The ‘Prequin Global Private Equity & Venture Capital Report’ recorded that last year 994 Private Equity funds managed an estimated $3.8 trillion of corporate assets, with another $1.2 trillion of ‘Dry Powder’ waiting to be spent! It also highlighted that 2014 saw over $400 billion invested and over $500 billion of successful exits. That’s up from previous years. If you are considering getting some investment into your business It would certainly appear to be a great time to do it!
The type of funding vehicle and the associated terms will vary depending on whether you are looking for funding for a start-up, or to help accelerate the growth of a more established business. A private equity investment will generally be made by a private equity firm, a venture capital firm or an angel investor. Each of these categories of investor have their own goals, preferences and investment strategies. All provide working capital to a target company to help expansion, new-product development, or restructure operations, management, or ownership.
The most common approaches in private equity are leveraged buyouts, venture capital, growth capital, distressed investments and mezzanine capital. In a leveraged buyout transaction a private equity firm buys majority control of an existing firm. This is distinct from a venture capital or growth capital investment, in which the investors (typically venture capital firms or angel investors) invest in start-ups or growing companies, and rarely obtain majority control.
This article has appeared in our blog at www.korolit.com. You will also find the referenced articles here as well.
Investors rarely make or break a business, but they can make life easier or harder for the business owners and that’s why considerable thought needs to go into who and what is needed to generate the best outcome.
Ideally use your established network of contacts to recommend potential partners and then start to add in introductory meetings to explain your plans and likely requirements. A good investor will be prepared to build an understanding of your business over time as this will help to reduce their financial risk. It also helps to ensure that the target (you) starts to prepare the ground which will make the Due Diligence exercise (refer to our earlier article) more efficient and therefore less expensive.
Investors are busy people and just like salespeople need to qualify their leads and justify where their time is being spent. The level and frequency of access you get is going to be in relationship to the potential value of the transaction, and how imminent the investment is going to be. Managing expectations is important so be very clear up-front re your plans and agree how best to keep a dialogue going. If you find any reluctance to put in any time at this stage view it as a warning sign that the investor may not a be a good fit to your business.
Money is always going to be centre stage, but not to the exclusion of other considerations, hence we strongly suggest that you create a balanced scorecard to assess potential investment partners across the period of investment. Key considerations will include:
- How well do they understand your business model, or have direct experience in your particular industry. Take a close look at their current portfolio and focus areas. What does this indicate about their broader knowledge of your business?
- Is this the first investment of this type for the investor? Without prior experience they may not have the right networks in place to help you, or the capability to add value for any advice and decision-making.
- Just as it may be important for the investor to understand your business, you need to understand how committed they will be to your particular area or business category. Do they have other portfolio companies in the same space? Are they planning to invest in more companies like yours, or are they retracting from this category?
It is worth bearing in mind that if you have an open diary policy at work that your colleagues in the office may take a look at your appointments, browse Google and jump to a few conclusions. At this initial stage we suggest that you avoid any speculation and keep these meetings private and preferably out of office. It’s also a good opportunity to take a look at your potential investors own offices and get a feel for what kind of business they run!
Any good sales person knows that you have a short initial window of opportunity to interest your target. The same applies to most investors as there are plenty of opportunities out there and they need to manage their time. Not surprisingly then a key irritation is lack of preparation.
A start-up business looking for VC funding will probably have had considerable focus on developing its business plan and will have refined this over time. More established businesses tend to lack up to date documented business plans, or have a good overall company presentation. Our general guidelines in developing a good investor pitch are to structure it as follows:
- A paragraph (“elevator pitch.”) verbal summary describing the essence of your business and its value
- Executive summary in not much more than one page that outlines the investment opportunity
- Presentation pack (10 mins target duration) which covers the ‘Who’, ‘Why’, ‘How’, ‘What’ and ‘When’, and particularly the ROI for an investor!
- Comprehensive documented business plan
We also strongly suggest taking a look at your own website and make sure that it is reasonably up to date and aligns with the presentation material. This is often used as a reference point by investors and will highlight any issues in marketing the business. The same applies to any social media channels in use.
All investors have well established templates that they use to assess potential targets, this is after all their core business! Similarly you need to prepare your own questions and these will probably include some or all of the following:
- Are they investing from their own money, from a large fund, or from a division of their company P&L? This will determine the goal and threshold for what they consider a successful investment outcome. It will also determine the valuation sensitivity.
- Does their fund allow for partial liquidation of the Founders shares?
- How large is the fund size and what are the minimal target exit multiples?
- In what % of deals does the investor choose to exercise pro-rata rights in future rounds?
- When do they exercise their pro-rata, do they typically lead future rounds, or act as followers?
- Are the investment decision making criteria and target timelines clear?
- What level of control will they expect as part of the transaction (none through advisory to a Board seat)?
- How involved are they likely to be (e.g. Strategy, Operations, Finance or Services Provider)?
- Will they insist on a management substitution clauses which allow an investor to replace any part of the management team they feels necessary if the existing team fail to meet agreed KPI’s?
Bear in mind that an investor will take a slice of your business based on an actual valuation. This means that their stake is fully justified. In contrast yours is likely to be vested over time. Contractually you might own only 25% today with the balance, excluding the investors slice, set aside as an option based on agreed KPI’s
It is also worth looking a bit deeper into your investors CV’s. Most have a 15- to 25-year career in the business and where they are can have an impact. In the early stages of their career their networks, understanding of the investment business and experience are not as strong. Their influence is also going to be much less than their more established and senior colleagues. They may also be under pressure to ‘perform’ and hence their motivations may not closely align with yours. Someone later in their career may not be willing to put in as much time and energy into helping you become successful as you might expect!
Large corporations have considerable internal resources but still bring in independent expertise to help them prepare, assess and complete investment transactions. It makes even more sense for mid-sized and smaller businesses to take a similar approach. Engage an independent and experienced consultancy to help you prepare your business, evaluate and complete the transaction. The costs of not doing this can be much higher if you find that you need to expend more time preparing during the assessment stage.
- Use your network of contacts to determine a shortlist of potential investors
- Engage early and build a relationship underpinned by a good level of disclosure
- Look for experience in your target market and a strong investors CV
- Create a balanced scorecard to assess fit and to compare your options
- Take time to evaluate the small-print
- Have someone independent and with experience of the process assist you