For most founders the early stages of business are “bootstrapped” - funded by friends and family, reinvested profits, salary sacrifice, personal credit cards, mortgages and the like.
Funding the business’s next stage of development presents a different challenge. A variety of factors, not least cash constraints and the amount of capital required, often mean that at this point the owner has to look for external finance.
There are essentially 2 forms of funding for any business – debt (loans) and equity (shares in your company) which are very different arrangements. This article focuses on the latter.
So what are the things a business needs to look out for when seeking equity investment?
The first point to make is while there are a multitude of sources of equity capital, “tapping” into these requires help. A starting point would be your accountants or lawyers who may well be able to guide you; bear in mind that your business’s sector, size, maturity and the investment requirement will immediately rule out and in a large number of potential investors. In short, the typical sources are wealthy (“high net worth”) individuals and venture capital firms or perhaps a combination of both. The approaches of these different investors can vary dramatically. (The British Private Equity & Venture Capital Association is a useful starting point).
Process
In terms of process, most investments follow a similar path. Good practice is to prepare an initial brief “taster” for an investor to review which is followed by a more formal business plan, presentations and discussions with investor(s) and finally an offer letter setting out the terms of the investor’s proposal. This will be followed by the “legals” – the formal legal documentation typically accompanied by an investor health check (“due diligence”) on your business. As a rule of thumb you should allow a few months from the start of investor discussions to receipt of the cash.
It is impossible to overstate the importance of first impressions. An owner must prepare thoroughly for the initial meetings with the investor. A solid grasp not just of your business and its financials but also your market and the threats and opportunities will be essential. You will also need to be able to explain the amount and purpose of the investment being sought.
The business plan is a key document and you would be well advised to seek professional help with its preparation. It should cover the business’s history, operations, management team, financial history and projected performance (always keep the latter “real” – you may well be asked to justify these forecasts later), an analysis of your market and the business’s “edge” within it. A one page executive summary is also useful. A good plan can’t guarantee success but a poor one guarantees failure.
So what will an investor look for?
A number of factors will influence any investor’s decision to invest:
you, your passion, commitment and experience. Investors avoid “lifestyle” businesses
strength and balance of your management team
your vision for the business, growth strategy and plans for an exit
the business’s edge (USP)
your systems (if your sector is heavily regulated an investor will be keen to understand your compliance functions)
financials and the business’s cash generation and profitability
sector, competition and growth opportunities (the potential “scalability” of your business)
Your business must also be “investor ready” so ensure that you have your “ducks in a row” before approaching investors e.g. IPR registrations, key employment contracts, property lease signed and so on. An investor will run its own due diligence on your business and it is vital that you have resolved any housekeeping issues before this exercise starts - or at least be in a position to point out any problems to the investor. Trust and transparency is key - investors respond more favourably to being told about an issue than discovering one.
What stake will the investor want?
Well, first off that’s the right question; unless you are in a strong position the question is rarely what stake are you prepared to offer. That said you should be clear about your “redlines” and if necessary be prepared to walk away. The investor’s position will be driven in part by the return they want to make on their investment and in part by their valuation of your business (which will never be the same as yours and the less mature the business the more subjective this becomes). Remember also that when discussing equity % investors typically speak in “pre-money” terms. In other words, their % will be calculated on the value of your business before they invest.
Some founders limit the amount of the investment to protect their equity %. Experience suggests that this is a mistake. If the money is on offer take it – a fast growing business can devour cash and returning to your investor for a “top-up” too soon is seldom well received.
What level of interference can you expect post-investment? Investors will not want to be involved in the day-to-day but they will invariably look for 3 things:
regular information
influence over major decisions
access (in the form of board representation)
It’s important to remember that third party finance brings accountability and good governance expectations – not necessarily bad things.
Remember to choose your investor carefully. In addition to personal chemistry and the depth of their pockets, an investor will ideally be a good sounding board and door opener with experience of your sector and valuable connections.
Dos and don’ts:
make sure your business is ready to receive investors – resolve any issues before you start
trust and transparency are key for an investor
get your management team and business plan in shape
know your market and the opportunities
don’t confuse value and price when choosing an investor
don’t be afraid to walk away
Do Lectures | Legal aspects of starting a business
Johnathan Rees was invited to speak at the Do Lectures, an inspirational ideas event. Johnathan’s talk, titled “Legal aspects of starting a business” led to a book “Do Protect – Legal Advice for Start-ups”. Johnathan says: “the book was an opportunity to share with as many “doers” as possible, the lessons I have learned during my many years of helping early stage businesses along their way.”
