Written by Rami Cassis
Many business owners will have ambitious plans to expand and grow this year. The conundrum they face is how to raise money yet retain control of the company they founded.
There’s a lot to be said for a business staying private. Business owners who stay in control are free to take the company in any direction they want. The sticking point comes when a business owner wants to raise capital and retain a controlling stake in their company.
Do owners go through the public markets, raise debt or enlist the help of a third-party investor such as private equity houses?
Many SMEs consider the private equity route and it certainly has many advantages. The sums involved can be significant, while private equity firms will be incentivised to ensure your business succeeds.
However, you won’t necessarily be able to run the business the way you like. You may lose control of the direction the business goes in – whether you give up a 20% or a 70% stake.
Private equity backers may well want you to continue to run the business but if fail to deliver the numbers you could be fired, lose your shareholding, or even be sued. Fees (not insignificant) will have to paid, while investor agreements will have lots of T&Cs. You have to be very careful in terms of what you negotiate.
Many SMEs may look to list publicly on an index such as AIM. A listing can provide a significant injection of funding. Depending on the amount raised and how diversified the new shareholder base is, existing shareholders can remain in control of the company.
However, there are other points to consider – not least the costs involved. Listing costs can be substantial, as a rough guide around 1% – 2% of market cap. And don’t underestimate the cost of management time required to stay engaged with investors.
The rationale of listing on a stock market index is to regularly attract equity funding from market investors, ideally institutions. Having a strong retail investor base might help the share price but will mean little in the way of real volume. Indeed, you need to have a market cap of at least £100m to have meaningful liquidity.
A firm’s ability to get funding is almost entirely predicated on its ability to deliver its numbers and how well like the story is by the public markets – which tend to be very future focused.
There are increasing alternatives emerging to private equity funding mainly as a result of dissatisfaction by many businesses with private equity investment. These alternatives can vary from angel type investors to family offices and the differences all effectively come down to the terms offered by the investor.
Family offices typically don’t ask for board seats or active participation while angel investors may – it really comes down to individuals.
Raising debt can be expensive depending on the contractual terms and income profile of the company. In some way, this is the riskiest route but by far the one which leaves the existing shareholders with the most control. In short, debt servicing will impact cashflow, so will need to be carefully planned for.
Debt covenants are a key point of negotiation with the bank. Make sure those leave the business with sufficient room in slow months. If a covenant is breached, most banks will view this as an opportunity of extracting substantially higher fees and onerous supervision of the business, usually under the guise that it needs a much closer look at trading.
On a personal level, based on what I know now, I should have been more patient, which would have enabled me to stay private for longer. I should have focused on greater organic growth and putting the right team in place, rather than race to the next deal. Moreover, cash generation is absolutely paramount, particularly for SME’s, which won’t have the balance sheet of large firms.
And don’t focus on adjusted EBITDA or even EBITDA – those rarely purely translate into free cash. Redeploying any cash generation into the business, using it for acquisitions or keeping it on the balance sheet for future opportunities are all sensible alternatives.