One of the major challenges entrepreneurs face is finding a funding partner. The decision should not simply be down to whether the investment takes the form of equity or debt, or even the cost of the equity or debt. Rather it is about the level of influence the funder has on the business and whether that partner is suitable for the business’s needs, not just today but going forward.
The advantage of debt
The independently-minded entrepreneur may prefer debt - such as secured lending, invoice discounting, property backed finance or simply an overdraft - because it appears to offer the possibility of retaining more control over the business and profits. With debt the lender has no equity share and the entrepreneur also gets to keep all the upside in equity value. Usually the lender has less influence over the strategy of the business, as long as the debt repayments are kept up to date. Generally there are covenants (obligations of the company to the lender) but these tend to be very financial in nature, such as the amount of profit needed to cover interest on the loan.
However, the basic lender/borrower nature of this relationship can have its detractions, especially where the business faces challenges. Simply put, the lender ranks ahead of the equity and may have a different agenda as a result.
Equity partners as enablers
It is often said that an equity investor’s role is to provide “more than just money”. It is invested in your business, and its interests should be aligned with yours; if your business succeeds, so does it. The added value is often cited as giving access to new customers, routes to market and helping to assist the company by utilising the equity investor’s experience of the challenges faced by growing businesses. At times the additional disciplines brought by equity investors can feel like a form of “tough love”. Thus decisions that were taken by the owner, perhaps solely with the finance director, now have an interested and empowered third party who has a significant say. As a company matures, this additional discipline can prove to be helpful. Equally, having an independent partner in the Boardroom who also has a significant stake in the business can be both reassuring and supportive to an entrepreneur. Nevertheless, this is a difficult transition for many owners and we look at this is in more detail below.
Equity partnerships: Living with loss of autonomy
Having built a business, one of the hardest things a business owner often faces is how to live side by side with a partner who is independent. Depending on the nature of the investment, and the kind of investor, the relationship can range from relatively passive, to a ‘hands on’ relationship with an investor wishing to be intimately involved in the strategy of the business and the decisions required to achieve a vision. Understanding what the investor is seeking from the relationship is critical, as an equity investor is going to be sitting alongside you for a long period of time, and the working of that relationship will be important to achieving that vision. This type of conversation should be had before either party signs on the dotted line, but it is often something that, in the desire to get the cheapest money while “giving away” the lowest equity percentage, is lost in the heat of trying to complete the deal.
How to choose your investor is a very important process. You have to remember that you don’t ‘give’ equity, you sell it in a willing agreement for a certain price and with contractual obligations attached.
Choosing a partner – some considerations:
Partnering is about selecting an investor you will be comfortable with in the Boardroom after the transaction has taken place. It is important to remember that the best terms may not come along with the best partner.
Considerations may include:
- The investor’s sector knowledge
- The investor’s investment time horizon
- The chemistry
- The people making the investment, a “deal team”, may differ from the people with whom you will deal with going forward, a “portfolio team”
- Other investees' experience with the investors
- Like any relationship, if values, personalities and needs are not aligned, it can spell disaster for the union from the beginning.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
The tax treatment depends on the individual circumstances of each client and may be subject to change in future.
Smith & Williamson LLP
Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.