Nov 132014

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Dr. Earl R. Smith II

In this article I would like to discuss ways to meet the financing needs of a growing company. Let’s start from this point: The CEOs principal contribution to the process is to make sure that the correct financing strategies are in place and well focused.

As CEO, you should make sure that the strategies deployed meet, at minimum, five basic criteria. First, are the financings that are being pursued adequate to the needs of the company? Second, are the right financial instruments being used? Third, are the right sources being approached? Fourth, how does each individual financing strategy fit into the overall capital structure of the company? And fifth, can the company afford the financing … is it really a good idea?

There are a wide range of financing options available to a company. My experience is that the range is often much wider than the focus of most management teams. The question turns on knowing how to finance what and when … and with what financial instrument.

It is the CEOs responsibility to review and approve the strategic plans for developing an efficient financial structure. Here are some suggested rules that might help:

Avoid Equity Financing R&D: I start with this one because it is, by far, the most frequently occurring error. As every MBA will tell you, one of the things they are taught early on is that you don’t fund research by selling equity in your company. The whole idea of a venture funded science project is fundamentally irrational and extremely high risk. And a venture capitalist’s willingness to do so doesn’t make it a good idea. There are other, far more efficient, ways to finance product or service development.

Here is the useful rule: Venture financing R&D is much like getting married for the tax exemptions. Both can be made to look good on paper, but the test is living with the decision and that can get to be very painful.

Avoid Financing Errors In Judgment: During the years that led up to the boom/bust, I was always astounded to find companies with no significant run rate, no customers to speak of and few if any products or services which were market ready … but they had a Vice President of Marketing and a rather large budget allocation for marketing.

I am reminded of a story that the great Mississippi comedian, Jerry Clower used to tell about these two good ol’ boys who stopped a train in the middle of nowhere by waving a red lantern through the darkness. When an angry engineer ask why they had stopped his train the reply came: “We were out hunting and just wanted to see if you wanted a possum.” “You idiots … you stopped this train just to ask me if I wanted a possum? Are you out of your minds? But since the train is already stopped, and I like possum, let me see him and how much do you want for him?”

“We haven’t caught one yet”, came the reply. “We just wanted to see if you wanted one.”

Here is a rule: If you are spending money to sell what you ‘hope to have’, your potential customers will generally treat you as a ‘might become’. If part of the pressure on your financial resources is because you are spending unwisely, financing an error in judgment is a very costly undertaking.

Avoid Myopic Financing Strategies: The great Lotfi Zadeh, father of fuzzy logic, was fond of saying that “when all you have is a hammer, everything starts to look like a nail”. I am constantly amazed at the maniacally myopic approaches that some CEOs have adopted towards financing their company’s growth. It is as if they see their company as a nail, and only the hammer of venture capital will do. These accumulators of the ‘thanks, but no thanks’ seem to be dedicated to going over and over to wells that again and again prove dry. It just doesn’t seem to occur to these people that these repetitive responses are an indicator of an unavoidable truth. I am often lead to ask “just what part of ‘no’ don’t you understand?”

But look people, here is the real world. Venture Capitalists are, for the most part, highly professional people who are having to search harder and harder for good investment opportunities. While you are chasing them and getting turned down, they are spending significant portions of their days looking for good investment opportunities. So, as hungry as they are to invest, what should it tell you if three or four of them have turned you down? Just exactly what part of ‘no’ are you having trouble understanding?

Here are a couple of rules: If four or five professional venture capitalists, who are experienced in your industry, have told you ‘no’, the overwhelming probability is that the next thirty five or forty will give you exactly the same response. I’d look for another way. If you’ve tended to bet the farm on one possibility, you need to stop gambling and start thinking. It is always better to think than gamble. Recidivism is no substitute for learning.

Don’t Ignore Options: I have been astounded in conversations with CEOs who seemed totally focused on the question of arranging financial resources but equally as focused on ignoring alternatives to equity financing. The truth is that there are many more ways to skin that cat.

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