Avoiding funding mistakes

Funding is the one thorny topic every entrepreneur must tackle if their enterprise is to survive and thrive. Securing the right kind of investor, level of investment and managing the process effectively is often the difference between having a future in business or booking a one-way ticket to bankruptcy.

Despite this fundamental fact, many entrepreneurs still make basic mistakes as they embark on the fundraising trail.

Not enough cash

One of the most common errors is not raising enough money at the outset for their expansion plans, a failing born of unfounded optimism and/or an impatience to get exciting growth plans in motion as soon as possible.

Unfortunately, this issue can lead to serious problems down the track. If
the business plan is sound and management capable, professional investors (be they business angels or venture capitalists) will often be more than happy to put in a little more to give the venture a contingency fund to deal with unexpected costs and problems. However, the goodwill shown by investors can evaporate swiftly if you have to go back very soon with cap in hand to ask for more cash. Your ability as a leader will be seriously questioned when you are asked – in a blunt manner – why you didn’t anticipate asking for the revised amount in the first place.

Nick Hood, senior London partner at business recovery specialist Begbies Traynor, points out a related problem. In his opinion, as well as failing to raise enough initially, many business leaders fail to communicate effectively that their expansion plans will necessitate further rounds of financing.

Says Hood, ‘Make sure at the start that your investor has the appetite for a second round of fundraising. It may seem odd to ask that when they’ve only just given you their initial investment, but you’re bound to need more funding in the future. I’ve met entrepreneurs who only found out later that their backer was unwilling to contribute more, which meant they had to bring in additional finance – and face the horror of further diluting their equity.’

Amidst all the warnings though, PricewaterhouseCoopers partner Nigel Reynolds argues that, while failure to raise enough money can prove to be a nightmare, it can, conversely, instil good disciplines in growing companies.

As he explains, ‘When the tech bubble burst in 2000, many companies found the stock market flotation option closed off and venture capitalists giving them the cold shoulder. As a result, they had to find other ways to keep going, continue growing and make their way to profit.

‘And, interestingly, those companies not able to raise money following the crash became more cost conscious than they would have been otherwise and were far more disciplined,’ he adds. ‘In some ways it was a blessing in disguise.’

The right cash for the right reasons

In his own particular spin on this issue, Chris Lane, a partner at accountancy and auditing firm Kingston Smith, stresses the importance of raising the right finance for the right reasons.

‘I’ve met entrepreneurs looking to start up companies who have been laughed out of court by banks, which are clearly not in the business of providing risk capital. Make sure you evaluate different types of financing depending on what your needs are. For example, if you’re looking to finance new equipment, look at lease finance if the sums add up.’

Borrowing from banks to finance growth needs to be carefully considered, since big banks are not averse to weeding out troublesome company accounts to cut down on the time needed to service their whole portfolio (not to mention improve their risk profiles).

Moreover, ‘just because someone will lend you money, doesn’t mean that you should borrow it!’ counsels Hood at Begbies. ‘You would be amazed by the number of entrepreneurs I talk to that are aghast when the bank wants them to repay their facility and move their account somewhere else. So, my advice is that you must manage your relationship with your bank as you would those with your key suppliers and customers.’

Marriages of inconvenience

One of the classic mistakes made by cash-hungry growth companies is to rush into the arms of the wrong investor, be it business angel, venture capitalist, mezzanine finance provider or bank. Andrew Millington, corporate finance partner at Mazars, the advisory and accountancy group, says, ‘Choosing the wrong backer is akin to a rushed marriage. You’re desperate to get hitched so you tie the knot after a whirlwind romance, but all too soon your backers declare they don’t love you anymore and say you have to get them their money back, either by selling your business or buying back your shares.’

That can spell disaster for a business owner who has built up a successful enterprise and isn’t ready to let it go, especially if there is still unfulfilled potential to be realised. Millington says, ‘Make sure you find out first whether your financial backers have a long-term interest in your particular sector or if they are just opportunists. It is also vital to ascertain whether or not they have the same views on the future of the business as you do.’

Chris Lane urges a healthy amount of caution when it comes to sourcing finance from professional investors. ‘Remember that business angels are professional equity providers, as are venture capitalists. You can always go to friends, family and fools for financing and they will not ask to see your business plan. But once you step into the business angel arena, you will be looking to raise a specific sum for which the angel will want a specific percentage of your company as equity.

‘Angels and venture capitalists are not into lifestyle businesses. They are only interested in making a return that’s 20 times their investment.’

In addition, they may wish to have significant strategic input. Hood says he has seen his fair share of horror stories where interference from business angels meets entrepreneurial resistance. ‘It is crucial that you find the right business angel for you, and it ought to be someone bringing more to the party than just money, such as mentoring skills or contacts.’

Failing to set the boundaries of funding and manage expectations with angels can lead to disaster if your investor develops itchy feet. Business angels are typically wily characters who will find numerous ways of upsetting the apple cart if things don’t go to plan. For instance, they might decide to just sell their stake without referring to you, pressure you into strategic decisions that you don’t agree with, or push for an untimely trade sale or flotation. Devilish angels could also destabilise the business by disrupting board meetings or stepping on your toes.

Investors wearing two hats

‘Conflict can also arise if you accept an integrated debt and equity package (a loan as well as a proportion of your equity) from one particular lender or institution,’ warns Millington. ‘That can create a clash because, in effect, they are a hybrid person. Are they viewing their involvement from an equity or a debt perspective?

As an equity provider, they may well insist on a place on your company’s board and might become disgruntled if you don’t do well for them on the equity side (not paying them a dividend, for example). This could then affect their attitude toward debt provision, perhaps making them more forceful about repayment.

‘Many growing companies take in equity investment when they don’t need to,’ claims Lane. ‘For example, I’ve seen business chiefs reject the idea of taking out a loan when this is the best option in their set of circumstances, and others fail to consider finance through factoring because they don’t know much about how it works. Either option could have enabled them to keep all the equity in their company.’

He also believes, ‘Too many fast-growing firms get into trouble through overtrading. The entrepreneur goes for so much growth that eventually they just can’t finance it, so the company runs out of cash and they cannot pay the wages. Remember, cash is the oil that makes all the wheels turn.’

Grasp all the finer details

Hood believes that relying on leasing and hire purchase to fund growth can be problematic as well. He says, ‘Just because the leasing company is funding this machine or that fleet doesn’t mean that you own the assets. It’s still the finance company’s even if you get halfway through paying it back.

‘And if the pricing of the lending seems too good to be true, make sure you look carefully at the small print and the exit route,’ he cautions.

Likewise, sloppy forecasting is a fertile area where financial howlers can bloom. ‘It’s vital that you have really robust and detailed financial forecasting, and make sure you do your budget more than once a year,’ states Hood. ‘In fact, as a fast-growing company I think it’s important to look at your budgets quarterly to keep up with changes.

Financing growth is a tricky and arduous proposition at the best of times, but to sidestep potential disaster you need to have a full financial understanding of where your company is at now, where it’s heading and the different funding routes available to help it get there.

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