What investors need to hear

When selling a stake in your business, you need to figure out exactly what your new shareholders want.

When selling a stake in your business, you need to figure out exactly what your new shareholders want.

When selling a stake in your business, you need to figure out exactly what your new shareholders want.

You’ve spent a long time focusing on your customers, building a great product or service and creating a dynamic company in an exciting new market. You’ve carefully handled your cash flow and invested time and money into the business, and you can make good margins from the business platform you’ve built.

The thing is, you know that if only you had additional cash the business could climb to the next level. But what would happen if you brought in external shareholders? You know all about your customers and your staff, and you are used to making the critical decisions yourself. Besides, you’ve heard the horror stories from other entrepreneurs about losing control, cram-downs and fire sales. What will happen when you bring in external equity shareholders as investors?

Raising capital from outside shareholders is a major step for any small business. Out of 20 million SMEs in Europe, about 1,200 raise venture capital each year, and an estimated similar number use angel rounds. To be clear, this means that 99.99 per cent of small businesses do not have external venture capital shareholders – and this is a good thing. In the US, about double that number of companies raise venture capital, but this is still a tiny fraction.

So first of all you need to consider whether you really need external shareholders at all. Most shareholders are primarily financial investors and simply want to make a good return over a period of time through a later sale of their shares in a business. A company is valued on profits, so put simply, if you are not going to become a high-growth and, ultimately, very profitable business that will be sold to an acquirer or listed through an IPO within three to seven years, then you probably shouldn’t seek external shareholders.

Devils and details

While most angels and VCs will have a broad agenda, actual deals can vary greatly. For example, you could raise investment from a specific fund within a VC firm. Perhaps the fund you are raising investment from is already in profit. This can affect the risk appetite of a VC firm, making them more cautious. Or maybe the fund has not performed well to date and this can make a VC firm hungrier for risk.

VCs typically raise ten-year-funds. If you raise investment early in the fund’s life the VCs may have a different expected time horizon than a fund in the fifth year of its life. What is the typical size of investment in the VC fund? Will you be a major project for them or just a sideshow? This could indicate their desire or ability to invest further cash later on. But beyond these nuances VCs will simply be focused on helping you build the most valuable business as quickly as possible, and as such they are well aligned with the other shareholders.

Corporate investors, on the other hand, can and do come with alternative agendas. Please don’t misread that statement – in our deals we very regularly invest alongside great corporate VCs and have several fantastic corporate limited partners in our funds. These relationships are very valuable, and the extra help that many corporate investors bring to a small business far outweighs any negatives. But the fact is that corporates do have their own agendas, based upon their own business strategies, customers and markets.

While some corporates are seeking VC-type financial returns, there is always a need for some “strategic” benefit to arise from their activities. Problems can arise as a corporate’s agenda will change over time, or the person who did the original deal may move on (which happens quite regularly in corporates and less so in VC firms). In my experience, you will find yourself falling back on the original deal documents and shareholder agreements more often with a corporate investor than a VC.

Corporate clout

Today, many more industries around the world are adopting the Silicon Valley-style model of “open innovation”, whereby corporates scale back their own internal R&D functions and outsource more to the market and independent VC-backed start-ups.

As part of this, a corporate makes some minority investments in a wide portfolio of companies alongside VCs, but also readily acquires VC-backed start-ups as part of their own strategic roadmap. This is all very healthy for the balance sheets and the efficiency of the large corporate and also the VC and start-up ecosystem, as these successful exits return the cash back into the industry, allowing the next generation of start-ups to be funded.

Regardless of what type of investor you bring into your company, do not underestimate the need to carefully check the shareholders’ agreement and other deal documents, and how they might work in different scenarios. VCs are generally focused on performance and looking to see whether you are executing a plan or not.

On the agenda

A corporate agenda can be very different as they may want to acquire the company or put it out of business as they have a competing product, or perhaps they don’t want you to deal commercially with their competitors. My advice is to limit corporate ownership to a small minority percentage if possible, have a VC co-invest alongside the corporate and lead the deal terms, and insist that the company can be readily marketed when sold to ensure that buyers will not be put off by any corporate investment.

Remember, corporate investment is on the up, and this a very good thing, especially in a world where financial investment is scarce. The benefits and strategic help can be enormous, but aligning interests requires more care.

Simon Cook is the CEO of venture capital firm DFJ Esprit and has been a key player in the UK venture capital industry since 1995.  For more information about DFJ Esprit see: www.dfjesprit.com/home

Nick Britton

Nick Britton

Nick was the Managing Editor for growthbusiness.co.uk when it was owned by Vitesse Media, before moving on to become Head of Investment Group and Editor at What Investment and thence to Head of Intermediary...

Related Topics