- Players: Michelle Krastanov and Marthinus Erasmus
- Company: Arbor Capital
- What they do: Provide a comprehensive range of integrated corporate finance; capital raising and listing-related advisory services.
- Visit: arborcapital.co.za
Imagine you are the owner of a business that has been operating successfully for almost two decades. Your turnover is over R50 million, and you’re established in your market.
Now imagine you’re heading towards a wall. Your cash flow is going to run out before a big cash injection in four short months, and you’re desperate to keep the business running until that happens. That desperation leads you to a less-than-scrupulous lender and you agree to incredibly onerous terms: You loan the cash you need at an exhorbitant interest rate, you give a portion of your business away for free, and you hand over all of your securities. You even relinquish management control over the business.
No doubt you’re thinking this could never happen to you. And yet it happens to more established businesses than you’d think possible.
Related: New Ways SMEs Can Find Funding
In this particular case, by the time the owners of the company came to Arbor Capital for assistance, they were weeks away from signing over their business to their funders. Their desperate measures had placed them in a worse position — which had been their lenders’ intention from the beginning.
Had there been a different solution available to them? Absolutely, say Marthinus Erasmus and Michelle Krastanov. Unplanned debt or equity funding can be very expensive. Planned funding on the other hand is structured to suit the business’s real needs.
In this case, the business’s owners could see that their cash flow showed they would hit a wall within four months, but that there was a big influx of cash thereafter. The business was solid but they were affected by seasonal issues. Instead of almost signing the business away, they could have structured a funding package to suit the business’s needs.
The sustainable solution would have been a mix of short term bridging finance and long term debt and equity finance. Their cash window was four months — they just needed bridging finance.
Arbor Capital was able to help them get out of their onerous funding contract, and then secure the correct finance for their business needs, and helped them avoid losing everything.
The lesson? With proper planning and realistic assessments of the business, the correct funding solutions can be found that avoid situations like the one outlined above.
How often do business owners choose the incorrect funding structures for their needs?
Unfortunately it happens more often than you’d think, but it’s not always because of unscrupulous lenders. Far more common is a situation where business owners just don’t do their homework and end up securing the wrong capital for their needs.
We’ve seen a lot of businesses that secured funding from equity investors or companies looking to expand through acquisitions, and after a few months both parties realise that their values or objectives aren’t aligned, or their expectations of each other weren’t clearly stipulated. The entrepreneur now has a 30%, 40% or even 50% shareholder in their business who isn’t happy, and they’re under even more pressure than they were to begin with.
Related: How to Write a Funding Proposal
How can situations like this be avoided?
Business owners need to carefully assess their business needs before choosing a funding or financing structure. There are so many ways to inject cash into a business, but what you choose should align with your specific needs.
In cases like the one mentioned above, everyone usually did the right thing and followed through with due diligences and so on, but it’s still not working out because it was the wrong funding structure to begin with.
What options can people choose from?
There are so many options for business owners to consider when raising finance. This depends on the size and nature of the business, the short and long term objectives and includes equity, debt, mezzanine finance (such as convertible preference shares), trade finance incentive funding or a combination of different types of funding.
This depends on the business’s needs, what repayments it can afford, how much equity the business owner is willing to give away, and so on. Combination solutions in particular are overlooked by business owners, and yet they’re often the best solution. The sources of such funding include the banks, private equity (includes private wealth) investors, BEE investors, listings and the DTI and IDC.
How can business owners determine which funding solution is best suited to their needs?
Start by answering very specific questions about your business: What type of money are you looking for? How much do you need? For what purpose do you need it? Are you looking at long or short term debt? Long and short term debt in particular serve different purposes.
The next step is to critically evaluate your own answers. How much money do you actually need? We find that business owners often believe they need more cash than they actually do, either because there’s cash sitting in their business that they can unlock, or because they actually need the cash in different stages and not all at once. The converse of not securing enough funding can be equally damaging.
Similarly, perhaps you’re looking for debt funding but the business won’t be able to sustain the repayment plan. If you can’t afford the repayments you can’t take debt funding. Interrogate your cash flows and forecasts. Can you afford the interest? What will the cash achieve? Will cash flow and profits improve? Higher sales lead to higher working capital requirements, and costs go up too. On the other hand, you might be averse to equity funding and unwilling to dilute your shareholding. It’s important to be realistic.
For example, a business approaches us and says they need assistance securing R70 million in debt funding. After going through this process, we realise that they actually only need R40 million now, and an additional R20 million in 18 months’ time.
The business cannot afford R60 million debt funding, but it can afford R30 million. By understanding these factors, the business owners are able to secure a loan of R30 million, and find an equity partner for R10 million now, and an additional R10 million in 18 months’ time, at which time the business could take an additional R10 million loan.
The owners don’t give away too much equity, they don’t take a bigger loan than they can afford and they secure the correct amount of capital for their needs. This can all mean the difference between a rewarding growth experience and a failed growth attempt.
What are the most important red flags that business owners should be aware of?
The incorrect financing solution can do irreparable harm to a business. So many owners fall into the trap of believing that money solves all business problems. This isn’t true. Business owners who need equity funding take debt and end up struggling with repayments, or the opposite happens and too much of the company is given away too soon for too little.
On the flip side, too much cash too early and you may start spending for the sake of spending, burning through cash and irreparably damaging your business.
Find the right solution, only take as much money as you need, and remember that all funding comes with strings attached — always. There are no exceptions to this rule. If someone has invested in your business or given you money, you’re reporting back to them, whether it’s a bank manager, a private equity investor or shareholders in a listed company. Any external funding comes with someone who wants to track how the business is doing.
Related: 10 Tips for Finding Seed Funding
How can business owners make growth funding work to their advantage?
Evaluate your business and choose the correct financing structure. This should be a practical and objective decision, not a subjective one. Similarly, look far enough into the future to make financing preparations as early as possible.
Match your funding structure to your growth curve. If you are comfortable with annual growth of 10% to 15%, you can save the finances you will need and internally fund your growth. If you’re looking for 40% annual growth, you will need external funding.
Remember that long-term capital never comes back. It sits in the business, working. You’ll only unlock it when you sell the company.
Most importantly though, run a good, clean business. Funders and financiers alike will evaluate your business with a fine-tooth comb.
Match the right growth funding to your needs to ensure your solution doesn’t become your biggest stumbling block.