Fun&thrilling capital policies

Hello. This is Irino, a strategy consultant.

I will explain about capital policies today.

The positioning in your business plan document

Executive summary
Background
Management team
Company overview
Management and business principles
Product/service overview
How your profits are made
Analysis of the market and the competitors
Marketing and sales strategies
Operation plans
Personnel strategies
Start-up strategies
Growth strategies
Exit strategies
Financial plans :
– Sales forecast
– Cost plans
– Financing forecast
– Capital policies
Risk management
Project management

Do’s & Don’ts for Beginners

■　Don’t believe stock options can improve people’s motivation

I know some business managers who try to improve people’s motivation by offering stock options to board members and employees. However, you can’t expect much from it. The reason is because many members who have invested in stocks privately nowadays know that most stock options are just something extra that was added to their salaries and stock prices of venture companies don’t go up as much as expected.

Companies have to really grow more after IPO than before IPO. However, if companies make use of stock options after IPO, then employees will feel a strong sense of exhaustion because they realize that one phase has been achieved. Many staff members who played the leading roles will decide to resign together with the financial exit.

Essentially, it is better not to rely on stock options. It is important to make a system that will raise salaries depending on the profits made. It’s also important to provide employees with nonmonetary rewards by showing appreciation, recognizing efforts and giving them meaningful and satisfying jobs.

Do’s & Don’ts for Intermediate Entrepreneurs

■　Don’t stop communicating with investors after receiving funds

There are some entrepreneurs who stop contacting stockholders after receiving investments. These entrepreneurs might not want to bother the stockholders or they would like stockholders to leave everything up to them. Well, there are many reasons for sure, but it is not very good. The reason is because venture companies will certainly go through a phase in which their businesses don’t go well and things will be worse if a quarrel takes place with investors during such a difficult time. There are many entrepreneurs who contact and report to investors when their businesses are going well, but many of them can’t actively report to investors when things don’t go well. If entrepreneurs report even bad news and consult with investors on a regular basis, then petty quarrels can be avoided and both investors and entrepreneurs can try to work out a solution constructively together when businesses are going bad.

Do’s & Don’ts for the Master Class Entrepreneurs

■　Try to balance debts and equity so you can reduce WACC of your company

Some people try to cover the necessary funds with equity finance only, but this is not good. Equity is unlike debt and you don’t have to return it, but the expected rate of return is surprisingly high. For example, if you were to convert it into an unsecured loan rate, VC’s expected rate of return is about 50 to 60%. This is as high as illegal loans.

On the other hand, debts are money you have to return, but you can write off interest expenses to avoid tax, so the money you must pay back may be unexpectedly cheaper than you think. For example, let’s say the interest rate of a business loan for small businesses is 10%. If the effective tax rate is 30%, then the actual rate of one’s debt cost is 7%. Japanese government’s financial corporation offers a very cheap debt finance loan for new and starting companies at the interest rate of 4 to 5 %.

So, in many cases, it is better to get into debt to a degree rather than trying to get the funds with equity only because the overall interest rate (≒capital cost) a company has to pay back will be less as a result.

Interest rate a company as a whole has to pay

= Capital cost (WACC)

= Weighted average of (debt cost + stock cost)

　Debt cost = (interest-bearing liabilities / interest-bearing liabilities + total market value) × interest rate × (1 – effective tax rate)

　Stock cost = (total market value / interest-bearing liabilities + total market value) × stockholders’ expected rate of return

Advanced entrepreneurs Have this formula in mind and try to balance equity and debts so you can reduce the overall capital cost（≒WACC) of your company. If you want to reduce WACC to the extreme, then

Debts : Equity = 70% : 30%

is a good target. However, if you can’t pay back your debts and get a dishonored bill, then it will be a matter of life and death for your company. So, Equity of 40% is a good guiding line considering all the safety factors.

Editor’s note : Social lending/finance

Recently, I wrote an article about person-to-person lending for a magazine. Including small amount financing, it seems person-to-person lending in a broad sense is becoming more popular. As far as the amount of money goes, it is perhaps not an adequate means of fundraising, but I feel this new structure of financing has possibilities and is an indication of how things will be.

That’s it for today.

Irino

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