Guy Rigby explains which boxes need to be ticked on a growing business' way to attracting external equity.
In order to attract external equity, whether from a business angel, an institutional investor, or even a corporate investor, a number of boxes will need to be ticked. Here are ten of the key drivers:
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 detailed research in advance.
Dress sensibly, be on time, know your market and understand your shortcomings.
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.
Be enthusiastic, but realistic. Don’t make outrageous claims or forecasts.
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 intellectual property 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? Investors have to be able to buy-in to the overall vision. This requires the communication of that vision in an articulate and appealing way.
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 and acquisitions at Smith & Williamson, spent 13 years at private equity house, 3i. “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."
Investor James Caan’s advice echoes the importance placed on the management team when evaluating investment opportunities. “Management quality is the single most important intangible that outweighs all others when assessing the future potential of any business,” says Caan. “What the business will do in the future relies very much on how the management thinks, how they operate and how they make business decisions.”
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.
In general, investment doesn’t happen until due diligence has been completed. Due diligence is a process of discovery normally carried out by professionals, designed to provide assurance to an investor in relation to the current state of affairs of the business, as well as its future prospects.
If there are false claims or misstatements, they are likely to be discovered at this due diligence stage, often resulting in the withdrawal of the prospective investor. Even if they escape detection through due diligence, the problems are likely to surface later on, damaging the relationship with your new investor and potentially undermining your future.
So, don’t bury bad news or focus only on the positives - just tell it like it is. If there are problems in particular areas, highlight them and explain how you will address them. By doing this, you will gain the trust and support of your investor, who will probably offer his help.
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.
Getting the right advice when you take in new investment can be crucial to your future wealth. There will almost certainly be an agreement containing clauses designed to protect the investor and you will need to understand these and work with your adviser to negotiate the best possible outcome.
Many entrepreneurs are in too much of a hurry at this stage, with the challenge and buzz of raising the funding giving way to the less interesting aspects of completing investment agreements and other formalities. Don’t be one of the many who only discover what they have signed up to after it’s too late.
7. Financial results and forecasts
It goes without saying that your business plan will include your historical financial statements as well as realistic assumptions and forecasts supporting your future trading activity. These are fundamental to any successful presentation.
Be particularly 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.
Take time out with your finance director or your financial advisers, so that you fully understand your numbers and the drivers affecting your cash flow and profitability. Become familiar with commonly used financial language and its meaning. Finally, be aware of key threats and sensitivities.
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. Notwithstanding this, your business plan should include a separate section setting out the amount you are seeking and the purpose for which it is sought. In this way, your investor will be able to identify precisely what it is that he is funding and will be able to weigh up the likely consequences of his investment.
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.
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? 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.
Guy Rigby is head of entrepreneurs at Smith & Williamson.