PREPARING FOR DEBT OR EQUITY: Building Your Financial Foundation

Lisa Rawls, President Evergreen Financial Services

The Financial CEO…is it you?

 Do you understand the financial management of your business on a daily basis?...OR….

 Are you more involved with product sales and “fighting fires”?

Reactive CEO?

 YOU ARE NOT ALONE!

 Thousands of small business owners define their business day as…

REACTIVE (not PROACTIVE)

Building Blocks for the Proactive CEO…

 Build…a BUSINESS PLAN  Build…the TEAM  Build…the PRODUCT  Build…the FINANCIAL DISCIPLINE

Now what?

MONEY!

Capitalizing Your Business Options:



The hard way.



The other hard way.



The

really

hard way.

Capitalizing Your Business Options:



The hard way.



The other hard way.



The

really

hard way.

Debt Equity Bootstrapping

Debt

The Good News  Other people’s money!

 No loss of ownership.

The Bad News 

Debt service:

Lenders want a little bit back every month.

  Often a bad match for startup’s cash flow.

Lenders not really interested in your company until 2-3 years of proven track record.

Equity

The Good News   No monthly payments.

Goals of investors are fully aligned with founders:  Company success  Capital gains  Large dollar volume available.

 Long time horizon.

The Bad News  Loss of ownership.

 Eventual loss of control.

 Founder now reports to Board of Directors.

 Emotional issue for many founders.

 Focus on exit strategy.

 Equity investors expect sale, merger, or IPO.

Bootstrapping

The Good News     No loss of ownership.

No monthly payments.

No covenants.

“The American Way.” The Bad News  Threatens domestic tranquility.

 Difficult to make large capital commitments.

 Hard to recruit top notch talent.

 Risk of losing strategic focus by chasing tactical opportunities.

 Triple your exit strategy timeline

Equity: Who Can I Call???

Stage Pre-Seed Seed/Start Up Early Later

Source Founders, Friends and Family Individual Angels

Funding Gap between $500,000 and $2,000,000/$5,000,000

(depending on region) Investment $25,000 to $100,000 $100,000 to $500,000 Venture Funds $2,000,000/$5,000,000 and up

Venture Capital vs Angel Capital 2006

$25.6B

51,000 deals Mostly early stage 2006 Angel Investment source: UNH CVR Mostly later stage 3,416 deals $25.5B

2006 VC Investment source: NVCA/PWC/VE 864 Early Stage 312 Seed

Why an Angel?

A really great angel helps an entrepreneur:

1.

2.

See around the corner Gain a sober second opinion 3.

4.

5.

Network with people who can help build the business By being an ambassador Gain credibility in a field Source: David Pecaut, Boston Consulting Group, 9/06 NAO

Companies Backed by Angels

Average Size Investment Per Round 2007

< $150,000 $150,000 - $250,000 $250,000 - $500,000 $500,000 - $750,000 > $750,000 0 10 Source: 2008 ACA Angel Group Confidence Survey 20 30 40 Percent of Groups

Angel Rating System

Management Team Size of Opportunity Product or Service Sales Channels Stage of Business Size of this round Need for more funding Quality of plan 0-30% 0-25% 0-10% 0-10% 0-10% 0 - 5% 0 - 5% 0 - 5%

You Got a Meeting!



Congratulations!

 Do more homework on the angel group.

 Understand how you fit their:  Existing portfolio  Stage of fund  Internal industry model  An investor pitch is not the same as a customer sales pitch!

Sell your company—not your product!

Getting the Term Sheet



Again, congratulations!

 Full disclosure on both sides.

 Don’t expect to negotiate every item… pick your battles.

 Make sure you understand everything in the term sheet!  Term sheets exist for a reason  Negotiating after document prep gets very expensive!

After the Deal

 Now for the fun part!

 You have new bosses (the board).

 They want to turn equity into cash someday.

 They will forgive almost anything… 

Except

being lied to!

 Over-communicate, under-promise, and over deliver.

The Bank Challenge

 No more good ‘ole boy banking  Highly regulated with strict credit underwriting guidelines  The bank loan process is not for the faint of heart – long, lengthy, with lots of questions about your strengths AND weaknesses.

What Does Your Banker REALLY Want to Know?

The 5 “C”s of Credit..

 Capacity (cash flow) It’s ALL about your cash flow!

Can it service your debt?

 Credit  Collateral  Character  Capital (net worth)

Capacity/Cash Flow

 Does your company throw off enough cash to successfully service the bank debt (plus a little more!!)?

Net Income + Deprec/Amort + Interest expense Total debt payments (principal + interest) EQUALS Debt Service Coverage Ratio Ratio should be greater than 1.20 times. The higher the number, the more times your profit can pay your debt payments!

Capacity/Cash Flow

 Are you charging enough for your product?

Gross Margin = Sales – COGS Gross Sales This ratio indicates whether you’re selling your product for a profit and how well you’re managing your product costs.  This percentage rate can — and will — vary greatly from business to business, even those within the same industry. Sales, location, size and intensity of competition are all factors that affect the gross profit rate.

Capacity/Cash Flow

 “Our financial statement says we’re making money…but where is it???”  The answer…it’s invested in your company assets (Accounts Receivable, Inventory, Equipment and Real Estate)  How does your banker determine how well you’re managing these key financial areas?

RATIO ANALYSIS

Capacity/Cash Flow

 “Putting out the daily fires” is how the business owner feels the heat of managing daily cash flow → inadequate working capital  Can the banker figure this out without asking?

Current Ratio = Current Assets Current Liabilities The current ratio reveals your business's ability to meet its current obligations on a daily basis. The larger the ratio, the less heat you feel on a daily basis.

Capacity/Cash Flow

 Accounts Receivable Collection Days A/R Days on Hand = Accounts Receivable x 365 Sales  A litmus test for the quality of your receivables, giving you the average length of the collection period. As a rule, outstanding receivables should not exceed credit terms by 10-15 days.

Capacity/Cash Flow

 Inventory Days on Hand Inventory DOH = Inventory x 365 COGS This indicates the efficiency of the company’s purchasing, selling and manufacturing processes as it relates to the movement of inventory.

A good ratio to track over time and compare to other companies in your industry.

Credit

 Yes, your personal credit must be good! Maybe even outstanding.  You are the company and the company is you – Personal guarantees and the benefit of good personal credit habits.

 Beacon scores vary – generally, over 650 is acceptable. The higher the score, the higher the banker’s comfort level.

Collateral

 Rule of thumb: Finance short-term cash needs with short-term assets (Accounts Receivable, Inventory, Stocks, Bonds) Finance long-term cash needs with long-term assets (Equipment, Real Estate)

Collateral

 Margin requirements Equipment Existing real estate New construction 75% of cost 75-80% of A/V 80-90% of cost  You’ve got to have “skin in the game!”

Character

I hope I shall always possess firmness and virtue enough to maintain what I consider the most enviable of all titles, the character of an Honest Man.

George Washington

Capital

 Without a strong capital position, there is no company…in the banker’s mind.

 What is my debt-to-worth ratio? What does that mean?

D/W = Total Liabilities/Total Equity A high ratio here means less protection for creditors. A low ratio, on the other hand, indicates a wider safety cushion (i.e., creditors feel the owner's funds can help absorb possible losses of income and capital).

The Bank Loan Process

 Research your lenders – locally and regionally. Who is small business friendly?

 Be able to present 3 years of quality financial statements prepared by a CPA. You don’t need an audit – a compiled or reviewed statement is fine.

 Be able to present 3 years of company tax returns prepared by a CPA.

 Provide the most recent internal financial information that you can.

The Bank Loan Process

 Provide a current personal financial statement on each owner of the company.  Provide copies of personal tax returns for at least 2 years on each owner of the company.

 Provide your updated business plan.

 Provide other documentation such as A/R agings, A/P agings, equipment list, real estate appraisals, corporate documents.

The Bank Loan Process

 Prepare a complete package and deliver it to your lender.

 Invite your lender to visit you at your location. NOT UNTIL YOU’VE CLEANED UP AND ORGANIZED! First impressions are critical!

 Answer all questions and concerns directly.

 Wait for their proposal. If you’ve provided a complete package for their review, you should have an answer within 2 weeks.

The Bank Loan Process

 The amount of collateral involved will determine how long until loan closing/funding.  Real estate loans can take as long as 60 days, but…  A/R, Inventory and Equipment loans can take as little as 1-2 weeks to close.

 Don’t forget the closing costs – ask for a closing statement prior to closing.

Ongoing Financial Discipline

 Budgeting process is critical.

 Keep your financial team (CPA, insurance agent, attorney, banker) involved.

 Weekly cash flow management  Monthly review of financial statements, including ratio analysis

Lisa Rawls Evergreen Financial Services

 Financial consulting and CFO services  Has assisted over 500 small to medium-sized companies with their financing needs over the past 20 years.  Corporate banker background  Equipment and product manufacturing, wholesale & distribution, commercial real estate development  Currently creating an Angel Investment Fund for the NE Georgia business community.  Graduate of Georgia Tech Lisa Rawls 770-380-1898 Email: [email protected]