Market Readiness: What does this mean in a capital raise scenario?

We review at a lot of requests for financing at Kaeros Capital Advisors. While in a perfect world we’d like to help every client that comes through our doors, the reality is that some businesses simply aren’t ready for a capital raise, whether it be debt or equity.

Interestingly, the number one reason why we aren’t able to engage a new client is the same reason why we are typically successful during a capital raise, market readiness. 

So, what does this mean?  

Our experience tells us that any business looking to become “market ready” must demonstrate a strong foundation in the following three areas. Ultimately, by building this foundation prior to seeking new forms of capital, you are increasing your chances of a successful financing close.     

1. Strong Financial health – lenders and investors will want to see a consistent pattern of earnings, EBITDA and profitability growth, typically over a 3 to 5-year period, which demonstrates a viable going-concern business. Having a clean, or “normalized” income statement is paramount. This means for example, that if you’re the business owner that you’re not using your company as a personal chequing account. That is, only legitimate and necessary expenses that are incurred to sustain and grow the business should be expensed. Personal costs related to meals and entertainment, vacations and vehicles, among others, that are expensed above and beyond what is needed to run day-to-day operations should be curtailed well advance of seeking to raise capital.

From a balance sheet perspective, paying down existing debts (particularly high-interest loans and lines of credit that are either at or near their limit),  collecting on outstanding shareholder loans and third party debts owed to the company, reducing dividends as appropriate to bolster a firm’s equity, and ensuring there is an adequate level of liquidity (i.e. cash in the bank) to fund on-going working capital, are all important. 

Often, we’ll engage outside consultants such as D-Squared Consulting based in Burnaby B.C. to help us get a company “market ready”.  

Denise Wong, founder of D-Squared further reinforces the above concepts by noting that it is imperative that business and personal transactions be separate at all times. Lenders and government agencies see transactions between the business and the owner to be non-arms length and so it is best practice to ensure that all transactions done between the business and the shareholder are verifiable and have an audit trail. If such transactions lack transparency, a level of doubt can be cast on the accuracy and trustworthiness of the numbers presented. Essentially, the valuation of the business can be severely impacted, and one ends up with an undervalued business. 

Broadly speaking, a financially healthy business is one that has:

1.    Profits – to show that costs are controlled, and the business is viable;

2.    Positive operating cash flows – to show that the operations itself generates cash;

3.    Strong liquidity – to show that cash is managed well so current assets can cover current liabilities at any given time to weather any unforeseen circumstances; and

4.    Balanced debt to equity – to show the business has deployed assets and debt effectively and isn’t over-leveraged.

These are a few key metrics that accountants can use to measure the health of a business. It’s important that a business owner reviews these metrics regularly to monitor the health, and any changes in the health, of the business. Also, knowing how the business performs relative to its industry peers is a crucial insight. Being above or below industry benchmarks can also impact a business’ valuation.

2. Strong Reporting Capabilities – lenders looking to provide capital to a business will all want to see its ability to quickly produce internal financial information, that is both reliable and up to date.  Depending on the type of capital a business is trying to raise, the reporting requirements, can vary between limited to quite onerous. For example, providing accounts receivable and inventory listings, for an operating line that is margined (i.e. assets are pledged in support of that facility) is common. Where a lender is providing a subordinated debt facility, standard requirements would include monthly or quarterly income, balance sheet and cash flow statements to assess ability to repay its loans. It should be noted that these reporting requirements are needed both leading up to a capital raise as well as post-closing when the money’s in the bank. Being able to quickly produce historical financials, working capital listings and financial forecasts, among others, are standard reporting requirements.

Denise at D-Squared explains furthers. The accounting department should be the most routine and organized department within any organization given the inherent deadlines imposed on them for government filings and by stakeholders for specific reporting.  However, this is usually what we see after an organization has gone through many cycles of the accounting process and the process has become routine.

Too many times, we see young organizations struggle with market readiness because they do not have a cadence or schedule for when key functions such as financial analysis and reconciliations are done. Many smaller organizations fall into the “we’ll do it when we need it” trap. When schedules or information is called upon for financing, so much time has elapsed that some of the knowledge has been forgotten and takes time to investigate. Because there is not a lot of time to provide the information, errors can happen or through the investigation, major errors can be uncovered. Regardless, the longer the time it takes to provide data, the lower the potential lenders’ confidence that their investment will be managed appropriately. The first thing we do, at D-Squared Consulting, to assess if a company is market ready is to make an inventory of key documents that are required for due diligence and ensure a plan is in place to complete them if they aren’t already.

3. Management and Employee alignment – To steal a line from one of my favourite business books, Good to Great, having “the right people on the bus”, particularly during a capital raise is of the utmost importance. To pull off a successful financing close, which can often run anywhere from 60 to 365 days depending on level of deal complexity, all staff need to be aligned and pushing in the same direction. Of critical important is having a strong CFO or VP Finance that can pool necessary resources together to prepare various financial, operational, accounting due diligence materials for us as advisors, but ultimately for lenders. Having a great product or service is not enough if the company’s story cannot be told through up-to-date financial data including trends in sales, profits, working capital, leverage and cash flows.

Focusing specifically on an organization’s accounting team resources, quite often we see company’s lacking in critical accounting and financial reporting expertise. Specifically, accounting teams not equipped to handle fiscal year-end financial consolidations, as well as staff that aren’t able to prepare proper financial projections, complete with income statement, balance sheet and cash flow statements, are common.

In her consulting practice, Denise Wong says she often sees, particularly in smaller organizations, a lack of clarity around what an accounting team is supposed to do. Finance and Accounting is very broad and starts with bookkeeping and transaction processing. Many organizations only employ a bookkeeper and a year-end accountant to do taxes and financial statements. There is nothing wrong with this set-up, but if owners or managers are looking for better information to run the business there is a huge gap between the daily processing and the annual financials. For companies looking to raise capital, there is a need to fill in the gap with key reports to tell the story of the business operations.

When we work with clients to get market ready, we ensure not only that their financial health is validated through metrics mentioned above, but that their reporting and supporting documents are accurate and complete. Then, we analyze the data into useable information that helps validate that the business is a sustainable and viable operation worth the investment or financing from respective investors or lenders. Going through the process of raising capital can be long and arduous. It’s definitely a project any company who wants to be successful in their capital raise would want extra resources to assist with.

Before our work at Kaeros can begin, an assessment of the strength of the above factors needs to be completed. Following said assessment, and in partnership external third parties who are experts in the fields of accounting, business valuation and human resources, we help lay a proper “market ready” foundation.  

If you are thinking about raising capital and have some questions about whether you’re market ready, please send me an email to trevor.palmquist@kaeroscapital.com and I’d be happy to explore some options with you. 

Cheers, Trevor

Founder and Managing Director