Raising Capital

Q&A: Capital raising involves three key factors

An entrepreneur from Woolloomooloo, New South Wales asks:

I own 100% of a $1.8 million EBITDA company. Investors have made unsolicited offers to buy a minority stake so I can expand. I am torn. The investors imagine a larger operation and I like the thought of the possible rewards. Conversely, my company produces its own cash, with reserves for a modest expansion. I could expand without them but more slowly. Which way should I go?


Kenelm Tonkin,
Chairman, Tonkin Corporation answers:

Congratulations! Most businesses never reach this point. This is the ‘big piece of a small pie’ versus ‘small piece of a big pie’ choice. Do you grow slowly by yourself or accelerate the process with investor funds?

Consider three factors: reward, urgency and independence.

With reward, imagine two competing pie charts showing anticipated profit for the next year. The first represents the status quo, is solid blue to indicate your 100% holding and is of a size to indicate a $1.8 million EBITDA business. The second is split blue and red to represent the new ownership structure and is bigger to indicate a larger EBITDA. In the blue slice of each chart, there is a label specifying your dollar share of the annual profit. So, the status quo chart says $1.8 million. The figure in the second chart depends on two levers: (1) your percentage holding after you have diluted yourself, and (2) the anticipated EBITDA of the expanded company. So, if you retained 75%, less than a $2.4 million profit from the higher-capacity leaves you worse-off, and more, better-off. At a dilution to 50%, you need an EBITDA of at least $3.8 million to be no worse-off. Of course, your percentage emerges before signing a shareholder’s agreement and depends on your negotiation skill. Correctly anticipating future profit is always a black art.

Urgency may drive your decision. First-mover advantage or market imperatives may dictate acceleration and perhaps annual retained earnings of $1.8 million are insufficient for expansion. Serial entrepreneurs successful with the ‘expand and sell’ process may see the advantages of urgency. Perhaps the personal financial needs of the business owner become relevant in the urgency applied.

The need for independence may well feature in your decision. Accepting investors affects entrepreneurial control in real ways through 'matters requiring consent' provisions from mandatory dividends to capital expenditure, from exit mechanisms to CEO remuneration.

The ‘grow slowly by yourself’ option is for the fiercely independent and patient entrepreneur who can accept lower rewards. The ‘accelerate with investors’ option is for those in a hurry to exit for the higher rewards and who are more comfortable letting go. Before you decide, examine your own predispositions carefully. Once you start accepting investors, the process of reversal is difficult.

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