Q&A: Capital raising involves three key factors
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?
An entrepreneur from Woolloomooloo, New South Wales asks:
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.