As a business grows there is pressure to generate free cash flow to fund this growth. The free cash flow may not be sufficient for sustainable growth and this means external funds will be required. For many small medium enterprises there is often confusion about the choice between raising capital through debt or equity; each of which have their own advantages and disadvantages.
The most appropriate source of capital will be determined by your business and personal objectives, the financial and commercial position of your business and current market conditions. We work closely with our clients offering comprehensive capital raising services where we evaluate the best capital raising strategy for each clients unique circumstances.
We cannot stress the importance to do your homework on your business before embarking on the journey to raise equity or debt capital. No private investor or bank will participate unless and until your business is investment ready for the capital raising. Our capital raising services covers several key steps.
A) Information Memorandums
The first stage of any capital raising program begins with a thorough evaluation of the Business Plan and translating the need for capital expansion/refinance into a formal Information Memorandum (IM). An IM is the most efficient way of providing a large volume of information about a company to investors/lenders.
Even though there may be one person or a small group of people performing due diligence on the company at its premises, there is also a need to communicate with a wider range of decision-makers (e.g. investment committees, boards, advisors) that may never appear on site. The IM is by far the best way to do this.
When Lindfield Partners prepares an IM, we generally aim to provide investors with details of clients, market position, operations, finance (three way financial forecast covering P&L, Balance Sheet and Cash Forecast), business risks and use of money – information sufficient for investors/lenders to prepare a non-binding bid/loan facility, with an indication of the bidder’s valuation of the company.
Typically, the CEO or business owner will lead a small team of experts in the main areas (e.g. sales/marketing, legal and finance) that will need to be covered in the IM.
Deliverables and deadlines should be decided for each member of the team. When this process is complete, the final version of the IM should be reviewed by the owner, CEO, and all members of the team, to ensure consistency, completeness and accuracy.
As a sanity-check, the Seller(s) and their advisors need to ask themselves what information they would require if they were buying/lending to the company – using a company they know little/nothing about as their reference point.
Given the IM is designed to solicit a non-binding offer on the company, with valuation, the omission of one or more key facts may give a distorted valuation, and provides investor/lenders with an opportunity to renegotiate their offer or simply say no thank you!!!.
B) Private Investors
People often believe that business angels, venture capital and private equity are all one and the same. But there are important differences to know about.
Firstly let’s make sure what is understood by that last term. Private equity is simply shares (equity or securities) in a company that is not listed on the stock market. This term has also been used to describe the broader group of firms that are operating as private equity owners of companies.
Both Angel Investors and Venture Capitalists will hold private equity having made investments directly into private companies.
However Business Angel Investors will be individuals, often successful business people, who are investing their own personal funds into a potentially rewarding business opportunity. Whereas Venture Capital is invested by firms or companies that use other people’s money. They raise that money by offering investors a chance to take part in a fund that is then used to buy shares in a private company.
The fact that business angels are using their own money and venture capitalists are using other people’s affects their capacity for risk and of course an individual angel investor doesn’t have as much to invest as a venture capital firm. The main characteristics of each are:
Business Angel Investor
- An individual investor
- May be willing to invest in early-stage or start-up businesses, as well as established companies
- Investment amounts: $10k – $100k, sometimes a bit more, groups could go up to $1m
- Have experience and contacts to contribute
- May be willing to be “hands-off” or “hands-on” adding important skill
- A company or business rather than an individual
- Seldom interested in early-stage, unless compelling reasons (e.g. high tech with already successful founders)
- Investment amounts: $1M +
- Have contacts
- Require seat on board
Generally if the business is at an early stage then Business Angels are the most likely source of funding. Venture Capital firms may come on board at a later stage when the concept is proven and initial revenues obtained in order to more quickly expand the company.
C) Shareholder Agreements
Shareholders’ agreements are used most often in closely held private companies where there tends to be a close correlation between the owners (shareholders) and management or the directors. In large, widely held companies many shareholders have a predominantly passive investment interest. In closely held private companies, there is a greater likelihood that the owners will wish to vary standard corporate governance practises and procedures to reflect the relationship between the shareholders and between each shareholder and the company and to document their agreements about particular ways in which the affairs of a company are to be governed.
Angel or private equity investors may not have majority shareholding positions but frequently want levels of control over the affairs of companies in which they invest that exceed what would otherwise be available to them as minority shareholders.
They may also require terms to be agreed that relate to their exit from an investee company in due course. The shareholders may also want agreement up front about how disputes or deadlocks in management are to be resolved so as to avoid or reduce the risk of litigation which is all too often very expensive, time consuming, impact on reputation and value destroying.
At Lindfield Partners we would recommend the following contents to be included in shareholders’ agreements in Australia. Typical contents in shareholders’ agreements include the following:
- Management and director structure: Regulation of the management and director structure of the company, including the right of shareholders to appoint/remove nominee directors, when directors are deemed to be removed,
- Appointment and powers of the managing director and management.
- Shareholder and director meetings: Regulation of the conduct of shareholders and directors meetings, including how and when meetings may be called,
- Quorum requirements and specifying those resolutions that require unanimous director approval or those resolutions (e.g. issuing new shares, incurring significant debt, acquiring or disposing of significant assets, and changing the business) that require consent by shareholders (as opposed to directors) by unanimous consent or a specified percentage of votes.
- Class rights: The rights (including veto rights where appropriate) attaching to different classes of shares in the company.
- Accounts, funding and dividends: Provision of a system in which the company’s budgets, accounts and business plan must be approved by shareholders, or require such content to be provided to shareholders with an opportunity to comment; clauses regulating the provision of (further) debt or equity funding by shareholders to the company; specification of a dividend or other profit distribution policy.
- Optional/deemed transfers, valuation, exit: Provision of a mechanism (including restrictions on transfer) in which shares can be transferred and events which will deem a transfer of shares to have occurred or which may give a party a right to call for a transfer of shares and also a methodology or formula by which the value of the transferred shares is to be determined; drag along and tag along rights; provisions dealing with the timing of and methodology for an exit or “liquidity” event.
- Contracts with the company, non-compete and confidentiality: Stipulation of the terms upon which shareholders or their nominees may be employed or have contractual dealings with the company; the provision of non-compete and confidentiality clauses with respect to shareholders and the company.
- Breach, dispute and deadlock resolution: Specification of breach of agreement provisions and the consequences of a breach; stipulation of dispute resolution procedures between shareholders and provisions which deal with deadlocks that may occur at Board level or under the shareholders’ agreement or otherwise; forum and governing law provisions.
- Accession: Stipulation that before shares can be issued or transferred to a new shareholder, that person must execute a deed of accession so as to become a party to and be bound by the shareholders’ agreement.
D) Bank Finance
Lenders will ask for a lot of in-depth information about the financial history of the business. It’s also important for you to create a convincing and detailed business plan which should include a profit and loss budget and cash flow forecast. The information you use to build your business plan may also be needed by the lender to assess your project. This includes both the past and future plans for your business, the people working in it and the market itself.
The outcome of your application is strongly influenced by how well your proposal is researched and how well it is presented
Banks and other lenders will look at your businesses risk profile when considering your loan application. Understanding what lenders look for and what they consider risky will help you present your business in a favourable manner.
As a general rule, lenders look for:
- the level and nature of your security (what you’re offering to give them if you can’t repay the loan)
- your ability to make regular loan repayments (cash flow risk)
- your ability to ultimately repay the debt (business risk), including any other debts you might already have.
You need to be able to assess the level of cash flow or business risk in your specific circumstances. A projection of the cash requirements of the business is most important to a lender, as it is the actual cash left after expenses that will repay the loan, not income. It also shows you are an effective manager.
A lender’s perception of risk
The following factors can influence your lender’s perception of risk. If a number of these areas apply to you and your business you may need to consider another source of finance.
- start-up businesses incorporate financial, business and management risk
- lack of security
- lack of business history
- industry sector, factors will include levels of competition, barriers to entry, profitability profile and current economic conditions
- highly seasonal businesses e.g. ski resorts, agriculture. You’ll need to demonstrate how you’ll deal with cash flow pressures in the off season
- lack of planning, market knowledge and finance skills
- poor credit history.
Watch out! Before entering into a payment arrangement with the Tax Office, businesses should discuss this with their current or future lenders. Many businesses are unaware that entering into a payment arrangement with the Tax Office or other government agencies may adversely affect their current and future financing arrangements. For instance, a lender may not lend to a business if it is currently in a payment arrangement.