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VENTURE AND GROWTH FINANCING

THE ENTREPRENEUR'S ACHILLES'HEEL

"Happiness to an entrepreneur is a positive cash flow."

- Fred Adler, Venture Capitalist

Finance can be arcane, complicated, and sometimes dangerous in the life of a business. But entrepreneurial finance, gathering the financial resources through value assessment and allocation for start-up or growth, differs from the more traditional corporate finance taught at business schools.

The Three Core Principles of Entrepreneurial Finance*

There are three core principles of entrepreneurial finance: (1) more cash is preferred to less cash, (2) cash sooner is preferred to cash later, and (3) less risky cash is preferred to more risky cash. While these princi­ples seem simple enough, entrepreneurs, chief executive officers, and division managers often seem to ignore them. To many small business owners, financial analysis seems intimidating. Even management teams, comfortable with the financial issues, may not be adept at linking strategic and financial decisions to their companies' growth challenges and choices. Take, for example, the following predicaments:

Reviewing the year-end results just handed to you by your account­ant or chief financial officer, you see no surprises - except that the company loss is even larger than you had projected three months ear­lier. Therefore, for the fourth year in a row, you will have to walk into the boardroom and deliver bad news. A family-owned business since 1945, the company has survived and prospered with average annual sales growth of 17 percent. In fact, the company's market share has actually increased during recent years despite the losses. With the annual growth rate in the industry averaging less than 5 percent, your mature markets offer few opportunities for sustaining higher growth. How can this be happening? Where do you and your company go from here? How do you explain to the board that for four years you have increased sales and market share but produced losses? How will you propose to turn the situation around?

During the past twenty years, your cable television company has experienced rapid growth through the expansion of existing proper­ties and numerous acquisitions. At your company's peak, your net worth reached $2 5 million. The next decade of expansion was fueled by the high leverage common in the cable industry and valuations soared. Ten years later, your company had a market value in the $500 million range. You had a mere $300 million in debt, and you owned 100 percent of the company. Just two years later, your $200 million net worth is an astonishing zero! Additionally, you now face a per­sonally exhausting and financially punishing restructuring battle to survive; personal bankruptcy is a very real possibility How could this happen? Can the company be salvaged?1

At mid-decade, your company was the industry leader, meeting as well as exceeding your mid-decade business plan targets for annual sales, profitability, and new stores. Exceeding these targets while dou­bling sales and profitability each year has propelled your stock price from $ 15 at the initial public offering to the mid-$3 0s. Meanwhile, you still own a large chunk of the company. Then the shocker - at decade's end your company loses $78 million on just over $90 million in sales! The value of your stock plummets. A brutal restruc­turing follows in which the stock is stripped from the original man­agement team, including you, and you are ousted from the company you founded and loved. Why did the company spin out of control? Why couldn't you as the founder have anticipated its demise? Could you have saved the company in time?

Financial Management Myopia: It Can't Happen to Me

All of these situations have three things in common. First, they are real companies and these events actually happened. Second, each of these companies was led by successful entrepreneurs who knew enough to prepare audited financial statements.* Third, in each example, the prob­lems stemmed from financial management myopia, a combination of self-delusion and just plain not understanding the complex dynamics and interplay between financial management and business strategy. Why is this so?

Getting Beyond "Collect Early, Pay Late"

During our thirty-plus years as educators, authors, directors, founders, and investors in entrepreneurial companies, we have met a few thou­sand entrepreneurs and managers, including executives participating in an executive MBA program, MBA students, Kauffman Fellows, com­pany founders, presidents, members of the Young Presidents' Organi­zation, and the chief executive officers of middle-market companies. By their own admission, they felt uniformly uncomfortable, if not down­right intimidated and terrified, by their lack of expertise in financial analysis and its relationship to management and strategy. No doubt about it, the vast majority of small business owners are strategically disadvantaged by this lack of confidence in financial management. Beyond "collect early, pay late," there is precious little sophistication and enor­mous unease when it comes to these complex and dynamic financial interrelationships. Even good managers who are reveling in major sales increases and profit increases often fail to realize until it's too late the impact increased sales have on the cash flow required to finance the increased receivables and inventory.

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