Why raising debt, cash and equity isn’t always a good thing? I think in the Silicon Valley, a VC start-up world is almost normalised that you’ve got to raise millions. Now, of course, if you’re trying to be the next Uber, Airbnb, you’ve got some kind of invention that takes millions of pounds to create, yeah, you’re probably going to need to raise external finance. But I think a lot of people assume that it’s the “done thing” without really thinking about the downsides.
Now, the opposite of raising debt, cash and giving away equity is bootstrapping or self-funding the business. That could be you personally loan it some money, or you fund it through cash flow. So, the first point, and I’m going to make about 10 points here.
1. The first point, is, try and fund through cash flow if you can, which means sell some stuff, put some money in the bank, and then reinvest the profits into more marketing, hiring, IP, stock, or whatever it is, that your business has that’s an overhead. Because selling out from the start just dilute your equity, which of course, you know, but then when you have to go for Round 2, Round 3 of raising more and more finance, you’re diluting on diluted dilution.
2. Okay, so, when we need money, we often don’t see the cost, because we have these like what you call them, rose-tinted glasses, we have the happy eyes. Oh, I need the money. I need the money. I need the money. We see only the downside of not having money, and the upside of having money. We don’t see the downside of having money. So, the downside of having money, is, you immediately have extra stress on the overhead, because obviously, you have interest to pay. Now, if it’s a loan, you have to interest to pay. If you’re giving away equity, then the stress on the overhead, is, the shareholding, which it’ll ultimately lead to you getting a lower share of the profits.
3. So, that’s the next thing, which is the reduced shareholding. Now, if you reduce the shareholding, you could argue that raising equity and cash enables you to grow more, and therefore, you’d rather have 50 percent of a much bigger pie. I mean, that’s the reason why you should raise debt, cash and give away equity, but I’m talking about the opposite. The downside, is, you have reduced shareholding. So, if you sell half your company, then you have half of the sale value when you sell it. Of course, you have half of all profits through dividend or whatever else. Of course, you’ve got to then talk about managing salaries. Do they take a salary or not? How are they paid? How are you paid?
4. That brings me onto the next point, is, often small start-up businesses are lifestyle businesses, which means people use them as a sort of a self-function, if you like. So, you can put certain expenses through. Or, you sort of underpay yourself for a long time. Or, sometimes, you pay yourself a lot of money. When you’ve got external shareholders, that’s all over. You have to buy the book is the wrong word. But there are certainly expenses that you can offset, and things that you can run through your business as a lifestyle business. The external shareholders wouldn’t necessary want you to do all, would want to be involved in the discussion.
I’ll give you an example with an LLP. You can run cars legitimately through an LLP. You make sure you speak to an Accountant or someone qualified, before you go and do this. But, if you decide to put a Lamborghini, a Ferrari, an Aston Martin and a Koenigsegg for your LLP, then your external shareholders might have something to say about that.
5. Of course, the next thing then, is, you’ve got reduced control. So, when it’s your business, you can do what you want, when you want. You can make the decisions that you want. You’re flexible. You can pivot. You’re lean. You’re agile. Then when you have other shareholders, you have responsibility, of course. I mean you always have fiduciary duty in a business. But you have fiduciary duties to other shareholders. You have shareholder responsibility.
6. Now, of course, sometimes, people will just go for the easy money. If I were to raise debt and raise cash, and give away equity in my companies, which I’ve never done till this day. I’m still 50 percent shareholder, and my business partner 50 percent shareholder in all of our companies. But if I was, I would not see all money is equally the same, because I might give away a little bit more, but have someone who’s putting the money in, who’s got a lot of experience and contacts, or it’s someone with shared values, or someone who’s been in my niche before. I see that they’ve got knowledge that can really help me. By the same token, I wouldn’t take a better deal, where the money was coming at a price, or a cost, or with leverage, or some kind of controlling mechanism, or for someone I just didn’t think had any other value, or I didn’t like. So, money doesn’t have the same value. It has different values depending on how it comes, and what the terms of the money are. Like I said, when we’re desperate and we need the money, then we kind of, yeah, all right, I’ll just take whatever deal. Then later down the line, we have a bigger problem.
7. You, of course have reduced freedom, because you can no longer do, and say, and decide what you want, when you want. Now, by the way, that’s not always a bad thing. Maybe, I’ll have to do another Money Podcast and Video some time on the upsides of raising debt, cash and giving equity away. I think, that’s pretty clear. That’s kind of a thing, when a lot of people talk about that. But there’s not a lot of content on why you shouldn’t. People use cash to fuel growth. Cash is one of the mechanisms to fuel growth. It’s not the only one though. But it’s assumed that cash is the major mechanism of fuel and growth. But it can also be a bit of a red herring, in that you can use cash to fuel growth, but you can waste that cash.
8. Because if you use just cash to fuel growth, what you probably don’t use, is, creativity, innovation, ingenuity, some leverage. Like, the more money I’ve had to invest in my companies in marketing, the more I kind of go, yes, spend it. Yes, spend it. Yes, spend it. When I haven’t had money, I go, no, track it. No, split test it. You know, test it on a free platform first.
So, you have to be careful. Once you’ve got all this money, and you feel like you’ve got to spend it, and invest it. The shareholders are pressuring you to fuel the fast growth. You’ve got to spend, spend, spend this money, and you don’t necessarily spend it in a most lean or calculated way. It can just ruin creativity. I don’t know, if you have got a business, but when you start, you have to use all the assets you’ve got other than money. So, all that resourcefulness, and that latent creativity and that adaptability, that survival instinct, that all comes out and you hassle. You get on the phone. You’re doing 6 calls a day to sell, and all this kind of stuff that you don’t do, if you’ve got millions in the bank.
9. Okay, I mean this is kind of like a bit extreme, but it does happen in much bigger companies. But if you end up giving away shares, or going public, in the end you could be exposed to a hostile takeover. That would be a bit of a nightmare, if that was your business.
10. You could be over your head contractually, i.e., you’ve borrowed money, some smart lawyers, or VC firms, or private financers could tie you in knots, contractually. You’ve signed it, because you haven’t got a good lawyer, or their lawyer is much better than your lawyer. Or, you just sign it, because you’re desperate, and you need the money. Or, you’re not the sort of person that wants to read a contract. Then in the few years, and all these bombs go off, and the contract and there’s all these terms and things that you may be didn’t know about, that’s got to be on you, because you’ve got to do your research when you’re looking to raise money for a business.
But you know, that can happen. That’s not uncommon. Also, if you’re ever looking to sell, companies might ask for earn outs, which is like, we’ll pay you 50 percent now, and 50 percent in 2 years, when all this matrix have been hit. Those matrix don’t normally happen, and if you speak to most people who’ve sold companies, those earn outs don’t normally come to fruition. So, if you’re looking to sell your business completely, maybe you want to get out of it what you can get out of it in cash upfront. Then maybe the earn out is a bonus. Maybe, you don’t want to be tied to a business that you’ve sold, that you’ve moved away from. Maybe, you might lose your desire, or you have to deal with a whole new culture.
Okay, so, let me then remind you, and do a summary of why raising debt, cash and giving equity away, isn’t always a good thing? Sometimes, it is. Like, I said, I’ll do more content on it in the future.
- Okay, so, you might want the money now, but there’s always a cost.
- Those costs, sorry, everything else like, distress on the overhead.
- They reducing shareholding.
- Therefore, the ongoing reduced profits, you can take the reduced control this responsibility to other shareholders who you maybe don’t know very well yet, and don’t know, if you can work with. They may stifle you. Like, record producers who come in to try and stifle an artist. They may stifle you that. They may actually not be good for you in that regard.
- It’s no longer a lifestyle business, and you can’t run things, and put expense through that you want to, because you’ve got to run that by every shareholder.
- There could be a hostile takeover bit in a very extreme example though to be fair.
- You’re not using creativity leveraging ingenuity.
- You’re just using cash. You become lazy, and just reliant on the money.
- Sometimes, I’d like to trick myself that our cash position or our profitability is lower than it is, because it gets me resourcefully. It gets me committed, you know, just searching the depths of my brain to solve bigger problems. What Mark, my business partner, often do, is, take a few million out of the current accounts of the company. I’ll look at the bank statements, or you know, I’ve got to go and log online. Actually, I think, bloody hell, it’s only a few million quid in the bank, I better go and bring a few million quid in, when actually there’s a lot more. Mark just play a little trick on me.
- You can also get it over your head contractually. It can distract you from sales and marketing. Trying to sell the business, or raise money can spend months or years, distracting you from running the business, growing the business, serving the clients and customers, creating a culture, and ultimately, sales and marketing and scaling up.
Thanks for tuning in to The Money Podcast. Remember, if you don’t risk anything, you risk everything. Are you subscribed to the sister podcast for this podcast Money, which is my podcast, The Disruptive Entrepreneur? If you’re not, you can find it on iTunes or Stitcher. Or, you can type into any browser, bit.ly/disentpodcast. Yeah, I mean I interview people on that podcast. I had some amazing guests. Some big, big, big, big names, way bigger, punching above my way just like my marriage. All right, anyway, enough for that. Have a great day!