Key Question When Raising Equity: “If This, Then What?”

I need $1,500,000 to open a new distribution center in North Carolina. It’s a home run idea, but how much equity will I have to give up to raise that much?” Johnny (not his real name) and I have been good friends for seven years. We see each other socially several times a year, and once every 5 or 6 months we sit down to a serious conversation about his growing and vibrant medical supply business. “If I ever sell this business, I want you to handle it,” Johnny always says to me, but at the age of 43 and appearing to love every minute of every day, I don’t expect Johnny to be selling anytime soon.

However, Johnny is now facing a strategic decision that will dramatically affect the future value of his company. Several of his supplier relationships have encouraged him to establish a presence in the Carolinas. To do that, Johnny will need to establish a sales and distribution center there.

Johnny knows how to make big decisions. He’s done his homework to project revenue from the new territory, the cost to hire sales staff, and the working capital required to stock the distribution center.  He has even done a net present value analysis to justify the risk-adjusted return on the required $1.5 million investment (an approach to making financial decisions I unfortunately don’t see many small business owners doing).

Johnny is set to go as soon as he has the $1.5 million, and he is ready to sell equity in his company to raise it. However, Johnny does not know how much equity he needs to give up in exchange for that $1.5 million. Being the analytic guy he is, he’s done his homework to understand pre-money, post-money valuations. But Johnny has lost sight of the fundamental question an investor will ask, “If I give you this money, what kind of ROI can you get me and when do I get the money back?

This question forces an owner trying to raise capital to focus on how the capital will be used and how that use will generate a financial return. I told Johnny to set aside worry about valuation of his business, and instead focus on three questions: what the requested capital will be used for, how that use will transform the business, and the “exit plan” for the investor. Here’s the problem, too many business owners just assume that investment money comes in and stays parked in the business until the majority owner decides to sell the company. This is essentially saying to the minority investor, you’ll get your money back when I decide to give it back. To be fair, that works with some investors, the rare uber-patient investor. But most investors want to know, going in, what the getting out plan could be. I call it the “if this, then what? plan.”

I suggested to Johnny he turn his analytic brain toward developing a plan to show an investor how they could get their money out within three to four years of the investment. This “if this, then what?” discipline will increase his chance of getting the money, and ensure, when he gets the money, he’ll be in strategic sync with his investor.

 

JIM CUMBEE is President of Tennessee Valley Group, Inc. a retainer-based business brokerage and transition mediation firm in Franklin, TN. Cumbee is an attorney and has an MBA from Harvard Business School. He has a wide range of corporate and entrepreneurial experiences that make him one of the most sought-after business transition advisors in the state of Tennessee.

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Tennessee Valley Group

Jim Cumbee established Tennessee Valley Group to help business owners fulfill their dreams for life after business ownership. It’s a mission that his 30+ year career history had prepared him well for—in addition to being an attorney, transition mediator and business broker, Jim has been a buyer, seller, and entrepreneur. His broad range of experience gives him unique insight into how business buyers and sellers can achieve their goals.

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