Raising Capital for an Under-Performing Business
When starting a new business, you must have done your homework: how to take care of the logistics, the smaller details such as compliance documentation, and even the ways on how you can raise capital that you need to augment the available money. You must have looked into every possible avenue to raise the exact amount of capital you need to get your business off the ground and start earning money.
That may have been easy. But what if, in the course of your business, you realize that you are having a harder time than usual to get back the amount of capital you initially invested? What if your business was declared to be underperforming? The most logical answer and solution that you may hear would be to inject more capital into it so that you can effect changes and innovations to try and turn things around.
It’s a sound suggestion, and even your business advisors will most likely agree. However, there is that small problem of how to go about raising capital, especially considering the fact that the business is not doing as well as expected.
This guide will 1) show you the reality underperforming businesses have to face, 2) what to do before raising capital, and 3) how under-performing business can raise capital.
THE REALITY OF UNDERPERFORMING BUSINESSES
A business is considered to be underperforming if its potential just does not align with reality. In simpler terms, an underperforming business is one that is on its way to failing. If left unchecked, it might end up wrapping up its operations and declaring bankruptcy.
When asked, underperforming businesses may come up with a lot of reasons on why they are failing. According to author Ian Altman, the top 3 excuses of companies for their lower-than-expected performance are:
- Their business is different, hence, general business concepts don’t apply to them. This perception comes with the risk of being unyielding or closed to new ideas and concepts. They stick to what they think is best, without entertaining other possibilities that could improve business performance.
- They are used to a certain way of doing business, and they do not think they can try another tack. This is another excuse for being close-minded in business. Business concepts are constantly evolving, and refusal to evolve along with it means you will be left behind, including the performance of your business.
- They do not have enough resources, such as time, manpower and money. This is the most common excuse given by businesses that are not performing as expected. They blame it on lack of this or that. Money is a usual issue, and they often say, “if only we had more cash or capital, then we would be able to improve operations and increase the performance of the company”.
We will not go in detail when it comes to the reasons for the poor performance of companies, but we will address that last excuse: lack of capital. If only they had more capital, they’ll definitely be able to turn the failing company around.
Now here’s the catch: not a lot of investors or financial institutions are willing to invest in a company that appears to be failing. Lenders on the other hand will also be very hesitant to work with such companies. They are most likely to think that it is a poor investment, one that won’t give them a return on investment.
Large and established companies may have an easier time, but the small to medium-sized businesses are often struggling when it comes to raising capital. It is common to find that when they were just starting out and looking to raise capital, they may have already had a hard time attracting investors and capital providers to fund them. It is bound to be even tougher to convince existing or new investors to pump more money in a small company that is showing signs of struggle in performance. It’s certainly not going to be easy.
BEFORE ACTIVELY RAISING CAPITAL
It may have pained you, but it is time to face facts. The numbers don’t lie, and you have to accept the reality that your business is underperforming, and if nothing is done, it may be on its way to failure. Do you immediately decide that you need more capital, and proceed straight to employing capital-raising techniques? You have to stop for a while and check a few things first to ensure that you don’t find yourself in the same situation you are in.
Before spending any more money on the business, assessment of the current state of affairs in the business is crucial.
Determine the cause of cash and capital shortage
More often than not, a sure sign that a business is in trouble is a cash crisis. It may suddenly find itself having trouble paying its employees’ salaries and wages, or even fund the working capital of the company. Try to identify why you are experiencing this shortage, in order for you to evaluate whether the cause is something that you can have a solution for.
Assess the viability of business in the future
You have to ascertain whether the company is going to be worth saving. It doesn’t make a whole lot of business sense if you proceed to raise capital in order to save a business that will not really be viable several short months into the future, does it?
Identify other possible solutions
At this point, the most important question you have to address is this: is raising capital the only way for your business to regain its footing and improve its performance? What if there are other methods that you can employ in order to address the problem, without resorting to raising additional capital? Are these methods within reach?
Determine how much capital is needed
Naturally, you should know how much capital you will need in order to turn things around for your underperforming business. You also have to take into account the cost of capital once a potential investor has been found.
Identify the aspects of the business that may appeal to an external investor
You have to anticipate the possibility that you may fail to raise capital on your own, so you have to resort to external sources, which are commonly outside investors. Considering the fact that your business is already underperforming, you have to expect to be asked to defend your position, or provide justifications on why investors should listen to you and give their money to use as capital.
By identifying the commercial angles or benefits that you can use to attract the interest of an investor, you will be better prepared when you have to convince them to trust you with their money.
HOW UNDERPERFORMERS CAN RAISE CAPITAL
If you are determined to turn things around and you think that your underperforming business has a chance of becoming profitable and growing in the future, then you should next look into ways on how you can raise capital.
“Capital-ready” means the state where a business is adequately prepared to raise capital. Preparedness is a good sign that you are ready to take the challenge of improving the performance of the business, if only you will have additional capital to work with.
The Business Strategy Blog suggests the following documentation to be prepared in order to show how capital-ready you are.
- A business plan for the next one to three years, listing down clear strategies that you will undertake to achieve business goals.
- A financial model for the period covered in the business plan. This will show whether the business is viable, or whether it will turn in profits in its future operations. It is also in this model that you will indicate the amount of capital required.
- Updated due diligence business records that will lend your business and your plan credibility in the eyes of potential investors.
- An exit plan for your business, with emphasis on plans on repayment of outside capital sources. Naturally, potential investors and lenders want to cover all their bases, so if you can give them some assurance that they won’t be left high and dry when the business wraps up its operations, then you are increasing your chances of convincing them to trust you.
It may be possible for you to “raise” cash internally. Here, you have to seek self-help opportunities to improve cash position. They may undertake any of the following:
- Aggressive management of working capital. “Working capital” refers to the capital that the business utilizes in its day-to-day operations, and is indicative of the company’s efficiency. It is also the figure that represents the short-term financial health (liquidity) of a company. If the business has a positive working capital, operations can be sustained so the extra capital needed is for growth. In accounting records, working capital considers the current assets and current liabilities of the company, encompassing items such as cash, accounts receivables, inventory, accounts payable and current debts or obligations due. Out of the several strategies of managing working capital, the best approach would be the aggressive one if you are looking to raise capital internally. Aggressive working capital management means that you will focus on profitability. Therefore, you will depend greatly on trade credit and short-term finances, keeping your current assets (cash, accounts receivables and inventory) low, or at just-enough levels. Needless to say, this is a very high-risk strategy. However, as long as you ensure the smoothness of the operating cycle, then it can help you raise the capital that you need for your underperforming business.
- Reduction of operating costs. Look at your current operations. Are there areas where you can employ cost-cutting measures, so you can use the savings for other purposes instead? This calls for a study of your business processes and the costs incurred at every turn. Evaluate whether you are spending too much on a process, and identify the areas that you can stop or downgrade. An organizational audit may reveal that some employees on your payroll have redundant job descriptions. You may consider reassigning tasks to employees or dropping some items from the payroll. If your assessment reveals that you can save money by shortening your production process without compromising quality of your final products, you may decide to do so after realizing how much savings you can get out of it.
- Sell or divest idle assets. Take a look at your current inventory of fixed assets. There may be some assets that are underutilized or completely idle, and you may even be incurring maintenance costs on them. In short, you are spending money on them, but you’re not gaining any benefit from them. Consider selling these assets and add the proceeds to your capital.
- Sell or divest underperforming business segments or divisions. If your business is comprised of several business segments, identify those that are not performing well, or even incurring losses for your business. Conducting further study is advised, so you can decide on whether to close some segments or not.
- Debt restructuring. This is a popular solution for companies that are facing cash flow problems. It involves renegotiating the terms of existing debts that are already considered to be delinquent. There are several reasons for debt restructuring, and one of them is to raise capital.
Through debt restructuring, an underperforming business can avoid defaulting on an existing debt or obligation. They may also negotiate for lower interest rates, which translates to savings and a way to manage working capital more aggressively. You may also negotiate that your existing creditors or lenders will not have a share in your profits, as long as you meet your loan payments as they fall due.
Look to external sources of capital
If after looking in your own company for ways to raise capital and you still don’t have the amount that you seek, it is time to look outside of the company.
Good news: there are actually people who make a living from investing in underperforming business. Your job is to find them and convince them to invest in your business.
These types of investors are actively looking for underperformers, or businesses that incur more losses than gains, and evaluate their potential for a turnaround. Usually, they will buy out the founder or owner of the business, and send in their own people. Or they could hire a turnaround professional. In some cases, the investor will not send his own people, but choose to back the current management team of the company instead.
What do you do when you find these potential sources of capital? Keep in mind that the hardest part is to convince them to back your idea of turning your business around. This will ensure that you still have control over your business. Here’s what to do with these external sources of capital.
- Know who your potential investors are. Carry out a small some research on their expectations from you and your business. This is especially if you do not have a prior business relationship with them. Knowing their expectations will enable you to prepare your proposal in such a way that will easily convince them to invest in your business.
- When you are seeking external sources of capital, you have to position your business for capital-raising. Make sure that you are ready to receive the capital and take your business back to where it belongs. Know exactly what you will do with the money once it hits your bank account.
- Highlight the benefits to your potential investors. What is in it for them if they invest in your business? What can they expect to get if they invest on your business, despite the fact that it is underperforming? Investors expect a return on their investment, so it would be a good idea to highlight that part for them.
- Let them know how their money will be used. The investors will obviously want to know where their money will go, because they, too, want to ascertain whether they are making a good investment or not. You’d want to be specific on the activities you will carry out, so give them details of your action plan, not just the general idea mapped out on your business plan.
- Be honest. Investors are shrewd. They can easily tell right away whether you are being up front with them. Avoid sugarcoating. Tell them exactly what you need the additional capital for, and provide concrete backup for your claims.
- Do not be greedy. Ask only what you need. You have a plan in mind, you need money for it. Therefore, you should stick to that plan, including the costs you expect to incur in its execution. Asking for more will only give your business a bad impression (as if the fact that it is already performing below par is not already basis for a bad impression in the eyes of potential investors) so do not aggravate it.
Engage the help of an external advisor who is an expert in turnaround management
This is actually a good idea, especially if you already have your hands full trying to contain the crisis within the business. At times, you have to admit that you need help, and a turnaround professional can give you helpful input on how you can raise capital.
Underperforming businesses have a long and tough road ahead of them, and one of the biggest obstacles is raising capital. Expect to put a lot of work into raising capital, especially if you intend to obtain them from external sources. Do not expect to have an easy time of it, but do not lose heart, because it can still be done.
Welcome to the 22nd episode of our podcast with John Lee Dumas from EOFire! You can download the …
In Palo Alto, we meet co-founder and CEO of Totango, Guy Nirpaz. He shares his story how he …
"I believe that if you show people the problems and you show them to solutions they will be moved to …