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***WINNER STARTUP/SCALEUP BOOK OF THE YEAR: BUSINESS BOOK AWARDS 2022***
Before you get on the Money Train, here's what you need to know...
You have a great business idea but very little money. There are investors out there with lots of money looking for interesting new businesses to invest in. On the face of it, it's a match made in heaven - but beware the details of the deal you do...
You won't be dealing with inexperienced investors. The standard models that investors impose on start-ups and young companies can mean loss of control, overbearing input, disproportionate reward to the wrong shareholders, or founders being squeezed out of their own businesses. The shape of your investment agreements will drive the future success of your business and your ultimate rewards.
This book prepares you for the investment journey and helps you avoid the pitfalls. Once you choose to get on board the Money Train, it becomes a journey with a pre-determined destination. And it can be almost impossible to stop, change direction, or get off.
David Pattison has considerable experience chairing and advising companies looking to raise funds across a wide range of industries. In this book he shares what every young business needs to know about investors before they buy a ticket for the Money Train journey, meaning you have a better chance of riding up front, in control of the journey, rather than in the last passenger coach, being bounced around at high speed, uncomfortable and out of control.
Contents
Introduction
This chapter introduces me and gives the authenticity and 'permission' to have a point of view on the market. There will also be a brief synopsis of the businesses I have worked with/in and the transactions I have been involved in and the roles I played.
The Market
In this chapter I will explain how the market works:
What is expected of millennials entering the workspace and how that differs from the past.
What the investment 'model' is and the stages that businesses need to reach to get funding.
A brief description of the difference between an angel investor and seed capital. Why venture capital is different to private equity.
Why the model is broken and doesn't really work for investors or investee.
Why trying to do that old-fashioned thing of making a profit and not needing funding is a good thing.
The effect that the current tax regime has on investment decisions. EIS, SEIS and Entrepreneurs Relief.
How investment companies measure success and how they are structured and measured.
The Ten Things
1. Make sure the shareholders are aligned.
Most businesses have more than one founder or shareholder. It is really important that everybody has a shared vision for where they want the company to go. Is it a lifestyle business? Or is it about making money? If so how much? Do we want to change the world? If there are differences then these need to be planned for. Finding money to exit a significant shareholder is very difficult and usually expensive and distracting. If it needs planning for then do it early. communicate and keep talking . You can change your mind but you need to let people know. Investors almost demand that founders/shareholders are aligned. I have three example stories on this.
2. Taking money from the wrong people
Work out what you need money for and what help you need. Do you want a 'hands off' investor or do you want a strategic investor who can help you build the business. The easiest money isn't necessarily the best money. You don't have to like the investor but it helps if you respect them. Be very clear what you want the money for. In early stage raising well meaning angel investors can be very distracting and over zealous. Three examples here.
3. Don't believe that investors 'care'
All investors will claim to be different from the market. None of them are, with the exception of a few who have a little more patience and work over longer time spans. The bottom line is that they only care about one thing, their money. Making sure they don't lose any and making sure they are first in line for the rewards of the hard earned success. This is the most important thing to remember. If it goes wrong it can be really horrible. Two examples here (including one catastrophe).
4. Don't leave it too late to raise money
It always, always, always takes longer than you think to raise money. Six months is usually the minimum. Investors will use words like 'no brainer', 'a formality', 'right in our sweet spot'. But they still have to do due diligence and get through investment committee. In addition they normally have a raft of deals/potential deals on the go and getting to the top of that list and staying there is really tough. Keeping more than one player involved for as long as possible is imperative, but you will have to commit to one at some point. Don't do it when the money is running out. Plan the deal at least twelve months in advance if you can. Two examples here
5. Be ready for due diligence
Due diligence is when the investor looks very hard at all aspects of the business. This is not just looking at the finances of the company, it may involve IP protections and psychometric testing of the management team. Its never 'just a formality' and there is no such thing as 'soft' due diligence. Be prepared for massive distractions and questions that you cant imagine are important to answer. Many aren't but they tick boxes. From the start of the company, pre investment, impose good governance, have proper board meetings and minuted decisions. Starting with the right governance before you need it will stand you in good stead in the future. Three examples here
6. Cash arriving is the start not the end
After all the work and distraction of the fund raise the money arrives. Phew, off we go. But it doesn't work like that. This is the first day of your new company with new shareholders with new requirements. This is where the importance of the negotiation comes into play. You will have had to give up some things and agree to other compromises as part of the deal. You will have to behave differently and think hard about board meetings sand shareholder communications. Four examples here.
7. Take targets seriously
There is only one thing that will guarantee that an investor comes looking hard after they have put the money in and that is a series of missed targets. It is very likely that you will have signed up to hit targets as part of the investment agreement. If you miss them consistently there will be penalties. I have known people lose their companies because of missed targets. Depending on the business the targets are usually an annual budget reported on a monthly basis. Miss one month and you will be ok, miss three in a row and that is when the spotlight will start to shine. It is the most important thing to achieve post investment. Keep hitting your targets and you will be left alone, they will focus on the businesses in their portfolio with problems. Two examples here
8. Don't expect understanding
For the investee the chances of renegotiating a deal after its signed are practically nil. The chances of re negotiating an investment agreement term are virtually nil. Unless there is something substantial in it for the investor. You will probably have witnessed how, in your eyes, unreasonable the investor is through the negotiation process and that isn't going to change. You need to have fully understood the deal you are signing and what it really means. All investors fall into the 'a deals a deal' category with no exceptions. So make sure you know the deal and if there is a need for a change work out how you can do that within the provisions of the deal. Showing the investor you don't understand the deal is not a good look. Two examples here.
9. Be ready to switch strategies
Having committed to a strategy to achieve the targets it doesn't mean that you need to stick to it. Markets evolve, products change, opportunities come from left field, threats present themselves. Talking investors through a strategy change is fine as long as you can convince them that you will end up in the same place ie hitting the valuation they want for the business and them getting the financial returns they have planned for. You will need to present an evidence based proposition that can be challenged and still be credible. Two examples here.
10. Get the right advice and help
You will have noticed that there isn't a chapter here that talks about negotiating the deal. That's partly because no two deals are the same and most investment deals are pretty complicated. You don't just need to be a good negotiator you also need to understand the complexities of legalese and the levers of deals. If you don't understand what a preference share is and the affect they have then no matter how good a negotiator you are you will get turned over, with no escape clause, unless you are really fortunate. The best preparation is to get the best advice and legal help that you can afford. I always say that the person negotiating the deal shouldn't be the person who will, after the raise, work day to day with the investor. It always gets spikey and irritable. Its time consuming and distracting. Most businesses going through a fund raise suffer a drop in revenue at some point in the process. Ideally a good non-exec/advisor/Chairman should lead the negotiation with support from the CEO/Finance guy. A good lawyer will take a lot of the pain away, although they do have a tendency to extend the process by aiming off for unlikely events. All of this is pricey but good advice at this point will save/make a lot of money in the long run. Preparation and understanding are the two keys here. If you don't know then find someone you trust who does. Preferably someone who has done it before.
What investors need to know about founders/business owners
To help investors invest without destroying value, it's helpful to understand what you are dealing with. The emotional ties to a business cannot be underestimated. Whereas the business of investing is almost completely transactional, having your own business is an emotional rollercoaster.. It is their baby, it's the most brilliant business of all time, its not quite doing the revenue it should because the 'market doesn't understand'. Any type of criticism is seen as a direct attack, even if they know there are flaws within the business. Rather like telling people their children are badly behaved, they know they are but will defend them to the end. From personal experience I can describe the way to approach founders and make them feel positive about inputs and ideas. Not just subjectively. What nobody needs is a continual fight between the investors and the existing shareholders. Its exhausting and ultimately the business will suffer. This chapter will, hopefully smooth some of the negotiation. Four examples here.
