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December 17, 2018

You Need a "Financing Plan"

Rick Norland

Rick Norland
Owner/Thorington Corporation

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As every manager knows, the moment a business plan is complete, it is also outdated.  But it serves a purpose to communicate what the company is generally about and what it’s trying to accomplish.  Among the many topics discussed in a business plan is how the company plans to manage its finances.  Hopefully, this discussion extends beyond the creation of financial projections to include a financing plan, setting out management’s expectations of how much capital the company will require over the next three to five years and how it will be sourced. 

This financing plan is more than just a look at future cash needs though.  Companies should take the opportunity to integrate their financing plan with the corporate objectives of their other internal planning requirements and external stakeholders.  The financing plan should begin with inputs from the financial projections, technology and product plan, marketing and sales plan, human resources plan, and facilities plan.  It should then go beyond these internal inputs to also consider:

  • Optimizing shareholder value (i.e. tradeoffs between earnings per share and number of shares outstanding);
  • Utilizing all sources of capital, including debt, equity and off-balance sheet financing (e.g. leases);
  • Other corporate strategic objectives, such as marketing partners who may also invest;
  • Positioning for the next round of capital, including consideration of impact on capital structure, investor type, reporting requirements, among others;
  • The preferences of various investor types (i.e. private individuals, public sector, venture capital, public markets), including their respective return expectations, stage of growth preferences, and ultimate liquidity needs; and,
  • The company’s cash requirements and development milestones.

In summary, the financing plan describes how much capital will be raised when, from whom, and on what terms.  In reaching this simple outcome, there are a vast number of corporate and shareholder objectives that must be balanced and weighed against a number of other considerations.  The resulting process is often iterative and sometimes complex.  The output though is a plan that describes management’s intended means to finance the company over the next three to five years, and is fully integrated with other business planning elements.

Although each enterprise is different, and investors’ interest in the industry itself shifts every day, a few rules of thumb can guide IT companies seeking to manage and fund the development of their financing plan.

First, understand where you are in the growth cycle of your product, and develop an appropriate financing strategy. In a dynamic industry such as IT, this may not be as easy as it sounds. A variety of considerations — including gross revenue, profit or profit projections and product cycles — will assist you in locating your company on the growth curve. This, along with financial projections to indicate your capital requirements, will help to determine the right financing strategy.  We have a couple rules of thumb that may help – a company’s one year revenue projections are about the same as its current financing requirements.  Or, company’s tend to need between $100,000 and $1500,000 in new capital each year for every employee.

Second, try to determine where your company is going to end up.  Will it become a public company on some stock exchange or will it be acquired by a strategic buyer?  This decision alone can greatly impact how you manage your business.  For example, if you expect to complete an IPO, then you know that revenue and earnings growth will be important at that time.  You should manage the company to maximize growth and profitability in the meantime, being careful how much is spent on marketing and R&D so as to ensure profitability each year.  On the other hand, if you expect to be acquired, you won’t care as much about profits and revenue growth.  Instead, you’ll gladly spend money to maximize the value of your strategic asset, say on market share, geographic coverage, or new technology.  As well, a known exit strategy can influence your investor base and other decisions.  Pursuit of an IPO will guide you to a round of financings from financial institutions.  You may start working with a renowned investment intermediary for the larger financings.  An acquisition strategy will have you seeking corporate investors or VCs who prefer that type of exit strategy.  Equally, you may try to locate your tradeshow booth near the likely acquirers or establish alliances with them.

Third, do everything you can to build the valuation of your company before you start seeking investment. This sounds intuitive, but it’s frequently overlooked. Company A, whose primary asset is a “killer” application software, may achieve a specific valuation. Company B, with the same piece of software plus a superb marketing strategy and a board of directors with considerable “bench strength,” may be valued at twice as much. By paying attention to business basics you can increase the value assigned to your company. And the higher your company’s valuation, the less equity and control you’ll have to surrender to investors.

Fourth, know the difference between capital and “smart” capital. It’s a mistake, particularly in IT, to assume that all capital is created equal. Seek investment sources that will bring strategic value to your enterprise, well beyond the simple cash itself. If you’re a multimedia company, for example, you can find corporate investors or venture capital firms with previous investments in multimedia. What they’ve learned may be of value to your company, and their portfolios may contain potential alliances with marketing channel members, complementary technologies, and key suppliers or customers. An investor of this nature will help grow your business in ways a purely financial investor cannot.

Last, get help if you need it. Planning a financing strategy is risky business. A mistake can result in significant dilution to the current shareholders, even a change in control.

Comments? You can contact me directly via my AdvisoryCloud profile.

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