Tag: Capital Raising

Categories
Business

Finding An Investor

Whether you’re trying to find an Angel Investor or applying for a business loan, the first thing to do when raising capital is to work out how much money you need. I realise that sounds obvious, but it’s not as simple as you might first think.

To work out how much capital you need to raise, you’ll need to do a business plan to work out where you want the business to go and to justify the strategy.

You’ll then need to do some financial modeling to work out the strategy to get there. Initially this will be a basic cash flow projection, but you’ll need to model several scenarios with different levels of funding at each stage. You should also model how different types of funding will effect your strategy.

For example, if you run a farm and want to raise money to grow the business, you might initially think you just need money for a tractor. You might later want money for more land, working capital to hire people and more machinery.

After outlining the end goal in a business plan, forecasting growth (including costs, risk mitigation costs, market analysis, SWOT analysis, etc.), you’ll need to work out a plan for the money.

You’ll need to do financial modeling to show how cashflow is effected if you borrow in stages vs all at once, and various other strategies in between. It might be that raising more money up front means that you can be more profitable and cover costs more easily and reach your goals faster. It might be that smaller tranches work better for you.

You’ll need to model different strategies with different types of funding. If you get a loan, can you cover the costs? Can you get a big enough loan to reach your goals? If you get an Angel Investor, will the freedom of having no debt mean that the business grows faster? If so, will your 80% shareholding in the larger company be greater than your 100% shareholding in the smaller company? Can you model a strategy that enables you to increase the value of your shareholding after X years? What does the model look like if you mix loans and investors? Can a smaller round of fund raising get you the money you need to grow the value of the business so that you don’t have to sell such a large part of the business to get the rest of the funds you need?

Once you’ve modelled this, you could optionally get any business valuation you used in your modeling checked by a professional (this can be done later, but may save time doing it now to avoid reiteration of the financial modeling stage). The valuation can be checked by:

  • An accountant with valuation experience (less preferable because they don’t have access to market data so valuations tend to be out of line with reality a bit).
  • A business valuer.
  • A business broker (be aware that many brokers dont have the skill to do this for business where only shares are being sold instead of the whole business). I recommend Snowball Effect if you want a 3rd party opinion.
  • The discovery process when pitching to investors.

Once you’ve worked out your strategy and how much capital you need to raise, you need to seek a loan (which could be via an institution or private individual) or an investor. If you’re going with an institution, you can stop reading at this point because the institution will have their own process they will guide you through.

However, if you are looking for an investor, you’ll need a Pitch Deck or Information Memorandum (IM). This is basically just a document that presents your pitch to the investor. Accompanying the pitch will be a number of documents, such as the business plan you made earlier, and some basic financial information.

Once an investor is engaged, you should research them to make sure they’re a good fit for you. Are they a silent investor or do they want a position on the board, or something in between? Do they have skills, experience or contacts that will help? Do they have a conflict of interest / are they a competitor? Are they happy with the exit plan?

Once you’re happy the investor is someone you want to work with, you’ll have to disclose more information about the business. You may wish to ask the investor to sign a Non Disclosure Agreement (NDA) before proceeding. At this point an investor will want to see financial information, evidence of things disclosed in the IM, financial modeling, etc.

If both parties are happy to proceed, you’ll want to start negotiating terms and you’ll need some legal documents. Specifically you’ll need a Company Constitution and a Shareholder Agreement.

You’ll want to have a commercial lawyer create this. Getting a good lawyer is very important. All lawyers say that they do commercial law, but the fact is most are only good at family law. It’s very important that you get a lawyer that specializes in commercial law – which usually means hiring a big law firm. This is expensive, but will save you money in the long run because there will be fewer rewrites.

I hope this brief outline helps start your journey to success. Please feel free to ask questions or share your experiences & learnings below in the comments. Also, don’t forget that I am an Angel Investor, myself, so please contact me in the comments below if you are looking to raise capital (I won’t publish comments aimed at contacting me, so your message will stay private).

Categories
Investing

How Capital Raises Dilute Share Price

I’ve previously written about how Capital Raises (CRs) can actually be a good thing, whether you’re investing or not. Today I wanted to talk about how a CR can dilute share price, specifically for ailing companies.

After a CR, value in shareholdings for existing shareholders could be argued to be what it’s worth pre CR because even though the shares are are smaller percentage of the company value, those shares are also worth an equal fraction of the value of the money generated from the CR. In the case of well used funds, a CR can add increasing long term value to a company as that capital funds growth. In the case of an ailing company that is doing a CR to raise money to stay afloat, that money will be gone within a while (typically a year). In this case, the ailing company could be said to be worth what is was worth pre CR, but all shareholdings held before the CR would be diluted by any new shares issued, therefore lowering the share price.

For an analogy, consider a chocolate cake that is cut into 4 pieces and costs you $5 a slice. You buy a 1 slice (a quarter) of the cake for $5. The cake shop needs more money, so they cut all the slices in half (including the slice you bought). You now have to buy another slice to maintain the same amount of cake (1 quarter). You’ve now paid a total of $10, you own 2 slices, which is still the same amount of cake as you had originally.

Categories
Investing

Capital Raises Can Be A Good Thing

Investors always cringe at the announcement of a capital raise and the mind immediately triggers thoughts of dilution, but capital raises aren’t always bad. In fact, sometimes they can be a good thing – even dilution can be a good thing.

What Is A Capital Raise?

First of, lets start with the question What is a capital raise? A capital raise is where a company creates some new shares (although theoretically these could instead come from any treasury of shares, if the company holds any), then sells those shares to raise more capital. Typically the company constitution will stipulate that existing shareholders have first dibs on the opportunity to buy a proportion of these shares relative to their existing holding so the overall percentage of the company they own is not diluted – though this is not always the case, particularly with listed companies.

Why Do Companies Do Capital Raises?

The answer to this question holds the answer to the statement in the title of this article – that capital raises can be a good thing.

There are two main reasons companies do capital raises:

  1. Because they foresee themselves struggling to make ends meet and need a cash injection to keep the company running.
  2. Because they are raising money for inorganic growth.

Counter-intuitively, either of these two reasons can be good or bad for an investor.

The Benefits Of Capital Raises For Investors In Ailing Companies

Almost always it’s bad if a company is approaching shareholders, begging for money to make ends meet. It means that the company is not performant, which is bad for the outlook of the company. However, such capital raises are always done at a discount to the current share price (otherwise nobody would by the shares), and herein lies the opportunity for a shareholder to glean value. Share traders might take advantage of a below market value capital raise if they think they can sell the shares on the market for more, after the capital raise. This typically causes the share price to gradually drop to be equal to the value of the capital raise as shareholders sell at a profit.

Long term investors may also see such a capital raise as a benefit, but only on shares of companies that have longer term prospects and if they are able to take a larger percentage holding than they previously held. In this scenario, an investor might find the capital raise has value to them by calculating the future value of shares, minus future dilutions and opportunity cost each year before expected return to profitability (or whatever other position the investor wishes to exit). If the shares are cheap enough to be below the calculated value then a purchase might be favorable if they are able to take up a holding larger than their existing percentage holding in the company. There are also some odd scenarios whereby an investor may welcome dilution, for example if new investors are getting a bad deal and the dilution works up the value of the company (because there’s more money in the coffers or other reasons).

The Benefits Of Capital Raises For Investors In Companies Seeking Capital For Growth

Oddly, this one can also be good or bad – and this centers around how successfully the newly raised capital can be turned into growth, and of course the valuation. If the new shares are sold for less than the value of the growth they will add, a capital raise can be seen as a good thing for those participating – even if they get diluted, the overall value of the portfolio (diluted stocks plus new stock held) will be worth more than the investors position before the capital raise (undiluted stocks + cash).

Additionally, a capital raise can be good if the valuation is too high, and an existing stockholder accepts the dilution. In this scenario, the new investors pay for the growth, and the existing shareholders get diluted then the value of their stock increases beyond the pre-dilution value.

In summary, capital raises can be good or bad, depending on what they’re for, the valuation of the new stock and how the investor reacts to the capital raise.