While debt capital – even in its modern venture debt form – is linked to strict conditions, financing with equity capital depends to a large extent on not hard but soft facts, which need to be presented convincingly.
Accordingly, the persuasive power of the presentation, or rather the personality who presents, is very important. But why is that the case?
Because the expectations of a lender are – only in comparison of course- modest. He wants his capital investment back, plus interest. No multiple of the capital invested (unless, of course, it is not paid back on time).
The equity investor expects a much higher return than the interest rate on borrowed capital. For that to happen, however, the market opportunity must also be exceptional.
Confusingly, there are also equity investments that bear interest, but for the purposes of this article this can be considered an exception
1. Raising equity via IPOs
Even companies that do not want to go public in order to raise equity can learn valuable lessons amount from IPOs. In both a good and a bad way.
IPOs give the general public the opportunity to acquire shares in promising companies. It is therefore immediately clear that the success of the IPO depends crucially on the story with which it is advertised. After all the general public is not necessarily interested in historical financial figures (or financial forecasts for that matter). And an industry, especially when it comes to goods and services for companies, can be so complex that it takes a rather long time to understand drivers and risks.
One of the most important tasks is therefore to simplify information and place it in a positive overall context.
Interestingly, this most important rule for IPOs – “the story has to be right” – is often completely disregarded – or misunderstood – when it comes to private placements.
2. Raising equity via directly approaching private and institutional investors
Apart from IPOs companies have various equity financing options. The author of these lines last dealt with crowdfunding over 10 years ago, a branch of financing that was still in its infancy in Germany at the time compared to other countries and certainly kept developing.
This article is based on many years of experience in the equity financing of companies by business angels, venture capital and private equity investors as well as strategic investors.
You are a shareholder of a medium-sized company or start-up and would like to get a second opinion on your transaction project?
Similarities
The majority of the capital contributed in these transactions was contributed in the same way from an accounting point of view, from start-ups to SMEs. Following an increase in the company’s share capital, the newly issued shares are sold at nominal value and the actual investment is paid into the capital reserve.
As a result, the equity investor becomes a co-shareholder and enjoys exactly the same rights pro rata (i.e. in proportion to his share) – but in return, of course, also has certain obligations – like other shareholders who may hold a significantly larger share in the company.
If you leave five straight, the preparation of an investment project for a business angel is astonishingly similar to that of a venture capital or private equity investor or strategist. For the most part. In many cases, money and other resources will be needed as a basis for further growth. In individual situations, which I would see as major exceptions in Europe, the personality of investors alone can strengthen the image of the company and justify co-ownership rights (the more diligently the future role of these generally private individuals will have to be defined).
For all investor groups, the greatest possible transparency is recommended (with lenders making their decision dependent on a few core data), without of course producing a pure „data salad“ (which maybe a German expression).
Even a company that is only two years young can already have a wealth of highly interesting data to show (for example – in the B2B SaaS sector – data such as customer acquisition costs, growth and customer losses, or – in the e-commerce field – site visitors, conversions and shopping baskets). Not analyzing these data in the run-up to the desired equity investment since the company may not quite make millions in profits or sales yet is likely a big mistake.
One would also think that business angels only ever invest in their niche, just like the VCs, PEs and strategists mentioned above, and that one can therefore assume that they know the industry and so no require lengthy explanations.
Yes and no. To a certain extent, all these investors are of course professionals. However, not all contacts to the same degree. Every “capital procurement process” is about addressing all decision-makers – including those behind the scenes. Markets continue to develop precisely because different market participants assess developments differently. The conclusions of the party raising capital in relation to sectors and markets are therefore always worth reading and listening to.
Differences
Business angels, venture capital, private equity investors and strategists naturally tend to invest in different company phases – and with different objectives.
Apart from the founding team itself, the business angel takes the greatest risk, given that he (and sometimes, fortunately, she) cannot be sure that there will be a follow-up financing round. If not, the capital invested is almost certainly lost, which hurts the “angel” more, as he almost always invests less broadly in companies than other investor groups. However, this risk can also be precisely the reason why the angel joins the team as a very present advisor. This personal commitment cannot always be counted on from other investor groups.
Financial investors, whether from the venture capital or private equity sector, increasingly have the reputation of being equity partners in the same way that banks are debt partners. In other words, rather interchangeable. Anyone who subscribes to such sweeping statements may not fail in the search for equity capital, but will certainly as soon as the search and the process are complete.
Meaning: investing capital and contributing it as agreed is one thing. The other is to stand by the company as a sparring partner throughout the entire long process, either until the next financing round or until the exit, or at least not to make life difficult (for which there are many possibilities once you are a co-shareholder).
This requires the provision of resources that go far beyond capital. Know-how and networks are two examples. Or quite simply: time. What is the relationship between investment managers and portfolio companies? Do you get the face time when you need it? Which should be questioned and challenged beforehand.
If the process of “raising equity” is reasonably successful, opportunities to talk to a number of investors at length will arise too. Anyone who does not go into these discussions conscientiously prepared, comparing background research with the perceived personal chemistry, asking critical questions acts negligently. As a co-shareholder, the equity investor should, at a minmum, provide reliable advice on strategic issues and problems. Anyone who does not meet these requirements does not belong on the list of shareholders.
It goes without saying that VCs and PEs differ in that VCs only ever acquire a minority stake in the company in question, whereas PEs usually secure a majority, which naturally influences the balance of power in the company. For this reason, private equity companies are more likely to be classified as corporate buyers and not as minority investors, which is usually the case when we talk about raising equity. No rule without exception, as this transaction involving the pet food manufacturer Barfer’s Wellfood shows.
Similarly, one would not primarily think of “strategists” in this context, i.e. companies operating in the same segment. Don’t strategists always buy majority stakes in companies? Not at all, as evidenced by the minority stake bought by 3 strategists in former agency and current B2B SaaS player AX Semantics.
Many strategists have already founded investment companies specifically for the purpose of taking minority stakes. For good reasons: in quite a few cases it can make a lot of sense for an early stage company phase to enter into these kind of strategic partnerships.
Therefor, the question which partners are most likely to create synergies may easily arise in the case of minority investments.
Synergies are a good keyword because they almost always exist – and of course always turn out differently. In addition to a well-prepared investment case from the outset, understanding – and communicating – synergies is the best way to attract equity investors (as well as corporate buyers). The business angel always has a professional or investment history to refer to, private equity investors always pursue a strategy that you should be aware of and in turn often look for companies that fit in with existing portfolio companies. As for strategists, it goes without saying that you should know well how they are positioned – and where there are “strategic gaps” – even before you cautiously (but always confidently) knock on their door for capital.
Take aways
Don’t let yourself go crazy. The biggest challenge is always to stay calm. First and foremost, investors want transparency about the past, good prospects for the future and a team they can rely on. This set of information is the very similar for all investors, even when it comes to loans and credits. Equity capital investors take a greater risk, here the individuals are just as important as the legal entity they manage. In this case “story” means a logical narrative arc that identifies opportunities. More thoughts on this topic can be found here (albeit only in German)
If, as an important cherry on top, so to speak, you also understand who you are contacting as a potential investor, where this party comes from and is heading to, and perhaps even listen carefully during the initial discussions, your equity fundraising is well on its way.
