In this episode of Augurs on the Town, Josh talks with Patrick Donohue, President & CEO of Hill Capital Corporation. If you’re interested in funding the growth of your company or capital formation – this is a must watch interview.
Josh and Patrick discuss the concept of “capital matching”, alternatives to the Venture Capital path and what really drives a company’s valuation.
Connect with Patrick:
Learn more about Hill Capital Corp.:
Josh: Hi, everybody. This is Josh Becerra from Augurian. This is Episode 16 of Augurs on the Town. I’m here with Patrick Donohue, co-founder and CEO of Hill Capital Corporation. Thanks for being here. Patrick.
Patrick: Josh, great to be here. It’s so good to see you again, man. I can’t wait till we do it in person.
Josh: Yes. Well, COVID has been hard, but we’re getting there. I’m feeling super hopeful about all the restrictions being lifted. I was thinking back to when you and I met back at CoCo in the Grain Exchange, Downtown Minneapolis. You were doing a capital formation company called DealPen, and you are creating an educational platform called Investor for Finance People. You are the entrepreneur of entrepreneurs but always focused on capital, which I think is really cool. You’re most recently CEO of Hill Capital Corporation. Why don’t you tell us a little bit about that journey that you’ve been on through the finance world and what led you to get to where you are today with Hill Capital?
Patrick: It’s so interesting you asked this question, Josh, because over the years, as I’ve reflected back, and now that I’m older and have kids and seeing them growing up. I was like, where did I ever get that entrepreneurial spirit? As it turns out, actually, oh, I have it here. This was my lemonade stand picture by my grandfather, literally, lemonade stand Pat’s lemonade. I did put on LinkedIn, by the way. Back in the day, that’s where that started. Fast forward to like meeting you at CoCo and so forth, my whole background has been in finance. When I was in college, I don’t even remember using the word entrepreneur.
There was hopefully not entrepreneurial classes in the ’90s or anything like that. I always knew I wanted to start something on my own, but I guess as a young person back then, I had the preconceived notion that you had to have a decent amount of experience before you could go do something on your own.
Josh: Yes, right.
Patrick: Anyways, that’s what led me to finally jump off on my own is where you and I met was my first real entrepreneurial endeavor founding DealPen, and then we’ve spun off investor out of that as our educational courses.
Josh: Cool. For the audience, why don’t you tell them a little bit about Hill Capital Corporation? What you’re about.
Patrick: Yes, definitely. Hill Capital Corporation is an investment fund, we’re a $10 million fund, we’re making investments of $500,000 to $1 million in businesses that are really between Main Street and Wall Street that fall through the gaps of some of the traditional funding sources that are available for privately held companies. That’s why we put together Hill Capital a number of years ago. There was a number of people in our ecosystem that had reached out before, I’ll never forget a mini-demo event. This still happens, but we’ll go off to those mini demo events and got together with a few people, and they said, “Hey, here’s a challenge, and we’re trying to figure out if we could put something together to solve for it.” That’s how Hill Capital was born.
Josh: That’s very cool. A lot of the people who are in the audience for Augurs on the Town are marketers, founders, owners. There’s some C-suite professionals, a lot of them here in the Twin Cities, so you probably know a lot of these people because I know your networks like nobody else. Can you tell us a little bit about some of the high-level investment criteria that you have at Hill Capital so people know, trying [inaudible 00:03:54] to you at what stage of my business, those things?
Patrick: Let me start right there, we are always happy to have a conversation. Even if somebody reads or hears on this podcast on our video here that we have parameters, don’t let that hesitate. I’m always happy to have conversations and at a minimum, get to know somebody, and help them make any connections that we can for their journey. All that being said, one of the biggest things for us is that the rubber really meets the road for Hill Capital with what I’d say more established entrepreneurs, meaning that they’ve got some product-market fit.
That’s a big thing because we are not an accelerator. We’re not an incubator. We’re not a traditional venture capital fund that’s zero to one. That’s not us. The vast majority of our portfolio companies have a couple of million in revenue. The founders are like, the business plan are super excited to get it to 10 million. We’re not worried about a billion or 100 million. It’s just like get it from 5 to 10 million. That’s where we are really good fit, is to be able to put in that extra $500,000, $1 million to be able to spend money on sales and marketing, is primarily the use of our funds.
Josh: There you go. If you need a sales and marketing company, you know who to call, right?
Patrick: Exactly. That’s what it’s all about because they need to build their customer base, is the vast majority of it. If you think about it, that’s where the gap is. They can’t go to a bank and borrow $1 million from a bank to spend money on a sales and marketing program. That’s just not how banks lend and how they think about collateral and assets and stuff like that because those soft costs are too squishy for a traditional bank.
Josh: I can see you’re already talking all this finance stuff. When I think about capital and finance, I was thinking of you, Patrick. When we were preparing for this conversation, you used the term capital matching and you talked about founder-friendly models like Indie.vc, Earnest Capital, of course, Hill Capital is in there. Why do you think we’re seeing these new unique investor theses and funding models springing up?
Patrick: Oh my gosh, I should have pulled up a visual for us, I was thinking about this. I remember, I was in Silicon Valley about seven, eight years ago and Mike Maples, a venture capitalist, put up a slide and talked about this. If you think about an iceberg and the tip of the iceberg, he made this point and I’ve been seeing this and living it nearly my whole career for 20 years is that, the tip of the iceberg is, that’s where venture capital plays. The whole 95% of the iceberg is beneath the water. His whole point of giving this presentation at the Founders Institute, an event I was at, was he was saying, “Hey, we need more innovative models in our own finance.”
Again, just getting all sorts of hints from the universe like, yes, you need to go do this thing Hill Capital. Anyways, the biggest challenge with founders and entrepreneurs or just private companies is that the money that is available to them is very limited, so they get stuck in a bit of a mindset of they take what they can get. Unfortunately, that leads to poor outcomes. We could do both sides of this equation. Let’s say somebody needs something for the long-term, like spending money on a sales marketing program, most people don’t see results immediately in the first couple of months, let alone a year.
A lot of good branding and marketing, it takes a couple of years to really build it up and to get that strong ROI. Taking a short-term loan like a merchant cash advance, which a lot of the online lenders really are, it needs to paid back within six months, that’s not a fit because you’re making an investment more for a long-term return. Then there’s a lot of times where private companies, they need to make that next step up and they need to make a hire that should ideally be paid off in six months because they’re going to be able to do this, but they go out and sell equity, which is a very long-term forever basically till the company is sold.
They’ll go sell equity to bring in that money to make a hire. That’s the problem, is really helping people understand is like bringing in– I separate the world of finance for private businesses in two worlds; internal capital, the founder in the business, and then external capital. For external capital, to bring in external capital that has a short-term need yet that external capital is a long-term partner, not a match. It’s really being thoughtful about what type of external capital is being brought in, is it appropriately matched for what the business is looking to achieve?
Josh: That’s really smart to do that because as soon as there’s misalignment there, you’ve got people pushing around founders to get results quicker and it might not actually be able to happen because there’s still in two earlier stage. I definitely get this idea of capital matching and making sure that there’s alignment there because if there isn’t, it can really cause problems.
Patrick: It’s not healthy for anyone in the ecosystem. If you got a $25,000 or a $50,000 mismatch, you can solve for that, but usually, you’re talking hundreds of thousands if not millions of dollars and the vast majority of entrepreneurs, they can’t clean it up. If they can, it’s not easy.
Josh: For sure. One of the things that I’ve been doing a little bit of blogging on is valuations because I think there’s ways for an agency like ours to help a company get a higher valuation. I know that you’re in the process of actually completing a book about the drivers for premium valuation or characteristics that make a business more valuable. Tell us, what inspired that book?
Patrick: Well, a number of things inspired the book. Going back to DealPen and investor, a lot of the things that we created educational courses around are really captured within the book and helping entrepreneurs think about where and how to make their business more valuable. Again, it’s not even necessarily to sell the business, making a company more valuable provides choices. That’s what’s key. It provides choices. Then the entrepreneur can hold the business long term, they could hand over the next generation, they could sell if they want to, they could have a lifestyle business. That’s what’s important.
I’m so tired of seeing entrepreneurs basically forced to sell or forced into decisions because they have to satisfy external capital providers. On the piece of valuation, it’s a big subject, of course. 99% of the information out there is somehow talking about valuation multiples, around EBITDA, revenue and eyeballs, and all that type of stuff. It misses the mark. All of it misses the mark, and it drives me nuts because that’s correlation. A multiple of revenue or cash flow, that’s a correlation. It’s not causation. Causation is all the things like you do that are going into, how are you running your sales and marketing systems? What is your customer base look like? What are the things that are doing to cause the business to be valuable? Because then a transaction happens, there’s a sale price, and then it’s correlated, or it just so happened to be 10 times cash flow or 2 times sales, or whatever it is.
People, unfortunately, have been trained too much to look at a multiple. That’s not going to be the thing to work towards. It’s the valuation drivers of making sure the things that an entrepreneur truly can control, they’re working on those things to make the business valuable. That’s really some of the big punch lines out of the book.
Josh: That’s interesting. As an agency owner, sometimes there’s opportunities to participate in competitions for growth and put yourself up, measure yourself against other agencies. We’re a purely digital marketing agency, so we do TV and radio and outdoor and things like that. One of the things that it’s always been curious to me is how there are agencies that do that that will put in their revenue numbers the pass-through dollars. Yes, they invoice a client for $100,000 for a campaign or whatever, but they might pass 80,000 of that through to like the Radio, TV, but they’re claiming it as revenue. I think, if you’re going to do some valuation based on revenue, that’s fictitious. It doesn’t actually demonstrate the drivers like what you’re talking about.
Patrick: It’s all about the economic engine and what’s the real thing that’s driving profits long term. Again, something could be losing money right now. Even YouTube at some point was monetized. Even when Facebook bought Instagram, and Google bought YouTube, they were very early stage and people didn’t get it, but they monetized it and now people get it. It’s like, those are cash flow streams. That’s how you think about it. The really good entrepreneurs are able to not only build those value drivers but then they are able to articulate it to others to sell them on the future on the vision. That’s how some people can get a breakout valuation. That’s what our book and our content is all about is like, where and how does that happen? What can you do in your own world to enhance your valuation?
Josh: Very cool. Where do you sit, in your thinking, on this idea that CEO, they, as an entrepreneur, high growth. The job of the CEO is always to be raising more money. They’re always chasing the next round. You take money from investors and they want to see when is your, a round happening, when is the next round happening? What’s your thoughts about that treadmill that entrepreneurs can get themselves on by taking that money and then really having to always be focused so much heavily on the next round? I’m just curious about your thoughts on that.
Patrick: Well, in the majority of cases, I think it’s really sad. Josh, I can’t tell you how many conversations I’ve had with entrepreneurs, because we tell them about the Hill Capital model and how we see things. We’ve had a number of people basically breakdown or in tears, like, “I wish I would have thought of this or known this ahead of time,” because there’s a lot of people who convince themselves to lie to themselves and to lie to others. Maybe a lie is too strong of a word, but they went out there and sold that they could be the next billion-dollar thing so they could bring in $5 or $10 million into their business. Now they have to live up to it. For a lot of entrepreneurs, it’s become a very uncomfortable job. That’s what they wanted. I have [crosstalk]–
Josh: Articulate the other happier path that you would entrepreneurs to think about because I do think that all the headlines and all the news coverage is about like, “Hey, this company just closed this round.” It’s all about these huge rounds and companies bringing in a ton of money, but they might not actually be pre– they’re still pre-revenue.
Patrick: Some business models do really need to do that. Like some of the early social media companies, great examples. Really to be first-mover advantage and so on and so forth. They did need large rounds of capital and so on and so forth, but it is a treadmill. What I’ve started to speak up a bit more about is just, I want entrepreneurs to fully understand it and fully understand that they have choices because that’s not the only way you need to capitalize. I love in the Twin Cities, we had Kevin Spring started the Bootstrappers Breakfast. We’ve had other people talking about bootstrapping. I know Chad Halvorson, When I Work had talked a lot about that bootstrapping, I think that’s super important.
When you do think about bringing outside money, external capital, when and where is it a fit, but know what you’re signing up for? Because it’s no problem if you understand what you’re signing up for, but where I think it’s really tragic is when people don’t fully appreciate it until they’re 12 board meetings into it and realize like, “Oh, this is a very different job than what I was hoping for as an aspiring entrepreneur.” I did want to go back to one other point when your earlier question, what should the CEO be focused on? I don’t believe that they should be focused on the next round of capital.
However, I’m a big believer in, I always need to make sure the company is properly capitalized. That’s really key. It is very important for entrepreneurs to understand the motivations and the expectations of venture capital of institutional capital. The vast majority of venture capital, their models work when businesses raise future rounds on bigger valuation. They can mark it up and show an IRR back to their LPs.
Nothing right or wrong about it, just stating facts. It’s helpful for entrepreneurs to know that because they will find themselves, if they do bring in venture capital, a bit of a need to raise additional money so they can stake another notch on the wall on where they are in valuation.
That’s the challenge. There’s a lot of good blogs out there and videos out there that talk about the venture capital model. If this is news to people and they’re thinking about external capital, I’d encourage them to go learn about it because that’s, again– it’s not good or bad to take venture capital. It’s like understand who your partners are, whoever they are. That’s what’s important.
Josh: You just talked about or said that CEOs, of course, they can focus on raising the next round when it’s prudent and it’s the right time, but they should really be focused on making sure that their companies are in a good place from a capital perspective. Do you have any a rule of thumb that you could share? I don’t know. Maybe you don’t, but this idea should a company have two months’ worth of payroll sitting in the bank? What rules of thumb could you suggest to entrepreneurs that might be workable?
Patrick: A lot of this, of course, is continued upon the economic engine of the business and where a company is at and so forth. A couple of things I utilize as rules of thumb are, if it’s a startup phase and it’s purely just budgeting for expenses for the foreseeable future, making sure you have 18 months, because if it’s anything less than that, as a lot of us know, it takes a long time to fundraise. It’s not like you go out and just pitch a few angels and all of a sudden you have money in a checking account 60 or 90 days later. I’ve seen a lot of businesses take over a year to raise money.
Making sure that they’ve got plenty of room to be able to execute on that. If a business is operating and running like a lot of the businesses we look at invest in, what we work with our portfolio companies on is the concept of a core capital target. Again, it’s dependent on the business model, but a good rule of thumb is that two months’ worth of all operating expenses of cash on the balance sheet. Now, again, it depends on the business model and so forth and whether it has inventory or not, or receivables or not, and so on and so forth, but a good rule of thumb is two months’ worth out all operating expenses. Payroll, rent, any budgets that they need for marketing, and so forth. That’s important.
I think a lot of people would hear that and they’d be going, “Oh, that’s nuts.” A lot of us have been trained wrongly. I think in a lot of accounting finance courses in college and stuff is like, “I have all that cash on a balance sheet. That’s not efficient.” It might not be for a large publicly held company, but for us as private business owners, it’s super important because, to be able to thrive and to do well long term, we need to survive. The pandemic was a really good eye-opener to that. If all of a sudden revenues are off 50% and you’re locked into paying $20,000 in rent for a cool north loop office, you got you be ready to get to that because it’s really sad when people don’t have that properly budgeted and then they’re out of business.
Josh: That’s a great answer.
Patrick: Other companies have seen they need way more capital than what they fully appreciate.
Josh: I think that’s true for sure. Man, we could probably go on and on about this all day long, talking about capital, talking about valuations. I think you’ve dropped some really great golden nuggets along the way here. Maybe one last question. If someone wants to learn more about Hill Capital, or believes they’ve got a business that fits your investment criteria, how would you want them to get ahold of you?
Patrick: I am an open networker. One of our core values is collaboration and transparency. People are welcome to ping me, call direct on LinkedIn, email. Our emails are right on our website. Always happy. You can introduce me to whomever you see fit. If somebody knows somebody in common and feels better about doing it that way, that’s completely fine as well. I handle all inbound requests, get together the same. We work really hard to get back to people, put some time on the calendar at a bare minimum, get to know them, and point them in the right direction if it’s not except for us. We’re just trying to be part of the ecosystem.
Josh: That’s great, man. I really appreciate you. I appreciate your time, I appreciate your thoughts on this subject, and I wish you the best of luck with that book, man.
Patrick: Likewise. I’m so grateful for your friendship and all that you guys do for the ecosystem. That is awesome. I can’t wait to get this content out there because it is needed. We just want to help entrepreneurs really understand where and how they can be successful. That’s, at the end of the day, what it’s all about.
Josh: Awesome. Well, thank you, Patrick. That’s Patrick Donohue from the Hill Capital Cooperation. That’s a wrap on Augurs on the Town, Episode 16. Thanks, everybody. Bye.