When do you raise capital?

A big decision for business owners is whether to take outside capital. Let's assume you've decided to go ahead and raise outside money. When do you do it?

Here's the short answer, which is written in stone for all private equity people on Bay Street: Raise money when you can, not when you have to.

What does that mean?

It means raise money when economic conditions mean that private equity investors or lenders are pitching you. Raising money means selling a piece of your business (equity) or making a lender confident that you have the cash flow to pay back a loan (debt). You will find the situation much more pleasant in a seller's market rather than a buyer's market.

As with every other kind of market, capital markets go through cycles. At the peak of these cycles, such as 2007, so many investors are trying to put cash to work that money is cheap and terms are good. At the bottom of these cycles, meanwhile, such as from October to last spring, investors can tell you whatever terms they want because you need the cash.

Similarly, the attractiveness of investing in businesses goes through cycles. Nothing is more attractive to an investor than a company that doesn't need money. Then the investor feels privileged to be “allowed” to invest. I hear from prospective clients that they do not need money and that is exactly when to bring in private equity and boost your bottom line while taking risk off the table.

Bob Roy, Roynat, used to say, “Go and ask for money when you have a tan.” Along the same lines, nothing is less attractive than a company that needs money desperately and is talking up a storm to anyone.

So, from the perspective of a business owner, the best time to raise money is in a white-hot capital market when you do not really need it. In these periods, you should raise more money than you think you'll ever need.

The worst time to raise money, meanwhile, is at the bottom of the cycle when you're running low on cash. If you wait until then to start fund-raising, you will be forced into needlessly painful situations. Perhaps you will take debt at a higher rate or you may have to give up part of your business you did not plan to give. This is not a position of strength.

Of course, when times are good, many entrepreneurs make a common mistake: They plan the revenues for the year ahead based on the past few years growth. In doing so, they base their outlook for future cash requirements on this past success, instead of asking what would happen if, say, their revenue got cut in half. So, when the cycle turns, they get shocked and cannot believe their good times have stopped and they suddenly need money just to survive. We saw this unhappy situation with more than a few clients who could have avoided their cash squeeze.

Raising money when you can instead of when you need to means avoiding this mistake.

Never assume that good times will continue forever - because they won't. Instead, when everything is going smoothly, ask yourself how much cash you would need if the economy suddenly collapsed. And if someone is willing to give that money to you on reasonable terms, take it.

With the markets running now and interest rates unlikely to rise, now is a good time to raise capital. Give Loewen & Partners a call to help you raise capital.

Tim Hockey, TD Canada Trust, says stock options makes mercenaries of us

The SpencerStuart panel on executive compensation warmly applauded Tim Hockey and humanistic approach to executive compensation. Here are a few of Tim's key points:

Tim Hockey, Group Head, Canadian Banking, President and CEO, TD Canada Trust, says that executive compensation needs to be carefully balanced or else it can make mercenaries out of us all. Tim used the scale of “Patriot versus Mercenary” as a range of behaviours exhibited by management. In banking circles, a retail banker is a Patriot who does it for the community and on the other side is the investment banker who seeks revenue in the same manner as that of a Mercenary. Tim says that human capital must be made to be worth more.

What is the role of a business? As Peter Drucker says, it is to fulfil a customer’s unmet needs and get rewarded. At TD, every executive is compensated on customer satisfaction. If an executive is "incentivized" only on the stock price, that would not fit the TD culture. At TD, executives are to act in a Patriot way.

Jacoline Loewen, private equity expert, author of Money Magnet, panel of CBC show - Dollar Signs with Dianne Buckner on at 1:30 Saturdays.

David O'Brian says CEOs must be trustees of a business

More from the SpencerStuart Executive Compensation panel. Here is David O'Brian:

David O’Brian, Chairman of the Board, Royal Bank of Canada and EnCana Corporation, said in his time as CEO of Canadian Pacific that executives were more like trustees of a company than the types to "game the game" just to drive up the stock price. It is better to align management with shareholders interests and that although stock options have not worked well across the board, it would be foolish to throw out the baby with the bath water. David disagreed that CEOs would hype the stock although he did agree that the stock market could be a bit of a casino.The method of pay and the level of pay both play a part of it, and CEOs have been divided about it. How much do you have to pay to attract talent? This is a societal issue too.When looking at compensation, you want to reward for performance and judge it by net income before tax, level of employee engagement. At EnCana, customer satisfaction will not play a role but oil price and low costs of production is key.

When I was a CEO, I did not ask myself every day, “How can I maximize shareholder value?” Instead, I would ask, “How can I make this business model work better?” That is the nature of that business in comparison to banking, for example.Stock options can be part of the package but these need to be long term.

As Warren Buffet said, “In the short term, the stock market is a voting machine, but in the long term it is a weighing machine”. Compensation needs to be on the long term performance of the company.Restricted stock and deferred shares are better than stock options which give huge leverage. You can remove stock options but our tax system encourages short term stock options. Long term tax deferred past three years is not allowed and this needs to be changed.Senior executives should have share options deferred, but we also have to realize that they need the benefits of the job while they are in their high spending years of their families and lives.Originally, stock options were created for start up technology firms and oil & gas exploration companies who could not afford to retain the talent of executive they needed. This deferred cash payment was not an expense as there was nothing to expense it against. For executive compensation, as part of the package, stock options should be de-emphasized.

Roger Martin, Rotman, asks whether executives "gamed the game" because of their stock options?

With the US Government’s Pay Czar taking unprecedented action in cutting bankers’ salaries and bonuses, the go-go years seem a faded memory. Executive compensation is now a hot topic. What is fair pay and how should talent be rewarded? What went right and what went so badly awry? SpencerStuart, Canada’s top recruitment company, held a fascinating panel with heavy hitters Roger Martin, David O’Brian and Tim Hockey dissecting the past thirty years of corporate performance and how this will affect executive compensation in the years to come. Roger Martin shifted my thinking on compensation and since I am designing pay for a top CFO and COO in a public company right now, even changed the compensation plan. Here are some random takeaways from Roger Martin:

Roger Martin: The evidence is damning that the stakeholders doing very well from the Standard & Poor top 360 companies listed in the New York stock exchange are not the shareholders but the managers. Roger Martin, Dean of Rotman Business School, ran the statistics of management compensation and discovered that between 1980 to 1990, CEO compensation doubled for each dollar of income produced. In other words, CEOs did unbelievably well.

No big deal, you may say, but how about shareholders? How did they fare in the same time period? The shocking picture that emerges is that, no, shareholders did not do as well. The performance of companies worsened and the returns were worse than the previous period. What happened in this time period was that there was an article written in 1976 by Michael C. Jensen and William H. Meckling, discussing the merits of stock options. This philosophy of aligning executive interests with shareholders caught fire and within years, every Standard & Poor CEO wanted stock options as part of their compensation package.

Why? Don’t stock options make sense?

On the surface, stock options seemed like a great idea but as with many well meaning programs, they had unintended consequences. Jensen and Meckling said that it was good to get employees’ interests aligned with the shareholder interests and that seems to make good sense. However, the CEOs realized that one way to get share price up (improving stock options), was to boost shareholder expectations by raising the dreams of future performance. After all, what is a stock? It is a collective expectation of future performance. This hyping of the stock soon became the top way to raise the price, not through hard work and actual growth. Smart CEOs figured this out.They learned to game the game.

Roger Martin says that this thinking clouded CEOs’ behaviour. A CEO would do a flurry of activities. Do acquisitions that never pay off. Do aggressive accounting to change the value on the balance sheet. Expectations raced ahead of value. The CEOs knew they could not beat the expectations and needed to run up the stock, cash out and get out quickly. Consequently, Roger Martin believes that stock based compensation further diverges interests of shareholders and CEOs, and should be removed as a tool from a CEO compensation. Unless the stocks can only be recouped years after retirement, stocks should not be used as a reward.

Chrystia Freeland, US Managing Editor of Financial Times, thanked Roger Martin and commented that Facebook is a stock that is priced on future expectation. The Facebook CEO says not think of it as a business but as a service, but it has yet to make a profit. I think Rotman will pull ahead to be the leader in the MBA pack because we are fortunate to have erudite and involved Dean like Roger Martin who gets out into the real world and debates with the big hitters in industry. I like Roger's gutsy style and I recommend you buy his books to get more of his views. I changed my actions and so will you.

Death of Macho?

Not since the movie Wall Street, have financial bankers been tarred with such an ugly brush as during this recession. The shock waves have sent cracks into the foundation of the world of finance and there is definitely a great deal of self examination going on in Board rooms, and universities. Some are calling for the end of macho, saying it was this aggressive, male-dominated attitude of Wall Street that took us on this wild and devastating ride.

It is true that 80% of job losses in the US are male dominated roles in manufacturing and construction, leaving women to step into the bread winner role within their families. Reihan Salam believes the end of macho began years ago and that there has been a quiet revolution where power has shifted from men to women in the Western world. He says the Great Recession has sped up this transfer, “The consequence will be not only a mortal blow to the macho men’s club called finance capitalism that got the world into the current economic catastrophe; it will be a collective crisis for millions and millions of working men around the globe.”

Having seen financial instruments level their economy, Reihan Salam points out how the people of Iceland replaced their President with a woman who some say, brings a calmer and more level headed approach.

When it comes to Toronto's finance world, there has always been a wide spread between the type of males who dominate. Tim Hockey, President & CEO of TD Canada Trust, describes the range as Patriots and Mercenaries, with Patriots being the people at the branches working for their communities, while investment bankers need to seek out the revenue which requires a more "Mercenary" nature. Tarring them all with a macho brush is simply not valid.

Financial men are very diverse in character. Sure, you have the macho cowboys; but there are many intelligent, hand firmly on the rudder types too, who are strong, determined and have the energy to do the long hours. Ironically, their positions may be the first roles to get filled by women in the future because in my experience, these men help women get ahead. They want the skills for their teams and are not threatened by smart women. I have also observed that the finance community in Canada does work hard to get women up the career ladders.

I believe the trading floor where the adrenaline flows, will be the last position to be filled for women. It's not because men keep women out, it's because women self-select themselves out of direct sales and trading positions. Again, a trader needs to be more mercenary and aggressive; they are paid to take risks within the boundaries. The ability to take risk is what gives a competitive advantage.

I have two sons so I am very aware of the feminizing of boys in our culture. And I have to work hard to make my boys happy to be aggressive through sports, debating and martial arts, etc. Girls in Canada are now getting sports training too and are encouraged to debate and compete, so young females are changing. There will be female Madoffs in the future too. Women are not perfectly behaved, thoughtful, compassionate creatures who will not want to be greedy. We are just getting going because the birth control pill only started in our life times. Give it a few more decades.

So maybe Reihem Salam is right and that macho is at an end but I think that is a rather idealistic and sexist view and ask if women will prove to be any different in the long run?

blog at http://www.moneymagnetbook.blogspot.com

Jacoline Loewen, (jbloewen@loewenpartners.com) is a partner in a private equity firm, Loewen & Partners, dedicated to raising capital for family business owners and developing their growth strategies.