Guest Author: Derek van der Plaat, MBA, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap M&A International in Toronto.
Raising capital can be time consuming and expensive. Capital may be in the form of a loan or an investment. The lender/investor will seek a return on the capital in the form of interest, royalties, dividends, and/or capital gain. Different forms of capital require different degrees of investment in time, due diligence, and closing costs. The spectrum, as measured by ease and timeliness of closing, ranges from a bank secured term loan, being relatively quick and easy to a minority or majority equity investment which can be complex and arduous to complete. Simply put, low risk capital is cheap and fast, and high risk capital is expensive and time consuming.
A secured loan can close about as quickly as the proper documentation and legal searches can be completed. This usually takes several weeks. An unsecured financing requires an assessment of equity risk, if the issuer is not properly prepared, can take many months and, in a worst case scenario, unforeseen issues can derail the process entirely.
An unsecured, or equity based financing option is best approached in a prepared manner. Even if only 10% of the equity is being sold, the steps in the process are similar to those of selling the entire business. This includes writing a comprehensive business plan with a detailed use funds. Amount sought and use of funds are critical and, if the capital is for an acquisition then the investor may want to do due diligence on both companies and time the transactions to close at the same time. The amount should be enough to fund the plan plus a cushion to reduce risk.
Owner-entrepreneurs tend to under-estimate the difficulty of raising capital. Not being properly prepared can result in anticipated interest fading, a more expensive deal or, worst case, no deal at all.
If the required information is readily available, the preparation phase can be completed in about one month. Securing investor interest will take another month, investor presentations another month, negotiating an LOI and closing another 60-90 days. So six months, best case scenario. While technically the process can move faster, practically speaking, taking busy schedules into account, this is realistic. If the financial statements are not audited, then a quality of earnings review can add another 6 weeks to the process.
For a secured loan, pricing factors include credit quality of the borrower, the bank’s cost of funds and the level of competition in the marketplace. As an example, if the bank cost of funds is 3% and the credit quality warrants a 300 basis point premium, the bank would charge an interest rate of 6%. On the equity side, the cost of funds is much higher and to meet target returns, investors have to compensate for the fact that not all investments will turn out as planned. Equity investors target returns of 2-3 times their original investment at the end of a 5 to 7 year holding period. A “triple” in six years is the equivalent of 20% return per annum.
Hiring an Advisor
Raising capital is generally not normal course business. Therefore, hiring external resources to manage the process can be an ideal solution to these ad-hoc circumstances. While the cost of an advisor typically represents a few points of the equity raised, it may well be that this would otherwise have been given up by going it alone anyway. The intangible benefits of finding the right partner that is a cultural fit and has sector relationships to help grow the business are immeasurable. The benefits of outsourcing management of the capital raising process to an advisor include:
- Experienced strategic positioning and the preparation of a comprehensive information memorandum
- Identification and engagement of the most suitable potential investors
- Professional assistance in the preparation for presentations and due diligence
- Timely management of the process and securing the best price
- The strongest chance of closing
If raising capital is critical to your business’s success, then don’t take any chances. Start six to nine months in advance, assemble the best team and follow a process for success.