Is your business right for venture capital investment?
It's tough to get hold of in any case, but are you really in shape for investment?
Raising external finance is a time-consuming, rigorous process that’s fraught with pitfalls. Worse still, it’s not obvious what the rules are. All too frequently, entrepreneurs do their homework and approach a VC with what they believe is wanted – only to be rejected for failing to meet criteria not made clear at the start.
Directors of growing businesses usually have all sorts of questions about the process. For example, how long will it take? How much equity will I need to give up? How should I approach potential investors? Should I use professional help, and if so who? This new series of articles will answer all these and many more besides. We’ll explain what investors really want, giving practical tips you can use. We’ll also cover writing the business plan, working out which investors to approach, how to approach them, the role of professional advisors, negotiating a deal and the relationship afterwards.
Firstly, we explore whether or not your company is suitable for external investment. As the saying goes: “Fail to prepare, and prepare to fail.” And before you can even think about approaching a VC you need to determine whether your company is ready for investment. Otherwise, your route to capital could be a fruitless journey.
Is there an opportunity for return on investment?
The first issue you need to examine before you can seriously consider trying to raise capital is whether your business proposition will generate the kinds of returns investors are likely to seek. This is especially true of early stage companies, where there’s less of a guarantee of success and, therefore, investors are going to demand more of a return for their faith in you. On average they’ll want to see triple their original investment back, so consider the ramifications of this before you proceed.
“There’s a lot of soul searching to be done beforehand. What it comes down to is whether you can deliver the kind of returns they’re after,” says Simon Keeling, director at corporate financier Corbett Keeling, a company that specialises in advising businesses who need equity investment between £1m to £20m. What it comes down to is thinking about the kind of value your business will need to be worth in, for example, five years’ time and considering if that’s practical.
Are tyou running the right type of business?
According to Mark Wignall, MD of GLE Development, you might think you have a great company, but you need to ask yourself whether it’s the kind of operation that’s attractive to an investor. “Would it be able to stand up to the intense scrutiny and pressure raising capital puts on a business?”
Questioning whether you can live up to these demands should ultimately lead you to examine if you’re operating the right kind of company for external investment. VCs are not bothered with what they see as lifestyle businesses – ones that tick along nicely and are run simply for personal fulfilment. So if you’re not interested in rapid growth and reaching ambitious targets in terms of your company’s value it’s not a realistic option.
Does your management team stand up?
Experience goes a long way to winning over VCs, so deciding whether your business is right for external investment will also require a thorough examination of your management team. A background of success within your sector, and experience of profit and loss responsibility are important to potential investors. “We’d look very closely at the history of the people who are going to be running the business,” says Keeling. “We’re realistic, but somebody who’s had success in the past is always going to be that much more attractive.”
However, VCs appreciate in most early stage businesses there’s likely to be some sort of gap in the management team. As long as you recognise that and make steps to rectify the situation, this need not be a barrier. “If it’s at the MD or FD level then you’ve got a problem, but in other positions it’s less of an issue,” says Wignall. “For example, you might have a buyout team, who have been running the business, but don’t have the strategic experience for driving the business forward. So they could bring in a high quality ‘grey hair’ exec and the problem would be solved.”
Do you have a strong enough business concept?
While most VCs would argue a strong management team with an average idea is more likely to get funding than an average team with a strong proposition, a good business concept is still extremely important. While no entrepreneur believes their business is based on shaky foundations, you still need to consider whether it’s strong enough for investment.
“You need to have identified a problem in the market, a solution to that problem and, most importantly, why someone would pay enough money to have it solved. A lot of the companies we see tend to be focused on the features of their product, rather than the benefits and whether anyone’s actually going to pay to use it,” says First Stage Capital’s Jason Purcell.
And to help determine whether your business idea really is robust enough, a little professional help can go a long way. “Not every business idea is a good one and there are implications that need to be understood, and a bit of honest advice and objectivity can really benefit” says Teresa Graham, advisor to Baker Tilly. The firm, along with etc consultancy, runs an investment readiness course to help companies prepare for raising capital. “Some businesses are based on an idea that came from a conversation in the pub, but a lot more information is needed to establish whether the proposition is sound.”
Is there enough potential for growth?
Any equity-backed business will need to grow dramatically if it’s to deliver the returns needed. It’s much easier to take market share in a growing market. VCs are seeking these markets and it’s why sectors fall in and out of favour. “You might operate in a very good sector, but what if it becomes saturated sector. If you were in financial services in the past few years it would have been unattractive, but now it’s coming back. It’s better if you’re moving with the tide rather than fighting against it,” says Keeling. But, that’s not to say the right proposition in mature markets can’t deliver sufficient growth – you’ll just need to convince investors why you’ll take market share from current companies.
So it’s vital to examine both your market and your potential to take a piece of it. But don’t be tempted to overstate your case. In fact this can be off-putting to investors. “Be realistic about your growth and about just how you’re going to get there,” says Graham. “Remember that investors like to put money into businesses in tranches, so they prefer for you to have reached particular milestones before the next round of finance is released. Make your growth predictions with this in mind.”
Finally, if you feel your business does pass these tests the next step is to prepare yourself for just how rigorous and time-consuming raising capital is. The whole process will take up a lot of your time and, if you’re not careful, can easily distract you from the day-to-day running of your business at a time when it’s arguably most important. It’s not unusual for companies seeking funding to see a dip in performance in the months prior to securing the money, so make sure you’ve got somebody reliable to delegate to or consider an interim manager perhaps to add bulk to your team. “It’s bloody hard,” says Stephen Goschalk, director of corporate finance at Insinger de Beaufort. “Be prepared to be rejected because it’s far more likely someone will say no rather than yes.”