Raising Finance
From Entrepedia: The Entrepreneurship Wiki
This page is based on information provided by Patrick Angier of Beer and Partners Ltd.
Say your business is growing nicely but with plenty of potential. You are probably a relatively young business, or you are looking to inject some new life into a business you have bought, inherited or taken over.
If you had access to an extra £10k, £100k, £500k, £2m, £10m you can solve all these problems and be well on your way to the new car, wife, husband, partner, office, country estate, penthouse, yacht and debt and care free lifestyle we all aspire to. But how do you raise this funding?
There are no right but plenty of wrong ways: it's not easy, and the bad news is that you will only know that it was the right way if you are successful. What is right for one business is definitely not right for another. But there is one fundamental rule – raising finance is not so much a technical exercise, rather a selling exercise – you are selling to somebody else the ability to make money out of your business. Personalities and personal chemistry are as, if not more, important than the underlying business. As a result, the financial instruments used will be simple – no complicated financial engineering required.
Contents |
Considerations
Firstly take some time out and have a very hard look at yourself, your own stage in life, personal aspirations plus other interests including family etc. Raising finance is a stressful and disruptive activity that will require your full attention. You need some stability elsewhere and if you are also facing personal pressures in other parts of your life at least take these into account. Then have a very hard look at your business and business strategy and processes. Any potential funders definitely will.
Cash Flow
“Cash is king” - whilst profit and loss is of importance and of great interest to accountants and the tax man, access to ready cash is the difference between going bust and being successful. To often companies grow too quickly and run out of cash even they are technically very profitable. You need a very clear understanding of your bank position and what effects your cash flow. Most rapidly growing businesses are cash hungry, with a significant “J Curve” or “Hockey Stick” cash flow – need to invest now for future revenues and earnings.
Earnings, margins, profitability and the business model – probably the absolute key. Does the business make money. Most financing decisions are based on some multiple of turnover and earnings – usual EBITDA (earnings before interest, depreciation an amortisation)
Customers
Who are they, why do they buy from you (if you don’t know ask them) and how do you find new ones and get further business out of existing? Most importantly, when do you get revenues from your customers? Some businesses such as retail, have lots of customers buying small amounts. At the other extreme is the small drug development company where the only sale will be when the company and its technology is acquired by a big pharma. If you don’t have any customers, find some - businesses without customers are almost unfundable. If they are buying from you now, so much the better, but some form of relationship that will result in revenues is almost essential.
And More...
You need to have a very clear understanding of your cost of sales: exactly how much it costs your business to produce and deliver your product / service to your customers. And don’t forget little things like the costs of acquiring your customers, staff costs (including your own time), VAT, professional and finance charges – most entrepreneurs conveniently forget these!
Be aware of your staff, your core assets, technologies and other key resources. You can scrounge, steal, borrow, or beg, so long as you have a very clear understanding of the skills and resources that are available to you.
It is amazing how often people who are driving businesses can’t answer these basic questions when presenting to funders – “let me refer to my accountant” is not the right answer. You need to have good, reliable management information at your fingertips, and you need to be able to produce simple management accounts very quickly. It is very good discipline to set up a simple management information and accounts system right at the start of the business, and for everybody within the company to use it. When times start getting tough, you will need accurate information to make the correct decision rather than just your instincts.
Internal Funding
Your customers are the key source of funding for all businesses. Chances are that customers are buying or will buy from you because you are offering them something that will give them a competitive advantage over and above the competition. So why are the first customers offered a “discount” with payment several weeks after delivery, rather than being offered exclusivity in return for deposit payments now and stage payments as the product is being delivered.You may well have under utilised staff and other assets. Can you deploy your development staff on other revenue earning projects for perhaps three months of the year – these may not be closely related to your core project, but they will contribute to your overheads and develop relationships with customers. Do you have a plant and machinery that, with minor modification, can be used elsewhere and become a profit rather than cost centre? What about your private funds: have you shaken the piggy bank hard? In many businesses there is plenty of funding available from yourself. Streamlining, cost savings, and bootstrapping are the obvious. Have you any tax credits that you can reclaim now? Are you and your fellow directors drawings appropriate for the stage of business – do you really need that big company car? Can your staff cover their own costs in return for a bigger share in the upside?
External Funding
You have considered the above, now lets look at external funding. First thing to bear in mind is that using external finance, whether an overdraft facility from a high street bank or pure equity from a venture capitalist will change the dynamics of the business. External funders of any description WILL want to have involvement in the business and they WILL want regular reports especially into the finances. And once the funds have gone in and if they not happy they WILL take appropriate (in their eyes) action.
If you have been to business school you have probably had “Is Debt better than Equity? Discuss” as an essay title. You will no doubt have been exposed to WACCs, Betas, NPVs, IRRs and discussions on the appropriate debt / equity mix. If you haven’t don’t worry – much of this relates to large corporates rather than entrepreneurial companies and is to some extent academic. For an early stage entrepreneurially driven company you often don’t have a huge amount of choice or time. The principle choices are:
Lenders
These will vary from the prime lenders (the big high street banks, RBS, Barclays along with the slightly smaller Clydesdale etc) to the specialist sub-prime lenders to loan sharks swimming at the bottom. There are a whole raft of “products” they use, from basic overdraft facilities through to invoice financing, trade financing, and leveraged debt, or Small Firms Loan Guarantee Scheme. Frankly, debt providers don’t really care about your business and how you make your money. What they do care about is whether or not you can repay the money plus any interest, and if you default how easy is it to recover the money.Lending, certainly for the big banks, in the sub £2m market is about low margins and high volumes. If you consider that a typical manager has 150 clients in his portfolio to manage, cost of his money is say 0.25% above LIBOR and he is lending it out at 2 to 4% above LIBOR, his actual margin on any particular lending situation is not high. And it only takes one or two bad debts to wipe out any profit he makes out of his portfolio – that’s why banks have strict lending criteria and you either meet them or you don’t. Also individual managers also have very strict guidelines to which they operate.
What a bank manager wants to see is a clear simple proposition supported by solid evidence that you can repay the loans with appropriate easily recoverable security to cover the loan plus interest in the event of a default. Its important to understand how the various banks operate, their differences and similarities, and in particular which managers are open for new business and which ones are in fire-fighting mode. Within most banks there are individuals and teams tasked with providing banking services to the stars of the future. You need to identify and access these individuals directly as they can then steer you through the appropriate channels.
There are a good number of much smaller more specialist lenders coming into the market. These typically have tens of staff, as opposed to the thousands of the big banks, with a debt book of a few million. They are borrowing money at probably 1% above LIBOR and then lending it out at various rates depending upon the nature of the transaction and the security. They can’t compete with the banks on the large business nor in the volume market.
Where these lenders work is by being specialists and flexible. Their target market is the rapidly growing entrepreneur run business. Examples are the specialist trade and invoice financiers who can be used to smooth the cashflow nightmares associated with large orders given by big companies who expect to pay 60 days after delivery. They are not so worried about you and your businesses track record and credit rating, rather it is the quality of your customers and their ability to pay that is the key. Yes their money is more expensive than a high street bank, but this can often mean the difference between servicing a large order and making the associated profit or having to turn away business.
If you have core assets – in particular plant, machinery and buildings – there are several ways in which these can be refinanced to provide you with immediate cash to be used elsewhere. Most of these specialists don’t and can’t afford to have a public face – they prefer to work through specialist brokers and introducers.
Equity
In its simplest form an equity investor is buying shares in your company now so that he can have a share of any future profits. As soon as you have equity investors, the company is no longer yours, rather it belongs to the shareholders of which you happen to be one.
With equity investment into private companies, the risks associated with the investment are very easily quantified – if the company doesn’t perform the investors will loose their money. They have no security and no means of recovering their money. Even if the company makes small profits and runs at a break even level, an investors money is locked in – there is usually no means by which he can sell his shares, and other share holders (i.e. the management) often will not have the funds to buy his shares from him.
To compensate for these very real risks an investor will look for a substantial financial return. As a rough rule of thumb an investor in private equity is looking to at least double his money every two / three years. Investors will make their return in two ways:
- Dividends — i.e. the company makes profits which are paid out to shareholders
- Capital gain — i.e. the investor sells his shares at (hopefully) a higher price to another party who wants to participate in future revenues. The most common route is through a trade sale where another company buys the business for strategic reasons – to acquire new technology, customers or territory. The alternative is to offer the shares to other investors and this is often associated with a listing on a public market.
The investor will also want to be closely associated with the company, certainly in the early days, to ensure that his funds are being put to good use. This will usually mean a seat on the board for the investor or his representative and the right to veto major changes in the business. Every investor has a different style and methodology. But there are two principle types:
- Fund managers and gatekeepers — i.e. those managing and making investments on behalf of others. The venture capital houses are the principle example (www.bvca.co.uk - for details on the majority in the UK), but we know plenty of private investors who choose to have their funds managed by another party, and a portion of this is earmarked at early stage private companies. There are also a number of syndicates, where members of the syndicate choose to follow a lead investor. Fund managers have to justify their investment decision to others.
- Investing their own funds — these will range from the banks, VC houses and corporate companies investing from their own balance sheet, to private individuals (business angels) investing their own money. They are making their own decision and the softer issues such as gut feelings have an important role to play in their decision making process.
You will need a detailed business plan supported by detailed information. But more importantly you need to have a very clear grasp of your business and strategy and most importantly how you are going to provide the financial returns to your funders. But you also need to have a clear understanding of your potential funder, their style of funding and whether or not they are receptive to new propositions. Don’t forget that most private equity investors, as well as their cash, can bring a wealth of expertise to the business. Where many, especially the Venture Capitalists, are particularly useful is helping to drive the exit valuation – i.e. the price at which they sell their shares. Bear in mind that you are also a share holder and your shareholding will also benefit as a result.
If you can’t summarise your business case and proposition clearly on the back of an envelope or in a three minute discussion, you will not get the initial attention of a future funder.
Tips
The first key decision is getting a funder to commit time and resources to looking at your proposition. Once this decision is taken you then need to provide the key information clearly in a timely manner. Often the difference between a successful funding and no funding comes down to how easy it is for the funder to actually do his due diligence and make the deal happen. If he needs to spend several days sifting through your filing system to find that key contract or details of a patent, he won’t – he will simply move on to an easier transaction. If you haven’t done your homework you won’t get the to the first stage. If you do get to the first stage, you need to be sure you can complete.
When considering external funding, do take advice, particularly from those who are dealing with the funders on a daily basis and make sure that you have access to the widest possible constituency of potential funders.
And on a final note, don’t underestimate the importance of personal chemistry. When sourcing external funding you are looking for partners for the long term. You will inevitably run into difficulties at some point and if you do not have an open and good working relationship with your funders the business will founder. If you cannot work with them at the start, what hope do you have for the future?
