How to Finance a Turnaround


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


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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Raising Money as a New Company


CFO Studio Magazine, 4th Quarter 2012
By Bert Marchio, CFO of Edge Therapeutics

If you face the challenge of raising money for an established company, you can gener­ally rely on your firm’s numbers to make your case.

For example, an investment-grade com­pany can use its earnings and credit ratings to prove its worth. A company with a non-in­vestment-grade credit rating or no rating can focus on its EBITDA multiple or assets such as accounts receivable, inventory, real estate, and intellectual property.

But if you’re working with a company that’s just starting out, one that hasn’t gener­ated any revenue yet and has no tangible assets to borrow against, it would seem that your options are significantly limited. In such a situation, how do you raise money?

Start by Selling Yourself

If you don’t have trailing EBITDA or assets to offer, you will initially be selling your management team and your vision.

Who’s likely to buy your story? Your best candidates are:

  • You and the other members of your management team.
  • The people most likely to believe in you: your family and closest friends.

So get ready to use a home-equity line, dig into your savings, and buttonhole your rich uncle or father-in-law as soon as you can.

Your Next Steps

As your company grows, you’ll need to find new sources of funding to fuel that expan­sion. Possibilities include:

  • Angel investors
  • Government or foundation grants
  • Venture capital firms
  • Hedge funds
  • Private-equity investors
  • Strategic investors

You’ll need more sophisticated tools to convince these sources to invest: an elevator pitch, a mission statement, and a very refined PowerPoint presentation summarizing your company’s unique features.

Your ability to sell your vision and your management team will be critical to your success. Just as important will be your ability to show your investors how they will benefit from your success. Understand that financial return may not be the only consideration for every investor. If you have a potential investor who lost a child to a fatal disease, the fact that your company offers the hope of a cure for that disease might be key. Similarly, a new field treatment for soldiers wounded in combat might help you land a Department of Defense grant.

When courting investors, review things that reduce the investment risk, such as:

  • Your management team’s previous success in similar enterprises.
  • Your team’s focus on minimizing the company’s “burn rate” and spend­ing only to drive value growth while preserving resources (e.g., reducing overhead by operating as a virtual company).
  • Unique technology your company offers; regulatory barriers or other obstacles that will hinder the success of or eliminate competitors.
  • Established market demand for your company’s offerings.
  • Multiple exit opportunities for investors.

Attracting leaders in your industry to your board as key early investors will greatly help you bring others into the fold. These high-profile investors provide a “Good Housekeeping seal of approval” and give others the comfort of knowing that there’s “adult supervision” on your board.

Finding These Investors

Network, network, network, and not just with Financial Executives International (FEI) and the Financial Executives Networking Group (FENG). You’ll need to get out of your FEI and FENG finance-focused comfort zone and get involved with organizations in your industry, government-sponsored groups that support early-stage compa­nies, and other centers of influence (for example, lawyers, accounting firms, consulting firms, etc.) with connections to high-net-worth individuals and investment firms.

Beggars can’t be choosers. Nevertheless, you’ll want to know whether potential investors bring anything to the table besides money. For example, are they opinion leaders? Do they have reputations for being able to identify good investments at an early stage? Do they have great track records?

As your firm and story develop, pre­senting your company at an investment conference or an industry association meeting may help you attract larger investors or strategic partners that may wish to buy into the economic promise of your product. A big pharmaceutical company or a tech giant, for instance, might want to partner with you if you’ve developed something of inter­est in their field.

And don’t neglect to cultivate key vendors who may benefit significantly from your firm’s success. For example, contract research organizations may deeply discount their services in exchange for an equity stake in a pre-revenue company.

Finally, get to know the investment bankers who specialize in your indus­try and focus on early-stage companies. The best ones will understand your vision, present you with good ideas and honest feedback, and help you raise capital. The ones you want to avoid will focus on “doing a deal” regardless of whether it’s in your best long-term interest.

What About Borrowing?

If you’ve successfully raised equity and are not rapidly burning through your investable cash, you now have an asset that banks can lend against. But you will pay to borrow your own funds.

If your firm’s intellectual property has progressed to the point where a secured lender (e.g., hedge fund) may be willing to lend against that asset, carefully consider the terms of the loan: What if Murphy’s Law holds and timetables slip? Generally you’ll find yourself using equity or equity-like products to capitalize a pre-revenue company even though they are more expensive than debt instruments.

That’s how it is when your company is young and has yet to make its mark in the marketplace.

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The Cost of Conducting Business in China


CFO Studio Magazine, 1st Quarter 2012

By Michael P. Eldredge, COO & CFO

THE BIG COMPANIES HAVE DONE IT, so why shouldn’t a smaller U.S. manufacturer take the risk to move or open operations in China to improve profits? The issue isn’t that a company shouldn’t, but rather that it should do its homework before ever committing to the idea. Just because the big boys have established China facilities does not mean a smaller business may enjoy the same economical success.

Let’s consider the fact that China labor costs (and employee benefits) are much cheaper than in the United States. We know this from many sources, but it is certainly documented in many U.S. news forums. A U.S. company with manufacturing operations in China may find labor costs to be inexpensive, but don’t be fooled by this one aspect of cost. In most cases, the employer must also must pay for an employee‘s daily meals and living quarters. Often, the employee‘s housing can be compared to a rented college dorm room that provides a roof overhead for an average of six people, with shared bath facilities.

Real estate isn’t cheap in China. In fact, in many of the most sought-after areas of the country, the cost of renting is not that much different per square foot than in the United States.

Then there are the utilities and what we call “common area maintenance fees.” These costs are in China, too. So, does it still seem that things are significantly cheaper by moving to or setting up operations in China? Let’s continue our analysis.

Naturally, a manufacturing shop needs supervision. Local supervisors’ pay is often cheaper than in the United States, but let’s now consider the cost of placing a U.S. manager at the facility in the role of general manager (an “expat,” or expatriate as they are called). Not only will this U.S. manager demand a

higher salary for the overseas assignment, but the manager will often require a company car and subsidized housing, too. Well, this isn’t cheap…is it? How about the cost of supporting the company’s administration traveling to China to check and keep audits on the facility? How many middlemen are going to be involved just to land your product into your customers’ hands? Everyone is looking for his piece of the income stream. Why build this non-value-added hierarchy?

How does a company protect its business from the well-known China “copy“ industry? If you can make it, they can copy it — and sometimes misrepresent the product with a likeness of your label. Corporate must keep a close eye on this; doing so costs something, including the cost of lost revenue to these unscrupulous entrepreneurs. To protect your investment overseas does not come without a price.

Smaller companies are more likely to be modestly financed. As such, it might not be a good idea to leverage resources in trying to manage an overseas operation. In fact, it might be better to keep manufacturing in the United States. Our country can certainly use the jobs, and why share taxable profits with other countries? Now you ask yourself, “How can this be done?“ I’ll tell you the secret: keep your spending under control, employ a little frugality, encourage your employees to follow this culture and build your business with a mind-set for efficiencies.

While my article isn’t written to discourage smaller companies from seeking out less expensive venues to manufacture, it is written to share my experiences. What you need to do is investigate your opportunities and clearly do your homework. In doing so, become aware of the potential added costs and risks of doing business in China. These might offset your desired savings or worse yet, even cost you more. Build your products here and save, while also strengthening the backbone of U.S. employment, which rests on our small businesses.

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