“Where will the money come from?”
It was Q3 of 1997 and I was the new President & Chair of our family-owned chain of supermarkets. We had just bought out a founding family member in part with a large, bank-financed down payment and term payout. Cash was thin. Super Walmarts were about to open in all three of our geographic markets. And 520 employees were looking to me for direction and security in the face of their new and more competitive environment. My sibling shareholders were neither patient nor supportive as they tried to maintain brave faces in their new and inexperienced positions as directors in a complex and capital intensive business. Earnings were okay, but not as robust as they needed to be to comply with the bank’s covenants. There was no way we could compete with the Super Walmarts unless we found cash—now–for repairs, updates and expansion.
My job was to explore every alternative and develop a capital plan that would both document our strategy and signal to the banks that we were not just relying on their faith in us as operators. I wanted them to know that we were attentive to their covenants and were exhausting all possibilities. Other than an equity raise, I evaluated and squeezed capital out of every option I could find. Ultimately, we made it all work, never thinking that our capital plan would evolve into a model that has since worked for other companies and as an educational tool for CEOs. In the years since, working with CEOs in a round table setting where they explore capital options with one another, my learning has reached a whole new level—and Capital Access Forum has become a platform for insightful and beneficial dialogue. It begins with a key strategic and pragmatic question that CEOs, boards and banks must ask, or should ask, on a routine basis: “Where will the money/capital come from?”
What is capital access planning?
Capital access, or capital planning, is a concept that, while fundamental and critical, continues to be vague and illusive to many. As a result, it’s often misunderstood or overlooked in managing and financing our businesses. I work at the side of CEOs and owner/operators as well as third- party financing sources to make the capital access playing field level. For our purposes here, “capital access planning” is a customized outline (& time line) of options for funding the future capital or money requirements necessary to fuel and/or sustain ongoing growth and business viability. We don’t need to use the high-brow language of investment bankers. In contrast, the concept of capital access represents a finite world of options that all CEOs and owner/operators need to be as familiar with as they are with the back of their own hands. My challenge, and one that I welcome, is to work with CEOs and boards to ensure that capital access is top of mind in the strategic process. When fellow CEOs are in an environment where they can confidentially share their successes and creative ideas in this vital area, options become more real and attainable.
Capital is sourced from six finite umbrella categories:
Equity Investment – is the founder’s investment and/or subsequent rounds of third-party investment that is typically in the form of an ownership stake in the company. Returns on this equity investment can come from either dividends or longer term increases in shareholder value realized through a future buyout. In theory, the risk and rewards at this level of investment are greater, warranting a higher return on the investment.
Debt – can be either private or bank debt and does not typically include an ownership stake. The attractive element of debt is that it is “non-dilutive,” meaning that the face interest rate paid is the consideration for this debt capital. Most bank debt is secured with the assets of the company and includes a contractual rate, amortization and maturity. Typically, debt also requires personal guarantees. Bank debt is rarely an option until the company has demonstrated a sustainable history of positive cash flow (see retained earnings below) and a reasonable balance sheet profile. Note: Some equity investors will elect to invest first in a debt instrument (secured by the assets of the company) with an option to convert the debt to equity at a later date based on a pre-determined value.
Vendor Debt – often offered by trade vendors/suppliers to extend repayment terms to customers in the hope that the risk associated with these liberal or extended terms will be rewarded with a long-term customer relationship. This type of financing gained new traction after the 2008 economic downturn and the tightening of bank lending. Many vendors viewed extended trade terms as the only way to keep their customers (and themselves) in business. A part of the logic hinges on the presumption that vendors better understand the risks associated with their customer’s operations and therefore can assume a level of risk that banks are prohibited from assuming. I used vendor financing extensively during my CEO tenure and, while beneficial, there were intangible costs and limitations that restricted future sell options and or competitive sourcing. I illustrate the intangibles to underscore a silent or less obvious cost associated with vendor financing. My purpose is to sensitize CEOs who may be seduced by vendor overtures early on and later regret other implications weaved into the agreement.
Retained Earnings – the Holy Grail of capital access because it is obviously non-dilutive and widens the door to so many other capital access options. “Retained earnings” is the term used to describe the net profit after taxes that the company generates and retains for future growth needs. On the balance sheet, retained earnings are reflected in the capital/shareholder equity section. The only way to generate retained earnings is to operate at a profit and then elect to retain those after-tax profits rather than pay them out in dividends to equity owners. When a company demonstrates an ability to consistently generate retained earnings, the equity, debt and vendor debt options all go to a new and attractive level of availability. New equity is less dilutive based on the higher valuation and assumed lower risk. Bank debt risk is mitigated significantly when retained earnings and balance sheet strength are evident. Supplier/vendor terms are much easier to negotiate, again due to the predictability of cash flow/retained earnings and the stronger balance sheet as evidenced by both liquidity and leverage measures. A key component of establishing a retained earnings policy as a capital access option is the hammering out of a capital plan that, coincidently, addresses each of the named categories outlined within the plan, along with a dividend policy. Dividend policies address two things: (1) equity owner’s needs /demands for current income on their investment; and (2) the delicate balance of retaining earnings towards making sure all other capital access options remain open and viable, consistent with strategic options (expansion, acquisitions, divestures etc.).
Sale/Refinance of Assets – to generate capital. When certain assets are no longer critical to operations and/or management, companies may elect to sell and leaseback assets to generate capital. During my CEO tenure, I sold/refinanced real estate assets to both generate cash and re-posture my company’s balance sheet for future financings. The real estate was sold to a related entity controlled by the equity owners in the company with a companion long-term lease. By taking the real estate assets off of the operating company’s balance sheet, we improved cash reserves, reduced liabilities and postured the operating company as a stand-alone entity for planned future sale. After the sale, we enjoyed cash flow from the real estate leases and, ultimately, another level of return when the real estate assets were later sold. The point: evaluate the balance sheet to determine if there are undervalued assets or assets that are not critical to current operations that can be converted to cash/capital. (GAAP requires presenting the assets at original cost less depreciation, in contrast to personal balance sheets that allow valuing assets at their current market value.)
Other – a catchall category for any capital sources not included in the five named options above. Among other sources this could be:
- · Cash value of life insurance (This was an unanticipated surprise and very timely for me.)
- · A joint venture (Will they advance funds in support of a profitable future relationship?)
- · Economic development grants
- · A legal settlement
Always be on the lookout for other sources of funding/cash/capital that may be on the horizon. It spends as well as cash from investors and/or bank and vendors. If you’re thinking to yourself:
“Are we strategically optimizing and planning for our future capital needs? What else is available?”
Then we should talk!
Assuming a fit, you will meet quarterly with other CEOs from other non-competitive industry sectors and together, under confidentiality agreements, take apart each partner’s financials and fine-tune the strategies for each capital access option. This process predictably provides insights, contacts, strategies and relationships otherwise not available between the participating partners. We document the pros and cons of each option, alternative options and costs; and together formulate strategies that are reported and reviewed within this partner community each quarter. The benefits, apart from the natural collegial relationships that evolve, include a heightened sense and appreciation of what others are doing; opportunities within your company that otherwise were overlooked or misunderstood; and finally, a next level of beneficial exchange with your bank. We all need money to run our businesses, and a finite plan of options with quarterly reviews moves the process from a hazy theory to a fulfilling and rewarding realization. Don Van Winkle