Small Business Owners And Financial Viability of New Investments

Question: How can small business owners assess the financial viability of a major investment in their business?

Answer: For financing any investment in their business, the management must understand why any such investment is needed.

The financing may be needed either to expand organically through new markets, machinery, technology or physical assets which would be classified as Capital Expenditure, or else grow from operations and meeting Working Capital needs that would be classified as Operating Expenditure.

– OpEx that business may absorb can be best serviced by a bank as the standard and relatively less rigorous terms of the bank will ensure that debt falls cheaper than equity.

– CapEx on the other hand implies substantial investments that could only be met by the interests of equity investors who would however demand the assurance that their invested equity would grow to their expected value.

The financial viability of such equity financing would be met only if the time-frame of returns from the business matches those of the returns expected by investors. This would determine the interest of investors in injecting capital into the business that could achieve the high-returns that they are seeking in the given period.

In addiiton, the mode of financing must also be transparent and it must be lucidly laid-out and planned, whether the investor is looking for dividends or a buyout on his stake to achieve his expected returns.

Question on Venture Capital Funding

Question: I often hear that entrepreneurs are worried about VC involvement. Does a Venture Capitalist necessarily threaten the business owner’s interests and position?

Answer: It is probably inherent in human behavior that many business owners prefer to run their business with their personal capital and avoid any external involvement. There would, of course, be those who are strongly motivated by their ideas but lack the needed corpus of funds due to which they venture out for external financing.

When approaching VCs, one may get discomforted by the kind of questions put up but that is the case only since they are direct and wish to probe if the business can deliver the returns projected, as well as check the commitment of founders/management.

Entrepreneurs looking for funding should feel intimidated by VCs if they trust the business potential of their ideas. Alternatively, they can turn to pooling in capital from personal sources and grow their business gradually from the relatively small capital employed if they wish to avoid VCs.

Venture capitalist involvement does not imply that it would be conflicting to the business owner’s interests and clarity of goals and terms of the business can act as a safeguard. Any possible friction/misunderstanding can be prevented by keeping all terms written and well-documented while dealing with VCs.

Question on Venture Funding and Investments

Question: What are the hidden areas and factors that a small business-owner needs to watch out from while reaching out to investors and financiers? How can I protect my interests from highly aggressive investors willing to provide me financial support?

Answer: The basic mandate that a small business seeking investments should set for itself, is to have a detailed business plan substantiated with quantifiable data. The depth may not necessarily be gauged by the number of pages of the plan but the clarity of vision, resources and expectations.

The entrepreneur must maintain clear list of “haves” and “have-nots” to ensure that one is clear on what to expect from an investor. He must have a clear perception of whether he is looking only for capital or business expertise as well from the investor.

In addition, all key business functions must be well described: team members and backgrounds, sales & marketing plans, financial projections.

Foresight must also be employed to identify the problem areas like cash-negative positions that may arise in the business and there are a number of precedents when such unforeseen situations led to the failure of a business plan.

The entrepreneur must not feel threatened in projecting one’s strong business capabilities such as IT, automation or manufacturing process to investors. Intellectual property can be shared after non-disclosure agreements (NDA).

Be ready to face skeptical financiers in banks or lenders who don’t have expertise in your business area.

Please understand that only about 1 in 100 business plans gets funding. So there are many business plans that are not upto the mark. VCs have to be conservative because they are the guardian of investor funds and have to protect their downside risks.

The way to go in protecting one’s interest with investors would be to maintain transparency in milestones and expectations from the business. This should be further enforced by keeping the terms and facts of the agreement documented as far as possible.

Fund Raising: Requirements for IPO or Private Placement

Some of the most common questions we are receiving is how to get investors for a start-up or an early stage venture. Here is one recent question we received:

“Is there a minimum size in revenues or profitability for a company to access the public markets through IPO? Can private placements also raise similar level of funds in the Indian market today? Any notes or guidance here will be appreciated.”

Here’s a brief answer by Vivek Lodha, Director- Investment Banking of HEM Group. He is also a member of 7Avenues.

A company can access IPO market with a minimum track record of profitability in 3 out of past 5 years. In case, company is not 3 years old, it can still go for an IPO but with other terms and conditions satisfying given in SEBI guidelines. As of private placements, this is an alternative and quicker route to raising money, and then eventually leading to an IPO as the investor would also need an exit route. But, one must always remember that going for a Private Placement would be at a 20-25% discounted price to what you are planning for IPO. A lot of Private Equity firms buy stake in companies and then exit after IPOs.

You can also refer to this Public Issue FAQ, and the website of Hem Financial Services Limited (HFSL) for anyone interested to learn more about doing IPOs or Private Placements in India.

Interested people can contact Vivek directly with any doubts
and queries by email to: vivek @ hemonline.com

He has the expertise to advise you on the following topics:

• Managing the IPO as Lead Manager
• Underwriting
• Syndicating IPOs and FPOs
• Project counseling and advisory assistance
• Private Equity Placements

Start-up Problem: Less Capital & Broken Plans -What to do?

I joined a start-up 4 months back as its CEO, after discussing the business plans and growth objectives with the promoter/investor. The company is based in India, and the promoter/investor had intended to set up a branch in the USA around this time, and we had jointly prepared business plan, sales and financial estimates, and it was approved when the company was started 4 months ago.

Then problems came-up: insufficient funding given by the promoter/investor for the approved business plan, which meant I could not recruit the right people, and the overall technical capability is much less than what is required to go the US/Europe. We are facing serious problems, and obviously the business numbers are not being met. At the same time, my promoter/investor has decided to give 15% stock of the company instead of cash salary that was agreed at the time of my joining.

So today, after 4 months of full time work here, I have not got a single rupee/dollar. Can you please advise me? Thanks. Best Regards, A Kumar

Kumar, this is a difficult situation for you, and this is not uncommon in start-ups, to switch compensation between cash and stock, depending on how things are happening. In your case, it does look like your promoter/investor is not fully committed to this business yet (assuming he is not facing genuine capital shortage).

Please have a direct conversation with him, and tell him you want to make the company successful, but the current state of affairs is bad, and there are two options only:
(a) X amount of funds need to be made available to the company within next Y days, of which you will a modest Z rupees/dollars as your salary and allocate the remaining into the business. Or (b) You will be forced to leave because of promises that have not been kept.

Do not postpone this important conversation…the sooner the better.

I hope it helped, and feel free to reply on this post if you want further help.
Best Wishes/ Shankar