Who’s the boss? The tricky balance between keeping control and raising money

There’s a lot to be said for a business staying private. Business founders and owners who stay in control are free to take the company in any direction they want. If they have any shareholders, they are likely to be few in numbers and so there is less kowtowing to be done. For business owners who have built a company and simply want out, there’s no dilemma. It’s relatively straightforward should they want to sell — there’s nothing to talk about other than how to present their company in the best light.

The sticking point comes when a business owner wants to raise capital and retain a stake in their company. It could be the business needs or wants an injection of capital to invest or seek an acquisition. Do owners go through the public markets, raise debt or enlist the help of a third-party investor such as a private equity house?

Firstly, there is the public listing. Many small and midmarket-sized companies may look to float on an index such as Aim, and this can provide a significant injection of funding. Depending on the amount raised and how diversified the new shareholder base is, existing shareholders can retain 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 the management time required to stay engaged with investors. There are lots of meetings and presentations to keep your shareholders happy.

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 and depth of share price sustainability. Indeed, you need to have a market cap of at least £100m to have meaningful liquidity and attract a reasonably wide pool of investors. Below this level, many funds are not mandated to invest and so the company will typically have poor trade volume.

A firm’s ability to get funding is almost entirely predicated on its forecasting success and ability to deliver its numbers. A poor year where a forecast is not met will almost certainly prevent raising further funds that year — unless they are offered at a heavy discount, which will have a detrimental impact on the share price. There is a further downside. Investors may decide to vote with their feet if they don’t like the direction the company is taking.

And then there is the internal issue. Many employees are simply tracking the share price. Such a fixation is not healthy, because it takes their mind away from their day job.

The second route is private equity. This is an increasingly popular option and certainly has its advantages for small and medium-sized businesses. 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 how you like. You may lose control of the direction the business goes in — and this can be the case whether you give up a 20% stake or a 70% stake. Private equity backers may well want you to continue to run the business but, if you fail to deliver the numbers you could soon be fired, lose your shareholding, or even be sued.

Fees (and not insignificant ones) will have to be paid, while investor agreements will be put in place that will have lots of T&Cs. You have to be very careful in terms of what you negotiate. In my experience, getting the right legal advice is of paramount importance, as you could end up conceding terms that are completely onerous.

Your third option for raising money is to take on debt. This can be expensive, depending on the contractual terms and income profile of the company. 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. This can become a big distraction for management teams.

In some ways, this is the riskiest route, if the business gets into trouble. If trading holds up, however, this leaves the shareholders and management with the most control, with little to no intervention from the bank.

Many entrepreneurs want the freedom of not being told what to do with their business. Yet, it can be difficult to get objective advice on the best course of action, when they want to raise capital to grow. There’s no shortage of advice from bankers, accountants and lawyers but they work on the advisory side and it is not their own money they are dealing with.

Going public, using private equity or raising debt through a third party all have their place, but owners need to be clear what they are getting into.

Source: Private Equity News