Should Small and Midsize Businesses Accept Outside Capital?
By Richard Lee, CFO of Azul Partners, the parent company of Spend Matters. Richard is also Managing Director of Spend Matters Group, LLC and RJSL Group.
All my start-ups after Orbitz were bootstrapped, so I get rather passionate about this topic. Whenever inquiries come in from small business owners regarding the logistics of getting outside capital – valuation expectations, how much control to relinquish, what changes in operating agreement are necessary, re-classing voting rights and shares, guaranteed distributions regardless of performance (sort of like Jay Cutler’s new deal) – I ask one simple question. Why do you think you need outside capital?
I’m often dismayed by the answers I hear back. They range from funds for rainy days to taking money off the table for the founders. One thing you should realize is that it’s irrelevant why you think you need outside capital. Investors will only invest if prospects meet their investment thesis, in addition to a couple of other crucial criteria:
- Management team in place: if it comes down to poorer business model with great executive team vs. great business model with poor executive team, investors will always choose the former over the latter. There’s no such thing as great business with poor management; it won’t last. So the lesson for business owners is, choose your management team wisely as your business grows.
- Scalable business model: investors will invest if exponential return in cost-of-goods-sold (COGS) investment can be forecasted, when there’s significant operating leverage. Whether the business is technology-based or processes-based, business owners will have to demonstrate that an investor do not need to continue to spend corresponding OPEX dollars in order for it to grow.
So really think about why you need outside money and what you will use it for before approaching and accepting the capital. Besides, there’s some truth to old saying that taking venture capital funds is like making a deal with the devil. Do you really want or need to do that?