In an ideal universe, companies grow and achieve vital corporate initiatives through ever-increasing cash flow. But the reality for most franchisors, public or private, is that expansions and capital expenditures require an infusion of cash.
Whether the goal is to take over a competitor, build or purchase new facilities, launch a new product, or expand into a new territory, there are only two ways (beyond franchise fees and royalties, of course) to obtain money: take on debt or sell equity.
In deciding which option to choose, important variables include the reason funds are needed, the company's current circumstances, and its style of ownership and management. Accordingly, careful consideration, strategic thinking, thorough planning, and sound decision-making are essential when it comes to financial expansion ventures.
One size does not fit all
Aside from a multitude of microeconomic considerations specific to each enterprise, a constellation of macroeconomic factors enters into the decision-making process. How well is the economy faring? Is the business's industry sector growing? What are the potential direct and indirect impacts of monetary policy?
Sometimes it's easy to get lost in the nebula of marketplace variables and financial complexities and lose sight of some very basic elements that need to be in place before one can go out and raise cash. Here are a few common-sense guidelines that may sound obvious, but are quite frequently overlooked.
Create a comprehensive document that demonstrates how the initiative that requires funding is aligned with the company's overall strategic plan. How exactly will the money be used, and which strategic objective will it help to meet? This document serves three purposes. One, it shows investors, venture capitalists, and lenders that the company has done its homework and has thoroughly researched its growth potential, industry, and competition. Two, the plan will be the primary tool and map for orderly growth. Three, relating the current short-term objective to long-term strategy may show which type of financing is optimal in the long run
Establish precisely how much money is needed to accomplish the endeavor. Any attempt to raise a more or less arbitrary amount will always end in failure. First, it's a sign of poor planning and will lead either to a shortfall or to poor execution. Two, if management has not properly gauged what it needs, how can it articulately convey its requirements and objectives in discussions with investors or lenders? Three, the exact amount of money needed may be the deciding factor in choosing one type of financing over another.
Determine which type of financing works best: debt or sale of equity. If quick growth is necessary, raising money through the sale of stock may provide the best opportunity for fast action. However, wider equity participation implies a dilution of ownership, which may not be acceptable to some business owners. On the other hand, debt successfully serviced means being able to postpone the sale of equity until a succeeding stage of growth, when the business has become much healthier. At that time, a sale of equity means less dilution of ownership.
Provide accurate, timely, and complete information to investors, including an honest expectation of return on investment. Remember, timing is everything for investors. Their strategy is to make a large return by being the first in on a new venture. For this purpose, they want reliable, timely information so they can act before the crowds move in. But they also need to be sure they are not proceeding on false performance claims, or investing in a company involved in financing practices that may be dilutive to ownership.
Never proceed with the planned venture until the full amount of necessary capital is in the bank. Becoming undercapitalized is a common and dangerous mistake. Many companies procure a portion of the capital needed and then rush into implementation in the hopes of raising the remainder along the way. In almost every case, the economy works against them, and the shortfall turns the entire project into an unrecoverable investment.
Never raise more money than needed to meet the objective. Selling more equity than necessary serves only to dilute the ownership position at a lower valuation. And in the case of debt, why pay interest on unneeded funds? As tempting as it may seem, don't take all the cookies at once. It's much smarter to raise just the right amount of money, accomplish the objective, grow, and improve the company's capitalization. By the time capital is needed again, perhaps a few years later, the business will have grown. Then it can raise additional capital through sale of equity with less dilution, or take on debt at a lower interest cost.
Getting the stars to align
The IBMs and Microsofts of the world didn't reach astronomical size with a big bang. They made the stars line up for them by adopting sound growth principles right from the start. Those principles are neither complex nor mysterious. They boil down to simple good business practices revolving around an intelligently crafted plan and a series of smart financial decisions that align each expansion phase in the direction of the long-term strategic goal.
Jeff Stone is managing director of Crescent Fund, a Wall Street private equity consulting and promotional firm that provides corporate capitalization and investor relations consulting services. Crescent Fund manages a private equity fund and invests in private equity investments. Visit www.crescentfund.com.
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