To Raise or Not To Raise? That Is the Question

June 1, 2012 by

CEOs are constantly facing new challenges and dilemmas; they are tasked with wearing multiple hats, answering to various stakeholders, driving revenue growth, expanding margins, managing a team, etc. Raising capital can throw yet another challenge into the mix.

For a company that has been bootstrapped by its founders, the dilemma is somewhat magnified. With no experience of raising outside capital historically, the decision to bring on a new financial partner can be a hefty choice, and one not to be made lightly. For the most part, these CEO-owners have contributed meaningful dollars into the company — likely taking significant personal pay-cuts to ensure they make payroll every month — and dedicated 100% of their time and attention to the business (not to say that’s not also the case with venture-backed companies, of course). They’ve learned to do more with less and figured out exactly how to maximize capital efficiency. Quite frankly, the CEO of a bootstrapped company is probably a VC’s dream.

More to that point, that CEO has found a way to get his company to break-even — perhaps even turn a profit — very quickly and with very little investment. She might even be able to pay herself meaningful dividends while continuing to grow the business.

So why on earth would a CEO like that ever want to raise capital? Here is their big dilemma:

If I raise outside capital, I can then invest in the resources I’ve been holding back on, growing more quickly, increasing market share, and increasing customer satisfaction at the same time. That said, I currently own 100% of my company, and I don’t answer to anyone else – I like that. A VC is just going to come in and tell me how to run my business.”

I’ve had this conversation countless times with CEOs. They may very well recognize some of the value of bringing on a professional investor, but it always comes back to how things will change when an investor comes along. It’s true, things will change, but not always in the way the CEO is thinking:

  • The company will be well-capitalized and ready to execute as opportunities come up.
  • With the financial backing of an institutional investor, customers may be able to place a bit more confidence in the business, growing sales.
  • Depending on the nature of the transaction, the CEO/owner may be able to take some chips off the table – so that she can now focus her attention on growing the business without the daily worry of paying the mortgage or saving for her kids’ college tuition.
  • The CEO will have a board-level advisor in a Partner who has been in this situation before and has experience in working with growing companies, ultimately readying them for the ideal exit opportunity. By professionalizing the BoD with outside directors, the CEO will gain unique perspectives on her company that she may not have had access to in the past.
  • Ideally, the investor who the CEO picks will also bring added value to the table outside of capital. With OpenView, we look to help our portfolio companies by providing them with access to our team and resources in OpenView Labs.

Will the CEO have to give up some ownership in her business to bring on an investor? Of course. But, as we all have heard, owning even just a sliver of a big business can be much more meaningful than owning 100% of a small business that doesn’t go anywhere. That’s not to say that having a VC will guarantee a big, great outcome; nor to say that by not having a VC on board the company won’t have a spectacular exit – there have been plenty of cases proving the opposite!

In any case, it’s a decision that shouldn’t be taken lightly; if the CEO wants to run the business as a lifestyle company that she eventually passes on to her children, raising outside money is not the best decision. If the end goal is positioning the company for a big exit, maximizing overall return, however, then bringing on a value-add partner might be an excellent next step in the company’s life.

photo by: 401K
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Discussion

  • http://one.valeski.org Jud Valeski

    Great post! I think you missed an element though; post-investment exit scenarios. The more valuable the business that has been built, the higher the valuation. That helps w/ dilution, but hurts in the open investment/acquisition market because a price gets “set.”

    If a VC invests in a firm and leaves it with a $250m post-money valuation, as far as the market is concerned, that firm must have an exit at $250m+ now in order for the money to work. As those numbers get bigger, the number of exit scenarios tents to get smaller.

    That’s all well and good in some scenarios, but can be limiting in others.

    • Ricky Pelletier

      Thanks for the comment, Jud.  I agree with your point (I’m certain that there are plenty of other points that I overlooked as well); raising capital does set some expectations on current and future value.  Where this becomes even more magnified is when a company raises a LOT of money at high valuations.  Not only does it limit future financing rounds (future investors may not want to invest in a company that has burned through a substantial amount of cash at a high valuation — there is a much smaller set of investors who can and will participate), but now in order for that venture firm to hit its return metrics they have to sell for what might be an unattainable figure.  It can certainly create a misalignment between investors and management.  
      As you point out, raising capital can be a great thing or a complete pain!  It is up to the management team to figure out the right raise for the company and do their diligence on the investor and the investor’s expectations to make sure everyone is in agreement on what a successful partnership would look like.

      Thanks again for the comment!

  • Anonymous

    Ricky – your blog hit home as we are going through this exact dilemma. 

    Some additional things to consider:
    1) The CEO will typically be a hands on operator in the business (no investor management or reporting at this stage) and hence the time that this process takes will remove him/her from the that role – typically leaving a hole that is hard to fill.

    2) Finding the right investor/partner is a skill unto itself and there are various merchant bankers or lawyers that specialise in running this process and shielding the CEO from the time consuming process of kissing a lot of frogs.

    3) One buyer doesn’t create the appropriate competitive process that will ensure you get the best offer on the table. You need to have a few suitors to keep them honest and to ensure market forces drive the valuation to the right number.

    4) There is a time and resource cost of having outside investors that will need to be borne by the admin dept in the form of improved reporting, financial analysis and governance.

    5) Bringing on an investor brings a timetable to the business that did not exist before. The cash bears an IRR and the VC doesn’t have the same patience that founders can live with. Decisions need to be made faster and results expected sooner.

    VC cash can end up being the best or worst thing that happens to a business…

    • Ricky Pelletier

      Mike — thanks for the comment and great points!  On point # 1, that is an excellent observation that I overlooked in my post — an owner-operator will need to devote a pretty meaningful amount of his or her time to the capital raise:  identifying firms, pitching partners, pulling materials together, etc.  Hopefully, in the end it is worth it and hopefully the CEO has been able to surround themselves with a high-quality team who can keep delivering.  Agreed though — there may be a bit of a gap that needs filling (and plenty of all-nighters for the CEO).  

      On point number 2 — yes there can be great help around the table in finding a good partner, but there is no good substitute for meeting with folks and figuring out if there is a fit for yourself.  Advisers can bring plenty to the table, but they can also bring plenty of unnecessary process to the raise.  It may end up taking up more of your time going through a process with a banker and may delay the raise just due to the way the timing works (rather than just meeting with the top handful of VCs you’d like to work with and selecting from that group).  That said, there are also some excellent advisers out there who can be extremely beneficial, so doing diligence on who you select with respect to that front is also very crucial.  

      Point # 3 is valid — it definitely makes sense to speak with multiple suitors to understand valuation and what they may bring to the table outside of cash; very important point.

      Point # 4, while valid, is pretty minimal and I would hope that the value the investor brings well outweighs any of the additional admin duties that the investment brings on.  While it’s important to be aware of this aspect, I wouldn’t let it deter you from raising capital if it will help you grow and increase the value of your business.

      Point # 5 — good point; investor capital typically has some form of timetable attached to it.  That said, a good investor will be less focused on IRR and more on multiple of money — if the company is growing well and there is continued growth ahead, why would the investor want to sell early?  If it takes 8 years, but the investor is able to return an above average multple to its LPs, everyone will be OK with the time it took to build the business.  That said, if the goal is to build more of a lifestyle business, chances are there will be some timeline misalignment between management and the investors — setting those expectations at the onset of a relationship is hugely important.

      With all that said, let me know if it makes sense to chat — I’d love to hear a bit more about Striata and see if we might be helpful (putting my sourcing hat on for a minute!) — at the very least, we can continue this dialogue in a more conversational manner.

      In either case, best of luck with your decision and thanks for the comment!

      • James

        Great article, thanks for info, it hits home for us at our stage of development. After 4 years of development we are at the point you are discussing, my only comment is one of balance, and “its all about timing” you have to work long and hard to come to the exact moment of proposing your concept to any investor, not too early, and certainly not to late. Cheers!

        • Ricky Pelletier

          Good point and quite true.  That exact moment of when is right will look very different for each and every company, but chances are when it is time to make the decision, you’ll know!

          Take care and good luck!