If you want to attract capital you need to make sure your business is ready for investment. You also need to understand how investors think, because this will help you to find the financial partners right for your business. In the end, it’s not only about money but about securing the support you need to make a business successful.
There are two main types of capital investment:
1) Private equity finance – where investors provide funding in return for shares in your business that are not listed on the stock exchange
2) Debt finance – financiers who provide capital in return for repayment with interest at a later date – usually banks.
It is important to decide which type of investment is right for your business before rushing into a decision…..and if you can build the company without an investor at all that is even better! Usually, businesses will look for private equity investment only when they find it hard to obtain debt financing (why give up shares when you can pay back a loan, right?). Securing debt finance can be a real challenge if you lack a track record and have few tangible assets to offer as collateral. In this situation it will be difficult for any bank to support you.
Note* Be wary of other ‘debt financing solutions’ out there. The terms of the agreement are not always friendly with often times sneaky charges and unfavorable conditions tucked away for the entrepreneur to discover later. VC4Africa is not a financial advisor so please speak to your lawyer before signing anything! :)
Given your business has potential for high growth, there is reason to look to private equity investors as a viable alternative. The potential growth in your business is what allows them to make profits on their investment in the long term, and this return can offset the risks they take.
Differences between private equity finance and bank loans
Banks have a legal right to charge interest on a loan and can ask for repayment on a specific date. This is the case whether or not your business succeeds and whether or not you can actually pay back the amount borrowed. Banks want to make sure they are going to get their money back no matter what happens to the business. Usually they require you to secure your loan against business or personal assets – such as your home – which can be extremely risky.
Private equity investors do not have these legal rights to interest and capital repayment. The only way they can get their money back is through a capital gain if your business succeeds. They will want to take out more than they invested when they exit from your business. As a result, they look for high-growth potential businesses to invest in and are more likely to be hands on in the business. In the right situation, they bring useful expertise into your business, can help you open doors and support you through the business development process. They can also play a key role in setting up additional rounds of funding if the company needs it.
Is your business ready for investment?
If you have been in business for some time, possible investors will be interested in knowing about your past activities and performance. They will want a clear picture of what has happened in the past and it is a good idea to clear any previous debts. Be forthcoming with any liabilities. You don’t want surprises to emerge during the due diligence process which is almost always a deal breaker. If issues like this emerge later in the relationship they will only sour any potential for collaboration. An unhappy investor can be a real burden on a young company still working to prove itself.
Note* Recently we had an entrepreneur who didn’t tell us about a rogue employee, who after a dispute on payment, established a mirror company. This did not look good when the possible investor discovered the issue. It wasn’t that the problem couldn’t be overcome, but that the entrepreneur couldn’t be trusted with business decisions. If the entrepreneur doesn’t divulge an issue on this scale imagine what else he is hiding? Needless to say the investor walked away.
It is important to mention these things and especially when there might be issues concerning intellectual property. Investors will want to know about your IP and what you have done to protect it. Especially if anyone outside the business has the potential to put a claim on it. This may be the case if you’ve developed new products or services in collaboration with anyone outside the business.
In all reality, raising capital can be time consuming endeavor. You should plan to only do this a few times during the development of your business. Be aware…fundraising can be a full time operation! You should also make sure that you are ready for investment by considering the following points:
Why do you need funding? – Ideally for a specific reason such as expansion, to develop a new product or enter a new market. Whatever the reason, be able to explain why the investment is needed and how it will improve the business. More importantly, how will this investment impact your bottom line?
How much funding do you need? – Don’t underestimate how much you need. It is much harder to come back later and ask for more. Remember, the investor will want more equity. In this case it is better to be conservative up front and to spend the time working through all of the possible costs.
When do you need the funding? – Is there a timeline attached to the funding i.e. in line with a new product launch or change in Govt. regulation? And do you need the money all at once or can it be paid in installments and after certain performance measures are met? Think about the timeline and use this to help structure the deal.
How are you going to pay the money back? – Only take on investment you need. Money is not free. Whatever you borrow will have to be paid back. Your investor will want to know how you plan to achieve this and how long it will take? Paying back late can be very expensive and a huge waste of resources. The less you require up front the less your liabilities are down the road.
Be realistic please – Do you have a working prototype or demo? Has the product been tested and do you have feedback? Do you already have customers who have signed contacts or paid for your product in cash? If you don’t have this kind of traction than be realistic with your business needs. Sure 2.5 million would be useful but maybe you only need 25 thousand to prove the business has potential. And once you have this proof you have the results needed to attract new partners. How much do you need to take the next step in building your business and go from there!
What are your views on the subject and do you have experience you are willing to share building a company with either debt. or equity financing?