Thursday, November 5, 2009

One way to Clean up a Balance Sheet

As a CFO I am always trying to attain a clean balance sheet especially for my start-up clients who are looking for second round financing.

If you are an entrepreneur looking for outside investment capital it is a good idea to try and clean up your balance sheet. If you have current stockholders who put money into the company as debt ask them if they will convert the debt to equity. New investors who are contemplating putting new money into a company want the dollars to go to something that will move the business forward like machinery and equipment or Research and Development. They certainly do not want their new money going to service or payoff existing stockholder debt. Investors shy away from situations where the new money is going to payoff or service existing stockholder debt.

Asking existing stockholders to convert existing debt to equity is not an easy thing to do. Believe me, I have done it and I recognize the difficulty. You are asking people who stepped up to the plate, probably when the company was just an idea and put real money in the company to increase their risk. Furthermore, there was probably a legitimate reason for the stockholder to put money in as debt in the first place. However the facts must be faced. The company probably needs the new money in order to go to the next level. Cleaning up the balance sheet will help. Sometimes the company needs the money not only to go to the next level but to also survive!! If this is the case and the company needs the money to survive the existing stockholder has a lot of incentive to convert their debt to equity. If they do not convert and the balance sheet is unattractive, it is likely the company will not get the needed investment capital and it is likely the stockholder will not get their debt instrument paid.

Although the stockholder increases their risk by converting the debt to equity they are potentially increasing the value of their stock and giving the company a chance to get to the next level which was the dream that stockholder had when they originally put the money into the company.