We have an investor who insists on providing us with funding on a monthly cashflow basis. It makes me feel like I’m holding out the hat all the time. Is this a standard funding approach or are there better ways?
Many high-net worth and/or inexperienced investors opt for cashflow funding strategies believing them to be the most efficient. If the business needs money we provide it, otherwise it runs on its own steam.
From the investors perspective there is a compelling logic to this. It provides the investor with a sense of power over the company which in turn makes him feel more in control of the destiny of his investment.
What the investor fails to understand are the operational consequences of this approach.
If a management team doesn’t know from month to month whether or not the business will have sufficient cash to operate, it becomes paralysed.
Simple issues, such as hiring staff, become difficult. If you are not certain that they will have a job in two months time, it’s very hard to ask them (potentially) to leave an existing job to join you.
While the investor might enjoy it each time you front at the end of the month requesting cash, this paradigm saps energy, increases stress levels and diminishes motivation.
The bottom line is that whereas an investor may consider this approach to be the financial equivalent of “drip irrigation” – frugal and efficient – in fact it is the equivalent of “Chinese water torture”. Ultimately, it is self-destructive.
Sophisticated venture investors understand that entrepreneurs need to develop a business plan and that funding should be committed in realistic tranches (if not all up front) against that plan so that management can be certain of the funding runway available and can focus on execution.
If, at the end of the runway, the company hasn’t achieved its targets, then the situation needs to be reviewed in detail and a new definition of success developed. The investor then decides if the story is sufficiently compelling or if it’s time to cut losses.
This discipline is critical… it is in the investor’s interest to create an environment for management that is most conducive to achieving success.
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Doron Ben-Meir has been an active venture capital manager for the last eight years. He founded Prescient Venture Capital and prior to that was a consulting investment director of Momentum Funds Management. He was a serial entrepreneur over a 12 year period, co-founding five new technology-based businesses.
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James was the editor and publisher of SmartCompany and LeadingCompany for five years. He is now the Australian Financial Review‘s companies & markets editor, and a former BRW editor.
