Let me start with a disclosure. I have recently teamed up with an old friend at White Horse Capital, which focuses on raising Series A & B rounds of over £2 million, broadly for tech focused businesses with sensible customer traction. This has reminded me of the many discussions about the costs of raising finance I have had as an entrepreneur raising finance and with clients when I used to run a placement business for hedge fund investment.
Growth often requires debt and/or equity capital to fund expansion, machinery, new hires, technology and even inventory prior to the associated future revenue. If you don’t raise the necessary finance, or don’t know how to go about it and don’t have the right support then your business can’t grow. If you can raise capital, then what is the cost of that capital? That doesn’t just cover advisor fees, legal fees, due diligence costs or even front-loaded investor fees. A badly written, or one-sided shareholder agreement, could result in you very quickly being diluted or even removed from running and owning your own business. You might think that sounds aggressive and rare, but I have seen it happen, and multiple times.
If you used to work for Goldman Sachs or McKinsey before a stint in a venture capital fund and your mother is a corporate finance lawyer in the City, then you may well have the social capital and network to secure finance from wealthy individuals and can be introduced to institutional investors. If not, then you are faced with a complicated and incredibly time-consuming process as well as a bewildering number of prospective investors to sift through. Access to capital should not be limited by socio-economic, geographic or social factors to ensure that talent, ambition and innovation is connected with significant amounts of money that is available for early stage investment. Although the government has plans to level up the economy, the vast majority of the capital available is managed by funds that have offices in central London. As personal networks are often local, or at best regional, this can present another barrier to a successful fundraising process.
Raising finance is a time-consuming sales process
Think of it as a simple sales funnel and process. There is a universe of funds – your prospects. You need to focus on those with investment strategies that align with your business – suspects. Once the suspects are determined, you then have to find a way to connect with a busy decision maker in order to gauge interest – a qualified lead. Then you have to arrange and attend meetings, present, follow up and answer questions to work out who is really interested – an opportunity. If you have a number of interested investors, you have to attend more meetings, run a data room, efficiently respond to due diligence, instruct lawyers, negotiate, structure, liaise with existing investors, select an investor and secure the funding – closing.
The entire process is time consuming and you will require support of some kind, especially if you are new to raising institutional funding. I have seen many entrepreneurs share optimistic revenue targets at the start of a process; then, due to the numerous and time consuming tasks associated with the capital raise process, suffer from slow progress and lower actual revenue during the sixth month of a process resulting in terms worsening or investor interest dissipating. This is often due to the fact that raising finance can result in founders taking their eye off the business ball.
It is possible to find a list of funds and go to work on Linkedin or by attending events and by knocking on proverbial doors, but there are many more sources of finance that are not so easily found. For example, there are also many well-established family offices managing significant sums of money for wealthy families and entrepreneurs that are notoriously difficult to identify and approach.
Understanding the market
What is it worth to shortcut the process and maximise your chances of success on the best terms? Introducers may just make a call or connect you with a decision-maker by email, whereas good advisory firm will run and support you through the entire process. Fees for an equity fundraise are typically 5%, or more – this is what small cap public companies will pay their broker too. The percentage for raising debt can be lower, but the sum raised can be significant. On top of that you can expect a legal bill running into tens of thousands, fees charged by investment funds and your business will be expected to cover the costs of due diligence, which may be more than the legal fees. You are raising, say, £3 million you can expect total transaction costs of up to 10%. You need to build that into your cash flow model. While more cost can mean more investment, a good advisory firm may effectively negate the issue by negotiating more favourable valuation terms than you might achieve unaided. Watch my Youtube video here on the impact of the small print in investment or debt agreements.
Many serious investors are clearly not looking to put a structure in place that disincentivises the founders – they are key to success and they are backing the team as much as the business. However, if you place yourself in an investor’s shoes, they have one chance to balance protection for their investors and fund with terms that work for founders. Venture capital funds apply portfolio theory whereby one or two investments that will return the fund (i.e. knock the ball out of the park and return sufficient profit to cover any losses), several that do not scale as expected and may take time to exit (if ever) and some will inevitably fail. Fund managers use their returns to raise the next, ideally, larger fund. As an entrepreneur you have to understand that although many funds are now more founder friendly, their objective is to maximise returns and minimise losses for the fund. I always say that if the shareholder agreement is ever pulled out of a drawer – apart from at exit – then things have not gone well. It is then, that the small print really matters. Some investors may not like their investees paying broker fees, so they have to be at-market, but in a competitive market for deals many investors accept that they cannot cover the entire market. It is also worth placing yourself in the shoes of a broker when discussing retainers. Success-only are less interesting if your client needs support to restructure their shareholder structure, or if they have not written a coherent business plan and don’t have a financial model that will stand up to professional scrutiny. In the event that a retainer is charged, how it is treated when investment is secured is another negotiation and it depends on the work required and risk taken. Brokers can manage expectations on both sides and act as a mediator, especially when you get down to the details of valuations and share rights. Read my previous blog on how to value a business.
The opportunity cost
What is the cost of not raising the funds you require to grow or even stay in business? I have been there myself and I know what it feels like to be running out of cash facing a payroll you may not be able to cover. What is the value of that lost opportunity or the impact of the months you spent unsuccessfully trying to raise finance? The other painful lesson I learned is that even after months of work and even contract negotiations with the associated legal costs, a financing is not over until the contract is signed and the funds have cleared. Read my blog about my thoughts on that the experience of an entrepreneur that I met here.
My personal view and experience
I am raising finance for a new business myself and am happy to pay a 5% commission for successful introductions as I have experience of managing financing and don’t need support. Even if you want to incentivise your own personal network to make introductions, a cash incentive can focus minds and ensure they carve out some time to make those calls and follow up.
I don’t need to say that you should minimise your business costs at all times. When it comes to raising finance, you want to secure right amount on the right terms from the right investor as quickly as possible. Weigh up all of the costs - both actual and opportunity. Going back to the sales funnel analogy, would you pay for a third party to source critical sales leads, qualify them, support you through the sales process and possibly unfamiliar contract negotiations and then ensure that you close the deal whilst retaining a positive working relationship with the other party? You probably would so that you focus on your most important job – maintaining momentum and growing your business.
If you have sensible customer traction and are interested in raising over £2m of Series A or B finance for a tech focused, get in touch: email@example.com
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