The final instalment of the Hassans’ Entrepreneurship Series, David looks at Raising Capital – securing investment from third parties.
External investment is often a vital step in taking a business to the next level and accelerating growth. Although a traditional business loan will be preferable for those who are looking for a more straightforward borrowing arrangement and wish to retain full ownership over their business, many founders aim to secure investment through the sale of shares in their company. This approach has the benefit of sharing the risk among multiple investing parties, removes the pressure of immediate repayment and can create long-term strategic partnerships between entrepreneurs and investors. This form of investment can also provide access to significant funding amounts (especially where venture capital or growth capital is sought).
Founders are therefore often tempted to embark on fund-raising campaigns. Although they should not be afraid to seek the money which is needed to meet their ambitions, the funding amounts and the terms of such funding will need to be appropriate to the needs of the business and its owner. The following considerations may be helpful in safeguarding the interests of business owners and preventing damage to their business.
Defining your funding needs and preparing your pitch
Securing external funding will usually involve a significant degree of preparation on the part of the founders. This will usually involve the preparation of a detailed business plan and comprehensive research which identifies the amount of investment sought, how the investment will be used and will aim to land on a realistic valuation for the business. There will also be a need to work on a concise “elevator pitch” and investor presentation materials which highlight the strengths and opportunities relating to your business.
Business owners often underestimate the time, effort and costs which need to be incurred as part of the fund-raising process. This preparation can drag on for months and consume a large amount of the owner’s mental bandwidth which would otherwise be dedicated to the ongoing functioning of their business. There will also usually be significant fees payable to professional service providers (such as business consultants, accountants and lawyers) and various other operational expenses.
It is therefore important that business owners remain aware of the demands on their time and the unavoidable costs involved in preparing for external investment. It is vital that the valuation preparations and presentation materials are put together in an honest, diligent and accurate manner given that the inclusion of false or misleading information can result in legal liability and reputational harm.
Negotiating the terms and structure
The most traditional structure of an investment deal is an equity investment whereby the investing party takes a portion of the shares in the company. It will be important to carefully consider the implications of the terms agreed in the investment agreement and any relevant agreements governing the shareholder relationship going forward.
Unfavourable terms could limit the ability of the founder to continue running the business in line with their vision, especially in cases where excessive governance and control has been granted to the investing parties. A poorly structured deal may result in a disproportionate dilution of the founder’s ownership stake or diminished influence in strategic decisions. A business owner will therefore need to be conscious of the important ownership percentage thresholds under law which relate to decision-making as well as the effect of any specific veto rights granted to investors under the terms agreed between the parties. A founder wishing to retain control of day-to-day operations should also resist appointments to the board of directors which would tip the numbers of decision-makers at board level out of their favour.
Some investors will also want to be offered shares with preferential dividend rights which prioritise the repayment of their investment over payments ordinarily due to the other existing shareholders. While this makes the investment opportunity more attractive, founders will also need to ensure that these terms are not overly favourable to investors and should consider the overall impact on the founder’s position and the business’ ability to reinvest profits into its continued growth. A lot of these decisions will ultimately depend on the relative bargaining strength of the founder and investors.
Regulatory and compliance considerations
Many entrepreneurs will jump at the opportunity to receive any injection of capital to continue expanding their business. However, while most investors will insist on a detailed due diligence review of the state of the business in which they will be investing, it is equally vital for the founder to conduct their own due diligence analysis on the potential investors coming on board. This will assist in assessing whether the investors are compatible with the founder’s vision and whether they have the industry expertise and track record to support the business effectively. Where the business operates in a regulated space, the founder will also need to make sure that parties involved (and the transactions envisaged as part of the investment process) do not create any conflicts of interest or breach any applicable licencing or regulatory requirements.
Securing external investment is often an aspiration for entrepreneurs seeking rapid expansion for their business. Ultimately, founders should be conscious that securing this funding (and, more importantly, benefitting from it) will be a time-consuming endeavour which requires a methodical approach.
External investment is often a vital step in taking a business to the next level and accelerating growth. Although a traditional business loan will be preferable for those who are looking for a more straightforward borrowing arrangement and wish to retain full ownership over their business, many founders aim to secure investment through the sale of shares in their company. This approach has the benefit of sharing the risk among multiple investing parties, removes the pressure of immediate repayment and can create long-term strategic partnerships between entrepreneurs and investors. This form of investment can also provide access to significant funding amounts (especially where venture capital or growth capital is sought).
Founders are therefore often tempted to embark on fund-raising campaigns. Although they should not be afraid to seek the money which is needed to meet their ambitions, the funding amounts and the terms of such funding will need to be appropriate to the needs of the business and its owner. The following considerations may be helpful in safeguarding the interests of business owners and preventing damage to their business.
Defining your funding needs and preparing your pitch
Securing external funding will usually involve a significant degree of preparation on the part of the founders. This will usually involve the preparation of a detailed business plan and comprehensive research which identifies the amount of investment sought, how the investment will be used and will aim to land on a realistic valuation for the business. There will also be a need to work on a concise “elevator pitch” and investor presentation materials which highlight the strengths and opportunities relating to your business.
Business owners often underestimate the time, effort and costs which need to be incurred as part of the fund-raising process. This preparation can drag on for months and consume a large amount of the owner’s mental bandwidth which would otherwise be dedicated to the ongoing functioning of their business. There will also usually be significant fees payable to professional service providers (such as business consultants, accountants and lawyers) and various other operational expenses.
It is therefore important that business owners remain aware of the demands on their time and the unavoidable costs involved in preparing for external investment. It is vital that the valuation preparations and presentation materials are put together in an honest, diligent and accurate manner given that the inclusion of false or misleading information can result in legal liability and reputational harm.
Negotiating the terms and structure
The most traditional structure of an investment deal is an equity investment whereby the investing party takes a portion of the shares in the company. It will be important to carefully consider the implications of the terms agreed in the investment agreement and any relevant agreements governing the shareholder relationship going forward.
Unfavourable terms could limit the ability of the founder to continue running the business in line with their vision, especially in cases where excessive governance and control has been granted to the investing parties. A poorly structured deal may result in a disproportionate dilution of the founder’s ownership stake or diminished influence in strategic decisions. A business owner will therefore need to be conscious of the important ownership percentage thresholds under law which relate to decision-making as well as the effect of any specific veto rights granted to investors under the terms agreed between the parties. A founder wishing to retain control of day-to-day operations should also resist appointments to the board of directors which would tip the numbers of decision-makers at board level out of their favour.
Some investors will also want to be offered shares with preferential dividend rights which prioritise the repayment of their investment over payments ordinarily due to the other existing shareholders. While this makes the investment opportunity more attractive, founders will also need to ensure that these terms are not overly favourable to investors and should consider the overall impact on the founder’s position and the business’ ability to reinvest profits into its continued growth. A lot of these decisions will ultimately depend on the relative bargaining strength of the founder and investors.
Regulatory and compliance considerations
Many entrepreneurs will jump at the opportunity to receive any injection of capital to continue expanding their business. However, while most investors will insist on a detailed due diligence review of the state of the business in which they will be investing, it is equally vital for the founder to conduct their own due diligence analysis on the potential investors coming on board. This will assist in assessing whether the investors are compatible with the founder’s vision and whether they have the industry expertise and track record to support the business effectively. Where the business operates in a regulated space, the founder will also need to make sure that parties involved (and the transactions envisaged as part of the investment process) do not create any conflicts of interest or breach any applicable licencing or regulatory requirements.
Securing external investment is often an aspiration for entrepreneurs seeking rapid expansion for their business. Ultimately, founders should be conscious that securing this funding (and, more importantly, benefitting from it) will be a time-consuming endeavour which requires a methodical approach.
