With India having touched down on the surface of the moon last year, an impressive achievement by all accounts, we are reminded of the dozens of failed attempts to do the same over the past 30 years. I have always been amazed at the degree to which these missions are planned, contingencies mapped out and single-point failures eliminated — only to result in disappointment in spite of the high degree of care and attention to the planning.
Cash flow is undoubtedly the rocket fuel of enterprise. Not only is cash necessary to fund day-to-day business operations like rent, payroll and inventory, but it can ignite business growth and expansion. The fundamental requirement to balance in and out flows was never more apparent than during the height of the Covid pandemic, when businesses, small and large, across an array of industries, were required by law to stop providing services or selling goods but remained pinned to recurring fixed expenses. For some, relief in the way of grants and subsidies were available, but the timing of the subsidies and the extent to which they actually covered hard costs created intense pressure on operators. Apart from perhaps the survivalist community, it was the rare gem of an entrepreneur that had planned contingencies for a worldwide pandemic.
Normally, a business will find itself in one of four life cycle stages: startup, growth, maturity and decline. While cash management is crucial in each stage, arguably an enterprise is most sensitive to liquidity needs during its launch. This is when expenses can precede revenue generation and R&D and scale-out efforts can rapidly drain the bank account. In an ideal world, a business can project its cash requirements in advance and prepare itself to seek financing. This preparation phase is key – to be sustainable a company not only needs a smart business plan but to be perceived as “investable” by the financing community. Refuelling is inevitable.
Enterprise financing usually comes in two flavours; debt or equity. Debt financing involves leveraging the assets of the business or the strength of existing cash-flows to borrow money from a lender, often a financial institution. Typical deal points include the principal amount of the loan, the term of the debt, the interest rate and the security package (i.e. collateral) granted to the lender. A borrower also needs to remain in good standing and fiscally healthy throughout the term, and most lenders mandate ongoing reporting and the maintenance of certain financial covenants (i.e. indicators of financial health). Importantly, debt financing does not involve the transfer of any ownership of the business and once repaid, falls away like a booster rocket.
Equity financing, on the other hand, involves the sale of shares in the capital structure of a business. This can take on many forms, but in essence, the enterprise sells an ownership stake in exchange for investment dollars. The typical negotiables of an equity deal include the type of security or share being sold, the valuation of the business (i.e. price per security), governance and investor rights (including voting rights) and dividend entitlements. Unlike debt financing, capital raised in an equity financing does not need to be repaid but the investor-company relationship can be in perpetuity (so select your investors wisely!).
Ultimately, most companies can only achieve a certain orbit based on founder money. Even if the principals can afford to fund startup and growth, it may be preferable to spread some of the risk to outside stakeholders such as financial institutions and equity investors. Understanding the company’s cash needs, pro-actively preparing the company to meet lender or investor needs and negotiating the right deal can be the difference between a thriving business and a crash on impact.
This blog post was written by Neil Schwartz, a Practice Lead of the Business Law team. Neil can be reached at 613-369-0357 or at neil.schwartz@mannlawyers.com.
