Understanding Capital Part 4: Get Out From Underneath Capital - Linden Legal Strategies |Business Attorneys For the New Economy

Capital. You’ll be hard-pressed to find a business that doesn’t need any to function and yet, for most businesses, understanding “capital” and capital needs can be a confusing and murky topic. Over the past two weeks, we’ve worked to take out some of the mystery related to capital (both what it is and how to raise it) in this four-part series, Understanding Capital. In our first installment, we provided a primer on the different types of capital. In Part 2, we talked about the more traditional ways of raising capital. In Part 3, we’ll talk about the non-traditional ways of raising capital. And finally, today we’re talking about how to get out from underneath capital.

 Reasons Why You May Want to Get Out From Underneath Capital

There are lots of reasons why business owners rework their capital structure. Knowing why the changes need to be made and what you hope to gain from the recapitalization are just as important as how you move forward. While these are some of the more “popular” reasons, this is by no means an exclusive list. Business owners tend to believe that they view their companies in rational terms, but for many – and especially founders, there can be just as much emotional reasoning tied up in the decision to restructure as there is legitimate business need.

Debt
  • Debt is negatively impacting cash flow
  • Repayment / finance terms may no longer be favorable to business
  • The business may want to sell the equipment / property that is securing the debt
  • The debt may require a personal guarantee from the owners
Equity
  • Control issues
  • Investors wanting long-term results on a short-term investment
  • Business needs change

In a perfect world, differences in investment strategy should be uncovered during the pre-investment phase. Unfortunately, though, it is often the case that those seeking capital are blinded by the urgency to find dollars to fund their dream before it is snatched up by someone else. Those with capital are often hearing what they want to hear: an investment opportunity that is better than any investment opportunity that ever was, with a bigger and faster return on investment than anyone can imagine. In fact, the misaligned investment strategies of the parties doesn’t facilitate anything other than (i) unhappiness of the investors with the underperformance of the investment both in speed and magnitude, and (ii) frustration for the In-the-Business- Owner who can’t understand why the investors are so unreasonable. The answer to each party is that they unfortunately got what they bargained for BUT not what they wanted.

How Do You Get Out From Underneath Capital?

Once you’ve determined that you need to recapitalize, the question becomes how you do it. Some examples of recapitalization include:

Debt
  • Restructuring the debt
  • Reworking your internal operations to pay off the debt
  • Taking on new investors or initiating a capital call from current investors to raise the money necessary to pay off the debt
Equity
  • Taking on debt to repurchase investors shares/interests
  • Finding new investors to purchase shares/interests of current investors
  • Using personal funds to purchase shares/interests of current investors

The first rule to remember is that you can get rid of investors BUT you can’t get rid of the business’ need for capital.  Scientists have long accepted that energy cannot be created or destroyed. Businessmen, however, have attempted to ignore the first and second rules of corporate finance–the need for capital cannot be destroyed and the removal of one source of capital results in another source of capital taking its place.

Where Do You Find New Sources of Capital?

To start, refer back to Part 2 and Part 3 of this series which breaks down the many different types of capital. If you’re looking to take on debt, start with your current financial partner or ask your attorney/accountant for referrals. There are lots of great lending institutions and investment bankers out there and all have different specialties and niches. Finding one that aligns with your goals and needs is key.

Another source of capital might be simply (but not easily) found within the operations of the business—i.e. by increasing revenues or decreasing expenses. Although this approach helps to avoid debt and keep investors at bay, it does little to grow the business. In fact, in most cases it will destroy the business because it is unsustainable and isn’t a growth plan at all.

The ease of finding new investors whose investment strategies mirror that of the company’s may be hard, but not insurmountable. There are lots of different types of investors, different investment strategies and creative ways to structure the business to meet short and long term goals. If you’re undergoing recapitalization, take stock in what worked (and didn’t work) and make sure that you align the business goals with your investors.

When you think you’re ready to recapitalize, reach out to your accountant, financial advisor and your attorney – this team should be consulted with and become an integral part of the planning and implementation of any plan.

 

This article is for informational purposes only and does not constitute legal advice nor does it create an attorney-client relationship.  Always consult appropriate legal counsel for specific questions related to your business. Some states may consider this attorney advertising.

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Terri Amernick is an attorney with Linden Legal Strategies PLLC, a Richmond, Virginia-based law firm focusing on business law and development. To learn more about how Linden Legal Strategies can help you start, grow and protect your business click here and schedule an initial consultation.