After all, this client had a track record of beating their projections! So, we went to market.

Lo and behold, we got excellent responses from numerous investors for the business plans of both of these dynamic companies. Qualified investors responded within a few days and we were able to schedule investor visits to both companies soon after. My clients and I were expecting a fast close.

During the first investor meeting for both Bob's start-up and David's established company, we were shocked to learn we had big problems. Investor concerns about the weaknesses we already knew about raised investors' uncertainty. As investor uncertainty increased, so did the cost of capital. PLUS, the investors we selected - based on their industry expertise - found a few more things to worry about. In other words, we were at risk of losing control.

Costly Surprises

For the start up, Bob already knew he needed a CEO. But he was surprised when investors uncovered that labor unions feared the impact of his automated equipment on their jobs and that municipalities were nervous about the public finding out the serious status of our infrastructure.

For the established company, David was shocked to learn that his conservatism backfired. Instead of establishing a floor - as he intended - investors perceived David's conservative projections as a cap on their upside. In addition, investors revealed the company's lack of inventory controls to manage the investment being sought, and a BIG difference of opinion between the R&D partner and the marketing partner as to which markets offered the best growth potential.

At this point in the money raising process, the valuation for the start-up meant that funding would cost Bob well in excess of a majority give up; and the valuation for the established company translated into funding costs approaching a third of David's company. Both were devastatingly unacceptable terms.

My clients thought the solution would be to find other investors, but I knew differently. Theses were the most knowledgeable investors and others would only have a lesser appreciation for their business.

The Entrepreneurial Investment Banker

A traditional investment banker wouldn't fret at this outcome. After all, an investment banker's job is to let the market set the price. It's the company's problem if they don't like the valuation they receive. In market terms, these were the best deals these companies could get, given their weaknesses.

But, for me as an entrepreneurial Investment Banker, this was definitely not good enough. (What I didn't explain at the outset is that I started my career as an entrepreneur and Capital Link is my third company.) These valuations did not reflect what I knew in my heart and mind was possible.

In their enthusiasm for getting cash, both companies had opted to go to market, before addressing the risks I had identified for them. Only now were they beginning to understand my concerns for them. Unfortunately, it was an expensive education. When this happened many years ago, I thought to myself, "If only I could figure out a way to let my clients see for themselves what I could see. Then we could team up to alter the outcome." Today, that is my "back door approach".

Step 1

The BACK DOOR APPROACH

See your company through investors' eyes before you formally enter the market

The ideal scenario would be to get investors to offer their candid reactions about my clients' strengths and weaknesses. But, without letting investors know who the company is. How? By introducing the company incognito - perhaps under a make-believe name! That would give my clients the opportunity to see any weaknesses investors identified before presenting themselves under their real name. Well, no company with integrity would do such a mischievous thing - introduce themselves under a phony name. But, I developed the next best thing. Investors I work with are willing to review "no name" profiles and offer my clients the candid feedback we urgently need BEFORE we formally go to market.

Knowing investor concerns up front allows my client the choice of resolving these issues or accepting the fact they will hove to pay for them in equity. The result would be the best deal because the company would not be penalized for any weaknesses it undertook to resolve. I call this my "back door" approach. What makes it a back door is that my clients get to see their company through investor's eyes, without jeopardizing their opportunity to create an excellent first impression as a platform for negotiating the best deal possible.

For Bob and David and their 2 companies which had already gone to market - it was too late for the back door because investors already associated them with their weaknesses. Now let's look at the benefits one of my recent clients, Michael, gained by using my back door approach.

Michael's Experience

Michael had learned how to make orthotics from his father and became fascinated with the possibility of improving the life style of people confined to wheelchairs. He developed a unique way to measure patients with physical deformities. This allowed him to create custom seats offering therapeutic benefits like easier breathing and greater scope of motion. After 3 years, the company had $3 million in sales and 80 employees. Michael came to me looking for capital to expand.

Instead of the first step being to write a business plan, as most of my colleagues would do, I advised Michael of the investor issues I could see which would limit his access to the best deal. For example, Michael did not have a marketing staff to use the capital he wanted to raise. In fact, the marketing strategy he wanted to finance was assembled by himself, an engineer. His quick answer was that he needed the money to hire someone to refine and implement the basic strategy he had developed. Logical in Michael's mind, but in mine, I knew this approach would translate into an additional 10-20% more equity give-up than necessary.

To clarify my insights for him, I offered Michael my back door approach. To start, I asked Michael to assemble his key managers for a brainstorming session. Together we analyzed the economic building blocks which drive value in Michael's business and I helped the team crystalize their vision of the company's future in economic terms. With this information, I - not the company - drafted an economic profile for investors (for all the same reasons it is so hard to write your own resume.) Like many of my clients, Michael and his team were amazed at the compelling economics that I highlighted which they had taken for granted. Everyone was very excited.

"No-Name" Market Feedback

I shared this "no name" economic profile with half a dozen specially selected investors, expert in Michael's kind of business. Within a short time, I had six investor insights to share.

Michael was impressed that "the market" valued him as an undisputed product development genius. "The market" loved the fact he had 14 patents on design and measurement procedures. But all six investors made the point that Mike diluted the value of his company by diverting his attention from product development. Michael realized that is what he was doing by not having a marketing specialist on board to leverage his talents.

He was surprised by feedback that "the market" was concerned about the labor intensive production process which resulted in a $1,000 selling price after a 25% remake ratio. Based on a decline from 50% remake, Michael had lulled himself into thinking that he had achieved an acceptable level. Now he realized otherwise.

Michael was shocked, but delighted, to learn that "the market" was enthusiastic about his "dream" plan to expand into seating systems for the automotive market and office furniture. Of course, this marketing strategy would effect the amount of dollars needed to implement his game plan.

Michael's Choices

Now that Michael could see investor concerns for himself - through the back door - he had to decide what to do. Michael had 2 choices:

1) he could accept the cost of these business weaknesses and pay more for the money he wanted, or

2) he could take action to resolve the business risks and pay less.

Michael now knew exactly where to focus his attention for the biggest return. But how do you find a solution when you don't fully understand a loosely defined problem? I offered Michael access to my Brain Trust.

Step 2

The BRAIN TRUST PROCESS

Generate solutions before funding

The Brain TrustÔ is made up of managers with 15-45 years of experience in all disciplines -marketing, finance, manufacturing, quality control etc.; and in all industries - high tech, low tech, service.

Financial Angels

What is unique about these managers is that they are NOT looking for JOBS. Unlike typical employees, who can only execute a strategy if you articulate it for them in great detail, Brain Trust managers share your vision and can design the strategy as well as supply the talent to get the job done. As fellow visionaries, all Brain Trust managers are willing to "invest". Brain Trust investments can take the form of either deferred compensation, below-market salaries and/or direct cash.

In fact, half of these Brain Trust managers are what I call Financial Angels. Financial Angels are experienced executives, many of whom may have recently sold a business, taken early retirement or otherwise have capital to invest side by side with their talents.

Uncovering Innovative Solutions

But a resource pool of solutions is not enough. I had to create an unconventional process to match the right solution with the current problems. So I reversed the resume flow. Instead of circulating manager resumes for my clients to consider, I circulate resumes on my client's vision, strengths and weaknesses for Brain Trust managers to consider. In this way, individual brain trust managers can play a pro-active role by selecting themselves based on matched goals. Brain Trust managers identify solutions to problems they can solve!

Let's face it, entrepreneurs may know where they want to go, but not always the best way to get there. Whereas managers know how to get there, they are just not sure where they want to go, yet! What is unique about the Brain Trust process is the ability to match needs with the right solutions.

So, instead of being limited to Michael's knowledge about his options, we circulated his vision and growth objective to the Brain Trust. One Brain Trust manager had just sold his interest in a company which designed medical reimbursement programs. He immediately zeroed in on pricing as a key issue effecting Michael's marketing strategy. This manager offered to design and install a software system for Michael's existing distributors which would allow insurance reimbursement at Point-of-Sale. Michael's effective selling price dropped from $1,000 to $200, by dint of 80% insurance reimbursement!

Michael was delighted to find someone so creative in attaining his goals. And the fellow was even willing to defer his compensation for the opportunity to share in the value he created because he was so excited about the company's upside. This is just one of the creative solution that surfaced through our unusual approach.

The implementation expertise of Brain Trust managers provided Michael with solutions to resolve the business risks investors had identified. This made it possible for Michael to alter the risk associated with his growth strategy BEFORE seeking investor funding. Plus, Brain Trust managers contributed clarity to the business strategy Michael needed to finance. With a clear view of the future we want to finance, its time to document it in a business plan.

Step 3

The BUSINESS PLAN

Address investor concerns and build value.

With market feedback from the back door approach, and resolutions to investor issues contributed by the Brain Trust, Michael was in an ideal position to write his business plan. Now his plan could be complete enough for investors to say, "if everything I see here is correct, I'm ready to invest, subject to due diligence". Writing a plan at this point, not earlier, allows my clients to use the capital raise process as a value-building exercise.

To achieve the greatest value, I encourage clients to share their optimum business strategy with investors. That is the one with the greatest business upside and the lowest investment risk. After all, I explained to Michael, if you don't tell the world what the upside of your business is, no one else will!

With his entrepreneurial creativity channeled, Michael found the process rewarding and he was amazed how quickly the business plan was completed. Perhaps Michael found it easier to invest the time and effort when he knew we had at least six interested investors waiting to review his full plan.

As the business plan took shape however, Michael became a little nervous when he realized the amount of resources called for by his dream strategy ... until I shared with him the power of my Financial Mosaic Approach.

Step 4

The FINANCIAL MOSAIC APPROACH

Divide your financing needs into equity and non-equity pieces

Like most business owners, Michael had assumed all the financing needs called for in his business plan would have to come from a single source. In his mind, that source was equity and he feared a potential loss of control. Instead, I explained my Mosaic Approach. Working with Michael, I showed him how to divide his financing needs into equity and non-equity pieces. With each piece we put in place, we lowered the cost of the next. In this way, we actually reduced the equity component, yet got Michael all the capital he wanted.

Imagine, in your mind's eye, a Mosaic; a picture composed of numerous small colored pieces, organized in a planned pattern. Individually, none is interesting or descriptive, but when methodically assembled by a skilled craftsmen, they take on a unified significance - like a unique piece of art. Now think of those flecks of color as different sources of capital (equity and non-equity), which together make up your unique financial solution. A byproduct of my Mosaic Approach is CONTROL. No single creditor is responsible for your success - you are hostage to no one.

Step 5

NEGOTIATE FROM A POSITION OF STRENGTH

Be an informed decision-maker

My Mosaic Approach is designed to position Michael to negotiate from a position of strength for all his credit needs. Equity investors are attracted to the leverage a Mosaic Approach affords their investment. As a result, Michael had alternative equity investors from which to choose. Competition made him an informed decision-maker. For the first time, Michael had confidence that the deal he accepted was the very best deal possible.

To summarize, going through the front door was A BIG MISTAKE! To get the best deal, we used a step by step approach. The result is access to more capital you ever imagined; the smallest equity component you ever thought possible; the highest valuation you ever dreamed of; the fastest, least expensive capital raise way you ever heard of!