Introduction to business investment
Getting investment for your business is a tough and complex process, but ultimately it could help you achieve your growth ambitions more quickly than other forms of business finance. We take a look at the pros and cons of securing investment for your business.
The business investor offering defined
In private equity and venture capital an individual, group of individuals or
company buys part of a business and makes money when the stake becomes more
valuable as the business grows.
If investors guess right and pick the right businesses to
back, they can make big profits buying and selling stakes. But business shrink
as well as grow, and investors often demand large percentages for their money
to justify the risk.
This type of funding (versus bank finance or asset funding, for example) is
certainly not for every entrepreneur. Not only will you hand over part of your
business and with it some of your independence, but your business will also be
subjected to intense scrutiny in a process called due diligence.
Your funders will normally demand a seat on your board,
giving them influence over company decisions, and will expect to be notified regarding
important day-to-day business decisions.
On the upside, your business should benefit from your new
advisors wealth of experience. Non-executive directors generally have
substantial business CVs and a wealth of relevant experience.
Pros and cons
Pros
• You get access to growth capital and help from experienced investors.
• They will push you to succeed.
• Added responsibility could help you tighten up your operations.
• You don't have to pay the money back.
• Your investor's experience could prove invaluable to your business.
• Your business could enjoy an enhanced reputation from going through the due diligence process.
Cons
• Due diligence is a long and exhausting experience.
• The close relationship with investors can be suffocating for independent-minded entrepreneurs.
• Investors can drive a hard bargain, demanding a big chunk of your business for less money than you might hope for.
• Their exit strategy might interfere with your business' future plans and force you into another round of funding with a new investor.
Types broad areas offunding
Generally speaking, there are three areas of private funding available, defined
by the size of investment achievable, the nature of the deal, the likely
relationship between you and your investors and the length of time the deal
will take. They are; business angel, venture capital and private equity.
Confusingly, the terms ‘venture capital' and ‘private
equity' are often used interchangeably, and sometimes simply refer to the
process of buying an equity stake in a business. Below is a stricter definition
of the three terms.
Business angels
Business angels are wealthy individuals who are usually successful business
people themselves, having started, run or occupied senior positions in a series
of businesses. Made famous in the BBC series ‘Dragons Den', business angels
operate alone or as part of a network, and usually invest in early stage
businesses with plenty of potential, for quick, significant returns at a high
risk.
www.bbaa.org.uk
www.envestors.co.uk
www.beerandpartners.com
www.angelsden.com
Venture capital
Venture capital is the preserve of ‘institutions'; or companies put together to
invest in fast-growing businesses. These are less likely to fund start-ups and
prefer established firms which need funding to complete their next growth
phase, whether that involves an acquisition, management buyout or simply new
products.
www.bvca.co.uk
www.closeventures.co.uk
www.core-cap.com
www.greshampe.com
Private equity
In its strictest definition, private equity means multi-million, and even
billion-pound deals focusing on big multi-national companies. This is the
domain of huge funds investing in household names, and is therefore probably
off your business' radar - for now.
www.apax.com
www.graphitecapital.com
www.hgcapital.net
VCTs and RVCFs
Founded in April 1995, the Venture Capital Trusts (VCTs) scheme provides
tax-efficient investment vehicles encouraging wealthy individuals to invest
money in UK enterprise.
Investors can contribute up to £200,000 under the scheme and businesses with
turnovers up to £7m qualify for investment.
Regional Venture Capital Funds (RVCFs) were set up to
achieve the same broad objectives as VCTs, the major difference being that
RVCFs have a regional focus.
All nine English regions have a dedicated fund, which can
dole out up to £250,000 per business in the first instance and a further
quarter of a million after six months. Each fund can also make further
investments in subsequent rounds.
http://www.hmrc.gov.uk/guidance/vct.htm
www.businesslink.gov.uk
Due diligence
Once you've hit upon the investment process most suited to your business,
you'll be required to pitch to your prospective investors.
The services of your
accountant/business adviser are useful here; they can help you spot your
business' most attractive features as well as some potential faults. Get in
touch with your legal team at this stage too - they will advise you on the nuts
and bolts of the process.
Investors, whether they're business angels or institutions,
pride themselves on their ability to separate good businesses from bad.
Therefore you must focus on convincing them that your business plan works.
It's important to put together an impressive business plan, and remember that
investors have businesses pitching to them every day. You must stand above the
other businesses and demonstrate that you will provide a return.
Assuring return on investment is the number one factor that will decide whether
you get investment or not. If you can demonstrate that they'll make some money
from your business' growth, then you're more than halfway there.
The other part of the process is convincing them that you're serious about the
future and that your business is a squeaky-clean outfit.
If you're good enough to solicit a ‘yes' from an investor, the next step is to
draw up a term sheet; a provisional and temporary contract outlining the
fundamental details of what you and your investor expect from each other.
Questions to ask:
- What are the terms of the deal?
- How much influence or control do they want on business decisions?
- What is the investor's investment strategy?
- How much access to the board will they want?
- What equity stake are they after for how much money?
- Can they provide more funding down the line?
- Can you speak with businesses currently on their books?
- • How much input will they expect?
The terms and conditions outlined in this document can change before a fully
binding contract is signed, but the overriding themes (amount of money and
equity stake, for example) are normally be stuck to.
Next comes due diligence, the most taxing part of the process. Investors want
to know just about all your business' secrets - down to management team CVs, product
portfolio, research and development spend, financial records, marketing plans, insurance
policies, sales records and even your competitors' strengths and weaknesses.
The more honest and accurate information you provide in your term sheet, the
less likely this process is to cause the break down in the deal when investors
start snooping around. Being realistic when you pitch will also remove the
likelihood of nasty surprises down the line.
If everything is as it should be, then you and your investor will sign a
shareholders' agreement, which is modelled on the term sheet but will include
more detail and is legally binding. Then the money's yours.
Securing funding this way will take several months, and the number of advisors
involved means the costs can be steep. Business angel funding should be cheaper
and take less time than institutional investment, but it's still a long haul.
Jargon-busting
The involvement of lawyers, accountants and a host of other advisors means the
jargon-levels are pushed to extremes. ‘Ratchets', ‘warrantees' and ‘bad
leavers' are all terms you might come across - so make sure you don't leave a
meeting until you're absolutely clear what has been said and what it means to
the deal.
Investor relations
With a seat on your board and a big stake in your company, you'd forgive your
investors for wanting to know where the business is headed. Reporting,
therefore, is a big part of the ongoing relationship with your new pals.
This has good and bad aspects to it. Your incoming board member should have
in-depth experience of your industry and will provide new contacts and
introductions to people who can help you.
But you'll also have to get approval for big spending projects and any other
significant shift in your business' direction. Expect monthly or quarterly
board meetings and the odd office visit from your investor, as well as regular
phone and email correspondence.
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