Your Source of Credit Advice

We all know how tight banks have gotten with lending over the past 24 months. Before that credit cards were handed out like candy, but today even having excellent credit doesn’t always guarantee approval. Meanwhile it has been next to impossible for those with poor or fair credit to get a half-way decent card. That brings us to the question, would it be best for those in this category to avoid credit cards altogether until the recession is over?

Unfortunately, it looks like those who have fair credit probably should avoid applying for any new cards until the economy is further along in its recovery. This is due to a number of reasons. First of all, most of the credit cards for fair credit which are currently available have very unfavorable terms. They are charging excessive annual fees, offering extremely low limits and some are even requiring a security deposit. Cards like these should be avoided at all costs.

The second reason to avoid these types of cards is because once the economy improves a bit more, those with fair credit will be able to qualify for cards with much better terms. So unless you absolutely need one, wouldn’t it be best to wait a few months?

On the other end of the spectrum, there are those who feel differently than me. Some people believe the recovery will take longer than a few months (possibly a few years) and they don’t want to wait that long to get a new credit card. While they do have a valid argument, they should at least consider waiting six more months before applying – that will give them a better idea of where the economy is heading. At that time, if it still looks like it’s not going anywhere, then they can make a more informed decision as to whether or not those unfavorable terms are actually worth it.

When we consider how spinouts go about their exit planning, it is instructive to consider the differences between them and other small- to medium-sized enterprises (SMEs) about which most of this book has been written. We will begin with business objectives.

typical SME in the UK will be solely owned, or have co-owners working full time in the business. Some will have outside investors in the form of family members, or perhaps a Business Angel or VC, usually holding a minority interest. In most SMEs the business and exit objectives of co-owners will usually be broadly similar, although the date they wish to exit could be different.

With most spinouts there will be at least three groups of shareholders, namely the inventor/academic, the university and the outside investors, so the individual shareholders will have institutions (whose objectives could be quite different from their own) as fellow shareholders.

The Higher Education Funding Council for England {HEFCE) was established in 1992 to administer public funds made available for the provision of teaching and research and related activities in higher education institutions. In 1995 the HEFCE commissioned RSM Robson Rhodes to conduct a study of related companies operating within the higher education sector, and to produce guidance for the sector in the form of recommended practice guidelines.

The report included the following background comments: Institutions set up related companies for a variety of reasons. These include: to carry out activities of a commercial nature; to reward, and retain, key academic personnel; to avoid demands on the institution’s management resources; or as a means of conducting joint ventures. With the increased pressures on funding, institutions are seeking alternative sources of income and are looking to expand their commercial activities. It is likely, therefore, that related companies will play an increasingly significant role within the higher education sector in the future. The activities of related companies can vary considerably, including exploitation of the commercial potential from research and intellectual property OP). They may also help to attract private funders to share in the risks and rewards of ventures which institutions may not otherwise be able to fund.

By establishing a related company to undertake a commercial activity, an institution may be able to ensure that its powers are not exceeded, that its legal duties (specifically under the law relating to charities) are not breached, and that its governors reduce the risk of personal liability. By carrying out activities through a company it may be possible to limit liabilities which may arise, for example through negligence or breach of contract claims.

Spinouts also face the same problems in achieving a successful exit as other SMEs; and most of the exit planning issues I have covered in this book will apply equally to them. Where they are different, perhaps, is in the number of times they will seek investment through the various funding ’rounds’ that are an integral part of their growth and development.

Preparing for each of these funding rounds can be seen as analogous to grooming the business for several exits. The academics whose discovery or invention is being commercialised usually manage spinouts at start-up. However, many academics find it difficult to handle the extra burden of managing a commercial enterprise and later (perhaps following second round of funding), it is not uncommon for professional, perhaps more commercially-minded, managers to be introduced to the company. The board of directors will usually contain representatives from the company’s management, the university and the outside investors.

University spinout companies are usually set up by academics wishing to commercialise their research, supported by the university where the research has been undertaken. The university will usually own the intellectual property (IP) arising out of the research undertaken by its employed academics.

The university will typically hold its shares through a special purpose company, following the model for spinout companies in the UK laid down in the RSM Robson Rhodes Report.

Initial ‘seed corn’ capital to get the business started is usually provided by the university or by government funding through, for example, the Higher Education Innovation Fund. Following this initial funding, the company will attempt to secure further finance from Business Angels and/or venture capitalists (VCs). Consequently, it is usual for spinout companies to have three groups of shareholders, namely the inventor/academics, the university itself and outside investors. These three groups of shareholders will usually have different business objectives and ambitions and this will, obviously, influence their exit aspirations. The formal relationship between the various groups of shareholders will be governed by a shareholders’ agreement produced either by the university or the outside investors.

Sir Christopher Evans, Chairman of Merlin Biosciences and considered to be Britain’s most famous biotech entrepreneur said: ‘Once created, university spinouts face the same challenges as any other start-up, principally finding finance, attracting and keeping key personnel and delivering on their business models.’

If, after thorough analysis of your capital requirements, you still believe your business needs extra funding, be it for expansion, capital equipment, or working capital, you now need to consider the following:

a) Is the capital a long-term requirement, or a short-term one?

b) Do you personally have the resources (assets or security) to provide this extra capital?

c) Can the capital be secured from sources of loan funds, including:

• traditional lenders, such as banks?
• family or friends?
• government agencies?

If you decide, in the event, that the only way you are going to secure the funds you need is through issuing shares to others, you could still do it in a way that could maintain your complete control over the company and your exit planning flexibility. For example, you could issue shares of a different class to your own shares. These could be shares that are entitled to a preferential dividend and repayment at their face value (or value at which they were issued), but have no voting rights, or rights to a share of capital proceeds in a winding up or sale. By issuing such shares you achieve your objective of raising extra capital, without having a shareholder who could compromise your ability to sell 100% of the company.

For an established business there are usually two reasons why additional capital is required. The first is for business growth or expansion (either through acquisition or organic growth) and the second is to fund trading losses. The questions you need to ask yourself are whether you really need the extra money and whether you can raise this funding from external sources in the form of debt, without the need to sell equity in your business.

In the case of requiring capital for expansion, the first step you could take is to ensure that you have produced a realistic business plan with rigorously tested cash flow forecasts that show unequivocally that you need the extra funding. If this is indeed the case, the next step is to consider why you are considering bringing in an equity partner. Is it because you cannot raise the money elsewhere, or is it because the prospective partner also brings other assets to the business, such as a technical or professional skill that you do not possess and which is not easy to acquire elsewhere? On the question of raising the money elsewhere, have you approached the likely funders, such as a high street bank; or have you avoided this because you do not have a professionally produced business plan?

In many under-performing businesses the idea that additional capital will solve the problem is a misconception. Often, throwing money at the business is not a solution to the problem, it merely delays discovery of the solution. If your business is losing money, the first thing you need to establish is does the business really need extra capital, or does the answer to its problems lie elsewhere, perhaps in closer cost control, or expansion of the product line, or reducing your
own drawings?

Before we consider the alternatives to having co-owners, I wish to make the general point that there are always potential risks in having co-owners in a business and that you should be sure that the advantages of having them outweigh the disadvantages. Two of the most obvious risks with having co-owners are as follows:

The risk of fall out between you and your co-owner and the subsequent risk to your business and possible major disruption to your life. (Think of how many unfortunate examples you personally know where this has happened!)

The risk that your co-owner will make it difficult for you to exit the business at the time and at the price of your choosing. Bearing these in mind, we can now look at the most common reasons given for taking in co-owners and analyse whether there are other ways of achieving the same results.

Where you are considering having a co-owner, you have an opportunity before committing to this path of evaluating the pros and cons of this proposition. In this regard, it might assist you to consider why others have thought if necessary to work with co-owners.

When I have asked business owners why they thought they needed to bring in a co-owner, the most common reasons given have been as follows:

• the potential co-owners will provide the additional (or start-up) capital that the business needs;
• the need to add technical and/or managerial support to the business, which is best achieved by offering equity to the individuals with these skills;
• the desire to lock in, reward or motivate existing key staff members by providing shares or share options;
• the need to placate family members by bringing them into the business.

Your own reasons for wishing to have a co-owner could be included in this list. But, is bringing in a co-owner the only or, indeed, the best solution to the problem? Are there alternative ways to achieve your objectives?

Co-owners in a business are either shareholders (who own shares in a company), or partners (who own interests in the capital of a partnership). Co-owners should be distinguished from directors and employees, who may or may not be shareholders, no matter how senior or important they may be. Co-owners can be passive shareholders, such as sometimes happens with venture capitalists; or active ones, such as working shareholders who are also directors or employees. The decision to have partners or fellow shareholders in your business is a difficult one, which could have a profound effect on your ability both to plan for, and to execute a successful exit. The information in this chapter should assist you in making this decision.

Where two or more entrepreneurs have decided that by pooling their combined financial resources and skills base they could start a successful business together, the issue is not so much whether to have co-owners, but how best to regulate their relationships. How this should be done is explained in the next chapter on shareholders’ and partnership
agreements. So, what are the issues to consider when a business owner (or someone thinking of starting a business) thinks he would like to, or needs to bring in a co-owner?