Introduction

For many business owners, their business is an accumulation of enormous efforts over a lengthy period of time: a schooling career, tertiary education, mentorship, saying no to many social get-togethers, hard work, mistakes, parting ways with savings, more hard work. The list is endless. Given the sacrifices made in building a business, it is no surprise that deciding to expose it to potential investors, is an emotional rollercoaster.

And while one might assume that seeking investment is predominantly a financial transaction, this isn’t entirely true because a large component of the process has a qualitative dimension to it. It is as much about telling your story, giving the investor confidence in your team,  and positioning your brand right, as it is about proving that your business’s financial performance makes for a sound investment.

In order to have a relatively frictionless experience, all aspects associated with seeking investment for your business need to be identified, unpacked and then packaged in a manner that is the most appropriate for your business. One stone left unturned may make all the difference in whether you achieve the desired outcome or not.

Channels for Investment

The context of the particular case will largely determine what type of investment opportunity is best suited for you and your business. You might be looking for someone to help you grow your business and who is strategically and operationally involved with its day-to-day running. This sort of investor might be best incentivised through an offer of an equity stake in your business. Alternatively, if you would prefer to remain in total control, and can prove that your business is in a strong cash-flow position, debt financing might be the better-suited solution for you.

On the contrary, you may not even have thought about whether or not you are ready to take investment and so you wouldn’t know what investment medium would be appropriate for you.  A good question to ask yourself would be, how you would react if an investor made you an offer that’s too good to pass up.

There is no blanket answer as to what investment channel is the best. One would need to ask the right questions and assess the details of their particular needs in order to determine what channel could work for the business.

With that said, there are four main types of investment that can broadly be defined as follows:

  • Equity – where the investor takes ownership in your business (usually, part ownership, unless you are exiting your business fully).
  • Debt – a debt financier lends you a sum of money for an agreement to pay back the sum with interest at an agreed future date.
  • A combination of both equity and debt – referred to as ‘mezzanine’ financing where the investor has a right to convert his ‘interest’ in the company to equity in the case that the borrower defaults on the loan.
  • Government grants or loans – the government provides funding on the basis that certain criteria are met.

How Best to Prepare

The most important part of raising investment is what comes before the transaction, for this will define the success of the transaction itself. The pre-investment phase also determines what your experience and your team’s experience will be like once the deal has been concluded. This phase includes strategy, planning and ensuring that your financial information is reliable (that you can provide a clean set of financials to the investor).

The post-transaction phase is also important to consider: are you being managed by the new investor and told how to run ‘your’ business? Or,  did you intend on stepping away from the business, but the transaction has created more stress and pressure than you’ve experienced before?

A successful transaction is in the eye of the beholder, but there are a few key items that should be kept at the forefront when seeking investment:

  • All factors considered, are you getting the maximum value for your business?
  • Are the terms of the transaction fair?
  • Is there alignment between your business and the investor from a values and vision point of view?

Smooth Sailing?

It’s always advisable to manage expectations, and in the context of looking for investment, it is only fair to know that it is a ‘testing’ process. This is largely because the business owner does not hold the power, the buyer or lender does. This is not the nature of the relationship in every instance, but certainly in most.

With the investor guiding the process, one may find that it is executed at their pace, which is often slower than the business owner’s preferred timelines. It is also possible that you could be ‘lead on’ by the investor – you may be lead to believe that there is a strong likelihood of a particular transaction being successful, only to find out shortly before finalising the deal, that the investor has changed their mind and that your business is not quite a part of ‘their risk appetite.’

Having recently walked the road with a client in applying for traditional debt financing at various banks the timeline from the date of application to receiving the terms of the deal were in the region of six to eight weeks. During this time period, there are ongoing communications between the funder and the business owner or the financial professional facilitating the transaction. Communications will take the form of requests, for:

  • Supporting documentation
  • Details pertaining to your financial statements
  • Forecasted performance expectations or
  • Information that you have already disclosed but that the funder has overlooked due to the ineffective internal processes within the investing organisation (traditional banks).

The Right Tools for the Job

The end goal is to try and identify the ‘right partner,’ who is prepared to make the ‘right offer.’ Part of this process is conducting what has been termed a ‘reverse due-diligence.’ This involves completing an assessment of your potential partner and allows you to maintain a degree of control along the way.

Before considering the suitability of the investor you need to take a step back and first clearly define what you are looking for and identify the items that you are not prepared to compromise on. The importance of knowing what you are looking for cannot be over-emphasized. In times of pressure and emotional turmoil, you will need a reference point against which to measure whether the offer on the table is the right one or not.

Once your strategy has been formulated, an overview of your business and its financial performance are packaged into one document, referred to as an Information Memorandum. This will be the investor’s first touch-point with the business (unless the investor has an existing relationship with your business), and hence it is of great importance that this is compiled in such a manner that justly describes all components of your business. A high-quality Information Memorandum attempts to premeditate areas of question for the reader and answer these questions in advance.

The Information Memorandum is a foot in the door, after which the real fun starts – the investor performing a due-diligence on your business. It is expected that during this phase you will question whether you are comfortable sending across such highly confidential information, such as customer and supplier relationship details, historic bank records, personal income statements and balance sheets of the shareholders. This is standard practice and a part of any professional due-diligence process. An ‘open-cards’ policy that promotes complete transparency is the best approach. Where the investor ‘discovers’ a part of your business that you were trying to hide, this will damage the value of your business and the level of credibility of the information that has been put forward.

There will always be questions in response to the information that you present to the investor, and as long as you can explain yourself, the investor is generally understanding and accepts that running a business is not an exact science.

Conclusion

As a business owner, you can be confident in the fact that no one knows your business as well as you do. You know where your business currently stands, and you know where you would like your business to be in the future. How you will get there, in the context of an investment narrative, is critical. It is a challenge for SMEs to successfully obtain funding in today’s economic environment and even where business owners do manage to raise funding successfully, it is still tricky to secure the right terms and ensure that you are not taken for a ride in the process. Thus, having the right professionals on your team to support you through the process, will add tremendous value.

Perhaps this paints a rather intimidating picture of the investment journey, however, just like most things in life, the fact that it is not an easy process, makes it so much more satisfying when it is a success.

If you have any questions or require support in determining how best to raise funding, please schedule a call.

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One of the main challenges for early-stage businesses in South Africa is access to funding. This is not as a result of a lack of available finance but rather due to a range of issues, including, but not limited to, regulations, complex finance application processes, and the economic climate. An important component to successfully financing your business’s growth is identifying what strategy is the most suitable for both you as the owner and for your business.

The following types of funding may be worthy considerations in determining how you are going to fund your next business concept or unlock growth in an existing business.

1. Angel Investors

An angel investor is a wealthy individual that provides funding in exchange for equity in the business. The investment may be made by a single investor or a group of investors that invest their personal finance in the growth of the business. These types of investors are referred to as ‘angels’ because they are willing to invest their personal funds into a higher risk business when no one else will.

Advantages

  • The right investor may have a more hands-on approach and provide value with relevant industry experience.
  • Private investors can react faster to ad hoc challenges and a changing business environment.
  • The investor may be ‘well-connected’ and introduce you to new opportunities.
  • The pace of the transaction from beginning to end is quicker.

Disadvantages

  • Emphasis must be on identifying an investor that is a ‘good fit’ for the business to avoid unhealthy business relationships.
  • The inclusion of such an investor may make it seem as if you have lost an element of control.
  • The investment opportunity will need to be one of high growth in order to attract such an investor.

2. Venture Capital

Venture capital is focused on early-stage businesses with high-growth potential. Funding is provided by a venture capital company or fund. There are more defined timelines with venture capital, in that, the venture capital company or fund invests in businesses with the intention of selling their stake for a profit after a certain period of time.

Advantages

  • The investment sizes are generally larger than investments made by angel investors.
  • Access to a network of investors with good business acumen.
  • Growth focused investors driving the performance of the business.
  • Seek a minority stake in the business (in most cases).
  • Opportunity to approach the venture capital company for additional funding rounds in exchange for more equity in the business.

Disadvantages

  • Increased pressure to meet performance targets. The venture capital company will maintain a watchful eye over the performance of the business and exercise pressure if financial performance is not satisfactory.
  • Difficult to meet the high-growth requirements needed to convince the venture capital company or fund that your business is investment worthy.
  • Strong competition from other businesses for obtaining venture capital funding.
  • Loss of control in strategic business decision making.

3. Private Equity

A private equity company or fund is money pooled from a group of investors with the purpose of investing it in investment-ready businesses that make for a promising investment opportunity. This usually involves an entire private equity firm and a group of people whose focus is to help the business grow.  Private equity, in comparison to venture capital, is aimed at more developed businesses, that have been trading for a longer period of time and as a result, the investment is considered less risky in nature.

Advantages

  • Access to a pool of investors with high expertise and sought after business acumen.
  • Relationships with private equity companies can be a driver of high growth.
  • Private equity deals provide large sums of funding.
  • Here the investor has a lot at stake (a lot of ‘skin in the game’) and is generally well incentivised to ensure that the business grows.

Disadvantages

  • Private equity funds usually invest with the intention of exiting after a period of time for a profit. The focus on the value that can be derived from the business is primarily in terms of profit.
  • It is unlikely that a private equity company will be looking for a minority stake – they usually seek a controlling stake and want to dictate how the business should be run.
  • The process of convincing the private equity company that this is a sound investment is likely to be time-consuming.

4. Debt Financing

Debt financiers may be able to assist with raising finance. In return for lending the money, the financier receives a promise to have the principal and interest repaid at an agreed future date.

Advantages

  • No equity is given-up.
  • Debt has a defined end (once you repay the total amount borrowed). Equity is indefinite in the sense that the investor will own a portion of your business.
  • You are not required to report to a group of investors regarding the performance of the business.
  • The financier doesn’t dictate business strategy or how the business should be run (all aspects of control are maintained).

Disadvantages

  • Lack of assistance from a person or group of people with good business acumen and high levels of expertise.
  • Collateral will need to be provided to secure the loan.
  • Lengthy and stringent application process.

5. Equity Funding through Private Network

Business owners approach their private network (referred to in the industry as  ‘friends, family or fools’) for funding in exchange for equity in the business. A private campaign differs from a campaign by way of a public offering in the sense that the investment opportunity cannot be offered to members of the public – the offer can only be communicated to a private group of investors. For example, emailing a defined group of investors in your network.

Advantages

  • Administratively less burdensome than an offer to the public.
  • Less compliance surrounding company structure than with the inclusion of a public company.
  • Formation of a business relationship with a group of people that are in your private network rather than people from the general public.
  • The pace of the transaction from beginning to end is quicker than with a public offer.

Disadvantages

  • One must be cautious regarding legislative requirements defining private offers and public offers.
  • Loss of publicity and the ‘hype’ associated with an offer made to the public.
  • Reliance on responsiveness from investors before one can discuss the investment opportunity in detail.
  • Your ‘reach’ in terms of the number of investors that you may contact is limited to your private network.

5. Equity Crowdfunding (Public Offering)

This is not your most traditional method of raising finance, however, equity crowdfunding is a topic that is receiving a lot of attention of late. The investment opportunity is not limited to a private group of people, the ‘crowd’ is much larger in the sense that the offer is made to the public. Businesses that have a large number of followers offer their ‘crowd’ ownership in their business. For the investor, the transaction may be more of an emotional one in that they want to support the business and see the brand succeed.

Advantages

  • Sell a piece of your business directly to your audience. Your customers hold equity in your business.
  • Added marketing benefits associated with a successful campaign.
  • Psychological influence of the ‘bandwagon effect’ – potential investors are excited by the investments that have already been committed.
  • Control of strategic decision making is maintained – a large number of people own a small portion of the business, rather than one or two investors dictating how the business should be managed.

Disadvantages

  • Limited track record in South Africa.
  • Stringent regulation surrounding offers to the public.
  • Time-consuming and administratively intense.
  • Where a campaign does not reach the intended target, the funds raised must be returned to the investors.

In a South African context, where SMEs really can be the drivers of improved economic performance, the question, “how can early-stage business owners grow their business”, is all the more prevalent.  If you are a business owner, you are fortunate in the sense that there are various options available to you. The strategy that you choose to adopt will largely determine whether you are successful or not, and more importantly whether you enjoy the process along the way.

If you have any questions or require support in determining how best to raise funding, please schedule a call.

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