Have enough cash

This blog was prompted by two recent events I have witnessed in the public markets, but also holds for privately held companies as well. The “mantra” for companies is often “always have enough cash for the next 9-12 months”; and this is for a very good reason as the cost of capital when a crunch comes is a lot higher than if you can plan ahead.

In the first event, a listed med-tech company raised money just over a year ago for an acquisition and to fund itself for the next 12-18 months as the business grew. Unfortunately, revenue growth was well below the company’s expectations, and this precipitated the situation whereby new customers would not sign up as they knew the company was stretched financially and may not be around in the future…thereby making revenue generation even harder. The situation was made worse by the directors saying that the company had strategic value that the market didn’t recognise and they were going to look at options to sell the business. By the time they publicly admitted that the company was running out of money, there was only enough cash to continue trading for the next 2 weeks… and inevitably the share price fell over 80% and they were forced to raise money at that level, resulting in huge dilution to all existing holders, including the management who owned a big percentage of the business. As far as i am concerned, this is a shocking dereliction of duty by the board, and they should have acted far sooner rather than hoping that new business would be signed and taking the company right to the brink of insolvency.

The second event is similar in that, pre-emptive action would have protected the company and avoided a cash crunch and heavy dilution. In this instance, a pharmaceutical company with a material improvement on the existing available product formulation was trying to sell into the lucrative US marketplace. It raised what it felt was sufficient money to cover two years worth of costs of the sales force, and assumed that sales would accelerate after the first 6-9 months. When it recently reported that the first 6 months of sales were lower than people were expecting, that was a bit of a disappointment…but what was more worrying is that they had used up almost half the cash they had raised, meaning that any continued sales delay would result in a cash crunch – you can guess what happened to the shares – they fell 40% in the next 2 days. If the company had taken the opportunity to raise just a little more cash in the preceding few months, or had been a bit more careful ramping up the cost base (albeit a necessity in this case), then the inevitable dilutive share issue could have been avoided.

These scenarios play out in the private markets as well, although usually in a much less extreme way as there is not the same level of share valuation mechanisms, with daily pricing of a company. This often makes it easier to avoid the same level of dilution of equity in a cash raising situation – assuming that the company is not about to become insolvent. As a result, companies can sometimes “get away with” having a little bit less cash (say 3-6m at worst) and also protect their valuation and reduce the level of dilution when raising the additional capital. Having said that, private companies can also get themselves into difficulty – I had a recent situation where a company was in takeover discussions with a much larger player and these lasted four months and looked days away from being signed off when the acquirer walked away. By then, the target company was distracted strategically as they were expecting to sign the deal, and in a very tight financial position. They were essentially forced into doing a deal with the underbidder, who obviously reduced the price they were prepared to pay, and the company ended up being sold 6 weeks later for 75% lower than the initial bid. With a stronger balance sheet they would have had a much better negotiating hand.

Many Founders I speak to complain of feeling like they are always on the treadmill of fundraising and don’t have enough time and headspace to run the actual business and do the necessary strategic thinking, as they are always pitching. Solutions to this can involve having a dedicated person to handle the funding – although most potential investors will want to hear the pitch from the Founder themselves. Another solution is to have concentrated funding windows, when you get all the pitches arranged over a 2-4 week period – it’s exhausting, but does free up more time for the business of running the business.