CFO Studio Magazine, 4th Quarter 2012
By Andrew Savadelis, CFO of Lumenergi

STEPS FOR SUCCESS IN FUNDING THE RESTRUCTURING OF A COMPANY

When looking to fund the turnaround of a company, there are numerous types of inves­tors to consider. These include commercial banks, venture banks, private equity (PE), mezzanine players, venture capital (VC), venture debt, angel investors, and more. While many of these purport to play in a variety of spaces, the reality is that they rarely venture (pardon the pun) far beyond their comfort zone or base invest­ment profile.

In the case of small- to mid-sized compa­nies that are turnaround candidates, the party is very quickly whittled down to the private equity and venture players. From there, it depends upon the size and stage of the company. If the organization is generating revenue, then the full gamut of the PE to VC community is available to court.

If the company is sans revenue, but has other attributes, such as strong technology, and is at an early revenue stage, then the PE players tend to drop off and the primary pitch is to the venture capital and possibly the venture debt community.

But in all cases, the investors are making an “educated bet” in three primary areas:

• Management/team capability and experience
• Markets
• Product or service differentiation

In my experience, the investors overwhelm­ingly are making their investment decisions on the perceived ability of management. After they vet the markets and products, the question is whether the investors believe management has the industry and operating experience to execute the turnaround plan and deliver results within the time-frame expected.

Further, potential investors want to know whether the management team has the capability to think on its feet and react to issues and concerns that inevitably arise in any company, let alone under the added pressures of a turnaround situation.

So what does it take to convince inves­tors to put up new money in a company? A well-vetted plan with financial projections that takes into account the current cash burn along with the expected cash burn. This must also include how the team is going to re-market or position the company, plus what an exit strategy and related timing would look like.

It requires that all of the management team be well-versed in the plan, cohesive in their agreement on the plan, and able to deliver the plan to investors, albeit from their respec­tive roles within the company. During the fund-raising process, the management team needs to appreciate the fact that they are always “on.”

A Personal Experience

In one situation, we had two major investors lined up and in the final due diligence phase. Then, during a dinner meet­ing, the senior scientist spent an hour in a side discussion telling one of the partners of the investing group how dif­ficult it was to do our process and keep things straight.

That consortium of inves­tors literally fell apart the next day, and it took another three months to find another investor to close the deal. When asked, “What were you thinking?” the scientist responded, “I did not realize dinner was part of the business meeting [scheduled for the next morning].”

I almost asked, “Are you kidding?”

The net of this experience is that you must be prepared for anything. Often non-financial types do not understand the process or the mindset of the investment community.

The team also needs to understand that investors, and especially potential new investors, are looking for a reason to not invest and move to the next candidate company on their list. So a key to the company successfully wooing new investors is to have some success in implementing its plan, i.e., doing what you said you were going to do, and within a relatively reasonable time-frame.

While this has always been a key factor in attracting new investors in a turnaround, in today’s financial markets where many venture capital firms are keeping their powder dry for current portfolio companies, it shows that a viable plan has become of even more importance.

In my current company, our new manage­ment team came on board in March and we immediately implemented a plan to re-brand and reposition the organization in the market, as well as rebuild the sales force and agency network that the company needed in order to realize any level of sales.

The normal sales cycle in our industry is a minimum of nine months, with more than 12 months common, so we put a financial plan together that allowed us to prove the concept of the company and establish a credible sales fun­nel. This provided the cred­ibility to market and allowed us to sell the company to new venture capital and venture debt investors.

As we have progressed over the last six months, we have in fact built the sales funnel as projected, run the operations tightly but not oppressively, and have attracted significant interest from new investors. It is also critical that the current investor group back the company as well; however, in many cases, the current investors often need new investors to come in as a way to solidify and prove within their own partnerships that con­tinued investment is a worthwhile endeavor.

Private Versus Public

Much of this advice is oriented toward a private company. Public companies in the turnaround mode have a somewhat easier time of attracting potential investors, primarily because they have a readymade exit strategy. In the private world, the lack of a readily available market means that the inves­tor may have to hold the investment much longer than planned.

In a public company, although the report­ing and disclosure issues are much more stringent, the ability to exit their investment at almost any time creates the perception that the investment is more liquid and hence somewhat less risky.

Once one or more investors have decided to invest in the company, a key issue involves the valuation, or price the investor will pay.

If the company is public, the valuation question is relatively straightforward and revolves around the level of discount from market that the management team and board are willing to accept and comfortable with, and will normally range from 5 to 10 percent, although deeper discounts are not unusual.

If the company is private, the pricing will depend upon numerous issues. Although existing shareholders would prefer an “up” round (increase in share price and valuation), if the company is in the first stage of a turn­around, a “down” round and recapitalization of the company is not unusual.

It is also one of the few times that a new management team coming on board has leverage over the amount of ownership they can negotiate. In a recapitalization, the pricing is usually highly negotiated. If the company is already in a positive phase of a turnaround, the pricing will usually be an up round, but how much will depend upon how far along and successful the turnaround plan is, and how badly new money is needed to keep the company moving along.

Regardless of whether the company is public or private, tech or non-tech, big or small, profitable or not, the one thing to always remember: The deal is not done until the money is in the bank.

Until then, anything — and I mean any­thing — can kill the deal.

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