As a growing business, you may need to consider raising external finance. It may be for working capital; to place a big order; to make a capital investment in new equipment or facilities; fund an acquisition, or to recruit a new team or someone with particular expertise.
But where should you get the money from? How much do you need? What should you expect from the fundraising process, and when should you say “no”?
Equity or debt?
There are different ways to raise money but these generally fall into two categories – equity or debt.
Equity means giving shares in your company in return for money. You don’t (usually) have to pay back the money at a particular time or pay interest on it. Instead the investor will own part of your company and expect a share of any return if it is sold, or of any dividends paid if the company makes enough profit. The investor shares in the upside of the business, as well as the risk of it underperforming.
By contrast, with debt you will retain ownership of your company but will have to repay the debt and interest on it.
It is important when looking for external finance that you think carefully about the amount you believe you require. Too much and you may give away more equity than needed or pay interest on money that you don’t require; equally too little and you may need to raise additional finance within a short period of time, against a backdrop of changing market conditions. It’s a good idea to consider the purpose and planning for any contingencies/over runs that you may incur. Another area often overlooked is the additional working capital businesses require as they grow which should be factored into the quantum of financing.
A long term view
Before you decide what sort of investment to take, it is worth carefully considering your future plans for the business, including whether you expect to sell it. One thing that can surprise some business owners that are new to fundraising are the effects of investment on their business. For example does the equity investor expect to put a director on your board, or to be able to veto certain key decisions? Will you have to provide them with regular reports? How is the personality fit? Can you see yourself working with them, and do you both have the same vision for the business?
From a growth perspective, the benefits can be extensive: opening doors to new customers or markets that would previously been out of reach, access to additional marketing and financial expertise, and/or accelerating product development.
When we work with entrepreneurs and investors, whilst the legal and financial due diligence issues are important, we focus more on whether the two parties may have different expectations for the business and whether they will get along. It can be very hard to ‘divorce’ from your equity investor, so do take your time and get to know them well before you dive in. Ask questions about how they manage their portfolio. Talk to their other investee companies. Find out whether the person negotiating the deal with you is the same person who will be attending your board meetings every month.
The sky is the limit
Crowdfunding can be a really exciting way to combine raising investment with profile-raising. If it goes well, you will have a huge base of new investors, who are interested in you and in your product, and who will help to increase your market by telling their friends about you. Your investors may also be your first customers, so they can help identify what your customers want and get a conversation going among your user community. In addition, you have a diversified shareholder base who are likely to be more passive as investors, even if no less vocal about your performance. When it works well, it can be hugely successful such as in the case of Brewdog, which netted its 2010 investors a 2,800% return.
There are of course other stories when it hasn’t gone quite so well (as the developers of mini-drone Zano found), but the key advice is to do your homework. Start the fundraising process in plenty of time so you can explore all the options without pressure. Keeping an eye on your goal, whether it be to continue grow to exit/IPO or otherwise, can help define the best path forward. A bad deal really can be worse than no deal in the long term. Don’t be too proud (or too desperate) to say “no” if the terms aren’t right or if the personalities don’t fit.
Authors: Jenny Robertson, Partner at Stevens & Bolton and Anu Tayal, Corporate Finance Director at Roffe Swayne
Originally published on Fresher Business Thinking