What are the pros and cons of having investors?

So, you’ve put some of that redundancy money into this business idea you had. Then you’ve borrowed a bit more from the family to give you enough to get the business up and running, and joy of joys you’re actually making a little money. The problem is now that, to start making some serious money, you need to grow the business significantly and to do that you need to raise additional finance.

Before talking about potential sources of finance, however, there is one thing that needs to be mentioned. This is to make sure that you have a proper, rock-solid business plan to demonstrate to potential lenders/investors that you have a realistic view of where you need to take the business and how you get there. Without such a plan the chances of raising finance are greatly reduced.

The obvious first choice for finance is your bank. They might be prepared to help but they will certainly want security against any loan. That will usually mean a charge against your property (assuming you have one). Also you will be tied in to a specific repayment schedule with its effect on cash flow.

To cut a long story short a better alternative might be to look for investors. At this point many people shy away from the subject usually based on the argument “they will want to take control of my business”. In most cases that will not be true, although in many cases they will be looking for a reasonable share of the equity. The question then is “what is reasonable?”. Let’s say you (and the family?) have already put £50,000 into the business but you now need to raise a further £100,000 to take it to the next level for stock, marketing and a couple of new members of staff. Does that mean I have to give away 66% of my business? No, it certainly does not! With the help (if you need it) of a good accountant or finance broker you will normally be able to negotiate a much better deal based on a number of arguments e.g.

  1. The value of the business has already grown significantly since you put your funds into it.
  2. You, and maybe other directors, have put a considerable amount of what is called ‘sweat equity’ into the business to get it where it is without taking significant amounts out by way of salaries or dividends.
  3. There is often the option to divide the total sum of investment between an equity-based portion with the balance being provided as either a secured or unsecured loan at an agreed rate over an agreed period.

Particularly if you are new to the game of running your own business then one of the advantages of taking on an investor (or investors) is that, because these are normally successful business people, they bring to the table not only the funding you seek but also a lot of knowledge and experience that can be of immense help when looking to develop the business. The ideal, of course, is to find investors who have in-depth experience of the market that you are operating in. Their contacts in this regard can be invaluable.

It is always important to try to ensure that, for obvious reasons, whoever you take as investor, they are someone that you can get along with, particularly if they are going to be involved in helping to run the business. The decision on this should come from the pre-investment discussions/negotiations. On this same theme it is also vital that you ensure that the terms of any loan/investment are clearly defined in a legal document i.e. either a loan or shareholders agreement signed by all parties. Among other thinks the agreement should define clearly what the investor will get out of the deal and their possible exit route(s). Too many early stage companies overlook this important step, so choose carefully. As a friend of mine said “A good angel is a boon . . . a fallen angel can be a nightmare!”

Much of what I have said so far relates particularly to investments into early stage businesses. It must be said, however that even mature businesses seeking additional investment need to give careful consideration of the terms of any proposed investment. It is essential to always get the advice of a competent commercial lawyer to ensure that there are no hidden traps in the proposed investment e.g. anyone owning in excess of 25% of shares in a company can veto board decisions unless otherwise stated in the SHA (Shareholders Agreement).

I briefly mentioned the question of equity on offer in return for investment. This is always a difficult question. The most important factor is to be as realistic as possible. Offer a reasonable amount of equity. This can often be based on a ratio of amount to be invested against perceived value of the business. This in itself raises another potential ‘bone of contention’. Who is to say what a fair valuation of the business is? This is where a business valuation specialist may be the best solution.

When seeking investment it is essential to ensure that there are no ‘skeletons’ in any cupboards as a competent investor will undoubtedly unearth them whilst carrying out their due diligence. So be warned!

There is much else that can be said about taking on board investors, but in general this will be an action that will benefit the business as long as your choice of investor and the terms under which the investment is made are properly vetted.

Peter Douglas
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Peter Douglas

Peter was one of the original Founders of BFS. Having successfully completed a Degree in Business Studies he spent over 20 years in Export Sales and Marketing. He then decided to give up the globetrotting life and, with his wife, bought a small business which they ran together. Peter has been involved in running SME’s ever since and set up BFS in 2002 having spent time getting an education in commercial finance. He says "Whilst it is hard work I have never had so much fun as running BFS. Nothing gives more satisfaction than helping SME’s to grow or regain their strength".