23 Aug How to navigate the seas of capital raising
How to navigate the seas of capital raising
For entrepreneurs looking to take advantage of growth opportunities, finding the right kind of capital can be a make-or-break decision. Accessing finance will not only impact the financial future of your company, but could have a direct impact on day-to-day management. Poor choices made today will result in long-term implications that could put you out of business.
Raising debt capital can be tough, even for business owners with a running business who have gone through the motions before. There is no simple equation which can be applied to every company. However, for companies which have adequate equity, there is certainly finance available and many ways to access it.
Working with many hundreds of companies over the years has allowed the Paragon team significant insight into what various lenders are looking for. We have also gained an understanding of the implications of choosing particular types of financing and seen how these choices can impact a company in the future.
Using this experience we have put together a brief (and by no means exhaustive) outline of what you as a business owner should be aware of as you embark on this journey.
1.Understand what lenders are looking for
At the outset it’s vital to understand what lenders are looking for in a company. This may sound obvious, but so often we see business owners approaching lenders with a great opportunity but they have simply not taken the time to understand how to package and present their ideas.
All lenders will look at the fundamentals of the company they are engaging with. Having a solid track record is vital, particularly when approaching the more traditional lenders, like the banks. Business owners can expect potential lenders to conduct a thorough review of the business track record, including all the necessary due diligence requirements.
Lenders will look at how revenue has been derived up to this point, including ‘stickiness of revenue’. This includes questioning if you have signed contracts in place for the foreseeable future. Business owners should prepare short- medium- and long-term revenue forecasts based on past performance as well as future (well researched and defendable) market opportunities. More than anything a business must be sustainable if it hopes to attract financial support.
Once all of your supporting numbers are in place, lenders will do their own financial modeling. This will take a closer look at issues such as current debt to equity ratios. If a business is asking for a large amount of finance, but has little or no equity, this will raise red flags. Similarly, if an entrepreneur approaches a lender with a track record of one or two million in revenue per year over the past two years and suddenly forecasts revenue of three or four times that going forward, this will also raise eyebrows. Any forecasting should be based on reality, not simply best-case scenarios. Presenting incorrect or incomplete data is difficult to come back from and this should be avoided at all costs.
No ship is considered fit to sail without a good captain and crew. All potential lenders will look at how the business has been run in the past. This will include how the fundamentals of day-to-day business have been handled. Is the business fully compliant in terms of its sector requirements? Has it been paying its taxes? How are its creditors and debtors managed? Are its books up to date and independently audited? Are there solid mechanisms in place to manage collections and payments? All of these questions will form part of the due diligence checklist and business owners should have all the necessary documentation to quickly and easily prove that the business is in shipshape form.
Finally, all lenders will look for skin in the game. They want to know that the owner of the operation looking for their money has something to lose if things don’t work out.
2. Presenting your business according to the specific audience
Pitching to lenders is a skill. Many incubators fast-tracking start-up companies spend inordinate amounts of time training entrepreneurs on how to pitch their business to potential lenders. This includes short, sharp presentations which get the future opportunity across simply and effectively. Not everyone is a born salesperson and it’s important to understand that in many cases, you may only have a few minutes to catch an investor’s eye. Working with organisations which have experience in how to go about this, is a must. Banks may not appreciate a snappy video presentation, but some angel and venture capital outfits may love the idea. Take some time to know you audience and adapt your pitch appropriately. If you are unsure, work with specialists who do this for their living.
3. Know what type of funding is available
There are more types of funding available than most business owners know. Most of us have a mental image of a stern man sitting behind a big desk at a banking branch. The reality couldn’t be further from the truth. It’s a good idea for business owners to have a good understanding of the types of financing available. Here are just a few options:
Senior debt – (frequently referred to as senior loans), is debt that takes priority over other unsecured or otherwise more ‘junior’ debt owed by the issuer. Senior debt has greater seniority in the issuer’s capital structure than subordinated debt. Most loans from financial institutions form part of senior debt.
Junior debt is a class of debt which is prioritised lower than other classes of debt. This is often in the form of an unsecured loan which has no collateral attached to it. Secured loans (with collateral) such as a second bond can also be part of secured junior debt.
Mezzanine debt is the middle layer of capital that falls between secured senior debt and equity. This type of capital is usually not secured by assets, and is lent based on a business’ ability to repay the debt from cash flow.
Factoring is a financial transaction and a type of debt finance where business sells its accounts receivable (invoices) to a third party at a discount. A business will sometimes factor its receivable assets to meet its immediate cash needs.
Equipment finance can help improve cash flow and also improve working capital. It typically involves a lender giving a business access to finance that is secured by a piece of equipment.
At Paragon, we are used to crafting complex deals mixing and matching the financial vehicles based on requirements, appetite for risk, the timeframe for when the money is needed, as well as the long-term aspirations of the company. This may include bridging finance, factoring some of the debtors book, unlocking finance from unencumbered equipment and even securing an overdraft facility.
4. Finding the right partner to raise capital
Most entrepreneurs will turn to their own networks first when looking for financing. However, family lending has a far greater chance of failure. Family and friends may be your biggest fans, but they are not in the money lending business. What’s more, their own circumstances may change over time and they may suddenly need their money back, leaving your business high and dry.
It’s been our experience that entrepreneurs look for funding in all the wrong places. Successful businesses choose their partners carefully, spending time to find a backer who is not only willing, but who understands the business and the sector in which you operate.
Understanding which particular finance is best for a company is no simple task. More importantly understanding how to craft financing for deals is the job of the financial specialists. Finding the right financing match for each company and each specific deal is not a about applying a cookie-cutter approach, which is often the case when approaching the traditional financiers.
Entrepreneurs need to weigh up the premium they would pay for being with a non-traditional funder, against the experience that funder may have in understanding their business, and having the ability to move ahead quickly in order to take advantage of the opportunity on the table.
Entrepreneurs need to put a factor on the ease of doing business. The ease of doing business with an alternate lender often far outweighs the rate you will pay and paying a premium may just be worth it in the end. Paragon has around 100 lenders on its books. Not only will this ensure the business owner will find the right home for their debt, but also means deals can be acted on quickly, giving them the competitive edge.