Attracting Money To Finance Growth

It Takes Money.

to make money, and it takes a lot of legwork to attract money to finance growth — even in this era of seemingly free-flowing dollars for dot-com start-ups. Here’s how to get your fair share.


In 1998 Family Christian Stores Inc. was looking to raise capital to fund future growth and provide liquidity for investors from the 1994 leveraged buyout of the retail chain. Rather than focusing solely on either taking the company public or raising venture capital, Craig Wassenaar, the company’s executive vice president, and CFO opted to pursue both options simultaneously.


Although this strategy may sound unusual, it paid off for Family Christian Stores, a Grand Rapids, Michigan based retailer with about 350 stores in 37 states. “The parallel track made us very efficient,” Wassenaar said because much of the preparation for an initial public offering (IPO) mirrors steps for obtaining venture capital funding. More importantly, when the IPO market went soft in the summer of 1998, Family Christian Stores was able to quickly and easily shift completely into pursuing venture capital funding. The company was able to access the capital it needed and postpone its IPO, rather than succumbing to pressure to go public in a questionable market.


If there is a lesson to be learned from Family Christian Stores’ experience, it is that companies must be prepared for anything when raising capital. This lesson is particularly relevant in today’s environment. Although it often seems like an endless abundance of capital is available, finance executives must prepare extensively for a search for financing.


Dot-Com or Not Com?

Is this the best of times or the worst of times for companies looking to raise capital? For the most part, the answer depends on who you are. “E-commerce start-ups have raised capital with ease and in amounts that one would consider historic in terms of proportions,” said Stewart Cohen, CEO of Paragon Capital LLC in Needham, Mass. “With so much of the focus being put on that area, it has been hard to attract capital to the more conventional opportunities.”


“Many venture capital funds that previously focused on non-tech deals are now looking for Internet-related deals,” agreed David Stone, a partner with law firm Seyfarth Shaw Fairweather & Geraldson in Chicago. Overall, “it seems that many deals are getting done, but even more people are out searching for capital.”


So, where does that leave non-Internet companies with strong operations, growth trends, and income that represent the “old” schools of thought? “Those companies should still be able to find capital from the established venture capital firms, and banks are continuing to lend money,” said Stone. “Until interest rates rise further and banks begin to spend more time on restructuring loans, this may be a good time to borrow funds.”


However, changes in the banking industry have affected companies’ access to capital. “Large banks do not have the appetite for middle-market companies, and regional lenders have been gobbled up in roll-ups,” said John Erickson, CFO of American Capital Strategies Ltd. in Bethesda, Md. As a result, “it is hard to know where to go [for funds].”


Companies that are planning to go public may also encounter changes in the IPO market. “The capitalization required to gain investor interest has increased,” said Erickson. In the past, a company worth at least $100 million would garner investor attention. However, in today’s market, companies need $500 million to $1 billion to attract interest. “This has an impact on these companies’ ability to raise capital,” he said.


Navigating the Changes

Although the competitive marketplace for capital can be intimidating, finance executives can do a lot to position their companies for growth financing. “Ultimately, the best way to raise capital is to remain true to the fundamentals of ‘blocking and tackling’ — running an efficient business with an eye to cash flow, growth opportunities, and profitability,” said Stone. Here are some ways to begin the pursuit of financing:


Market the company. Companies trying to raise capital should not overlook the importance of differentiating themselves from the competition. An integrated marketing and public relations campaign can help a business “package” a play for financing by clearly communicating the company’s value in the market before it presents the financing opportunity to investors. Like many companies, Family Christian Stores underestimated the need for such tactics. “We needed a better profile and PR communications strategy,” said Wassenaar. “It is difficult if you go to market when no one has ever heard of you.”


The company’s marketing should focus on how it stands out from the pack. “Many companies project an eerie feeling of ‘me too,’ ” said Joe Romano, senior account manager of HighGround Inc., a marketing and public relations firm in Boca Raton, Fla. For example, most companies are unable to illustrate how their business has gained credibility with leading analysts, industry writers, partners, and customers in their market segment. “Having a better mousetrap in a hyper-competitive environment for venture capital attention and money simply will not cut it,” Romano said. Companies need to be considered leaders in their fields. To communicate what it can bring to the table — its value proposition — an organization should focus on “what the market pain is, how the company solves this pain, and why the company is very distinct from other solutions in the market,” Romano suggested.


Although many companies think of public relations and marketing as directed toward customers and the press, the pre-financing campaign should also focus on communicating with industry analysts and channel partners. Validation from an industry-leading analyst and the press can enhance a company’s ability to form new channel partnerships, which investors see as a sign of validation within the business community. Strategic partnerships can create “a strong opening round with the investor community,” said Romano.


Know the business. In the pursuit of financing, finance executives stand front and center, with much of the company’s success or failure resting on their shoulders. Therefore, it is crucial that they make sure they are clear and conversant on all aspects of the company’s operations, growth strategy, business model, and so on. Finance executives should be ready for in-depth discussions of the company’s financials, including explanations of where the organization makes and loses money and what its return on invested capital is. “A big mistake is not being objective about the strengths and weaknesses of the business,” noted Erickson.


Also, “you need to keep the growth strategy focused so that you can articulate it in a way that will be understood by others,” said Wassenaar. “And you have to understand it yourself to be able to communicate it.” That means understanding how the company will create future wealth. Wassenaar said, “If you are a growth company, you must demonstrate that you can manage growth and handle it” — for example, by articulating ways in which your company has thought through issues such as the systems needed to support growth.


To determine how much capital the company needs, finance executives should work with others in the company to develop a “wish list” of investments the company would make with the desired capital. Then, by calculating the return on investment for each one, finance personnel can help set priorities, put together a plan to obtain the necessary capital and begin shopping around.


Find the right source. Identifying the right sources of capital can be the most difficult part of raising money. In the past, companies relied on an accountant or local investment banker to find capital. However, Erickson encourages companies to look farther afield to “identify pockets of capital with an appetite for your type of transaction.”


Most important, finance executives should remember that not all financing deals are created equal. It makes sense to shop around among as many as ten potential financing sources before agreeing to a deal. This approach puts less pressure on the company and the executives making their first presentation. They can give the first presentations to the banks or investors least likely to provide financing and can consider those presentations practice runs, said Rich Russakoff, president of Bottomline Consultants in Richmond, Va. The executives can fine-tune their presentation before giving it to more likely financing sources, and can better prepare to anticipate and answer investors’ questions and to address their needs. From a deal-making perspective, the more options a company has, the more leverage it has in negotiating terms. It can use leverage to get better interest rates, give up less equity, negotiate less restricting covenants, and minimize bank fees.


Ironically, even though Internet-related companies appear to be blocking some businesses’ access to capital, the Internet has the potential to open up financing opportunities. Several Web sites that are springing up to bring companies and sources of capital together, introducing a new level of efficiency to the process and potentially reducing the cost of capital.

Tailor the pitch. “A superb business plan is one of the tickets to capital,” said Russakoff. Therefore, once the company has identified several potential sources of capital, the next step is to develop “a professional request for financing that articulates where you are, where you are going and how you will get there,” said Erickson. Companies should emphasize what makes them unique — an innovative technology that can revolutionize an industry, strong bottom-line sales, increasing market share, steady increase in gross profits, etc.


It is also a good idea to tailor requests for capital to the sources the company is targeting. Although “money is a commodity and more readily available than ever before,” the prerequisite for gaining access to capital is a business plan that speaks to the capital market the company is targeting, said Russakoff. “What might attract venture capital might scare a [more conservative] bank.”


Build supportable business models. “The best way to kill a deal is not to be prepared, not to understand your business model and growth plans, or not be able to support your business model and growth plans,” said Stone. To avoid this, he recommended that finance executives make sure they have a good handle on their company’s financial statements, cash flows, accounts receivable and accounts payable; understand the sources of the organization’s pipeline for new business; know about accounting issues that could affect the profit-and-loss statement; and understand the business model and the assumptions that went into building the model.


“Most important, the model must be realistic and achievable, or the CFO will lose credibility that may never be recovered with a potential financing source,” said Stone. For example, many Internet start-ups create projections that bring them to $1 billion in revenue simply “because that is what they have been told they have to have to be successful,” he said. “Unfortunately, it is quite common that neither their business model nor business ‘space’ will support these rates of growth.”


Of course, obtaining capital is just the first, albeit very important, step in growing the company. The next challenge is to put that capital to work growing the company at a pace that is sustainable and maximizes return on invested capital.


Financing growth is no good unless a company also can manage the growth. Although there is no secret formula for effective growth management, the success of most growth efforts hinges on finance’s ability to structure a long-term plan, track key measures and provide advice to other managers.


Although it is difficult to view growth as anything but good for a company’s future, uncontrolled or unmanaged growth can be devastating to its future. There is no one-size-fits-all strategy for managing growth. Creating an effective plan depends on a host of factors, including many that rely on each company’s situation. Finance executives play a key role in managing their companies’ growth — from raising capital to fuel expansion to reining in overly ambitious plans that could cause the company to overheat. Finance executives need to know when to do both, while also supporting the type of growth that is in the company’s long-term best interests.


For The Boston Beer Co., managing growth occurred with a light hand. Moreover, although this approach ultimately served the company well, there were some glitches along the way. For 12 years, The Boston Beer Co., which produces Samuel Adams beer, grew 30 percent to 60 percent per year by focusing almost exclusively on increasing the top line. In fact, before the company hired its first CFO in the late 1980s, the company was so focused on increasing market share that it had few financial controls and little in the way of a financial infrastructure. Such a growth-management approach has its drawbacks, of course, as The Boston Beer Co. learned. Before the CFO arrived, cash flow difficulties caused by problems with the company’s accounts receivable and overall accounting systems forced it to tap into a $4 million pool of unused venture capital funding until it could straighten out its finances. Without that pool of funds, this “might have disrupted operations as we spent time sorting out financial problems,” said Jim Koch, the company’s president, and brewmaster.


Enter the new CFO, who joined the company in the late 1980s and spent the early part of his tenure sorting out the accounting crisis while also building organizational infrastructure, not just in accounting and finance but legal and human resources. At the time, “this was counterculture, but he was smart enough to get me to buy into the need for good financial controls,” which helped convince others in the company to cooperate, said Koch. “People did not even have budgets and didn’t understand the need for them. However, they very quickly saw that this would help them get their lives under control.”


Aside from the financial structure developed by the CFO, the company continued to manage its growth with a light hand. In fact, it was not until top-line growth slowed in 1998 and 1999, that the company addressed some important financial issues. By examining its entire cost structure and eliminating waste and inefficiencies, despite slow growth, the company increased earnings per share by 50 percent and increased gross margins by five to seven percentage points.


“Before then we were growing too fast to do it,” said Koch. He pointed out that putting the company’s energy toward eliminating costs during times of tremendous growth was like “trying to change the tires on a moving bus; it is better to wait until you get to the destination.” The company recognized that when the bus is moving, the growth is key, even if $1 million gets wasted in the process. “When your mission is growth, you are willing to tolerate much waste,” said Koch. “The important thing is to get a critical mass of market share and then go back to developing financial controls.”


What Is at Stake?

As The Boston Beer Co.’s experience illustrates, a company’s growth can be managed lightly, but it indeed must be managed. After all, this company has emerged stronger not only because of its phenomenal growth in market share but also because it managed growth when necessary by using appropriate financial controls. Now that the company’s market is growing again, the company will be a lot better off in the future. “There is a time to focus on the top line and a time to focus on the bottom line,” said Koch. “Sometimes it is easier to do one rather than the other.”


Several essential ingredients go into successfully managing growth: adequate capital or cash flow to finance it; the information infrastructure necessary to monitor and measure what is happening in the company at any given time and one that has the scalability to handle increasing demands; and a strong plan. “Most successful companies have done a great job of managing growth, making sure that the disciplines of the plan are met along the way and that everybody understands the metrics and analytics of performance,” said Stewart Cohen, CEO of Paragon Capital LLC, an asset-based lender to retailers in Needham, Mass.


“Managing growth is obviously critical,” said David Stone, a partner with law firm Seyfarth Shaw in Chicago. “Unmanaged or mismanaged growth leads to bad surprises, unfulfilled projects that produce no revenue, customer dissatisfaction, and expenses that exceed cash flows or available financing, which, in turn, creates possibly fatal liquidity problems.”


On the other hand, companies that manage their growth and can show sustained growth and improvement over time are often viewed as the most desirable candidates to receive equity or debt financing. After all, how well a company handles the fundamentals of operating the business toward profitable growth ultimately determines which companies will thrive and which will fight to survive. The struggles of many not-yet-profitable Internet start-ups that have been pummeled by investors in recent months are a good case in point. Even Inc., which seemed to flourish on its growth-before-profit approach, has replaced its former CFO with a CFO who has experience running profitable operations.


A Map for Growth

When it comes to planning the company’s growth, finance executives often become internal business advisers who support other managers and find creative ways to structure deals. They must also free up the necessary resources to finance growth, which requires a long-range plan that is in keeping with the long-term prospects of the business and its industry.


Another side to this prominent role exists growth cop. “Finance executives have to control growth and make sure that the plans for growth not only make good business sense but also can be sustained with anticipated cash flows and financing,” said Stone. “If they do not realistically look at the likelihood, availability, and cost of financing, the growth plans could collapse.” He recommended that companies temper or phase in overly optimistic growth plans based on available financing and cash flow.


When it comes to organic (internally generated) growth, finance executives have “to be the alter ego for the other members of the management team, asking tough questions of the management team wanting to invest,” said Kenneth S. Klipper, CFO of Tucker Anthony Sutro Corp., a Boston-based holding company. Among the most important of those queries should be a request for a quantified return on investment and return on capital for the investment.


When a company grows through acquisition, finance executives have two key roles. First, they have to ensure that the acquisition makes sense financially, from the purchase price to the impact on earnings, and they must convey the value of the company’s growth to investors, Wall Street analysts, internal staff, bankers and other stakeholders. “Wall Street has no patience for deals that are not immediately accretive in today’s marketplace,” noted Klipper.


Also, finance executives have to manage and ultimately realize the synergies or cost savings that are often expected from an acquisition. Unfortunately, “people usually overestimate the level of synergies, especially around expense cuts, that a deal can bring to the table,” said Klipper. “That is why I try to make a deal work on its merits without expense cuts or take a fraction of the represented savings,” when reviewing a potential transaction.


Regardless of how a company grows, the cost of capital is a major determinant of how fast it can grow and influences the investments it can make to spur growth. “You have to understand your cost of capital,” said John Erickson, CFO of American Capital Strategies Ltd. in Bethesda, Md. “There are often big disparities between how much a company can afford to grow” and how much it wants to grow, he said. If capital is cheap, a company may be able to grow faster than expected. However, if the cost of capital is high, the company can either curtail growth or plan to grow faster with a lower return.


The organization must also proactively address the cultural issues that might impede the changes that are necessary to nurture strong growth. “You overcome these issues by supporting and educating those who must embrace change along the way,” said Cohen. For example, sometimes the outcome of a transaction or decision can threaten certain individuals. “It is up to the CFO, who is typically viewed as the most objective individual, to ease any concerns and convince internal parties how this can be accomplished and why it is good for the overall organization,” said Klipper.


In the end, all growth opportunities should be judged on both their financial and subjective merits. “It is the CFO’s responsibility to ensure that growth is accomplished according to the company’s financial standards,” said Klipper.


Build the Infrastructure

In addition to developing a growth plan that makes financial and strategic sense, companies have to be prescient enough to think through all the issues associated with growth. In fact, a common mistake among growing companies is not developing the infrastructure to accommodate expanding information and data needs. “Think ahead and plan for growth by making sure you have the systems in place to track metrics,” said Erickson. After all, without adequate systems, there can be no timely reporting to provide the information for day-to-day management. “You need to have a set of relevant metrics that can be reviewed daily and weekly to see if you are meeting your objectives,” he said. Without current reports on these metrics, companies are flying blind.


To avoid this, Grand Rapids, Mich.-based Family Christian Stores did a major systems conversion to make sure it had the scalability necessary to grow. Now the company’s systems can handle data from up to 1,000 stores, leaving plenty of room for growth from the 360 stores the company currently owns and operates. The system is also designed to easily link up new stores “in a weekend starting the day the acquisition is made,” according to Craig Wassenaar, the company’s CFO. This “plug-in” simplicity has been a key factor in the company’s ability to grow. The Family Christian Stores opened or acquired 100 stores in 1998 and 66 in 1999 and planned to continue its expansion this year.


Rein in Growth if Necessary

“Growth should come in a manageable, well-thought-out manner that is consistent with an organization’s stated strategic goal,” said Klipper. Otherwise, its systems may be unable to keep up with its needs; its people will not be able to keep up with the demands placed on them; its customers will leave because it is unable to fulfill promises, and its product or service quality will suffer.


In these cases, the CFO must not only recognize the danger signs but also convince others that it is prudent to curb things temporarily. “The CFO may need to offer a reality check, and the CEO can be the biggest resistance point,” said Erickson. “The CEO is often more of a marketing person” so the CFO needs to show why certain growth scenarios are realistic or unrealistic. Above all, the CFO needs the strength and credibility to say no when a deal or growth strategy is flawed or otherwise does not serve the best interests of the company.


“Growth is an incredible double-edged sword,” said Stone. “Many company failures are the result of uncontrolled or misguided growth plans.” A key challenge for finance executives is to bridge the gap between the extremes of too much or too little growth to find the right pace and sidestep the hype surrounding unrealistic growth plans.


The best way to manage a company’s growth depends largely on individual circumstances. Richard L. Russakoff, president of Bottom Line Consultants in Richmond, Va. suggested that finance executives answer the following ten questions to gain some important insight and information for a growth plan.


  1. What is the company’s long-term vision? Does that include growth?


  1. What resources are necessary to accomplish those goals?


  1. What is the real cost of growth?


  1. What is the cost (in time and dollars) of acquiring capital?


  1. What is the cost of capital, including debt service and giving up equity?


  1. What are the risks (lost opportunities) of not growing?


  1. How will you guarantee the cash flow necessary to meet the company’s daily, weekly and monthly obligations?


  1. Do you have state-of-the-art systems in place to maximize purchasing dollars, receivables, and collections and to handle mergers or acquisitions?


  1. Is the company building value?


  1. Is there an exit strategy?