Raising finance is often a long game, and there are many different mechanisms, structures and ways to fund the growth of a company.
We see that sometimes there are alternative ways to look at the financing of a company; where the long process of working with a private equity fund is not necessary.
Many people look to private equity in order to plug the funding gap. However, we have seen in many instances that this does not actually work and there are time delays followed by sometimes inequitable terms. We have also been involved in many circumstances where funds have come into a company and actually stifled the level and rate of growth.
We have seen companies grow and aim to take out these partner funds as this growth continues. However, this is usually on a multiple of their initial investment and seen to be expensive. In the event that this is successful, then it will lead to long and protracted negotiations around the term and exit with feelings of discontent within the company and potential stifling of growth. This is in the event where a partner is poor.
What is private equity?
Private equity is a longer term asset class, used for the private funding from high net worth individuals and institutions to acquire a majority share of the company (equity). Increasing the value of the private company upon exiting is critical for private equity funds, so looking for underperforming companies with high growth potential is important.
Private equity explained from BVCA on Vimeo.
SOURCE: British Private Equity and Venture Capital Association
Is debt finance preferred?
In many cases debt is not looked at or properly understood, but there are many ways in which funds can flow into a company. These include vanilla to more structured mechanisms, but the beauty of doing this is that complete control is not given away in the company and sometimes – depending on how it is structured; payments on debt may be rolled up.
Is structured finance more expensive?
It is sometimes the case that complex, structured finance can be expensive, but if this is the case, then funds can be syndicated out to other providers. However, in most cases this is not actually the state of play as such structures or financing mechanisms can provide more comfort to the lender and actually creates a more scalable structure with security and control put in place that makes sense.
The main point to concentrate on when making a decision is control. Bringing in a large equity funded or quasi type investor will move this control into the owner’s hands. Private equity or venture capital investment agreements will include anti dilution provisions, so meaning that initial equity stakes will remain at the same level.
What are the typical investment structures for private equity or venture capital funds?
There are a number of ways that equity investments are used, such as:
- Common stock – This is a straight-line equity holding in a company – funding in exchange for a percentage of the shares.
- Preferred Stock – The equity is convertible to common stock and this is most likely to be at any point by the option of the holder. It is usually convertible into a fixed number of shares of common stock or a percentage of such stock on a future date. There is also usually a return mechanism such as a dividend, so that there can be income throughout the life of the investment.
- Debt and Equity Kicker – For an operating company they may go to the lending market and raise debt, which will have an inbuilt equity kicker. This is sometimes the case with alternative lenders, angel investors or family and friends.
- Convertible debt – This could be a convertible note or debenture and is usually convertible at the option of the investor into common stock of the company.
- Reverse Mergers – This happens when a private company merges into a public entity. This could be the case where a shell company is a public trading entity, but is not trading. However, it has remained in existence.