In the balance: Scale-up funding

David Hall, Managing Director YFM Equity Partners

David Hall, Managing Director YFM Equity Partners speaks to Zoya Malik, Managing Editor SME about the distinct lack of investment information available to SMEs that are looking to grow their business on how to identify and work with potential investors

Zoya: How does a business owner assess the right time to make a further investment into his/her business?

David: Businesses might need to raise funding for a number of reasons.  For example, a company may wish to change or develop their range of products and services and may need capital in order to facilitate the change and prepare for potential expansion and marketing costs.

Alternatively, they may find that they are unable to keep up with customer demand for their products or services and additional finance will enable a company to employ more staff, relocate to larger premises or even to buy out early investors in the company.  As a company grows, so will its need to adapt to increased demand and the pressures that additional sales brings.

Zoya: Where does a business owner find external investors for the best fit?

David: Choosing the right investor depends a great deal on what the company needs.  If a business is not yet generating any income, then it’s highly likely they will need an equity investment (for this stage called seed equity) which will provide the business with a cash injection in return for a stake in the company.

If, on the other hand, the company has an established but relatively small steady income and wants to grow steadily, they may need something that looks and behaves more like a loan, whereby the company repays the loan plus some form of interest. With this option, the less ‘secure’ the debt is, the higher the interest rate charged.  Funding providers for this option range from the high street banks (generally for lower amounts), ‘venture debt’ providers all the way through to Government sponsored/inspired funds/initiatives.

Throughout the northern regions and Scotland and Wales there are various powerhouse funds that can be accessed and each is tailored to the needs of their specific regions.

If a company has high growth ambitions and wants to achieve their goals quickly, their need is more likely to be for equity investment. For amounts of less than £2 million the sources of finance tend to be the powerhouse funds and also individuals or funds investing via an Enterprise Investment Scheme (EIS).  This also includes the growing crowd funding market.

For amounts of between £2-10 million, businesses are in what is called ‘Scale-Up territory’. These amounts tend to be available through formal funds.  Most of these are available through the British Private Equity & Venture Capital Association (BVCA) or can be accessed via specialist corporate finance advisors.  The company accountant or legal advisor might be a good place to start to explore this option in the first instance.

Zoya: What should one look for in a potential investor?

David: Each business is different and the answer to this will very much depend on how a company wishes to grow and at what pace.  The faster the company’s growth ambitions the more likely it is that an investor will want to be involved in helping achieve that growth through participation in the board and helping set the strategy for the company. The slower the pace of growth the less likely that will be the case.

If you have aggressive growth plans it would be sensible to find an investor who has experience of what you are setting out to achieve. If they’ve experienced a similar journey before and understand the challenges to scale and grow a business and how to build an infrastructure to support that, then they should be aligned with your objectives.

The key to making a relationship with an investor work is to have a plan and work together to achieve it.  That will ensure you both are fully aligned and agree how it’s going to be achieved and over what timescale. Having an investor who understands and accepts that the plan is likely to change and can demonstrate experience of ‘rolling with the punches,’ is also a real plus.

 Zoya: What role will investors play in the business?

David: Generally, the role an investor plays is one that adds value to the board. However, it is important to note that in general, investors won’t want to get involved in day-to-day operational decisions of the business. They have a more strategic view and will want to agree annual plans, monitor how the business is performing against those plans and anticipate key decisions and business milestones.

If a business in on the rapid growth plan, it is likely it will see the greatest amount of change and an investor will want to discuss and plan well ahead of time. It’s always more of a nuanced position than an absolute strategy, but it’s still down to the management team to deliver and execute the plan.

 Zoya: How worrisome is it for business owners when they consider losing control over their business, by accepting external investment?

David: Control is an emotive subject and often manifests itself when it relates to voting control. In accepting external equity into the business, it might be best to try to think about it as taking on an interested and active partner. Not one that’s looking to decide on operational detail, but one who is focussed on trying to help provide clarity on key decisions that add the most value to your business, whilst at the same time trying to avoid the things that will detract from value. In that sense all decisions will be taken jointly in the future.

Zoya: What is the difference between Venture Capital and Private Equity investment?

David: Private Equity is the term for equity that is generally used in more mature businesses, where there is an ownership change, not just through bringing in the private equity but also in the management team. Management buy-outs from existing owners are the most common form of transaction. These established businesses tend to be profitable and the transaction will more than likely involve something being bought and sold (requiring a sale and purchase agreement), as well as an investment in the company.

Venture capital tends to be where an investment is into a company at an earlier stage in its development or generally not yet profitable, where the management team is already running the businesses and in many cases might have been the founders or significant shareholders. Venture capital tends therefore to seek higher growth situations and opportunities.