Mary Mathews:
Some of the things I'm actually seeing in some of these capital raises agreements is honestly what I'll call sweetener terms, bringing the investor over the line to get the cash in, and they're being added to financing agreements and they're tricky, they're complex, some things sometimes we've never seen before, but it made sense for the investor and the company to come to this agreement, but that creates tricky accounting.
Narrator:
Welcome to Accounting for the Future Podcast, a BDO Canada podcast for financial leaders to navigate change and achieve business growth. We'll uncover the challenges financial leaders may not have dealt with yesterday, but will definitely have to manage for the future.
Anne-Marie Henson:
Hello and welcome to Accounting for the Future. I'm your host, Anne-Marie Henson. On today's episode, I'm joined by Mary Mathews, a partner in our accounting advisory group who does both accounting advisory work and work on accounting standards. Hi Mary, nice to have you back.
Mary Mathews:
Thanks, Anne-Marie.
Anne-Marie Henson:
Mary, you and I are here today to talk about a previously aired podcast about raising funds in a tough market. And this is interesting because the podcast aired over a year ago and yet we're continuing to see over the past year increase in interest rates. Inflation remains pretty high today and we're still talking about a potential recession. So all topics that are still very relevant today, and I am sure most of us wish they weren't, but we thought it'd be good context to talk a little bit about what's been going on this past year compared to 2020 through to the end of 2022, which was very, very volatile and went up and down a lot. What I think we've seen over the past year that's been really interesting, to say the least, is towards the second half of 2022, we really saw IPOs activity on the capital markets and just general capital raises slow down significantly from the record highs that we'd seen throughout 2020 and 2021.
Now, what I find I'm seeing with my client base and a lot of the companies and the information that we see that's available online is that companies are now transacting and they're no longer holding on to the valuations they were hoping to get last year. Whereas at the end of last year, a lot of the activity was drying up from a transactional perspective because I think companies weren't accepting the valuations that they were being offered Today, a lot of companies are realizing that they need the capital and are therefore willing to accept the lower valuations in order to raise money to help them with their future activities. So some of the things that really stuck out to me in this episode was the importance of preparation for that transaction, making sure that you're aware of what might be asked for, making sure that you prepare your data room well in advance of starting to talk to different investors because it really is more of an investor market today than it is an investee market today.
And the importance of having available not only historical information, which tells you part of the story, but forecasted information as well that's backed up with your assumptions. We all understand that things can change over time and quite rarely do your actual results match your forecasts exactly. But to at least have some appropriate basis on which you've prepared those forecasts remains really important today. So some things I was curious to know about Mary, in your line of work, because you do a lot of work advising public companies or companies that are trying to raise funds and that have been able to transact and to raise some money over the past year, I'd like to know a bit more about what you've seen in terms of these types of instruments that have been issued.
Mary Mathews:
Yeah. So the companies that I'm seeing being able to actually raise the finances, they're living through it. They need the cash they held on for as long as they could, but they are going to the market to raise capital to move ahead with their initiatives. And some of the things I'm actually seeing in some of these capital raises agreements is honestly what I'll call is sweetener terms, bringing the investor over the line to get the cash in and they're being added to financing agreements and they're tricky, they're complex, something sometimes we've never seen before, but it made sense for the investor and the company to come to this agreement. But that creates tricky accounting when these sweetener terms are added that are not the usual warrants that we usually see, but the conversion terms might be different or the value is based off of something, even a formula that adds in new variables.
The other thing I'm actually seeing is actually cashflow management. Companies have shares and they can use that as a basis for payment to some of their providers or their suppliers. And because of that, that does bring complexity, especially if you're a private company, a valuation of a share is maybe not something you've done recently. So we're having to advise clients to help them get through some of those complexities, and that's just a result of phrasing funds in a tough market.
Anne-Marie Henson:
Right. And I think one wise thing that our mentor, Armand, has always said that I do try to live by is the important thing in all this isn't that this strange or unusual accounting should drive your decision about whether or not to go out and get that agreement signed and provide these sweeteners to the investor, but understanding what the accounting could end up looking like is what's critical for you as a business owner or as the CFO of a company so that you can explain it properly to your investors, right?
Mary Mathews:
Exactly. Keeping everyone up to date or kind of aware of what's coming is really I think what we try to do. I've seen us both do it, kind of keep those business leaders aware of what's coming, not just for today to get the money in, but also what does that mean for your balance sheet to actually just go into the future knowing what you know.
Anne-Marie Henson:
Exactly. So I guess on that, let's hear more from Armand and his guest Jeffrey about some insight into raising funds in tough markets.
Jeffrey Stanger:
Sometimes easy money can lead to long-term failure with companies, especially in some new industries we've seen over the last few years. Companies that raise money in hard times like this need to delve deeper into their industry business model and market, which brings some new and more detailed insights.
Narrator:
Welcome to Accounting for the Future, a BDO Canada podcast for financial leaders to navigate change and achieve business growth. We'll uncover the challenges financial leaders may not have dealt with yesterday, but will definitely have to manage for the future.
Armand Capisciolto:
Hello and welcome to Accounting for the Future. I'm your host, Armand Capisciolto, BDO Canada's National Accounting Standards partner and leader of Accounting Advisory Services. On today's episode, I'm joined by Jeffrey Stanger. Jeffrey's been working with private and public companies for many years, most recently as co-founder of ITB solutions on how to successfully access capital markets working alongside registered investment dealers. Jeffrey, welcome to Accounting for the Future.
Jeffrey Stanger:
Thanks for having me. I've been looking forward to this. Very relevant topic with what's going on and it'd be interesting to discuss.
Armand Capisciolto:
Yeah, and it is very interesting times right now and I think a little bit of different times because I think anyone who's been advising companies in the capital markets knows 2020 and 2021, even though we were in the middle of a pandemic, were extremely busy years. The capital markets were very, very active, companies going public, raising additional money through the public markets. So really exciting years.
2022 so far has been a little different, right? It changes every day, but for a little while we were in kind of bear market territory, maybe we're still in bear market territory. We have inflation, we have rising interest rates. Depending on who you talk to, we are in a recession or maybe entering into a recession and who the heck knows how long that's going to be. So we've all seen a slow-down in the activity in the public markets.
Jeffrey, you work with a lot of early stage companies and early stage companies, they don't just go to the market once. They need to go to the market on a regular basis to progress their plans forward. How are the companies you work with faring in these, what I'll refer to as tighter capital markets?
Jeffrey Stanger:
Well, just a bit of my background. I've worked at two of Canada's recognized stock exchanges in listings for 16 years. So I've seen everything and all aspects of it. I've been in the market for 28 years. I was in gold mining when Bre-X came out as a fraud through the tech bubble in the 2000s, the '08-'09 crash. But during tough times, money can still be raised. It just takes a lot more work and a larger audience, and it's very good for smaller companies that Canada has a robust small cap market and investors that understand the small cap market.
In one way, it's unfortunate that it's been easy to raise money the last decade, but the current market tests the metal of management of companies and really shows what they're about because once that money dried up in certain industries, for example, cannabis, management didn't know how to handle to raise money. So starting off in a tough market just makes things easier in the future.
Armand Capisciolto:
Yeah. A couple of really interesting things there. You mentioned being in the industry for 28 years, and although we hear everybody talk about the headline inflation rate, and it's been 40 years since we've experienced inflation like this, we have some recent market turmoil that we have dealt with. So it's not completely foreign to everybody that's in the market right now.
The other thing that's really interesting, you talk about companies when it's more difficult and they're starting off in this difficult to just makes them better in the long run. That's a very interesting comment. But what I really want to ask you more about is you talk about companies showing the market what they're about, and I really like that saying. So the question I have for you is what can companies do in advance so when they need to raise money, they can show the market what they're really about?
Jeffrey Stanger:
Yeah, so preparation is key. You want to be ready when you speak with investors. You don't want to be packing your parachute after you've jumped out of the plane, so you have to have a presentation ready. Of course, you have to have your business and revenue model, historical if possible, as well as forecasted financials. And with those forecasted financials, you need to have detailed financial assumptions to follow up. You don't need that in the presentation. That's backup material that can be an appendix to the presentation or what have you.
As we all know, forecasted financials never translate into the real world, and there's been studies done by Stanford regarding startups and their forecasted financials. But the important thing for sophisticated investors is that it helps them understand that you understand your total market and your expenses. So the expenses can be a big problem. Everyone wants to keep them super low. I can do it without this and that, but even if you don't have realistic expenses, it's still higher than you think in the future.
Sophisticated investors understand that you won't be into earnings in the first year. They understand that, they're looking for the long-term, but you also have to make sure that you explain to them that you fully understand your market, your total available market, the market that you can acquire, and you also need to have your use of proceeds matching up with goals instead of just having, here's a use of proceeds, we're going to have 65% in working capital. Well, why does someone want to do that? They want their money being put to work. So that's important.
Armand Capisciolto:
It's interesting. It's interesting you talk about the forecast and showing the investors that you really understand your market and the total market. Very much aligned with your comment earlier that raising money in a tough market actually prepares you, because I assume when the market's tougher, the investors are asking tougher questions about the forecast, about the market. So the company just has to be more prepared, which actually has benefits beyond just the raise, right? It has benefits even as they move into operations.
Jeffrey Stanger:
Yes, very much so. The next part that a lot of companies don't prepare for is having their due diligence data room together. That can take some time, and once you have an investor interested and he wants to see the data room and you're spending, you know, a lot of companies say, "Oh, that'll take me a couple of days." Really, it turns out it takes you three weeks to a month. And then that investor might be interested in another deal by then because he is not only seeing your deal. He's seeing lots of deals. There's a new deal around the corner every second.
So it's really important to get that due diligence data room up. It's important to get things together with your future auditor of what's needed. You don't want to be walking in with a shoebox with receipts. I've written an article on my website, gopublicincanada.com with one of the co-founders of Wave Apps, an online accounting firm called Financial Foresight: Get the Accounting Right Right Now, and it talks about preparing in advance. Put that all in, even if you have no revenue, and it's just expenses. It just makes it easier.
Armand Capisciolto:
Yeah. Jeffrey, I love that and it's something we talk about all the time with the companies we work with and with the partners at BDO. When a company's thinking about accessing the public markets, they have to think about accessing the public markets before they actually want to. Again, I'm a GAAP guy. I love talking about GAAP. I always ask the question, why are you not using IFRS now if your goal is to be public in three years? Get your house in order before someone knocks on your door with a deal, because it's hard and that takes time. And unfortunately, I've seen deals fall apart because they couldn't get their financial statements and audits done in time that the investors were still interested, right?
Jeffrey Stanger:
Mm-hmm. Yep.
Armand Capisciolto:
So really good advice. I like that, getting the accounting right right now. Yeah. You also talked about a larger audience. And so in a market like this versus maybe what we've been dealing with the past two years, when you say larger, does that mean different? Explain what you're talking about with the audience?
Jeffrey Stanger:
You're going to have to talk to a lot more people, your list to find the right investors that..., Most of them that sophisticated investors I'm talking about, investment dealers, so on and so forth, that understand this market. Investment dealers will have certain investors that would be their lead order, and those are experienced, intelligent investors that if they come in, then you have a better chance of bringing in other investors. But to find that investor, you have to talk to quite a few registered firms, IIROC firms, and they'll be cautious. So what we talked about before, being prepared, that will really go a long way with them.
Now, at times, and this is not just for now, but in the future, so a lot of companies are concerned always about dilution, dilution, dilution, and working on numerous listings over 16 years, it's all about balance. You can go too far with being concerned about dilution that can hurt you detrimentally in the future. So a mentor of mine, he was a registered investment banker who financed over 700 companies, said, "If the ducks are quacking feed them." Meaning that if investors want to put in money, let them. Don't have too much of a concern about dilution that it stops that money coming in because money's the key to achieving your goals.
You also can't predict the future. Like many companies didn't predict, they thought that the market would soar, money would be easily attainable after we got out of the pandemic. And for example, in the '08-'09 crash, too many companies were before that happened, they were concerned about dilution, and they'd be, "Oh, I'm only going to raise 500,000 now at this price, put that to work, and then my stock will go up or my value will go up, and then I'll raise more money later." '08-'09 hit and they didn't survive because they couldn't raise any money at all. And it's really important to understand that dilution is a balance. And a lot of companies right now, when the market was well, they were concerned, oh, I'm going to wait. I'll just raise a bit of money. That's happened in the past year, and now they're raising money at much lower prices, and their whole concept of dilution is out the window.
Armand Capisciolto:
First of all, really like if the ducks are quacking, feed them. I may have to use that myself on occasion. But yeah, the dilution issue is such an interesting one. And for any company and especially the board, and when they're thinking about raising money, obviously you need to consider the needs of the current investors. You can't forget about those needs. But yeah, you use a really good example. I could have raised money at X, but if I was concerned about dilution, and then the market takes the dive it has taken, and you're an early stage company that whatever, whether you're a tech or biotech or whatever, you need money to keep things going, to keep that research going, and then it's now down 50% and you really need that money, otherwise you're not going to be able to progress the projects. You're diluting them worse.
So that whole idea of not being able to predict the future, and I think the other thing I think the past six months have been is a bit of a reality check for a lot of people in the market that it doesn't always go up. There are these things, right? We like to think it always goes up, and we all hope it.
Jeffrey Stanger:
We hope.
Armand Capisciolto:
We hope for it.
Jeffrey Stanger:
Yeah.
Armand Capisciolto:
But it doesn't always happen. Back to all the things that you mentioned, at the start of the things you've seen over your career, there's a lot of things that can move the markets negatively,
Jeffrey Stanger:
Yeah. Then they're raising money at much lower prices, and then everyone's unhappy, especially the people that put in money at the beginning. And then companies do a consolidation or as other people know, reverse split, and that doesn't work out either.
Armand Capisciolto:
Yes. Very interesting. A lot of interesting stuff. Any last comments you want to leave us with today?
Jeffrey Stanger:
Yeah. Sometimes easy money can lead to long-term failure with companies, especially in some new industries we've seen over the last few years. Companies that raise money in hard times like this need to delve deeper into their industry business model and market, which brings them new and more detailed insights. So companies uncover other opportunities and discover potential pitfalls to watch out for.
So recently, just this week, I had a client where we were investigating their market further than they previously done, and they found an additional revenue stream for their service plus reinforcement of their service for their original target. So they're quite happy about that, and that just makes the whole opportunity a lot better.
Armand Capisciolto:
Yeah, that's a great story, and I think when I reached out to you about talking with this topic about raising money in a tough market, it was like, "Okay, let's talk about the realities of it." But I think maybe I was taking a glass half empty approach to it. What you've shared is more of a glass half full approach that if you're going to raise money in a tough market and you can do that, and you do the insights, do the work that is needed to do that, from those insights, there's a lot of positives that can come out of getting yourself through a tough market like this.
Jeffrey Stanger:
Yeah, too many people just say, "I can't raise money, so forget it." But there are always people looking for opportunities, and this just makes you better. So, you know?
Armand Capisciolto:
Yeah, that's a great way to end it. So Jeffrey, thank you so much for your insights on this topic. Myself, our listeners, we appreciate your time and expertise. I'd like to thank you, our listeners for tuning in today. I'm Armand Capisciolto, and this has been BDO's Accounting for the Future. Please let us know if you found the topic interesting and useful, and remember to subscribe if you liked it. We'll see you next time.
Narrator:
Thank you for listening to BDO Canada's Accounting for the Future. Past episodes and related insights are available at www.bdo.ca/accountingforthefuture, or you can go to Apple Podcasts, Spotify, or Google Podcasts to subscribe. For more information on BDO Canada, visit bdo.ca.