Late last week, an industry friend sent me a link to a post on Pitchbook which presented an investment opportunity in the digital signage space. He wondered if I had seen it (I hadn’t) and whether I knew anything about it (I didn’t). In fact, I told him I was embarrassed that I couldn’t figure it out right away from the pitch itself, although I later hazarded a guess at Adflow Networks. A couple of days later, the DailyDOOH was on the case, also speculating that it was Adflow, which seemed to connect some of the dots within the pitch. That idea was dismissed by an Adflow executive, but that has not seemed to convince many observers. In the end, it doesn’t really matter who the mystery company is. What may be more worthy of discussion is why they would choose the approach they did to raise a significant amount of capital.
The pitch seeks $7 million in investment, ostensibly comprised of $5 million to make an acquisition of a partner company and $2 million for working capital. The PDF associated with the pitch provides a strong financial case for very rapid and profitable growth, both with and without the potential acquisition. It seems clear that this is not a start-up, but a real world scenario where a model is proven, contracts are in the drawer, risks are known or mitigated, and now it is about execution. Pro forma financials that show a $25 million top line with significant profits are the stuff of fast exits for investors, whether it be through a sale or an IPO. In short, a classic deal for a venture capital firm. Why then, does the mystery company choose to solicit investors from an internet site, represented by a third party whose web site seems more focused on executive search than investment banking?
The answer may lie in one sentence of the online pitch: “ownership wants to maintain majority control, so investor(s) must be willing to have minority position”. The ask is pegged at 100% of 2011 revenue for the primary company, and 262x of the combined companies’ 2011 EBITDA. Offering less than half of the company’s equity on that basis probably would not get one to first base with an institutional investor. If one is willing to accept the dramatic leap in projected EBITDA for 2012, the EBITDA multiple drops to 4.2x. Given further performance gains in 2013, that becomes somewhat easier to swallow… if you buy in to the projections. Everyone loves a hockey stick chart, but most VCs will want to understand why a marginally profitable company becomes very profitable overnight. My guess is that given the owners’ desire to maintain control after a large capital raise, they choose go after angels and private investors who are less likely to undertake the type of diligence that an institution does by routine. Raising that kind of money through individual investors can be a laborious and time consuming project. As in any business decision of this nature, there needs to be an objective that is clearly defined. In this case, the overarching objective seems to be maintaining control. But if their story is valid, is that the best decision?
There are times when working with venture capitalists makes great sense, even for companies used to the structure of angel funded or cash flow funded businesses. Among them are:
- When a significant raise is needed to meet strategic objectives
- When a company is entering a new phase in its life cycle
- When a strategic acquisition is in order
- When the potential need for a second raise lurks beyond the success of a first raise
A good venture capital or private equity firm can offer the experience and perspective to examine and enhance a business plan; the management input to help navigate the rougher waters of expansion phase businesses; the diligence, process and negotiation capabilities to evaluate and execute an acquisition; and the resources required to make a second institutional round a much less onerous prospect. To gain all of that, one must be willing to deal with the process and the terms of the institutional investor. This often includes a thorough diligence process, potentially contentious valuation discussions, board seats and/or control, and liquidation preferences. None of these are viewed by the average entrepreneur as a walk through the roses. To go from independent entrepreneur to employee-at-will of a board controlled by relative strangers can be a daunting prospect. But if the right institutional partner is chosen and that partner believes in your plan as much as you do, it is more often than not the right path to go down. Sometimes control is a less important objective than rapid achievement of a strategic plan and the ability to tap into greater resources.
I understand the mindset of the mystery company owners, as our own company has yet to take an institutional round. But when an opportunity to seize strategic advantage, to expand rapidly or to differentiate a company presents itself, certain things matter more than ownership percentage. Speed, execution, professionalism and deep resources can help create a pie so large that a smaller slice is worth more than the whole of the old pie. Three of the real tests of entrepreneurial management are the strategic calls they make around their own roles, organization structure and capital structure. If the pitch of the mystery company is reasonably valid, then they are facing all three tests right now. Scoffing at the advantages of an institutional investor at this stage may in fact give them a failing grade.