Lifecycle of a Business - So, you need to raise funds for your business?
Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.
With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.
So far, we’ve covered “First Things First” and “Directors: Lights, Camera, Action!” But now, let’s consider financing your business – “Show Me The Money”.
So, you need to raise funds for your business?
It is likely that at some stage after setting up a business you will need access to finance from third parties. You may have approached friends and family for loans and initial investments while your business was in in its earliest stages, but now be seeking a more significant financial boost as it grows. This could be prompted, for example, by a need to purchase a new property, recruit more employees, support cashflow, service existing debt or even to acquire the shares or assets of another business. Here, we will summarise some of the more common financing options available from institutional lenders and professional investors and the advantages and disadvantages of each.
Debt financing
If your business has a reasonable credit rating and is performing well, high street banks and institutional lenders may be willing to grant you a loan. Like a personal loan, you will be required to pay this back with interest over a period of time together with any fees payable.
A loan can be advanced by a single or multiple lenders (called a bilateral or syndicated loan respectively) and can be tailored to the needs of your business. There are several types of loan available, such as an overdraft that allows your business to withdraw more funds than it has available, a revolving facility under which a business can draw down, repay and then re-borrow amounts up to a certain limit or a term loan that is repayable after a set period of time, either in instalments over the life of the loan or in one bullet repayment at the end of the term.
A key advantage of debt financing is that it does not require you to give up a share of your business to another party, although lenders can impose control through different means. Depending on the size of your business, the nature of the lender and the amount of funds being lent, the loan documentation may include restrictions around how your business is operated and limits on the expenditure it is allowed to make and dividends it is permitted to pay during the term of the loan. Your business may also be required to give covenants to do and not do certain things, including for example, periodically providing the lender with detailed information about its financial status and/or undertaking not to incur further indebtedness or grant security over the business assets to a third party. Breach of the terms of your loan will allow the lender to accelerate and demand repayment and ultimately enforce any security or guarantee it has the benefit of.
A lender will usually wish to take security over your business’s assets (such as premises, intellectual property or money owed to you by customers) or shares in case you fail to repay your loan (in much the same way as your mortgage provider can take possession of your home if you don’t keep up with repayments). Additionally, some lenders may require you to provide a personal guarantee (either unlimited or capped at an agreed amount), guaranteeing the amounts to be repaid by your business under the loan agreement. This would mean you could be forced to liquidate private assets if your company defaults on its loan.
You will need to ensure that your business has sufficient funds to meet periodic interest payments and ultimately repay the capital lent to you, as well as the ability to meet any additional criteria a bank may wish to impose, such as financial reporting or insurance requirements. It is advisable to take legal advice if you are taking on debt financing to fully understand what you may and may not do for the term of your loan and the scope of any security package, and to ensure that you have enough flexibility to run your business.
Equity financing
Equity financing requires you to give up a share of the ownership of your company in exchange for funds. As well as cash, other benefits may also follow, for example, industry expertise and a broader investor base.
Private equity
Private equity funds or ‘houses’ use a combination of funds raised from institutional investors and their own cash to invest in specific sectors. Generally, they will subscribe for a large number of shares in a company, deploy industry knowledge to maximise its value and then, usually after a period of between five and seven years, ‘exit’ or sell their shares to another investor or list the company on a public market.
The structuring of a private equity transaction can be complex and is often tax-driven, but, in most instances, a private equity fund will incorporate a ‘stack’ or sequence of companies through which it will ultimately invest in a target company. The fund will subscribe for shares or loan notes in ‘Topco’, alongside a management team who will assume a minority share. If the private equity house requires additional funds to make the acquisition, debt will be provided by banks or other institutions to companies lower down the stack. Once any debt has been repaid, profits are then distributed upwards to the private equity fund and management team at the top of the structure.
Whilst it may seem daunting to give up a large share of your business, private equity houses can offer you the benefit of industry expertise, often through a dedicated management team, who are themselves incentivised by their shareholding to grow the business. Some businesses see the management model as a key advantage of private equity, preferring to develop closer personal relationships with a small group of individuals than dealing only with large institutional lenders.
That said, using private equity can be both time-consuming and costly at the outset and often involves a large number of legal documents. You will need support from various professional advisers, including lawyers and external consultants to market your business effectively to private equity funds. Once you have agreed upon your chosen investor, you and your lawyers will need to negotiate the acquisition agreement, which deals with the sale of shares in the business to the private equity house, and a suite of equity documents, which will govern matters such as the distribution of profits through the investment structure and the parties’ decision-making powers. For example, a private equity house is likely to request that the business doesn’t carry out certain matters without its consent or the consent of directors it appoints to your board.
Venture capital
Venture capital funds generally look to invest in young companies with an innovative business model or product. They usually subscribe for shares in an investee company and expect board representation, in exchange for which they will offer strategic guidance to the business for the term of their investment.
Whilst venture capital investments are typically less structurally complex than private equity investments, they tend to follow a sequence of funding rounds which can take a number of months or even years to complete, subject to how successful the business is. Initially, a venture capital fund might support a new company with ‘seed’ fundraising alongside wealthy individuals or ‘angel’ investors, allowing the business to meet set-up costs, such as hiring a premises and purchasing equipment. Once this seed investment has been made, the venture capital fund, sometimes accompanied by additional corporate investors, will provide more cash through several fundraising rounds, each of which is aimed at providing finance for certain purposes, for example, to meet employment expenses, carry out R&D projects and expand into new markets. The venture capital fund will eventually choose to realise its investment through a sale to another investor or private equity fund.
As with private equity, venture capital requires you to be comfortable with handing over a large equity stake in your business to a third party. It also requires time and considerable effort will be spent in marketing your company to prospective venture capital funds and achieving financial results once the fund parts with its money.
IPO
If your business is already achieving consistent financial results and you are seeking to broaden your shareholder base, an initial public offering might be worth considering. Also referred to as an ‘IPO’ or ‘float’, this is when a private company converts to a public company, is listed on a stock market and issues shares to the public for the first time. There are a number of public markets across the world, each with different eligibility criteria and continuing obligations requirements. These range from markets focussed on smaller start-up companies to those aimed at the large multinationals that we have all heard of.
As well as lawyers to help guide you through the IPO process, draft the various documents required and ensure your business’s compliance with the applicable rules for the relevant market, there will be various other professional advisers that you will need to instruct should you embark on a float. In particular, most IPOs will require the ongoing involvement of a professional adviser to ensure that the company complies with your chosen market’s requirements. Such advisers have different titles depending on the market in question, for example, a sponsor, corporate adviser or nomad (nominated adviser).
An IPO can be expensive and time-consuming and your business will be subject to additional scrutiny and reporting requirements, but it can also offer your company a wider and more varied shareholder base, incentivise your employees and increase both the profile of your business and the liquidity of your shares.
Final thoughts
Ultimately, choosing a source of financing that is best for your business is a very personal decision and worth careful consideration. The choice you make will depend on the amount that you want to raise, whether you want to dilute the ownership of your business, the costs involved and the stage that your business is at in its lifecycle.
If you have any questions around any of the financing options explained here, please contact our Corporate or Banking team who would be delighted to assist.
Disclaimer
This note reflects the law as at 6 November 2023. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.