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28 June, 2017 10:55 IST
Financial Planning
   
The financing debate: the best combinations and tools for raising funds
Source: IRIS (06-NOV-14)

Ask any entrepreneur about what is his #1 expectation from a CFO and he/ she is likely to tell you 'Raising funding'.  A CFO who has experience in raising debt (borrowings) and equity is an invaluable asset to any business.

Curiously, the best contribution that a CFO can make to the funding decision is to raise the question of 'whether this funding is needed at all?' Far too often, companies are guilty of raising funding for the incorrect requirements (examples: lavish offices, funding long credit periods of customers, production facilities with unrealistically high capacities, unplanned marketing and advertising etc). A CFO needs to be the conscience keeper of the business and ask this difficult question.  If he is convinced that the company needs funding for the right reasons, it becomes his/ her operational responsibility to go out and raise funds at the right pricing.

A fundamental principle of funding is to match the nature and tenure of the source of funds with the nature and tenure of the application of funds. Capex spends with long gestation periods are best financed through long term loans, working capital requirements for debtors and stocks are best funded through short term loans and new, 'risky' ventures are best financed through equity.  A number of companies raise funding (either debt or equity) for funding opex losses. This is a very bad idea, unless you have a very clear idea of how and when the opex losses are going to be recouped (eg: ecommerce). It is amazing how many companies make the fundamental mistake of raising long term money for short term purposes and vice versa.  CFOs need to take ownership for these decisions and be disciplined about it.

Once a CFO is clear about the nature and tenure of funding, he/ she need to think about the pricing of the financing line. Debt funding is usually easy to price, considering interest rates are discussed and negotiated with bankers and other lending institutions. Equity is far more difficult to price.  A common mistake that several entrepreneurs make is to think of equity as 'free money'. Nothing could be farther from the truth. A good CFO will educate his CEO/ Promoter why equity is probably the most expensive way to raise funding.

A good CFO also pays attention to the non-financial terms and conditions attaching to the financing line. These include tenure of the loan, repayment schedule, moratorium period, documentation charges, security requirements, collateral requirements, inspection procedures, frequency and costs, insurance of assets provided as collateral, frequency of reporting, consequences of breach of covenants, restrictions on end use of funds, and several other factors. Entrepreneurs need their CFOs to be able to navigate through these terms, negotiate with lenders and make a recommendation on the right solution.

Getting the financing mix right is the equivalent of a well cooked meal.  Like a good cook, the CFO needs to understand the business (the diner), the quantum of funding required (how much food to make), use the right mix of products (ingredients), buy the products at the right rate (price of ingredients), raise money from the right institutions (quality of the ingredient). 

Fortunately for businesses, CFOs have a wide variety of 'ingredients' to choose from today.  Apart from traditional working capital and term loans, CFOs can access public markets in India and overseas (eg: AIM), forex denominated debt in the form of External Commercial borrowings, rupee denominated debt from overseas or domestically in the form of Convertible Debentures, venture capital from angels or VC funds, growth equity from Private Equity firms, access public markets in India through BSE, NSE or SME exchange, raise loans and/ or structured debt instruments from NBFCs, raise bridge financing or high risk capital from hedge funds, raise performance linked quasi equity products like Compulsory Convertible Preference Shares. 

There is no shortage of capital in the market today. What is in shortage is good quality CFOs who can help entrepreneurs decide what is right financing mix for the company.  An incorrect choice can often be life threatening to businesses.

There can be no one 'correct' answer to 'what is the right funding mix'.  Just as the answer to the question on 'what is the best food to have' will depend on the time of the day, how hungry you are, what is available in the locality, your budget etc, the 'right funding mix' will depend on circumstances that are specific to you. 

Eat right (raise the right capital) and live long (grow your business)!

(Contributed by S Venkat, co-founder and vice president of MyCFO)


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