A major challenge scale-up businesses face is finding a funding partner.
In an ideal situation, deciding on your funding partner should be driven by who they are, not what they offer.
You have to consider how much influence the funder will have on your business, what other benefits they may bring and their suitability for your business needs – today and in the future.
In all likelihood, any investment offered will take the form of either an equity or debt instrument albeit there are an increasing number of funding options which can blur the lines between the two.
Debt: a preferred option?
The independently-minded entrepreneur may prefer debt (such as secured lending, invoice discounting, property-backed finance or simply an overdraft) because it appears to offer the possibility of retaining more control over the business and profits.
With debt, the lender usually has no equity share and the entrepreneur keeps all the upside in equity value. Typically, a debt lender has less influence over the strategy of the business, as long as the loan is serviced and no covenants are breached.
However, the basic lender-borrower nature of this relationship can have its drawbacks, especially where the business faces challenges. Simply put, the lender ranks ahead of the equity and may therefore have a different agenda.
Equity partners: bringing more to the table
It is often said that an equity investor’s role is to provide more than just money. An investor’s interests should be aligned with yours; if your business succeeds, so do they.
The added value an investor might bring is often described as giving access to new customers and routes to market. Investors can also help the company by using their experience of the challenges faced by growing businesses.
Increasingly, equity investment comes from high net worth individuals, who seek better returns for their funds than they can achieve through more traditional routes. Examples of this include the growth in peer-to-peer lending and crowd-funding platforms.
Building a relationship: is there a meeting of minds?
Some investors will be relatively passive and may simply want to see regular financial information. Others will be more active and will want to provide strategic input.
Entrepreneurs are often used to making decisions on their own without having to justify their actions. Sometimes the additional discipline brought by equity investors can feel like tough love.
As such, an interested and empowered third party who has a significant say can create some interesting dynamics in the boardroom - especially if the entrepreneur wasn’t even used to having regular board meetings!
However, as a company scales up, this additional professionalisation of process and procedures can be helpful. Equally, having an independent partner in the boardroom who both shares the risk and is keen to see a growth in shareholder value can be reassuring to an entrepreneur.
Equity partnerships: living with letting go
Having built a business, one of the hardest things a business owner can do is live side-by-side with an independent partner.
Understanding what the investor wants from the relationship beforehand is critical, as an equity investor is going to be sitting alongside you for a long period of time; the way that relationship works will be critical.
There is usually a period of due diligence before the parties sign up together; we recommend that references from other investee companies are taken in this time. Those referees should be both from investments that have been successful and those that have gone wrong.
Knowing how someone operates when the chips are down is useful to know, as a scale-up business may experience ups and downs as they grow.
Selecting an investor
Choosing an investor is a very important process. You should remember that the best terms may not always be accompanied by the best partner.
Considerations may include:
- Sector knowledge
- Their typical investment time horizon
- Chemistry between the parties
Ultimately, every business looking to grow will need investment. As businesses mature, they often have to consider equity investment as it often works better for accelerated growth. Entrepreneurs and scale-up leaders often struggle with this leap as it means, to them, giving away control and a big part of the pie.
However, if the pie keeps growing, having a slightly smaller piece of a much larger pie is more attractive than the status quo.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.