To accept funding or not? The tipping point for taking outside investment
There are thousands of decisions to make when running a business – from branding
to accounting and everything in-between, each choice can impact your
bottom line. And while many of these decisions can be made with simple
intuition and common sense, others require serious thought and even some
sleepless nights.
During my decade-long tenure at Volusion, Inc.,
one of the more complex decisions I’ve encountered was judging when to
accept outside investment. Fortunately, the company stands in the
favorable position of rapid growth and profitability, meaning interested
investors are proactively contacting us to talk.
Finally, after years of politely saying “no” to numerous parties, we
hit a turning point as an organization when we decided to move into the
enterprise space with our new platform, Mozu.
With ambitious goals ahead of us, we had reached the tipping point
where we could no longer go it alone – the time had come to look for
outside funding.
From this experience, I’ve gained important insights to guide the
process: when is the time to take outside funding, and what’s the best
way to go about it?
When is the right time to explore outside funding?
For many business owners and management teams, “now” can easily seem
like the right time to secure funding, and why not? It’s a validating
opportunity that can take your business to new heights.
An important notion to keep in mind, however, is that good things come to those who wait. There’s something to be said for delayed gratification, so don’t feel compelled to accept the first (or second or third) offer that comes your way.
Instead, honestly analyze the company’s business plan and finances to
determine whether the business needs to secure outside funding in order
to achieve its objectives, and if so, how much. Remember, a company
will relinquish some control and a share of the economic upside once it
accepts outside funding.
Of course, it would be ideal to retain the autonomy as long as possible to establish you and your management teams’ business vision, but some businesses absolutely require outside capital in order to scale.
But, for many businesses, including ours, there does come a tipping
point when it’s advantageous to accept outside funding. Although we were
able to self-fund for over a decade, we knew it necessary to augment
our business with additional capital to launch our new platform.
This process included several rounds of financial forecasting to
understand the cost of achieving where we wanted the business and brand
to be, and whether we could pay for that cost ourselves.
What are the main considerations when exploring third-party investments?
Once we made the decision to explore outside funding, the rush of
details arrived. In order to maximize your company’s leverage, it’s
important to create a process that will result in multiple offers.
Again, we were in the fortunate position to have several offers on
the table, but even if we only had one or two, there are several
components of funding arrangements that need to be sorted out, from a
standpoint of both logistics and intuition.
Here are four main questions to keep in mind during the vetting process:
1. Should we finance with debt or equity?
This is the ultimate question to consider when weighing funding
options. For us, because we chose to finance with debt, we gave up
almost no equity in the company, and therefore almost no dilution of
stock options.
Of course, debt financing requires scheduled repayments, plus interest, so you must be able to repay out of future cash flows.
If you choose to issue stock, valuation and the amount you’re raising determines how much equity the investors will receive, and you will give up, for their investment.
Investors might ask for 20 to 30 percent of your company, and perhaps
even an 8 to 10 percent dividend on top of that. This will have a
significant impact on the amount business owners could realize on the
sale or other liquidity event for the company.
2. How much control are you willing to sacrifice?
In addition, beyond financial control, many investors will require
some input into the operation of your business and even the right to
approve certain significant transactions and events.
In particular, some investors may insist on the right to block future
investments in, or the sale of, your company. They may also require you
to provide detailed reports and explanations before and after making
decisions to drive your business forward.
This can be a drain on your time and prevent you from acting quickly on market opportunities.
3. Is this someone you really want to partner with?
Just like a friendship or marriage, it’s important for business
partners to mutually understand and appreciate each other. I remember
spending hours trying to explain how our business operates to one
investor, an instant red flag that it wasn’t the right fit.
Furthermore, you want to determine whether this partner will support
you during periods of growing pains, or if they’re just there to reap
the benefits of your work.
In other words, will they step in and help you achieve what their
money is intended to achieve, or just sit back and go along for the
ride?
4. What are the full, exact terms of the agreement?
I cannot stress enough the importance of fully understanding the
terms of an investment agreement from top to bottom. Even when the
details seem straightforward, there are often multiple contingencies and
addendums that must be fully investigated and understood.
For example, in many agreements, specific performance milestones must be achieved to keep your funding as initially offered.
Because of the complexity of these transactions, and their impact on
your business going forward, you should find assistance from experienced
professionals to help you understand the intricacies of the details. In
our case, in addition to our inside council, we also hired an expert to
help us get the best deal and protect our interests.>>>
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