How to attract external equity
Attracting external equity, whether from a business angel, an institutional investor or even a corporate investor, requires an organised and dedicated approach. Here are ten key steps to funding success.
1. First Impressions
You only get one chance to make a first impression, so make sure you get it right. Many investors will decide not to proceed within the first 30 seconds of any discussion, or within a minute or two of picking up your business plan. Here’s how you can make sure you give it your best shot:
• Understand who you are talking to by doing your detailed research in advance. Where it is available, review your target investor’s criteria carefully to ensure that you and your business will fit. Don’t try to put a square peg in a round hole.
• Dress sensibly, be on time, know your market and understand your shortcomings. Think about your approach, test it on your friends and practise it to perfection. Don’t fall at the first fence.
• Explain clearly and concisely what you do and what you are trying to achieve. Build a picture of the future in your investor’s mind. Avoid the use of hearsay and jargon. Stick to the facts and keep it simple.
• Be enthusiastic, but realistic. Don’t make outrageous claims or forecasts. Investors may get close to accepting the impossible, but miracles are definitely a stretch.
2. Vision And Strategy
Your investor will want to understand your vision and your business strategy.
You will need to demonstrate your competitive advantage in your chosen area and explain why your particular approach will succeed. Have you got some IP that will disrupt the existing market? Have you got a newer, better, faster or cheaper business model? Or do you simply have a profitable existing business that requires funding for local or international expansion?
3. Business Plan
A well thought out and comprehensive business plan is an essential part of any investment proposition. Make sure yours includes detailed and plausible information on where you see the business in three to five years, along with the clearly identified critical success factors that you’ll achieve along the way.
4. Management Team
Your pitch should clearly demonstrate the capabilities and competencies of your team, giving assurance to your investor that they have the skills and experience to manage the business and maximise its potential. Be aware that the skills and experience required to run a smaller businesses may differ from those required by a larger business. If any skills are missing it may be worth bringing someone in or identifying a prospective candidate with a suitable skill set prior to seeking investment.
Brian Livingston, Head of Mergers & Acquisitions at Smith & Williamson, spent 13 years at private equity house, 3i. “When considering investing in a business, we used three criteria: management, management and management,” says Brian who added that it’s not about having the best product, but more about being in the best market with the best team behind that product.
“In a perfect world you are looking for a good management team in a good sector that is cash generative, with a well-thought out business plan and an established market position. Or, as someone once said to me, ‘you always want to back a digger but, ideally, they should be digging on top of a gold mine.’
5. Trust And Transparency
Investors don’t like surprises- they demand honesty and transparency. The quickest way to lose a potential investor is to sacrifice trust by embellishing the truth. Integrity is the name of the game and no business is ever entirely problem free.
“Nobody expects everything to be completely and utterly perfect,” says Brad Rosser. “So treat investors with common sense; be honest about the entire business from day one. Anything other than the truth slows deals down or kills them entirely.”
Honesty engenders trust and, as Julie Meyer says, “Trust is efficient.”
They say that you’re only as good as the company you keep and as Henry Kissinger, the American Politician and Nobel Peace Prize Laureate, famously said “Ninety per cent of the politicians give the other ten per cent a bad reputation.”
Raising external equity can involve a bevy of advisers, including accountants and lawyers on both sides and, often, a number of other experts. It’s important that you select experienced advisers who are both appropriate to the size of the transaction and who have seen it and done it before.
As Brian Livingston of Smith & Williamson says: “It’s a question of horses for courses. You don’t appoint the largest law firm to the smallest deal or vice versa, but you should always use someone who is known at the appropriate level in the market, and who the investor’s advisers respect.” Just call it the Goldilocks Principle- businesses should use advisers who are not too hot and not too cold, but just right.
7. Financial Results And Forecasts
It goes without saying that your business plan will include your historic financial statements as well as realistic assumptions and forecasts supporting your future trading activity.
Be prepared for questions around your working capital, the engine of your ongoing solvency, and consider the effectiveness of your KPIs and regular management information. Don’t just leave an understanding of this crucial area to your finance director or your financial advisers. This will probably not be enough to reassure your investor of your financial acumen and your ability to manage and grow his investment.
8. Funding Requirement And Purpose
Your financial forecasts will incorporate the funding you are seeking, although it may be difficult to forecast the precise financial impact. This is because the investment you receive may ultimately be structured so that only part of the funding is reflected as equity, with the balance being treated as preferred capital or as a loan. Until the eventual funding structure is known, it will be impossible to finalise your forecasts.
It is often difficult to assess exactly how much funding you will need. Whilst you will obviously allow for contingencies, your investor will be keen to ensure that you are not cutting it too fine. Think long-term, as the investor would far rather provide additional funding at the outset than find a shortfall emerging later on.
9. Valuation and Pricing
There are a number of ways of valuing a business. These will vary dependent upon the type of business, its profitability, its maturity and its future prospects. In a start up, values are often extremely difficult to assess, whereas this can be easier in more mature businesses.
Work with your advisers to establish a sensible valuation for your business. Whether this is based on hope value, assets or earnings, don’t be tempted to overvalue your ideas or achievements. Nothing will put an investor off more quickly than an excessive or insupportable valuation.
Remember that external equity can be expensive. The more you need, the more you will have to give away, so be realistic, cut your cloth and take in as little external funding as possible.
It’s very easy for an investor to put money into your business, but how will he get it back? A vague idea that you would like to buy his shares back at some future date is unlikely to be attractive. Taking in external equity means that you often need to ‘begin at the end’ in terms of thinking about exit, having a clear strategy and plan.
Who are the likely buyers of your business? What will the business need to look like in order to be attractive to them? Will the sale be to a trade buyer or competitor or might the business be attractive to a financial investor, such as a private equity firm? If the current funding round is the first step on the road to a buy and build strategy, where will the next round of funding come from? Should you be considering an IPO for the business?
These are yet more issues to discuss with your advisers. Plans may change as the business grows, but be aware of the possibilities and put your initial stake in the ground.
Note: The above article is an edited extract from Guy’s critically acclaimed book, From Vision to Exit- The Entrepreneur’s Guide to Building and Selling a Business, available in hard and soft copies from Amazon now.
By necessity this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Article correct at time of writing.
Notes to editor
About Smith & Williamson
Smith & Williamson is a leading firm of accountants and business advisers. The entrepreneurial and growth business sector is one of its key areas of focus and clients include both private and quoted companies, ranging from early stage to mature businesses with values of tens and hundreds of millions.
In addition to accountancy services, the firm offers an unusually broad range of expertise including tax, investment management, private banking and financial advisory services and operates from 11 principal offices. Nexia Smith & Williamson is the audit practice of Smith & Williamson and is an independent company.
Smith & Williamson Limited
Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International.