To raise capital, small business owners typically think about leveraging assets for bank loans or partnering with an equity investor. Both processes can be daunting because they involve giving others a say in your business. By founding three private-equity-backed startups, I’ve learned five “must-dos” for raising capital to grow a business.
It’s critical that you have a compelling growth strategy that fits the profile of the investors you’re targeting. Specifically:
- Think through your exit strategy. It may seem strange to embark on a growth path with an end in mind, but the timeline of your plan is pivotal to determining the right investors and financial structure for a deal. Private equity and VC firms will seek a stake in your company and governance rights in exchange for the growth capital, and they typically have a three- to five-year investment horizon. That means they’ll be looking for a relatively short-term return, most likely through a sale of your company. If you want a longer horizon, identify investors with a similar view, such as family-office-backed-private equity firms, and consider creating a unique financing model. For example, we founded my current startup using a special purpose limited partnership structure that allowed us to attract a number of investors who share our long-term view.
- Target the right investors with a compelling narrative. During the process of putting together my first startup, we wasted a lot of time meeting with the wrong investors—for example, VC and PE firms that had no experience in our industry. The investor pitch process is challenging under the best of circumstances. A study by DocSend and Harvard Business School professor Tom Eisenmann shows that companies needed an average of 40 investor meetings and about 12 weeks to close a financing round, with investors taking an average of three minutes and 44 seconds to review a pitch deck. Before approaching a potential investor, investigate how you fit their profile and tailor your messages so they align with the firm’s investment criteria. For example, all investors value a high level of sustainable sales—so be prepared to demonstrate the “stickiness” of you customer base, and how it can be modeled for growth. Also, investors look for hard assets that can be leveraged as part of sophisticated financing and tax strategies.
- Pick a financial partner you can work with. Inexperienced entrepreneurs may be tempted to accept investment capital despite having misgivings about the financial partner. They figure the growth plan will work without a hitch. That seldom happens and there will always be challenges to navigate. Ideally, a good VC or PE partner will want to be involved in the business, and a smart entrepreneur will want to leverage the expertise, connections and broader resources an established firm can offer. That won’t work if the chemistry isn’t right from the beginning. Get to know your prospective investors. For instance, ask to talk with the CEOs of other portfolio companies.
- Engage experienced advisors. Some entrepreneurs look to save money in deal costs by using advisors they’re comfortable with in running their small business. It’s a mistake to be cheap when engaging advisors in a PE deal. Experienced and knowledgeable investment advisors can save you a lot of time and trouble, in part because they know the general structure of a deal and can tell you when a PE partner is making a true concession, beyond the norm.
- Consider a full sale to an industry consolidator. The right industry consolidator could be the best partner to grow your small business. For example, my company acquires retail propane dealers in local markets, and we compete with large, publicly traded national firms for those acquisitions. We’re often chosen over those bigger companies because we act more like a PE investor than an acquirer. The companies we acquire keep their brand names and the operations stay local, including management personnel, pricing decisions, customer service and community relations. As the parent company, we stay in the background, providing capital and other resources, such as an enhanced supply chain, to help the local company grow. There are numerous examples of companies that successfully acquire and integrate local operations, and excel by supporting a growth strategy that includes leveraging the benefits of local autonomy. Gannet does it with local newspapers and, on a large scale, Warren Buffett does it with every company he acquires.
If you’re a small business owner who aspires to achieve entrepreneurial success, remember that you have a lot of assets that are potentially appealing to the right investor. The key is to articulate a compelling growth strategy and to identify a partner who values your experience and your enterprise, and can bring resources to bear that will help take you and your business to the next level. iBi
Thomas Knauff is founder and CEO of Energy Distribution Partners, which acquires and operates propane distribution companies and midstream assets. He is a serial entrepreneur, having founded three such companies, all backed by private equity. He has completed and integrated more than 79 acquisitions.