While Polus is focused on the $5M-$15M segment, we are not a fit for every company. Elsewhere on this site we have primarily discussed company fit in terms of psychology (i.e. frustrated, equity-focused owners) and structure (i.e. self-financed).
Here we want to illustrate financial/operational fit.
The figure to the right shows the prior three year financials of types of companies that we often see. It’s clear that they are growing quickly (>30%), they have high gross margins (>50%), and they have recently become profitable.
Anyone who has run a company like this knows that – while it’s great to be profitable – the business is not yet “at scale” and they still have a lot of work to do.
By “scale,” we mean that operations are not yet realizing their highest potential net profit margins on a sustainable basis. They are starting to get leverage on their sales and operating model, but to continue to grow they will outstrip the cash flow from profits.
That is a key fit for Entrepreneur-friendly Capital – the company still has opportunity and desire to grow.
In order to satisfy the demand for their product/service, the business needs more sales people, more account managers, and more product/service delivery staff. While their “at scale” operating model may be in place, they are behind on capacity – they still have to hire ahead of the demand to convert on the market opportunity. This results in increasing fixed costs, which eats into EBITDA ahead of the revenue.
This is an ideal situation for capital. The question is – should it be equity, debt, or Entrepreneur-friendly Capital?
Equity is the most cash flow-friendly – no repayment until exit, but the exit proceeds to the entrepreneurs/owners are reduced. Furthermore, this is the worst timing to sell equity – right before the greatest value creation (see what we mean here).
Private or bank debt is the least cash flow- and operationally- friendly – high fixed payments put a drag on cash regardless of revenue, and covenant-maintenance restricts uses. Furthermore, what is not well-known if one has not done a private debt deal – such debt usually carries significant warrant coverage, i.e. owners still get diluted sometimes up to 30%.
This is exactly the stretch of company development when owners are least amenable to equity dilution, because they can see the value creation happening – with just a bit of capital – in the very near future.
This is the best situation for Entrepreneur-friendly capital.
These companies have a line-of-sight market opportunity that is a good bet for at least three years of 20%+ growth. The use of capital is to increase capacity on a clear operating model – not for product development or other major or high risk CAPEX. And the P&L clearly shows that as the operating model capacity increases, the profit margins increase.
When paired with good psychological and structural fit, companies with this financial/operational profile are a great fit with Polus and Entrepreneur-friendly Capital.