Customer Driven Development - hype or solid foundation for growth? While many books have been…
Sooner or later, almost every company will find itself in need of a cash injection. This is especially true for start-up companies, which often require funding in its early stages and for growth companies, where opportunities for future earnings often require an upfront investment. This could be an investment to enter a new, international market or to develop that amazing high-potential product.
Ideally, any funding for product development, international expansion or any other reason would come from the companies’ or its owners’ cash reserves. Even better would be to fund it from the companies operations. This way, there is no dilution of ownership and/or company control. However, funding growth only from operations could be difficult or could lead to a growth rate which is too low to remain competitive. Hence, external financing will become a topic on the board meeting. External financing in the form of bank loans has almost evaporated due to stricter loan policies. Financing can also come from other investors like private persons (so called business angels), venture capital firms or in the case of more mature companies, private equity firms or other firms that could have a strategic interest in the company that needs financing.
Many are the entrepreneurs or CEO´s that are so convinced about the greatness of their own company that they underestimate the process of looking for external funding. Simply put, not every company is worth that 10M$ or more and not every investor is waiting impatiently to hand over his or her cash to that company. On the contrary, most companies are totally un-investable for external investors. This does not mean that those companies are bad but merely that they do not meet the typical investor requirements. Those requirements differ often from those of the persons that founded or are managing the company.
“Investability”, or investment readiness is off course subjective, but in general one can be assured that the following points increase your chance of acquiring funding from investors (these points are by no means exhaustive):
- A product or service needs to solve a real customer problem at a cost that the customer is willing to accept. This seems obvious but is remarkably often forgotten.
- A proof of sales or at least a high likelihood of upcoming sales. Sales is the ultimate proof of concept as is shows there is a market and a need.
- A large growth potential. These type of investments are high risk and therefor require high returns. High growth is a pre-requisite for high returns. Alternatively, in case of a potential merger, synergies between the merging companies need to be obvious and realisable.
- A strong team that is able to manage and grow the company or willing to recruit the necessary missing competences. This could even mean that current management would be willing to step aside when needed.
- A well thought-through plan or strategy on how to realise the growth potential.
- A reasonable company valuation. Typically a company is valued by a factor times the companies expected EBIT (earnings or profit) at a certain time in the future. This means that current earnings, projected growth rate and company valuation need to be in line with each other. E.g. doubling your EBIT in 3 years from $50k to $100k does not mean your company is worth that 10M$.
- The possibility of doing an exit from the company and/or getting a satisfactory dividend. Shares not listed on a stock market are worth nothing until they are sold. Without an exit opportunity or dividends the ROI on invested capital is basically zero.
What can you do concretely to increase your company value or your companies’ investability and the chance of getting external investors on board? Not surprisingly, focus on sales, sales, sales! In order to increase sales, get to know your customers, your markets and your competitors. Make sure you have all the resources in place to realise that growth potential. Increasing sales improves your earnings, your growth rate and hence your company value. It also reduces investment risk as cash flow becomes stronger and more predictable.
Last but not least, start writing an investment memorandum, even if you do not need any financing yet. It forces you to think like an investor. And what is good for your potential investor, is surely good for you!