Top Common Mistakes in Raising Capital

Red flags raised on common capital raising mistakes.

Red flags raised on common capital raising mistakes.

Everyone makes mistakes. It’s a fact of life. However, one aspect where one would not want to make mistakes is when raising capital to fund or expand an important project like an urgent care business. Unfortunately, according to legal and financial advisory experts, mistakes can be a common occurrence with entrepreneurs that are eager to raise funds for their goals. These experts discuss with The Ambulatory M&A Advisor the top common mistakes in raising capital, how they happen, and how to avoid them.

Having a Half-Baked Business Plan

Preparing to approach an investor for raising the funds for your expansion is one of the most important aspects of the process. This can literally make or break the funding of a center from an outside investor.

Jonathan Morphett, managing director, head of Investment Banking at Avondale Partners explains that the concept of a half-baked business plan is something that is commonly seen in the market. Although, Morphett says this issue is more common with earlier stage businesses, it can still be an issue when expansion is desired for a more mature business.

Morphett says that physician owners may have a business plan that works in their mind and may seem like a great opportunity and reason to build or expand their brand. At this point they are eager to meet with investors and pitch a home run.

However, Morphett says, in instances where capital fails to be raised or is raised on less desirable terms, there hasn’t been the preparatory work done to prove that the business plan is solid.

Morphett says investors will inspect how big your market size is, from where you draw your patients, who your competitors in the market are, what the regulatory environment for your particular business is, what your competitive advantages are, etc.

“Those kinds of considerations are really important and they are fundamental questions that any investor or acquirer of a business spends a lot of time focusing on,” Morphett says.

Stephen Scott, managing director at Avondale Partners agrees with Morphett’s conclusion and adds in some advice in regards to the team required for a successful attempt at creating a working business plan for investors.

“I think sometimes, especially in physician owned businesses; the business plan needs to have the insight from someone with finance and accounting expertise,” Scott says. “It’s going to be crucial that new investors can see a pathway to profitability and growth. It’s just not the business plan, per se, and operations, but especially in healthcare, investors want to understand what the reimbursement risks are and what headwinds or tailwinds of reimbursement in specific industries are, so that they can get comfortable with the projections of the business.”

Not Enough Money, Not Enough Time

Both Morphett and Scott say that improper judgment on the size of the capital raise can be a mistake that ultimately harms an entrepreneur’s business.

According to Scott, there is some art and science involved in judging the proper capital amount needed to properly fund a center or expansion.

Scott explains that having a good advisor to help you with that aspect of the process is crucial because they can represent an independent third party perspective for the founder of the business.

“You are guaranteed that every business plan has errors and flaws in it somewhere. No plan is perfect, and there are going to be bumps in the road. So I think there is a sense of making sure you go out and ask for the capital that you need so that you aren’t in a never ending capital raising mode,” Scott says.

He adds that often, CEOs of businesses can be caught up in capital raising cycles.

“These capital raising cycles take a while, and by the time they have funded one round, that’s already spent, the growth projections have changed and they need to go raise another round. The CEOs become professional raisers of capital versus really being able to focus on operating the business. I think that’s one flaw, if you don’t raise enough capital on the front end, you get in a cycle of always being in a capital raising mode and are not being able to focus on operations,” Scott says.

Morphett advises when planning a capital raise, you need to plan for the fact that there is a big time sink during that effort. Morphett says owners have to be thoughtful about how their business going to be managed during this process.

“If you’re in a constant capital raise mode, your actual business may suffer because you might not have the resources managing the business that you need while you are doing the financing process,” Morphett says.

Raising Funds Too Late

Bill Kennedy, director with Navigant Consulting says sitting on the sidelines and waiting to raise your funds when your goal is to expand your business, is also a common mistake that entrepreneurs make.

“There is a tremendous first mover advantage for urgent care. Urgent care in many ways is more of a retailing business and less of a healthcare business. Location is everything,” Kennedy says. “It’s really where do you site things…are you in a high traffic location where there is not a lot of competition but where people are going to be looking for you?”

Kennedy says in this growing market, there are only so many prime locations for entrepreneurs to build and expand.

“You’ve got to get your prime real estate before everybody else does,” Kennedy says. He explains that if a physician owner waits too long to jump on their expansion dreams, all of the prime locations in their area will have already been taken up.

“It’s very difficult to make an urgent care business work from around the corner in the back of the shopping center. It’s got to be front and center where people see it,” Kennedy says. “It’s not something that people will seek out and find. They go to one because they have driven by a few times and they know it’s there.”

Lack of Realistic Company Value

Kennedy says that one thing that primary care physicians or other urgent care owners fail to realize is that the value they have in mind of their center’s worth, is usually not a number that an investor will agree on.

“When doctors look at their urgent care center, and they are working there 40 hours a week, pulling out $500,000 dollars; they assume that that $500,000 dollars is value that somebody is going to pay for,” Kennedy says. “It’s not, because they are doing the work, you have got to pay somebody to do the work.  They are combining their equity return with their salary,” Kennedy explains that the reality is that the value of that center is lower than the owner’s expectations because somebody has to be paid in order to do the work, thus decreasing the cash flow available to an investor value.

“They look at their salary as something that an equity investor would give them a multiple on, and they won’t,” Kennedy says. “Owners tend to think something they built is more valuable than it is, and man don’t understand the trend in healthcare towards systems which provide the whole continuum of care.  This often makes it difficult to profitably carve out a small niche in the healthcare market.”

Kennedy says that other valuation mistakes are made because people want to sell something too soon. As an example, he says that a seller could approach an investor and try to sell their business based on the the last three months of results. 

“They have just reached the point where they are making money and then they want to sell. Somebody says “Well, you’ve got three months of profitability; there was an 18 month start up period. Let’s wait a little while to see how the business is really doing,””Kennedy says, expressing the potential seasonality or short history of profitability of success.

Too Little, Too Many Cooks in the Kitchen

Morphett says that there is the possibility of making a mistake by either having too many or too little hands in the investment pot.

“One of the jobs of the senior management of a business is the governance of the business. This is really important and if you’ve raised money from a whole bunch of friends and family, you don’t want to have 50 different voices on the board giving their input into how to run the business,” Morphett says.

Morphett advises that in high numbered investor situations, it’s good to make sure that there are a couple of share holder representatives that sit on the board, who also have very good business sense, commercial sense, and can help the founders of the business. It also means that you are only dealing with a few people and not 50, Morphett says.

He also says there is another end of the extreme with having a small number or just one investor.

“If I’m a founder of a business trying to raise capital, and I’m dealing with just one person, you often need to understand that person will have a significant influential voice on the business going forward,” Morphett says.

He says a common mistake in this situation is that owners and founders of businesses tend to overly focus on the price or value of any investment and don’t pay enough attention to the non price terms with that particular investment.

Roberto Castro, an attorney and Certified Valuation Analyst (CVA), Law Office of Roberto Castro PLLC, based in Central Washington State adds that as an initial matter, founders need to execute a substantial buy-sell agreement in place to address contingencies ranging from retirement, death, disability, bankruptcy and divorce.  The founders can expect to see substantial revisions to the buy-sell, especially if the funding source is a private equity group.  Castro notes that absent a buy-sell and one that is funded when disagreement arises, can quickly lead to costly litigation that may well undermine the vision of the business plan.

Morphett believes, “It’s great if you are getting a good value with that particular investment, but if there are all sorts of terms and conditions that come along with it, that make it hard for you to implement your strategy, then it’s probably not been a very successful deal. There are times where it’s better to go with an investor who maybe is offering you less value, but there is a better fit between the founders of the current business and the new investor. It is very important for there to be an alignment of vision, strategy and sufficient financial and operational flexibility so that the business can effectively implement its strategy and growth plans.”

 He adds that when making this type of decision it is important to find good financial and legal advice that will help the business owners during the financing process and evaluate the merit of financing proposals.

 Castro, advises that even though business owners looking to expand may want to stay with their existing financial sources and advisors; it can’t hurt them to explore alternative professional resources to assess the needs, develop various facility expansion plans and the associated mitigation risk strategy, and learn of new capital/funding sources.  As for professional advisors, there is a fair amount of movement in and out of established healthcare and valuation advisory services.  Many of these professionals leave and form competing firms.  These professional  and new firms can provide a compelling value proposition, and at a competitive price.  The same holds true for funding sources.

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