In the blink of an eye, investors can go from being overly optimistic to overly pessimistic about the safety of an asset
Professor Elisabeth Krecké
We are witnessing a major crisis today. In times like these, old established ways of raising new capital have practically withered. Banks are adopting more restrictive measures. Conventional investors are holding back. There is “blood in the street,” as Rothschild said. Many conventional sources of funds are preserving their liquidity: “cash is king”. Alternative sources, such as crowdfunding, angel investors, venture capitalists, are drying up.
This article discusses how to raise new capital during difficult or uncertain periods, characterized by extreme turbulence. It addresses the issue from the point of view of a CEO, entrepreneur or manager who is struggling to raise new funds for his/her business. Eight recommendations are provided.
While the issues addressed in this article apply primarily to those who seek funding, the recommendations also apply to creditors, but in a reversed way. Fund providers can make use of this note – simply change the arguments 180 degrees!
Eight recommendations to raising capital during a crisis:
Your profile as CEO (entrepreneur or leader of a business). As the head a business, it is imperative that you demonstrate successes and a relevant track record. There is nothing wrong with past failures as long as failure is not a pattern and can be explained as honest mistakes or cases of bad luck, rather than instances of severe misjudgment or unethical, sometimes even fraudulent, actions. When seeking out funding, good reputation is fundamental! Beyond this, the promoter needs to demonstrate that he/she:
Can sell, i.e. generate income
Can relate to customers
Controls the cost side, a moderate “burn rate”
Negotiates with banks, creditors, suppliers and owners
Is decisive and can move fast!
Navigates the environment
Knows how to “manage the message” during uncertainty
What is fundable? It is key that funding is being sought out for a fairly big and disruptive idea – an idea that attempts to solve an important problem. Yet, some traction is essential: it is always easier to fund a running business, with real customers and revenue, rather than a “good idea”. It is important to demonstrate that he/she understands the competition (“is there a window of opportunity?”) and is clear about how to effectively protect oneself against competitors’ moves. Keep in mind that in times of uncertainty, there is a compression on valuation. Timing your fundraising is critical, and it may make sense to wait a while instead to avoid a discount on valuation.
**Strong relationship with investors. **It is all about trust. The CEO should have a network of investors who know him/her and there is a relationship of trust. Consequently, it is always better to rely on a group of co-investors, as opposed to merely one. An honest, realistic outlook on possible additional future rounds of investing is key. There is perhaps nothing that can strain a relationship with investors more than lack of clarity on this matter.
**What are realistic sources of funding? **It is perhaps unrealistic to rely on the banking sector. In an emerging crisis, banks are focused on having enough funds to serve existing engagements that might go “sour”. There are, however, some alternative sources of raising funds. Still, the CEO must remember that “cash is king”, and that the financing conditions are likely to be tough. Some alternative financing sources are:
Venture funds, with spare cash
Individual investors, who might have spare cash
Corporations, with “venture divisions” with cash resources not yet committed
Special networks both on- and off-line
Solid investment platforms which are already used for virtual deal postings. They have diverse investor audiences, are well organized and can present more breadth and depth in terms of funding sources
What not to do. Here are four factors which might trigger negative sentiment among investors, and should therefore be avoided:
Coming up with an overly optimistic, unrealistic valuation can be “a kiss of death”. Similarly, dangerous is a move for an IPO when valuation (and stock price) is low. In such cases, old investors can get “wiped out” - and they typically do not like that! This leads to mistrust among investors who otherwise might have planned to continue investing!
Lack of cash flow is devastating. One can have “free” sales demonstrations to customers but failure to convert them into a stable cash flow is deadly.
Never try to promote a “good idea”. Rather, pitch investors with a full-fledged business concept. Attempts to raise funds too early are often based on unrealistic company valuations and may become deadly to the business.
Show “respect” to investors that come in with new capital. It might be tempting to “respect” new investors, since they are committing funds from their savings. However, the most effective way to show “respect” is to demonstrate a low burn rate. Disrespect is manifested by a new company when it attempts to grow too fast, sometimes entering new markets and introducing unrelated products.
**Modify your strategy. **Many CEOs and entrepreneurs find changing their strategy difficult, but prospective investors may “insist” on it! A modified strategy must show a clear path towards profitability. It must be focused and action orientated. At the same time, the plan should highlight how the firm is positioned to take advantage of future opportunities. A prospective investor will typically pay close attention to future upside potential. When navigating strategy, flexibility and open-mindedness are crucial. Do not get stuck or be rigid in strategy formulation. Crisis times bring constant change. No day is like the one before it. Strategies have to become more fluid. Accept this. It is also important for the fund seeker to show a deep understanding of his/her SWOT analysis, even more so than in “normal times”. One must be ready to extend the startup runway and go the distance.
**Greed. **Founders, entrepreneurs and CEOs of startups may at times be too “greedy”. They may get so optimistic that a sense of reality can escape them! It is hard for a founder to acknowledge that his/her project (and dream) has little to no value. There are many examples of entrepreneurs failing to capture value, due to unrealistic expectations and excessive greed. One such example is a well-publicized case of Norwegian Airlines who decided to reject an offer to be taken over by British Airways. The largest shareholder, a Norwegian national, decided to hold out. Today the company is on the brink of bankruptcy – the value is gone! In my firm S. Ugelstad Invest’s practice, I have encountered several cases of similar behavior. For instance, one CEO of a German energy company, to avoid dilution, decided to go for only a small amount of new cash, at a relatively high valuation. As a result, the firm soon ran out of cash. The CEO lost all of his investment! Another example is that of a book distribution company which decided to put an equity offer from a well-established media business, in order to try to negotiate a better deal with that firm’s competitor. In the end, neither deal materialized. The founders lost all by being too greedy. The start-up was essentially close to being bankrupt.
**What is entirely new? **Let me point out two realities that are currently emerging for startups, entrepreneurs and CEOs. One is entirely new, and the other is an old phenomenon in new clothes.
In the current crisis, caused by the coronavirus pandemic, we see the emergence of virtual road shows, whereby a project is presented to potential investors via interactive virtual means. We will likely see more of this after the crisis, as the format is proving to be highly cost effective! Additionally, many pitches, after digital pitch deck distribution, are followed up by online information meetings.
Convertible loans. As we know, a convertible loan represents a way for the entrepreneur of CEO to win more time. If the loan term is short or the deadline for repayment is close, then it is likely that the start-up will not be able to repay the loan. The risk is high for the existing owners to be “wiped out”. This includes the CEO/entrepreneur as well, since his/her share might be “wiped out” too. It goes without saying that a CEO must negotiate as long a payback period as possible. After all, he/she is more likely to be able to pay back the loan later!
Conclusions
It has been shown that while securing additional financing during a crisis is difficult, it is not impossible. There is no need to hibernate either. Realism is however necessary. Only then can the CEO of a start-up avoid becoming part of “the blood that runs in the streets”! Maintaining calmness is important. Finally, one must use good support mechanisms to help present the best case possible. A skilled, wise mentor, guide, colleague or family member can provide the needed extra boost. Investors are still looking to fund great businesses and back strong founders, so get ready to “fight the fight”!
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