Serial entrepreneur Hugh Cathey spends half or more of his time understanding the roadmap of where his latest company, ChromoCare, needs to go and how it should get there, including how to raise capital. Does the business need to put the brakes on or does it need to hit the accelerator?
“Unfortunately, school doesn’t teach you that,” he says. “This is my ninth early-stage company and you learn it by trying and failing, and then making course corrections and trying again.”
Cathey finds it critical to look outward.
“It’s like playing on a football team,” Cathey says. “You constantly want to know what the other teams are doing, what their best practices are. You want to be fully expert in your industry, not just your product individually, but your industry in general. And the only way you can be expert is if you are paying attention to what’s going on.”
Smart Business Dealmakers asked Cathey about his thoughts on raising capital.
Hugh Cathey is one of more than 40 host committee members who has helped shape the upcoming Smart Business Dealmakers Conference (formerly ASPIRE), presented by Ice Miller.
What is the value of understanding your company’s value on an ongoing basis?
ChromoCare, the company that I’m involved with now, I don’t anticipate there will be a transaction for a couple of years, but we’re often out looking to raise capital.
In order for [early] rounds to be successful, you have to have a good understanding of a proper valuation of your company and you don’t just stick your foot in the water once a year to find that out. Let’s say, on a quarterly basis, you need to think about whether the transactions going on in the marketplace could help support a particular valuation for your company.
You’re exposing yourself to the buyers that are out there. And you are, many times, exposing yourself to other potential business partners that can help build your company.
How would you gauge the market conditions for raising capital?
I wouldn’t say that it’s easy, but it’s not difficult to get in front of potential investors. In the genetics world, it’s all very cutting edge stuff, and I have never had a potential investor say they don’t want to hear about what we’re doing.
The smart investors are just like CEOs needing to be fundamentally aware of their sector and what’s going on. Investors need to understand what is going on, particularly, in the more leading edge or bleeding edge technology areas.
I would say that the market for capital is getting smarter. As you go through due diligence for a capital raise, I’m amazed at how smart they are. They ask questions that frankly I had never even thought about.
You’ve got to be very nimble on your feet, because 12 years ago, before the 2008-2009 crash, it was much easier to get money without the due diligence I see take place now.
Do you think companies are overvalued?
I really don’t. I moved to Ohio in ’96 to start up a telecommunications company. We had an IPO in September of ’97 and we raised $700 million on a company that was generating about $50 million in trailing 12-month revenue.
Then in ’99, we acquired a company doing $300 million in revenue and we paid a little over $3 billion for the company, all in debt. Those were crazy valuations. We built fiber optic networks around the country, and every time we’d raise money, I’d think, “This is insane.”
It’s nothing like that now. Although I will say that I am seeing a lot of deals done where the earnings of the company being acquired are not very robust. In other words, they’re growing top-line revenue, but they are not generating much EBIDTA. The valuations feel like they’re being done on a multiple of revenue, rather than a multiple of EBIDTA.
But they are not crazy numbers — they’re not 20 times revenue or something like that.
How else do outside conditions factor into your growth plans?
I might very well say, “OK, we’ll listen to potential buyers, but our Plan A is that we continue to grow the business toward a time when a new technology is finally developed by Ohio State, and that then creates a quantum leap forward for us in terms of valuation of our company.” So, do we sell in three years for $25 or $30 million? Or do we push it out five years and believe that maybe we can sell for $70 or $80 million? If that was the case, we would just hang on.
I’ve actually been through that process with my prior company, Healthspot, where we had a pretty significant acquisition offer from a Fortune 1000 company. It would have been about a 3x return on invested capital, and we decided against it. In our particular case that ended up being the wrong decision, but that doesn’t change the fact that, if other things hadn’t happened that crushed us, we probably could have gotten three or four times that original offer.
Investing is a gamble, and sometimes you win the gamble and sometimes you don’t.
If your time horizon changes, how do you communicate with your investors?
At the end of the day, the majority owners of the company, whether it’s me or whether it’s an outside investor, are going to make the decision. But even if it’s me and I have these outside investors, I’ve got to be very smart about communicating that to them. Because I may want to take the risk of holding on, but they may not want to.
Then, what you do is you search for longer-term capital. You find somebody that’s willing to come in and take out your early VC partner. At that point, it’s probably private equity, not venture capital, which typically has a longer cycle. They come in, they take out your Series A investors, and they’re prepared to wait for another two or three years to see the higher potential deal happen.