Raising capital is something almost every business goes through at some stage: applicable to start-ups and companies of all sizes all the way through to large listed companies. The process of raising capital is very complex, sometimes tedious, legally detailed, and generally long – a typical funding round takes over 9 months to complete. There’s a lot to comply with and consensus needs to be reached amongst several stakeholders with different interests at heart. It’s not cheap either – advisory fees on big deals (R100M and above) can easily add 2-3% on the deal. More shocking is that for smaller rounds typical of the SMB market (say under R1M) the total cost of raising the money can be as much as 25% of the money raised! In many cases all of these efforts meet with rejection and all of that effort goes wasted.
So sure there’s a better, easier, more efficient way to raise money?
The good news is that for established firms there is: in the next few articles we’re going to discuss how established businesses could raise money from themselves, primarily through operational improvements. The lessons here don’t directly apply to start-ups, although start-ups will do well to remember that running a tight ship will allow them to grow faster with less capital too. There’s another great spin-off from running your operations well: lenders and investors take great confidence in a well-run business and perceive it as lower risk, so not only is one able to raise the money more easily but often it comes at a lower cost too.
Here are the three key areas we need to focus on:
– Profitability: if your product is being correctly priced, your cost of sales managed tightly, and if your operational expenses are kept as lean as possible then you’ll have a few more % of your total sales to flow into your bank account. If you’re not doing this then you are simply giving away money to your customers, staff or suppliers along the way.
– Productivity: The people and the assets you employ need to be as productive as possible. If you are getting the most from your production, sales and administrative staff then you’ll be able to do more with a lower wages bill. Likewise, if you’re proactively maintaining your capital equipment to keep it productive over the long-term and if you’re making sure machines run round the clock, then you’ll be spending less money on capital equipment over the long-term and will have a more profitable business that generates more cash too.
– Working capital management: A tightly managed business optimises its Accounts Receivable (debtors), Inventory (stock) turnover, and Accounts Payable (creditors). A surprising amount of cash can be locked into the working capital cycle of any business and if the net amount is negative, then growing the business will drain cash that in turn will put the business at risk if the growth rate is too fast. Managing each of these in turn will allow your business to run as cash-positively as possible meaning that any cash injected from a capital raise will immediately be used more productively and with substantially lower risk.
These three areas are typically expressed as ratios, with the underlying data supplied from your latest financial statements (we’ll discuss which ratios apply in each of the subsequent articles). Assuming we’ve done the analysis of our business already, how do we know if our performance isn’t already very good (or very bad)? For some ratios (typically your liquidity ratios) there are absolute levels which any firm should avoid. For the ratios we’re talking about in this analysis almost everything depends on the industry you’re in. That means that you need to know how you’re doing compared to your industry peers, which in turn means you need to do some benchmarking – something most small businesses are very bad at.
While I will discuss various benchmarking options further down the line, your accountant or industry body will probably be able to give you rough guidelines. Step 1 is still do the analysis of your own ratios. Then objectively and deeply question how you can improve profitability, productivity and your working capital cycle. Benchmarks will guide you as to how well you are actually performing, but there is still a lot you can do without them.
Next week we’ll start to look in more detail at each of the 3 key areas we need to focus on, with example illustrated by real-life numbers. For a business trying to raise capital, you’ll be surprised at what’s possible with less effort and in a shorter time than chatting to your bank.