Leon Stephan, Advivo’s Managing Partner, outlines the essentials for raising capital from investors.
Going on to a new financial year, we often think “What can we do differently to make things better?”. When I ask business owners that question, a common response is “Well, if I had more capital I could do a lot more to accelerate the growth rate of my business”.
There are several ways to get more capital for growing your business, (ranked in my order of preference). Obviously, the best is retained profits, but there are also your personal savings, loans from banks and other financial institutions, and then private investment. I explore these in more detail below.
The last two come with prerequisites and conditions that sometimes make them unattainable or unattractive hence their ranking. Whatever option you choose research, risk assessment and financial modelling are essential, as ultimately the outcome must be an improved return on investment for shareholders.
Whilst covering the bases below, this article will focus on introducing new capital from external sources, particularly investors.
Organic Growth / Retained Profits
In my opinion, the best and often the most common (and possibly the easiest) method is through organic growth: that is, reinvesting retained profits back into the business to fund growth. Whilst this has two main advantages (i.e. lower risk and avoiding dilution of your control/shareholding in the business), it is generally much slower and, in some instances, can result in loss or first-mover advantage, letting your competitors gain prominence through increased market share.
Raising Debt
The second method is raising debt. This is traditionally done by approaching your bank or increasingly so other second-tier financiers who provide many more alternatives for specific purposes, utilising differing securities which means this is less restrictive than it used to be. This method can often involve pledging your personal assets such as your house as security for the loan, personal guarantees and other covenants and conditions that add risk to the business and your personal assets, particularly in times of market shocks, downturns in the economy and environmental crises/impacts.
The other major problem with a lot of debt structures, particularly from banks, is you want the capital to grow your business while they want you to be repaying the debt. There is therefore a fine line between what works, your cash flow affordability and the rate of growth you can achieve.
Raising Capital from Investors
The final method – and the focus of this article – is the raising of capital from investors. This can be debt, equity or hybrid structures. Regardless of which, the basics remain the same; like with any debt, you must be able to meet the repayment requirements and timing, and the possible consequences of not being able to do so. This also includes equity investments as quite often they include an exit timeline that has to be met.
Many people complain about the amount of information they must give a bank to support a loan application. I suggest this should not be seen as a problem, but rather a way to help you fully understand your business and the proposed growth, as well as the benefits and risks associated with taking on the debt. This knowledge will allow you to make a well-informed decision using market intelligence to model the future impact of the business. You want to be prepared in case things don’t go well or even go too well, so you know how the business and its resources will cope. This same information plus more is generally required to secure private investment capital and , most importantly, the reason must be to accelerate the growth of your business.
The information required if you are raising equity capital is generally more complex as it will need to delve deeper into competitors, risks, market share at present and how you will increase it, supported by detailed marketing plans as well as longer-ranged forecasts detailing projected returns on investors’ shareholdings and a proposed exit plan for the investor with timelines. This is a key issue to understand: even though you believe your business has the best products, greatest services, or a magic invention that is going to change the world, an investor is just that – an investor. Investors have a range of investment options to consider, some may have some preferences (ie. environmentally friendly etc), but ultimately they are chasing a superior return on investment and return of their capital for other investments in a given time frame. They will specifically want to know what the use of funds is, when we say ‘funding growth’, this will need to be specifically detailed and incorporated into projections and include resources that are needed and consumed to accelerate the growth of the business; including human and physical resources (such as plant and machinery), research, stock, debtors, capital for work in progress, debtors, etc.
How to Gain and Retain Investors
Many investors have a range of investment options to consider and, unless there is some other intrinsic appeal such as family connection, altruistic or environmental benefit, their investment decision will come down to return on investment, the level of risk they perceive, liquidity and, in many instances, when they receive a return of their capital. Different investors also have varying investment criteria from tech, to no start-up to hybrid property and business. So regardless of whether you have the best widget in the world, the investor needs to be able to compare their return on investment and benchmark that against other investment options of their criteria.
Detailed and well-researched information memorandums, financial forecasts and valuation modelling are the only way to achieve this and, generally, this will require capital in itself to obtain independent advice from professionals that have expertise in these fields. Not only must the capital-raising documents be accurate reliable and tell a compelling story, but they must also be legally compliant as must all capital-raising documents.
Many aspiring capital-raisers ignore this requirement and put themselves and their business at risk of having to return investor funds, legal action by regulators or, even worse, legal action from investors for providing inappropriate and misleading information.
Any capital-raising documentation should:
- Be legally compliant,
- Identify the section of the Corporations Act under which the offer document is being distributed,
- Be as detailed as possible with supporting facts to ensure a potential investor is not left with doubts or asking questions,
- Anticipate potential questions and address them before they are asked; and,
- Identify all risks and put forward appropriate mitigating strategies.
Ideally, a capital-raising document addresses all of the above and discusses the difficult issues of liquidity, exit strategy and control. It also needs to clearly articulate that an appropriately skilled and experienced board has considered all the issues, has a clear strategy, the right resources and sufficient capital to execute the implementation plan. Additionally, it needs to outline that the funds raised will have, including a provision for contingencies, sufficient capital to fund the business’s growth plans without the need to raise further capital or cause further dilution to the shareholding of the investors.
So, if you are going to raise capital, you need sufficient capital to even start the project and engage the right professionals, commission the research if needed, ensure any intellectual property is protected and that you have the right team to drive the business forward to success, delivering promised returns to existing and future shareholders. One way to give your business a head start on this is to search for investors with industry expertise and contacts that will benefit the business, not just a passive investor that adds no value other than money.
Finding the right source for funding your business will secure the capital you need to maximise business growth and ensure your business is sustainable for years to come. At Advivo, we have the skills and expertise to assist you with this and we’re always happy to help – contact us today!
