Raising money from private equity investors to fund growth is a well-trodden path for technology businesses, and the key to a securing the deal is preparation, says Jack Clipsham and Haodong Zhang. Here, they share the five key questions every private equity investor will ask a technology business looking for funding.
But first, before approaching any funder, a technology business needs to ask itself one important question: how much is it looking to raise? The answer will determine who might be interested in investing.
Companies looking for smaller amounts, typically under £2m, would be best looking towards family offices, high net worth individuals and private funds. Those businesses wanting more substantial amounts are best approaching larger private equity investors with institutional backing. There are a significant number of sources of funding and it is important to pitch to the right providers in terms of both amount and sector specialism.
Irrespective of the amount raised, senior management teams can expect to be asked the following five questions.
Q1. What are you going to do with the funds?
There are three good reasons why would-be funders ask this question. Firstly, to simply make sure the right kind of funding is being sought. Would, for example, debt funding or asset-based lending be more appropriate and less dilutive for shareholders.
Secondly, they will want to know whether it is a purpose they can back. Some funders will not invest in property even if it is a seen as a key part of the business’s development strategy, and others won’t want to provide a war chest just to allow a business to go looking for acquisitions.
And thirdly, and perhaps most critically, it is to make sure the management have a clear purpose for the funding. Investors do not want to see money sitting in a bank account earning little or no interest.
Q2. What stage of development is the business?
Most private equity firms are unlikely to invest in start-up businesses, preferring companies with proven business models. They will look for businesses that are revenue generating, profitable and delivering positive cashflows. They like to see businesses looking for development funding to deliver ‘more of the same’, rolling out a proven model that creates a bigger and more valuable version of the company. Early stage, even pre-revenue businesses can raise private equity, but it is important to approach the right funders.
Q3. What is the company’s strategic vision and who will deliver it?
All businesses looking for funding should be able to clearly and concisely articulate their vision. But that on its own is unlikely to be enough. Investors will want to see a strong management team capable of delivering that strategy. They will want to see evidence of relevant experience and a strong commercial background. If they have successfully raised funds before say so. Do not try and hide gaps in your management team – investment may still follow with the condition that those gaps are filled.
Q4. When is funding needed?
Businesses need to think in advance over how and when the funding will be needed. Will it be needed all at once or in tranches? If in tranches, the business will need to consider how to structure that deal. Will it involve multiple draw-downs based on an agreed valuation on day one, or with future tranches based on updated valuations? Either way future tranches are likely to be linked to agreed milestones.
Q5. Does the company qualify for EIS / VCT status?
EIS / VCT eligibility offers considerable tax benefits for investors, and companies that qualify will find that it opens up the opportunity to a much larger pool of investors that otherwise cannot invest. Spend time exploring whether your business is EIS / VCT compliant.
There will be, of course, many other questions you will be asked by equity investors before they decide to invest. It is a complex and often time-consuming process, and expert advice should always be sought. Undoubtedly you will also have questions of potential investors. Specialist corporate finance advisers, can help guide businesses through this process, helping identify appropriate funders and structuring the deal.