ឣ Provision of management expertise.The investor is likely to adopt a ‘hands-on’
approach, bringing management skills and experience often in the form of a non-executive director.
These should be weighed against the following disadvantages:
ឣ Dilution of control.The entrepreneur will inevitably have to accept a reduced share of the business equity and with that some loss of control and possibly a degree of change in business culture.
ឣ Greater accountability.Investors will require regular management information to monitor their investment (although the discipline of producing prompt, reliable data is in many ways an advantage!).
ឣ Demand for an ‘exit route’.The investor may exert pressure for an exit route at a date or using a mechanism that does not necessarily accord with management’s long-term plans (although some investors are taking increasingly long-term views themselves).
ឣ Cost. Fees associated with the capital-raising process will include pre-acqui- sition due diligence, and the appointment of financial, legal and tax advisers.
Additionally, investors will often require a high proportion of equity to achieve their required rate of return (typically 30 per cent IRR).
A management team seeking private equity or venture capital should consider the reputation of the PE house or VC fund, the degree of involvement sought, the flexi- bility of funding offered including capability to provide second-round finance if required, desired exit route and time line, and chemistry between the two parties.
The usual route to locating a source of funds suitable to the specific needs of the business is through an accountant or other adviser, although a company can also identify potential investors by contacting the British Venture Capital Association (BVCA).
In contrast to a listing, PE provides a more flexible form of financing. As the investors are often intimately involved with the business, the required levels of reporting and controls are less onerous than for public companies. In addition, investors will provide support over more difficult periods to ensure a high valuation is achieved on exit. To this extent, PE is often used to bridge a company from the private to the listed markets, typically enabling middle-market businesses to expand and to develop the appropriate controls and more predictable income streams that make them more suited to the public environment.
Corporate venturing
Corporate venturing typically occurs where a larger company invests cash and management resources in a smaller company. Whilst a venture capitalist is primarily concerned with return on investment, a corporate venturer may perceive additional value in such non-financial factors as:
ឣ access to developing technologies in complementary areas;
ឣ low-cost innovation and diversification into new products and markets;
ឣ intelligence surrounding competitive activity;
ឣ a future long-term partner or potential acquisition target.
The investee company may be able to take advantage of the investor’s existing marketing and distribution networks, get access to more competitive suppliers and pricing, and even gain an introduction to the investor company’s customer base.
However, it is important that the investee considers the longer-term implications of the association. Assuming the venture is profitable, the investor may well wish to acquire the balance of the investee’s shares, and this eventual option should be discussed by both parties at the outset.
Owing to the specific demands of a joint venture, finding a partner can often be difficult. Organizations most suited to partnering may already be operating in similar areas, so clear agreements to protect commercially sensitive data need to be put in place at an early stage.
Bank loans/overdrafts
Bank loans and overdrafts are the most common source of secured finance. The cost of such finance will reflect prevailing rates of interest as well as the lender’s perception of the risks involved – an immature company can expect to pay a higher rate than a business with a proven track record, although a lender may reduce the risk by obtaining a security over the company’s assets. Taking on further debt finance can be risky in times of rising interest rates or market uncertainty.
Overdrafts are relatively simple to arrange and are widely used to fund short- term working capital needs, with interest accruing only on the debt outstanding at any point in time. A disadvantage of overdrafts is that they are repayable upon demand, which can result in uncertainty for the business regarding the availability of funds for the medium or long term.
Leasing
Leasing offers a flexible source of finance, enabling management to alleviate the cash flow impact of capital expenditure. Leases fall into two categories: finance leases and operating leases. The former occurs when the lessee assumes substan- tially all the risks and rewards of ownership, whilst an operating lease is akin to renting an asset for a period of its life. A company can also release funds tied up in its own fixed asset base by establishing a ‘sale and leaseback’ arrangement whereby the asset is sold to a lessor and then leased back by the vendor, resulting in a one-off cash benefit followed by a stream of lease rental payments.
Invoice discounting and factoring
Debtor-based finance allows companies to borrow against the value of their sales ledger; it is often used as a means of financing in rapid growth situations, since it reduces the working capital requirements that arise from timing differences between incurring cost of sales and actually receiving cash from debtors.