What Not to Do When Raising Capital
When looking to expand or take the first steps in beginning the process of building your ambulatory care start-up, the first thing that should come to mind is where the money for the project will come from. Raising capital can be the step in the start-up process that catapults an idea into fruition and beyond. However, as in all situations, there are two sides to a coin, and prospective business owners can make some common mistakes in the capital raising process that can cost them dearly. The Ambulatory M&A Advisor has compiled some of the top mistakes that physician owners should avoid when considering raising capital.
Carmelo Gordian, partner at the law firm of Andrews Kurth says that in his extensive experience with Private Equity, one of the largest and most common mistakes he has seen is that of poor business planning.
“There are a couple of things that you should do that people expect and I think are standard. You certainly shouldn’t go in with an idea and not having truly vetted it. By vetted, I mean produced into writing in terms of a business summary that talks about the business, prospective customers, the market you are trying to attack, and why it would be successful,” Gordian says.
“That doesn’t mean that you just hand over those documents. You probably want to provide an executive summary, then present in person if possible and lastly provide more detailed information including any PowerPoint used to present. It’s important to be organized. For a lot of key investors where you want to succeed as a result, you really only get one bite at the apple; it is really foolish to not be well prepared and really take advantage of that one bite.”
Jonathan Morphett, managing director, head of Investment Banking at Avondale Partners explains that a presenter coming to the table unprepared with a proper business plan is something that is commonly seen in the market. Morphett says this issue is more common with earlier stage businesses but can still be an issue for a more mature business.
Morphett says that no matter how grand the business plan is in the physician owner’s mind, being eager to raise money alone with a half baked plan is simply not enough. With no preparatory work done, the pitch to investors can result in less than desired capital amounts or failure to raise capital.
In the same vein of planning for an investment pitch, particularly for the medical audience, Gordian says physician owners have got to understand that when talking to an organization like a venture capital firm or a growth equity firm, they should always take a look at what they have done historically from a deal perspective.
“Folks tend to want to do deals where there is some similarity in what they do; this is broader than just being a “Life Science” firm. There are Life Science firms but there are some that will do something in Pharmaceuticals, Services, Physician Practices and some that will not. You need to make that effort to understand, once you have identified who those folks are out there, that have the capital to invest in your business at the level that you are seeking,” Gordian says.
Jim Hill, Vice Chairman of Benesch Law and Chairman of the firm’s Private Equity Group says that another common mistake physician owners make while raising capital is simply unrealistic expectations of value for their business idea.
“When you are starting out as an early stage company, it’s a differentiator as most people stay away from pre-revenue,” Hill says; adding that in these situations, owners tend to think their compound annual growth rate revenue for their idea will always grow at a rapid rate due to superb execution.
“There is a lot of competition among healthcare businesses and it takes a critical mass and a strong, experienced management team to prove the value of a company,” Hill says. Hill goes on to explain that it is hard to get started and promote yourself to the point of success when financing funds can consume your time and hurt your operations.
Blayne Rush, President of Ambulatory Alliances LLC says that the issue of over valuing a business is especially huge with many physician owners that come up with some sort of concept.
“They think that concept is the most valuable thing out there. In reality, concepts are a dime a dozen; execution is where the gold is,” Rush says.
Rush says in many instances, physicians or their advisors, think they have an idea worth millions, but that’s not how things pan out in the market. Rush says a lot of times, ideas die because the physicians, entrepreneurs, their advisors etc. put a concept together and want to go to market with a ridiculous valuation on it. Because there is no common ground between investors and the business owner due to the outlandish valuation of the business, the concept never gets anywhere.
“You really have to understand the landscape, understand who the big players are in your market. You need to understand where regional offices are and differentiate. Private Equity firms really want to be informed as to the competitive nature of the landscape of your industry that you are picking. The most important part is how the competition is growing their business and how much you understand the competition in conjunction with how you plan to grow your own business,” Hill says.
Rush says that other ways entrepreneurs overvalue in healthcare is that they come up with a business plan in the early stage and put in huge salaries for themselves.
“You look at that and wonder where their contribution is in the plan. In other words, it appears that all the fund raising is, is an opportunity for them to pay themselves. That’s the first thing that comes to my mind when these people have these high salaries. They ought to be boot strapping it and making the least possible amount until they prove themselves successful. The money that you go out and raise, the investors understand that you have to get paid something, but whenever it is at the top of the market, that becomes a significant red flag,” Rush says.
Ill Prepared Counsel
Although raising capital may seem like a one man job where a business owner pitches an idea to potential investors, this is definitely not the case. Failure to associate oneself with proper counsel going into a capital raising pitch and trying to represent the business idea on all fronts is a mistake that many people make that costs them capital.
“Fundamentally, if you have got serious interests like a venture capital firm, they are going to insist on competent counsel. This is a firm that they recognize, a lawyer that they recognize that have done it, do it consistently. This is so the process can be efficient and carried out properly,” Gordian says.
Apart from that, Gordian says there are business ideas that have individual investors early on but not an institution. The problem with this is that the individuals may not have directed the business owner in the proper ways of knowing how to properly structure their capital raising process.
“The reason it’s important is because whatever decisions you make good or bad as it relates to those early investors, you have got to live with down the road. So, you really need to understand, if there are terms that you want,” Gordian says.
“For example, if you take your early investments in a series A preferred stock, if it’s a small class and it has certain rights that are generally known as blocking rights, you require their approval to do certain things; but, it’s a small number of people. For the amount of dollars that you might have had invested in your business, you would have given them far more control over your business than is probably appropriate. Later investors will see that. You will either have to go back and fix it, meaning renegotiate, or it may become a barrier to the later investors. They may look at your business as more trouble than it is worth and not necessarily want to fix what has already occurred.”
Rush says prospective owners also need to implement a proper valuation early on and work with some external advisors that are well informed in the capital raising process.
“This is helpful because they are not emotionally invested and will honestly predict what the market will most likely hold for your company’s value,” Rush says.
Raising Capital: Time Frame and Amounts
Rush says that wanting to raise capital quickly with little to no thought of time frame is an easy way to miss the opportunity to start a business.
“It really depends on where you are. There are early stage companies and they really have no operation history. Then there is the company that has the history and has been around for five years and wants to take their business to the next level. Those are two different types of businesses as far as capital raise goes. In both instances, this takes months, time and effort,” Rush says.
According to Rush some people think that raising capital is as simple as sending out emails or hiring an investment banker to raise large sums of money in a matter of a few months.
“It doesn’t work like that. We have to go out, put a lot of money, effort and time into fixing a lot of your documents, business plans etc. Then we have to go to the market answer questions, get them comfortable with the business. It just takes time. Two or three months is not going to get it,” Rush says.
“I walked away from a capital raise opportunity because they wanted it done in 90 days. They wanted to pay me a lot of money up front to do it, and there is no way I could meet that expectation. It just takes a lot longer than people expect. So if you think it’s going to take a year, you need to be set on that it’s going to take longer than a year. It depends on how big it is, and what your history is. If you have a history of good will and you have some cash flow, then that will probably be easier than if you ran negative for a while. There is higher risk in that.”