Failure to attract investment capital can often be the biggest "limiter" affecting the growth and development of a business. In some cases, it can even be critical to the ongoing viability of the enterprise itself, writes Lee Mitchell.
Raising capital, particularly for early stage or start-up ventures, has always been relatively tough in the Australian market.
However, the bubble has well and truly burst and over the last 12 to 18 months both debt and equity capital markets have become very challenging places indeed. Access to credit has tightened and investors' appetite to commit capital to new investments has significantly diminished - largely due to a renewed respect for business risk.
The news is not all bad though. Debt funding has not dried up completely and many of the private equity/venture capital players still have money to invest - particularly for sound, well run companies with good growth potential.
As lawyers we regularly assist private equity funds assessing investment targets as well as business owners looking to attract investment capital. An attractive story is necessary but is actually only a very small part of the overall investment process. Capital is invested in businesses (not products or ideas) and so much of the process comes down to an assessment of risk. Consequently, the greater the perceived risk the more likely it is that an investor will either walk or discount away things they are uncomfortable with.
So, what can you do to make your business attractive to a potential lender or investor? What we have consistently found is that successfully attracting capital depends to a great extent on presenting the business in a professional and "investor ready" manner. So, with that in mind here are our key suggestions:
Management team
A good management team is essential for an investor to have confidence that the business will be well run. Many investors see their investment first in the management team and second in the actual business opportunity. This does not mean you need to have an expensive, large management team, but you must be able to demonstrate you have the appropriate, committed team in place (or access to trusted advisers) to continue the growth of the business.
Good accounting records
One of the first things that lenders and investors examine are the company's financial records and so clear and professionally prepared historical financials are a must. If basic financial matters such as revenues, assets and expenses are unable to be verified this presents risks which will usually prove to be deal-breakers.
For equity investors the preparation of prospective financial information (projected cash flow and forecast profit etc) based on identified realistic and achievable assumptions will also be required as part of a business plan (see below).
Business Plan
A key way of communicating investor readiness is by means of a well constructed business plan. Investors will expect to see a business plan and one is essential to establish credibility. The plan should, at a minimum:
Capital & ownership structure
A company with numerous subsidiaries and shareholdings can lead to complex unwinding issues and valuation leakage given potential lack of clarity over ownership and control issues. If more than one business is being operated these should be separated and disengaged from as this tends to denote a lack of focus and commitment. Investors are more likely to back a person who is 100% committed.
For the same reason investors can often be uncomfortable with high levels of debt financing. High levels of debt finance send a message to investors that the owner may not be as committed to the business as someone who has "skin in the game". Founders will often be asked, as a condition of investment, to convert their debt to equity.
Clean up contracts and assets
Ensure all key contractual relationships (such as key customers and suppliers, employees, premises, distribution agreements etc) are properly documented and in force. These arrangements support the underlying cash flows that generate the profits on which investors (and lenders) base their investment decisions.
Investors and lenders also become uncomfortable if ownership of key intellectual property and other assets cannot be clearly identified. For this reasons steps should be taken to ensure all IT licences are in place, patents, trade marks and logos are properly registered and real property and other assets are properly identified and valued in the accounts.
Legal and financial audit
Consider, as part of the process of preparing a business plan, carrying out a financial and legal audit to identify any risks or other issues to enable them to be dealt with before an investor conducts their own enquiries. It is amazing how even simple matters like failing to notify ASIC of current directors and shareholdings can be a major turn-off.
Investment terms
Companies seeking capital need to be clear about how much money is required, how and when it is to be spent and the proportion of the equity in the company that this will represent (for venture capital investors).
Unrealistic expectations by owners as to the value of the business (especially in the current market) and the price of investment capital is often the reason why an opportunity may fall down. Valuations need to be justifiable by reference to objective criteria and must be set at a level that will allow for strong returns in the future. Failure to be reasonable about valuation or investment terms will spell failure. If in any doubt get a second opinion!
Prepare now
Approaching investors and lenders without proper professional preparation is a certain recipe for failure. In the current market where competition for limited funding is fierce it is critical to be "investor ready" if you want your business to stand out from the crowd.