Conventional Funding Model

Barriers to Success

To design a workable funding plan for the CEED Program, we had to devise solutions to the below described current problems that would have represented major barriers to success.

Liquidity and the High Cost of Capital

For small and medium sized private companies who need to bring in outside capital in order to grow and accomplish their goals, two key problems are the high cost of capital and the lack of liquidity on the part of investors. In fact, it is the latter that drives the former.

U.S. securities laws place major restrictions on private companies regarding who they can ask to invest and how they go about asking them to invest, plus investors lack the freedom to sell their interests in such companies whenever and wherever they want.  

The latter constraint creates a condition known as an "illiquid" position, i.e., the asset is not freely convertible into ready cash. Its counterpart, a liquid position, means that an investor can freely convert an asset into ready cash. Such is the case normally for an investor who owns stock in a public company. 

In contrast to the restrictions on reselling their shares in private companies, investors who hold freely tradeable shares in a public company have no such restrictions, and may sell their shares to anybody willing to buy them at any time. Their main difficulty is in locating a buyer, which is where stock exchanges come in, as they provide a convenient meeting place for buyers and sellers.

The normal way an investor can achieve liquidity in a small, private company is through the sale of the company or having it go public. However, in many cases the CEO and other parties do not want to sell the company or they remain too small to justify going public (a very expensive and difficult process). Thus investors in such a company are often left with an investment that they cannot retrieve.

Therefore, the investor community is understandably reluctant to invest in private, small and medium sized companies, because they go into the investment without knowing if they will ever get their money back out, let alone make a profit on it.

As a consequence, we observe a very clear pattern in the investor marketplace wherein investors demand a substantially higher percentage of the company if it is a private company than they do if it is a public company. This is reflected in the valuations of private companies versus public companies. 

U.S. Chamber of Commerce statistics show that sellers of private companies usually receive an average of four to six times their net earnings.  Public companies, in contrast, sell at an average of 20-25 times their net earnings. Some industries often support an even higher multiple, such as the high-tech industry. Thus it is quite reasonable to see a five times differential in favor of public companies over potentially identical private counterparts.