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Investment in return for equity in private companies

There comes a stage in the development of every owner managed company when more capital is required for expansion, development of a new product, the push into a new market or, quite simply, survival.

The owner manager will usually look to the normal routes of obtaining finance at such a time. His first call may be to his bank for an overdraft or term loan facility, but if this is not possible, he may look at other measures such as sale and lease back of equipment or debt factoring, to release capital in the short term and ease cash-flow. The owner may even dig into his own savings.

If none of these options are appropriate then the common fall back is to seek an outside investor prepared to inject capital in return for a stake in the equity of the company. Many owners resist going this far since in their minds they are “giving away” a stake in the business that they have worked long and hard to build up and would be diluting their own shareholding. It is important to acknowledge that there are positive aspects to encouraging equity investment from outside the company.

Equity could come from a variety of different sources. It is always best to approach people you know first (i.e. friends and family or even customers or suppliers). Only if capital is not available from such investors would you then look at wealthy individual investors (commonly referred to as “business angels”) or the more traditional venture capital providers.

Arranging a pre-determined exit

An equity investment into your company can be structured in such a way as to benefit the company and to give the investor an “exit” at a pre-determined point, thus leaving the original owner back in the position of being the 100% holder of the equity in the future.

Even if an investor wants a stake in the “equity” of the company (i.e. some of the ordinary shares), it is common for that investor to seek some sort of structured exit. For example, they may want to put in place an option arrangement whereby they can call for those shares to be bought back in the future. Whatever happens, most investors are satisfied if their investment is only for the short to medium term, and are not usually looking to be a long term partner.

Non-executive directors

Many individual and institutional investors expect to be able to put a non-executive director on the board of the company. There is often resistance from the owner who is concerned that such a director will be “meddling” in the affairs of his company.

In fact, owners should look at this from a more positive angle. No-one is going to want to be a non-executive director of a company (with all the responsibilities and liabilities that go with it) unless they can add something of benefit to the business. It is unlikely that a non-executive director is going to want to be hands-on on a day to day basis, but they will expect to be involved in major management decisions. A further advantage to a business with an external investor is the help and expertise that can be provided.

An individual investor or venture capitalist will usually have a number of useful contacts and can help open doors into new customers, as well as providing guidance on how to grow quickly. With institutional investors, it is possible to negotiate to find a non-executive director who has the appropriate complimentary skills to bring to the business and enhance the value of the investment. No institutional investor these days will impose a non-executive director on a company if they don’t feel that the chemistry is right. After all, they are trying to get a return from their investment and will do anything they can to try and enhance the value of the business.

Judge the position on its merits

The injection of fresh capital from an outside source should not be regarded with fear and suspicion but should be looked at on its merits. If you look at most successful businesses in recent times which have progressed from small beginnings, through dramatic expansion and on to floatation, most of them at sometime or another have had outside equity investors help them on their way.

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