By Kristen S. Jerome, CPA
Partner, Bauknight Pietras & Stormer
The best time to prepare your Company for investment by an outsider is LONG before you need the additional capital. This is your fundraising preparedness guide – no matter the round, amount or type you want to raise.
1. What kind of Company do you have?
a. Are you building a lifestyle company, one that you want to run until you retire, then turnover to the kids? If yes, stop reading now. This article is not addressed to you. A lifestyle company is a terrific endeavor, but wholly different than a company you want to build, scale, and monetize (exit). Start with the end goal in mind.
b. If your goal is to grow the company to scale and exit, it is critical to understand how a business like yours is valued. For example, SaaS companies typically are valued based on a multiple of monthly recurring revenues (“MRR”) or Earnings Before Interest, Taxes, Depreciation, and Amortization (and a bunch of other non-essential transactions – see #2c below – “EBITDA”). On the other hand, professional service companies are often valued based on a revenue or EBITDA multiple. Once you know how companies similar to yours are valued, you can manage the metrics that truly matter. Pro tip: don’t overextend your resources on an extensive suite of Key Performance Metrics (more on “KPIs” here). Manage what matters.
2. Practice good corporate housekeeping
Your Grandmother was right, cleanliness matters. It can be hard to look past dirty floors, sticky tables, and swarming flies to appreciate a good meal. Practice Good Corporate Housekeeping:
a. Maintain a clean set of well-organized corporate records (articles of incorporation, bylaws, stock records, board minutes, EIN, etc.) that you can access at the drop of a hat. While you are at it make sure you develop a solid relationship with a good corporate lawyer – one who helps clients with corporate governance and transactions on a regular basis.
b. If you’re past the Friends, Family and Fools round, you should have a clean, up-to-date capitalization table (aka “cap table”) so you can answer questions about ownership such as:
i. Who are the owners?
ii. How much do they own?
iii. What are their rights?
c. Financial statements tell the real story. Clean accounting records are invaluable.
i. Keep personal expenses out of the business.
ii. Generous charitable contributions and extravagant employee gifts are wonderful (really, you are so kind!), but keep a tight rein on non-recurring, non-operational expenses. They may inadvertently deflate your business valuation.
iii. Having family members involved in the business is OKAY (depending on your family of course…). But understand your Momma’s replacement cost (for the business role she is performing). Investors will adjust to “normalize” any transactions they perceive as not being market-rate.
iv. Your chart of accounts should be as simple as your operation allows. Your “ask my accountant” account should have a $0 balance. If you’re not familiar with the term “chart of accounts,” see #3 below.
v. Non-operating assets or those that won’t be valued with the core business, (buildings, planes, golf club memberships, personal luxury vehicles, and the like) should generally be carved out into separate LLC(s) or kept out of the business entirely in the first place.
vi. Cash, accounts receivable, accounts payable, and other high-transaction accounts should be reconciled at least monthly.
vii. Use caution when considering unusual tax structures, like owning your company through a ROTH IRA. Carefully consider the potential pros (potentially saving taxes) and cons (complicatiing potential investment transactions).
3. Assess your skill set!
Many entrepreneurs fail to acknowledge their own competency gaps. Did you know C Corps have advantages for both founders and investors? Did you know the IRS has published 23 factors to distinguish an employee from a contractor? Unless you have a background in accounting and the law, you may be neglecting the critical corporate infrastructure that shouts “BET ON ME!” Long-term, it’s much less costly to hire a professional to help in the areas where you lack time, skills, or interest in getting it right. So Mind the GAAP (<- that’s an accounting pun). Next, assess your team. Many savvy investors have found their industry/niche, and are generally looking for the right management team and company (in that order) to invest in and ride to the top. It’s all about the people.
4. Support your pitch!
As a founder, you will probably ace the “compelling story” side of your pitch, but be prepared with historical financial statements and a rolling budget/projection (24 months is a good starting point) to give your pitch legs. Investors are not charities. They expect clearly articulated plans for how you’ll provide returns on their investment in your business. Be prepared to blow their socks off…but then give them back their socks and their investment, and then some.
5. Are you ready for this can of worms?
During any due diligence process, the investor is in control. They are trying to answer the questions: Should I invest in this management team and company? How much should I risk? How should I structure the deal?
Make sure to get a non-disclosure agreement and then be transparent. Don’t be cagey. Nothing derails a deal faster than loss of trust.
Understand that with larger deals and more sophisticated investors, the due diligence process will be more invasive and time consuming (more attorneys, more accountants, more scrutiny). Don’t underestimate the time and effort involved. Take inventory of your responsibilities (like…continuing to run your business, seeing your family, hobbies – you have those, right?), and see #3 if you don’t have the bandwidth or skillset to juggle it all.
It doesn’t matter where you fall in your business cycle or entrepreneurial journey, today is a great day to think about whether your Company is a good bet for an outsider. Mind your Business for successful scaling.