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).


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.

So, after a CR, the company could be argued to be what it’s worth pre CR plus 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.


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.


Kathmandu (NZX:KMD) Quick Overview

The aim of this overview is to try to work out if there’s any value to be gleaned in the current Kathmandu Holdings Limited (KMD) share price. To be clear I’m only doing a quick overview – I don’t expect to be diving very deeply into KMD to determine what’s the most appropriate type of valuation for this company or the nuances of it’s operations, which an investor should probably be interested in. I’m simply skimming over this to see if there’s any value to be had, and on what terms.

So, as an investor rather than a trader, I’ll be looking at a longer term investment. I’m not looking to gamble on the short term prospects of state of the economy, market sentiment or the development of COVID19.

Therefore my approach will be to try to see if there’s any value in the current share price, based on the premise that in 2-3 years time KMD will be trading as it did in 2019. And in determining value in the current share price, I will be considering the opportunity cost of 2-3 years of investing lost to get back to the state of play in 2019, and whether there is likely to be another capital raise.

Working Out If KMD Will Do Another Capital Raise (CR)

KMD recently did a $207m CR and made ~$15m cost reduction initiatives, including rental costs and employer subsidies in NZ, AU and EU. I see that they managed to get just under $4m from NZ wage subsidies.

2018/19 Operating Expenses were $225.7m and $234.0m, respectively.

2019 Net Debt was $19.3m (down from 2018 by about $10m).

Gross Product Margin is about 60%.

The average NPAT over the last decade was $37m, not accounting for inflation. The past 2 years results were abnormally high compared to former years – probably should research why that it if I was going to dive deeper, but I won’t.

It looks like prior to the $207m capital raise, they didn’t have much in the bank to get them through (about $25m + $4m wage subsidy that’s not listed on the balance sheet) – out of which there are a bunch of current liabilities ($81m), which seem to rely on inventory being sold, as I understand the balance sheet.

A crude calculation suggests that they might have about $151m in cash + $123m in inventories ($65m of which need to be sold) to cover $219m worth of costs in the coming year.

The more I delve into this, the more I feel that it’s difficult to have any idea if they will likely need to raise capital (CR) again next year because there are too many variables to work out if they’ll be covered for the following year.

Nevertheless, they seem like they’re probably covered for this year, and the security of the following year will entirely depend on how well they do this year, or they’ll need another CR.

Finding Value In The Current Market Capitalization

Lets increase the current MC by 8% to account for the required rate of return to cover opportunity cost, then lets pessimistically assume that they do another CR next year, which dilutes shares, effectively increasing the price of them today by 30%. Then lets increase the MC by 8% again to account for the opportunity cost / required rate of return for investing for that year. This gives an effective current MC of $1,060m at todays price.

A MC of $1,060 against a future NPAT of $37m (which is the average across the past decade – a little low, I know, but coming out of a recession, profit won’t be amazing, so this value might be prudent), gives a ratio of 28 (3.5% dividend after tax, at best). Assuming that the year after, things return to recent year’s NPAT of ~$50m, this would be a ratio of about 21, which equates to a less than 5% dividend (after tax) in a couple of years time.

The prospect of a future 3.5 – 5% dividend (after tax) is not enticing enough to risk my money for, and get no 8% return for a couple of years prior.

Of course, this is the pessimistic view. Without a CR and with a small profit this year and a return to $37m NPAT the following year would give a ratio of just over 20 (5% dividend next year after tax, at best), or a ratio of ~15 if NPAT returns to $50m next year – giving a dividend of up to ~6.5% (after tax).

So, is there any value in the current share price? For me, not really, but it’s not that bad in a portfolio that wants a reliable OK (but not too exciting) dividend in a few years time. Addendum: Looking back, I originally said that there wasn’t value for me, but that was based on the belief that there wasn’t much growth in KMD. I now believe that this is wrong, making my projected PE a bargain (and still a good option for someone looking for a reliable dividend).

There’s a bit of a dividend trap there on the NZX website, which suggests that you could get a 15% dividend (before tax) based on previous dividends and today’s share price.

For me to be interested, I would want to be investing in KMD at about $0.50. Of course, it entirely depends on what your exit strategy is – someone buying as a trader may well find value here. Or someone looking at the numbers in their own way might find value – after all, this was a quick overview and I didn’t delve very deeply into any of the numbers, history or other factors that may effect my perception of value in KMD. Moral of the story, you may wish to do your own investigation to see if there’s value in KMD’s share price today.

Addendum: If KMD return to recent years NPAT, based on a Comparables Market valuation, one would expect that in a few years time, KMD would return to pre COVID19 share prices. If we assume no dilution during this period, an investor could see themselves doubling their money based on an exit strategy of a sale. If there’s a dilution of 30%, this could return only +40% (100% – 30% = 70% x 2 = 140%, or a 40% increase) during this period (Of course a 40% increase over 2 years is only 18% increase pa, compounding).

The downside risk would be two consecutive years of dilution, or no return to recent years performance. Alternatively the downside might be performance returning to recent years results, but not market sentiment. In which case, the above dividend return would be the exit strategy. Clearly any investment in KMD would be a sale with the view of a trade (depending on market sentiment) or an investment of 1-2 years, the fail scenario being if there were multiple consecutive years of capital raises before return to normal (100% – 30% = 70%, 70% – 30% = 49%, 49% x 2 = 98%; aka -2% change in value to portfolio).


Suitefiles Capital Raise

Back at the end of 2018, Suitefiles Limited successfully raised $1m via Snowball Effect, of which I was one of the lead investors. This money was used to fund additional growth, which has seen ARR go from $0.9m (at the point the original IM was put together in December[?] 2018) to over $1.4m (at the time of writing this article). Suitefiles is now doing another CR to fund more growth, again via Snowball Effect. I believe that this offer will become open to the public in May.

The reason I invested in Suitefiles was because I like the ARR model, I like the management, and I like the fact that they have a niche product in a large market. Finally, I liked the valuation because although it was expensive for a private company, it was cheap compared to the multiples of ARR used to value companies on the stock market.

I won’t provide any analysis on this investment because it’s a private company and obviously I have a conflict of interest, but if you’re interested, head over to Snowball Effect to get more information on investing in Suitefiles.