SME Fundraising – Pros, Cons & Tips
For many, the ideal model is never having to raise finances; the company can fund the initial startup themselves, and hereafter the business can grow at the rate the business generates profits. This model suits many SME CEOs who don’t want to have to answer to external investors. And a steady low growth business is usually the happy outcome. Funding only rears its head if there is a hiccup.
For others, there is merit in speed to market, and external funding is probably baked into the thinking from the outset.
The third group are those for whom funding has become a necessity as they can see that they are headed for a cash shortfall and need a cash injection to keep trading. Clearly, this group is in the worst case, as their negotiating position is the weakest.
The Very Basics
If you are planning to enter into a round of fund-raising, there are two boxes you need to tick:
1. You need a good, integrated business system underpinning your business. If you are running on paper and spreadsheets, you will not get very far. Indeed, SOS Inventory is often the solution recommended by financial advisers as the solution SMEs should adopt prior to fund raising.
2. You need a CFO who knows what he or she is doing. Ideally, the individual should have a strong track record of working in companies that are supported by external investors. This is particularly true if you are seeking venture capital/private equity funding, where the initial due diligence and downstream reporting requirements are onerous and can tear you apart if you are not familiar with them. Having your wife/husband doing the books part time is no longer a plan.
When to Raise Finance
The time to start looking is when you don’t need it. It takes time to onboard new investors, particularly a corporate investor such as a venture capital provider (VC) or a private equity provider (PE). They will be keen to talk with you, to learn about you and your business. There will be events in your area run by the banks, finance providers and accounting practices, all of whom make money when you raise money. You should attend these. Get to know your local providers. Use these events to educate them about your business, your vision and why your business is unique. That way when you come to talk with them later about a fund-raise, they will at least have heard of you, and hopefully know your story.
Sources of Finance
There are several different sources of finance you could consider, with differing impacts on your business. A few possible sources of finance are mentioned here.
The least intrusive is Crowd Funding, where small amounts are raised from a large number of people, but in general the idea or product behind the business will need crowd appeal. There are several, specific crowd funding platforms for funding business startups and innovation, such as KickStarter and Indiegogo.
In my experience, business banks (your bank) can be a good source of finance and not too intrusive. They have the benefit of knowing your business (as you bank with them), and they often offer term loans or overdrafts at reasonable rates without demanding a seat on the board.
Angel Funding can work well depending on the business angel you select. There are angel networks and you should meet with them (www.angelinvestmentnetwork.us). I personally started a business funded in part by a business angel from whom I eventually learnt a great deal. Over 14 years the business grew to $100m revenues, before I retired. Along the way, we made 15 acquisitions and took the business to the UK AIM stock market and had ups and down and tough patches along the way. I found that when I needed to move quickly to raise finance or secure an acquisition and didn’t have time to work through the usual investment channels, our angel stood by us and put up the money because he understood us. He understood the strategy and vision and he felt part of the team. He lived on a different continent, and yet he felt completely involved in the business. Communication is key for investor relations. Angel investors are intrusive as they will probably want a board seat. I was lucky, our business angel knew little about our sector and didn’t tell us how to run the business. But he was wise and gave sage advice. He was a real asset to us and became a great friend. Pick your angel wisely!
Venture Capital (VC) and Private Equity (PE)– The VC is probably what most people think of when they imagine early stage finance. Some will invest at start up; some once the business is up and running and proven. Private equity tends to be less an early stage investor (in my experience). They both tend to have specialist sectors, although some may claim to be generalists. Take a look at who your peers use, and how they get on with them. Let’s make no mistake; these guys are sharp. They are professional corporate investors. They will turn your business inside out with due diligence, and they will want equity participation and at least one board seat. They can be intrusive. In their hearts, they usually think they have something more than just finance to add to your business. So, expect active collaboration, and lots of financial analysis and reporting. Be sure you understand their terms. I have seen situations where a future underperformance in the business triggered a ratchet that gave the VC/PE investor a greater equity slice. As I said at the beginning, if you aren’t a sharp CFO who has worked with VC/PE backed companies before, you need to get one on board long before you start the investment round. For some SME entrepreneurs, VC/PE funding is highly successful; they welcome the increased rigor, the financial network and the opportunity to play in a bigger league.
I cannot stress enough the importance of good investor communications. Even if you have passive investors who haven’t insisted on active involvement, keeping them regularly up to date with developments is essential. I personally have always tried to draw my external investors into the business so they feel part of the team, that way they trust us, and when that unexpected sticky moment arrives (Corvid 19?) they are ready to support you. The method is simple enough – a monthly call or update newsletter covering cash, operations, sales, etc. works well. And even if you send a monthly update, call them as well.
In a few words, be careful what you wish for. If you are an entrepreneur who really wants to run the show, and really does not want to be beholding and accountable to others (because you left employment to get away from that), my advice is try to grow the business out of trading and investments from family and friends, and possibly some help from your bank. The intrusive nature of corporate investors is not for you.
If you are happy with the rigor that corporate investors bring to the table, and you see yourself as part of their world, networking with the major financial institutions and socializing your story, then go for it and good luck. For many it works out well.
To all of you, I reiterate, the time to start looking for external investment is when you don’t need it. Fund-raising takes much longer than you think, so prepping the market now, making them aware of the wonder of your amazing business is a good use of your time. As they used to say in the air force, “time spent on reconnaissance is seldom, if ever, wasted.”
Andy Makeham has enjoyed a lifetime in software business development, as a programmer, implementor and entrepreneur. He has grown, bought and sold many business software companies and floated one on the public markets. He has worked with private and private equity owners. Today Andy acts as a business development advisor to the software sector. In that capacity he is working with SOS Inventory.