We’ve found that there are four key areas to take into account:
1. What do I want/need from my Finance Director and am I aware of the broader value they can bring beyond the ‘typical’ finance responsibilities? This will tie directly into the business’s growth prospects.
2. What is the current state of my finance function and financial management information?
3. If we had a Finance Director currently in place, how would my target investors benefit?
4. How should I compensate a Finance Director?
While this can feel like big picture thinking, below is a brief guide on how to answer these important questions, to enable you to assess how a senior finance resource can impact the growth and success of your business.
What value can a Finance Director bring?
Industry expectations of a high-performing start-up Finance Director have changed. As a standard, the role of an FD extends beyond simple numerical updates - they’re an operator and a strategist, painting a picture with your financials to hugely influence critical decisions. To do this accurately, they should have relevant sector knowledge and know exactly ‘what good looks like’ in your industry.
For example, an FD that can streamline your supply chain or raise cash through FX hedging could stop you from making bad spending decisions and encourage you when you are making the right ones. A good FD will not just help you realise the value of your business; they will create the value.
What do you know about your company finances now?
Outsourced finance resources are a cost-effective means of keeping your finances in clean working order, especially in the early days. However, by their nature, they can become “out of sight, out of mind” and it is important that as a business leader, you are highly attuned to the financial wellbeing of your business. Do you have regular updates on month-to-month performance, are your forecasts balanced against your budget, do you know the cash runway you have available before you need to raise again?
Having a firm grip over your finances is essential when pitching to investors. Demonstrating a strong understanding of your business’s financial proposition is critical to securing the best possible round at the strongest valuation. If you feel unable to communicate the above with a level of confidence and expertise and you are heading into a funding round, or are planning one in the future, it is worth considering senior financial resource.
What value do investors get from a business that already has a Finance Director?
Investors are also “numbers people” – a significant contributor to their investment decision is the business’s current financial situation and future projections. If a business has clearly presented finances, it is much easier for an investor to assess fit and their anticipated risk / return. This reduces risk on both sides and enables a more transparent negotiation to take place, ensuring you are accepting offers from the right investors for the right reasons.
Raising equity capital is also an extremely resource intensive process that relies on momentum. An experienced FD that is already familiar with the business will be well-positioned to answer investors’ questions and keep the process moving.
Bringing in external equity capital also adds to the company’s financial complexity and investors often require regular, well-presented and error-checked financial information. Bringing an FD on board post-investment can leave an uncomfortable gap, at a time the business is attempting to deploy capital and accelerate growth.
How should I compensate a Finance Director?
Finance Directors are not cheap, but the great ones cover their costs extremely quickly. FDs are experts in streamlining cost efficiencies, spotting wider revenue opportunities and will typically cover their costs within their first year with you. It can be a significant upfront cost but if you can cope with the short term spend, the long-term gain will be worth it. Salaries can vary hugely across this space and in many cases, you must ‘spend to save’.
FD compensation typically breaks down into three categories: salary, bonus, and equity, which are often treated as a set of balancing scales. A willingness to be flexible across these three areas can be a mechanism for assessing candidate commitment. Equity, which may be in the form of ordinary shares or share options, varies according to owner discretion; salary and bonus on the other hand typically range between £100,000 - £150,000 per annum in base salary plus between 10-50% in bonus. A larger equity stake may compensate for a lower base salary and vice versa.
In summary, there is no golden rule on when you should hire an FD and there are numerous success stories of businesses that have hired their finance leadership both before and after fundraising. However, having a firm understanding of your business’s financials is critical to raising equity funding and managing investor relations thereafter; and hence, the timing of appointing an FD is more closely linked to the financial health and complexity of the business. Understanding this is ultimately instrumental in both the success of the hire and the overall longer-term success of the business.
Tactic No. 1 - embracing silence
Research conducted by The University of Groningen in the Netherlands showed that 4 seconds is enough to make someone feel unsettled. This creates a powerful strategy for negotiation that puts you in a position of strength.
Research has also shown that English speakers will pause for a second or two at most, so it's going to feel unnatural, but it is worth it. If you can fight the urge to fill just five seconds, your counterparty will say something.
Getting the other side talking serves two key purposes. First, it prevents you from over-justifying your points. You have a position, you've put it across and now you want to hear theirs. Explaining your point again and again has the potential to lead to a slip up that exposes a logical flaw, room for manoeuvre or portray you as defensive and unsure of your position.
Secondly, by introducing silence you are more likely to coax your counterparty into doing this themselves.
Tactic No. 2 - taking each point in turn
Once you have mastered silence, apply a drip-feed approach to each point of contention. In other words, negotiate each point in turn before moving on to the next. This is an unpopular strategy in the investment world because it favours the entrepreneur.
When negotiating a termsheet or an investment agreement, investors will usually ask you to present all of your points before they respond. This is a common tactic for any party that is defending a position.
In receipt of all of your points at once, it is easier to present a balanced counter-proposal that gives some, but not all, of your requests. It is easier to cherry-pick the points on which to move and the ones to dig in, and it's less awkward for them to respond with a hard "no" if they can balance it with what they are giving at the same time.
It is more difficult to do this when each point is taken in turn and your next move isn't revealed until an agreed position has been reached on the former point. There is a caveat though, which brings us to our final tactic - you don't want to do this to the point of annoyance.
Tactic No. 3 - being constructive
This is particularly relevant when you are negotiating with a potential investor and thus your ultimate goal is to create a workable partnership.
Stubbornness and an unwillingness to debate or compromise don't rank highly on any investor's list of desirable qualities. Demonstrating an understanding of your counterparty's points before responding will illustrate your ability to listen and strengthen your response, whether it is accommodating or not.
Being afraid of looking "weak" is common and often misplaced. On the contrary, changing your position on the basis of further information can make you appear consultative and able to compromise.
In summary, keeping front-of-mind the points that are truly important to you, presenting them in turn, embracing silence and listening to your counterpart, will set the tone for a constructive negotiation.
Tell us a bit about your business
The company was established to harness the valuable community using the LegalBeagles forum, which we founded over ten years ago. We decided to approach this in a highly ethical manner and built new free services for those consumers to access, such as JustBeagle, the UK's first all of market comparison site for legal services. Everything hinges back to the LegalBeagles forum which attracts 1.7 million visitors annually and plays a valuable role in helping consumers and SME's access justice.
Approximately how much did you raise and from whom?
We raised £750,000 in 2017 on top of £220,000 in 2016. Predominantly, we did this through individually introduced high net worth angel investors, but we also used the SyndicateRoom private angel funding platform to close our round, which worked very well.
What were you looking for in an investor?
We were looking for investors who shared our passion for making the world a better place and who respected our wishes to commoditise our assets ethically and fairly. We also sought investors who brought expertise and wisdom to the table.
What were the most challenging parts of the process?
In the early stage of the round we were invited to many VC meets which ultimately proved a to be a false start. We also found invitations to accelerators quite a distraction and quickly realised the whole process is a bit of a 'machine', often designed to create publicity and traction for other organisations.
What advice would you give to other entrepreneurs facing this particular challenge?
It is important to stay focused on the type of funding you need and remember that everyone you meet is ultimately going to try and make a buck out of you, whether it be by advising, introductions, coaching etc. We learnt to listen between all the hype and make decisions based on our real needs. Holding your nerve and being very objective about your business are essential qualities to a successful round closure.
Was there anything about the process that surprised you, or was unexpected?
Yes, a difficult investor who tried to 'take the whole round' and caused chaos in the process! It took good discipline to admit that this was not working for us. We also had some surprising comments, such as nervousness around the size of the (£30 billion) legal industry.
Is there anything you would have done differently, with hindsight?
One thing I would do differently is invest in a very well-designed pitch deck. One that can be adapted to various pitching situations, as we spent far too many hours producing new versions for each pitch event.
Overall, I am very happy with the mix of investors we gained and the wisdom we picked up along the way to meeting them. Yes, there are always things you would do differently but the stuff that didn't go perfectly created lots of learning for the future.
What advice would you give to other businesses thinking about fundraising?
Be very certain of what you are proposing, believe in it deep to your core and be passionate about it above all else. Investors often say that they invest in founders, not businesses; which is only partly true because no investor is going to back even the most charismatic founder pushing a terrible proposal. Even with our very solid LegalBeagles bedrock, we had to fight for every penny of funding. Also, be aware of the strain on your mental health - even the best days can be followed by a crashing low. Learning to anticipate and ride these moments allowed me to keep my sanity.
Connect challenges the modus operandi for investor outreach, tackling two key areas that are considered most detrimental and dilutive to value creation.
First, faced with substantial inbound demand, investors lean toward warm introductions from their network, and in doing so, capital is unevenly allocated across the spectrum of opportunity - those with lesser access to the network but with equal or superior prospects, may be overlooked.
Second, outreach begins at the pitching phase, which is already too late. Minority equity investment is inextricably linked to relationship building and partnership, and the most successful investments emerge where management and investor have had sufficient time to judge fit, build trust and establish credibility.
These are problems worth solving - better capital allocation will ensure that investment reaches the companies capable of delivering value, through job creation, growth and profitability, benefitting shareholders, stakeholders, the economy and society as a whole.
The Connect platform provides the mechanism to identify and surface investment opportunities in startups, scaleups and established businesses, for seed, venture and growth funds, without the need for the network. The platform assesses and identifies investment readiness and opportunity, and delivers the information that investors require to assess fit against their own mandate. This enables and encourages both companies and investors to develop longer term relationships in advance of fundraising.
Connect builds on the past four years which has seen Capitalex support over 600 UK SMEs with the knowledge and expertise required to raise investment and deliver successful shareholder outcomes.
Jessica Zoutsos, CEO and Founder of Capitalex commented “I couldn’t be more excited to bring this new service to market. We have established Capitalex as the trusted, industry-insider for UK SMEs considering equity capital and as such have benefitted from unique insight into the challenges these companies are facing. We want to see an end to the days where the strength of your network, as opposed to the strength of your business or proposition, is a significant contributory factor in your ability to secure investment and grow.”
Capitalex provides support to UK SMEs throughout the equity investment lifecycle – from fundraising through to the creation and realisation of value. The company was set up in 2016 to address the lack of access to the expertise and networks required to make a success of equity investment. The team of current and former venture capital, growth and private equity investors provide support to companies across all sectors, via an online platform and in-person consultancy.
In the very early stages of getting a business off the ground, there is very little discernible difference between these roles - in the vast majority of cases, the CEO is the individual that founded the company and that individual spends all of their time working on the business.
As companies grow and start seeking investment, these roles diverge and the differences between them become notable. Unfortunately, it's not uncommon for founders to struggle with this divergence and make poor decisions as a result. Many want to hang on to the CEO title for fear of losing control, without truly understanding the requirements of the role.
The CEO of a company ultimately reports to the shareholders, and must act in the best interests of all shareholders and stakeholders (for example, employees and customers). I have witnessed the damage a founder and majority owner can do acting as CEO when they are not the right person for the job. In this particular situation, their actions resulted in unworkable conditions for senior employees and financial loss for minority investors. In the end, everyone loses.
I have also seen the opposite - where a founder has not only accepted, but encouraged, the recruitment of a CEO and benefitted substantially from their decision.
That being said, there are many cases in which the same person can both found and run a company, and if they understand the differences between their two roles they will be best placed to make a success of it. They wear two hats, which don't always agree.
A common example of this is in the payment of dividends. Releasing cash from a growing business can help to reduce the level of personal risk a founder or majority shareholder takes; after all, they have all of their eggs in one basket. An external investor who has injected new capital in to the business is unlikely to warm to significant distributions - they want their cash to stay in the business and drive growth. They also hold a diversified portfolio which means they can afford to suffer a few failures - it won't mean the loss of their livelihoods. In this case, the shareholder and CEO hats want slightly different things, but the CEO must make the decision while taking into account the wishes of all shareholders.
This internal conflict can also arise at the point of exit. A £20m price tag might be attractive to a founder who started the business from nothing, but insufficient for an investor who came in at a £15m price 3 years ago. Although the shareholder would like to accept, the CEO has a more complex decision to make.
If you are a founder and CEO, it is worth approaching every decision with two hats and being prepared for the fact that they won't always agree. You may have to make decisions that suit the business more than they suit you personally, but this process will help you to prepare for bringing on board external investors.
Personally, I think there is no value in upholding any smoke and mirrors to the rules of the game of venture capital and therefore I thought I would share my insights with the aim of contributing to the demystification of the art of fundraising. Please note, the following points mostly relate to a scalable, VC-type company.
Articulate the problem
The first problem I have with countless decks that hit my inbox is the fact that so many fail to articulate the problem they are solving, what their product does and why they are going to win, in a clear and compelling fashion. This may sound simple, but achieving the aforementioned is actually incredibly difficult to do. It is also so important, given the sheer volume of opportunities that investors consider on a daily basis. Sometimes I have even managed to get through a full hour meeting without truly understanding the value proposition, not for lack of trying. Throw away the buzzwords and verbose VC vernacular and try to answer the basics in your deck to get you to a first meeting.
Know your VC
Another basic but common faux pas is a lack of homework on the VC that the entrepreneur is meeting or on the individual that the founder is sending their deck to. Not only does this give the investor a red flag and likely mean you as a founder begin the relationship from behind the baseline, it also is a huge missed opportunity to curry favour, in the best sense of the word. Researching common ground to align your company with the investment thesis, stage and personal preferences of certain investors is encouraged.
Ditch the NDA
Do not ask VCs to sign an NDA, at least not straight away anyway. This is a point that has been covered extensively by other investors so I won’t labour it, but please do put together pre-NDA materials at the very least and do only ask for an NDA if you genuinely have some secret sauce. Even then it is likely to put a lot of people’s back up.
Keep the cap table clean
A very disappointing fact to learn for an investor excited by a company is that the cap table is potentially a deal breaker. Typically, when an early-stage investor gets involved with a company, it is with the expectation that there will be multiple rounds of financing to accomplish the ultimate milestones. If the founder (s) has already been diluted heavily, investors can become nervous that the economics will not sustain the founder throughout the lifespan of the company with many more rounds of dilution to come. This misalignment is a huge fundraising risk. Whilst cap tables can be restructured it is not the default for early-stage investors with plenty of other opportunities to back. University TTOs and tax-driven individual investors are a recurring theme in unworkable cap tables that I have come across. Of course, all this being said, not every company enjoys a linear fundraising blueprint and many founders have been at the mercy of unfavourable terms when traction has not been as hoped for.
Tell your story
Stories have long been held as the best medium by which to impart knowledge. In the case of investor meetings showing as well as telling is also very helpful. Weaving in your demo to bring your product to life should be a huge asset to the pitch and is not always delivered by founders. Wrapped into telling an effective story is having the right people to do just that. If you as the CEO are going to do investor meetings alone, ensure that you can answer first-meeting-type questions on all aspects of the business, including technical ones even if you are not technical. If you cannot confidently do this then please bring your CTO. Investors invest in people and storytelling is an important way to express the boldness and magic of your vision instead of spending the full meeting getting lost in the minutiae and detail. However, please be careful to not come across with self-assured hubris and never lie or mislead.
Bottom up market sizing
One common feature of investment decks that I personally think is a mistake, although one that is echoed less often by my peers, is that of top-down market sizing. More often than not I find it a redundant and lazy slide. Bottom-up is usually far more interesting and compelling. Even better is when founders use this slide to articulate their kernel of insight about the market. Tangential to this, please know your competition better than the VC.
Prepare your numbers
For early-stage investment, typically, 5-year detailed forecast financial statements are unnecessary. However, I encourage at least an assumption driven 18-month model and a cash flow forecast. Firstly, this is likely to save the investor some work and more importantly, it helps the investors to understand your thinking and really get underneath how the business model will/does operate. It is also important to articulate how much you are raising (without a huge range attached), what the use of funds will be and what milestones the business will achieve with it. This helps investors understand whether the opportunity fits their own fund model. Whilst we are on financials I do not recommend explicitly putting a valuation expectation on your deck. Building a financial model might also help a company think about whether they “fit” the VC model where good can be the enemy of great.
Finally, I wanted to include a heavily espoused mistake which I do not believe in, which is that of a warm introduction. Some VCs demand it and for many, it is strongly preferred. The problem with this filter is that it is awful for diversity. A recent report by BBB, in collaboration with Diversity VC and BVCA, entitled UK VC & Female Founders, found that there was, in fact, a penalty associated with cold pitch deck submissions: “warm introductions are 13 times more likely to reach investment committee and be funded than cold submissions”. This disadvantage is clear for all-female teams with 36% warm introductions versus 42% of all-male teams. I think it is important for all founders to be aware of this data point, whilst championing the need for it to change.
Noticing that the building sat one storey lower than its neighbours, Arshad decided to build an apartment on the roof. The apartment was manufactured offsite and installed on-site in just 24 hours, subsequently selling for £1.3m and generating a healthy 35% margin.
Having previously created a business that provides temporary accommodation to hundreds of homeless families across London, Arshad was all too aware of the pressing need for more affordable homes in the capital and across the UK. Converting unused rooftops into homes not only addressed the challenge of sourcing land, it is inherently low carbon and sustainable. The company commissioned research that showed the potential for 180,000 new airspace homes worth approximately £54 billion in London alone.
Championing the concept with local and central Government was essential in unlocking novel funding facilities and policies needed to turn the idea into a reality. In July 2020, Parliament approved the inclusion of airspace within permitted development rights, embracing the notion that we should build up, not out.
This would not have been possible without equity investment. Arshad identified early-on that establishing such a significant asset class would need permanent capital behind it. BGF saw potential and invested £6.3m in 2018, following on with a further £3.0m in 2019.
We spoke to Arshad about his experience of setting up Apex Airspace, shaking up the real estate industry and securing investment.
Tell us about your “lightbulb” moment, when you first realised the potential of airspace development?
I remember walking through the streets of East London after having dinner with friends. As we strolled, I looked up to the roofline and noticed that on one side, the terraced building was a storey lower than on the other side. I realised then that the idea was not just a one-off with my office in Camden but, in fact, could be applied at scale and had the potential to create a substantial number of new homes. I thought of the value that could be delivered to the owners of these buildings and decided the idea had to be pursued.
What has been the greatest challenge in establishing the business and how have you overcome it?
I knew that it would be complex and that it would take time and endurance, but I didn't fully appreciate the power of the “status quo”. Real estate is one of the oldest and most established industries. The practices and approaches used are deeply embedded. Introducing the idea of utilising rooftops, instead of land, and offsite modular manufacture, in place of on-site construction, regardless of the strength of argument, represented a substantial shift in mindset. It took a lot of time and effort to encourage industry professionals to think outside of usual practice and warm up to the idea.
I think self-belief and perseverance are the biggest assets for any entrepreneur, because by the nature of entrepreneurialism, you are doing something untested and uncertainty draws doubt and nervousness.
The situation was no different for me – I had to back myself and my team to prove the concept before others would accept and back it.
At what point did you decide the business needed equity investment?
After we commissioned research into the market potential, beyond the office in Camden and that street in East London, which showed the potential to build 180,000 new homes across London, we decided it was time to raise capital and build the capability needed to make the asset class a reality. I knew that long term, permanent capital was the right approach initially.
What was your experience of raising equity investment?
In the beginning, it was hit and miss. It was the first time I had raised external equity investment and so it was difficult to get access to the right advisers and investors. I could tell our story to policy makers, peers and the media in a way that resonated and generated advocacy, but doing the same for investors was more challenging. Capitalex helped us to express our story in the language used by investors.
What advice would you give to other founders that are considering raising equity funding?
It is a major undertaking and you will need a lot of inner strength, patience and stamina. Don’t be put off by tough questions or challenge – investors are looking for risks and understanding these ultimately puts you in a stronger position going forward. Having conviction in your business and your idea is crucial, and will make the sacrifices you make worthwhile.
How has equity investment enabled you to grow the business?
Raising equity meant that we had in place permanent capital to invest in the team, technology, frameworks and processes needed to make the concept a reality. We have assembled an experienced team and worked hard to build a pipeline of over 2,000 homes. Our first schemes comprising 34 homes have progressed to the build phase and we’re gearing up for our first 100+ home scheme.
What’s next for Apex Airspace?
We are on a mission to unlock the potential of the airspace asset class, creating homes for everyone in an environmentally sustainable way that enhances quality of living and standards of safety for everyone in the development. We are facing both an environmental crisis and a housing crisis – by maximising the value and utilisation of existing real estate assets, we can help to address both.
Not only must you navigate an industry that is full of smoke and mirrors, confusing jargon and conflicts of interest, you must do so while attempting to keep your business running smoothly.
As an investor, I’ve seen the imbalance of knowledge between investors, advisors and entrepreneurs put too many businesses at a disadvantage. The unspoken reality is that identifying funding options, getting investment ready and surviving a process isn’t ground-breakingly difficult, it’s just unfamiliar.
While entrepreneurs are busy pushing the boundaries and disrupting their industries, the investment industry has remained largely unchanged for decades. Investors still use the same maths to value companies, the same terms to define the working relationship and the same approach to diligence the books.
It’s not as clever as we like to think it is, and if we were only willing to share this expertise, we would give many more businesses the confidence and tools to step forward.
In an industry where first impressions are critical and quick judgements are made, this would also make our lives, as investors, so much easier. Businesses should get a “yes” or a “no” for the right reasons, and only by getting entrepreneurs and investors speaking the same language can we be sure that something hasn’t been lost in communication.
Here at Capitalex we aim to correct this imbalance. We are a team of experienced current and former investors that have pulled together our collective knowledge of the fundraising landscape – drawn from our experience of investing hundreds of millions into UK SMEs.
By making the industry an open book, we hope to encourage and empower more business owners to successfully raise funding and deliver their ambitions.
Commencing in May, this fund will back early stage, innovative companies that have been impacted by Coronavirus by match-funding up to half of a bridge round completed with other, third party investors.
The fund is most suited to early stage companies that are loss making, cash depleting and reliant on external private or venture capital investors in order to continue to trade. As a result of Coronavirus, many private investors and VCs have reduced the amount that they are willing to invest and this has made it harder for innovative, high growth companies to raise equity.
The Future Fund attempts to provide a "bridge" for these businesses, allowing them to continue to trade until an equity round can be completed. It therefore takes the form of a convertible instrument, i.e. a loan that will convert at a discount to the price of the next round, similar to the commonly used Advanced Subscription Agreement (or "ASA"). A discount of 20% is typical, although if the match investors require a higher rate, then the Future Fund will follow suit.
A loan is also quicker to administer than equity - for a start, relying on a discount to the next round removes any need to establish or negotiate valuation. As a result, cash gets to these companies faster and can serve as a genuine bridge. The trade-off is that there remains uncertainty around the next funding round. Only a small proportion of companies that attempt to raise equity funding actually manage to do so, so it remains a distinct possibility that the loan will not convert at the discount and will instead revert to its usual terms - a minimum of 8% accrued interest and a 100% redemption premium. A company that raises £1m, will have to repay £2m, plus interest, on maturity.
Kicking the valuation can down the road also has its downsides - it may be that a subsequent round can be achieved, but with the volatility in the public markets, the pricing might not be where founders had hoped. A lower valuation, compounded by a portion of this new investment being at a further 20% discount, may be onerously dilutive to the existing shareholders.
On the flip side, the cost of funding between issuance and conversion is "only" 8% plus the additional dilution from the discount. For an investment into an early-stage, loss making business facing financial difficulty - that's not an unreasonable ask. From then on, the Government shares in the return made by the company’s most senior investors.
One particular challenge for companies accessing this scheme will be securing the match funding. Little detail has been provided on which investors will qualify as match funders. This type of convertible is relatively common among angels, syndicates and high net worth individuals, and they can, subject to certain conditions, be eligible for SEIS and EIS. However, the latest guidance issued by HMRC in January 2020 stated that loans should have a conversion long-stop date of no more than 6 months, which means the next funding round needs to be "just around the corner" to attract these types of investors.
For those investors a little higher up the food chain, such as seed funds and VC funds, equity and preferred equity are more commonly used instruments. For these funds to invest alongside the Future Fund, they will need to consider if they are comfortable aligning with the Government's terms. Ultimately, the Government will be relying upon the more established firms to be the conversion catalyst, so for the scheme to be effective, it is important that these funds remain active and continue to price risk and invest in equity.
Subject to a few clarifications from the Government, this scheme could have the potential to provide the boost that our startup ecosystem desperately needs. Let’s hope the devil isn’t in the detail.
Saranyah Douse is a member of the Development Capital team which invests growth capital into promising UK SMEs with a focus on B2B software. She shared her advice for companies considering raising growth capital.
In your opinion, what are the potential benefits for businesses that decide to raise growth capital, compared with those that do not?
Raising growth capital is an opportunity to accelerate growth and realise a business’s full potential; without it a business is effectively bootstrapped. We have a huge amount of respect for bootstrapped companies. They often have good cost discipline and a focus on sustainable growth. However, there are a number of advantages to taking on growth capital such as upfront investment in growth to scale quickly and effectively, the flexibility and cash headroom to pursue new opportunities, and the alternative perspective of having an institutional investor supporting the business.
What do you see as the most common rationale for raising growth capital?
Typically, a business has already established product-market fit, generating meaningful revenues and customers regularly using the product. The motivation for raising growth capital is to enter the next phase of the business lifecycle, not because the company has run out of cash. The business should have hit certain strategic milestones and is now looking to scale. Growth capital can accelerate progress, whether through sales and marketing expansion, internationalisation, or product enhancement.
Through which structures does the Development Capital team invest, i.e. equity and debt, and why?
We can invest a mix of debt and equity (unsecured loans, fixed-return preferred equity and/or minority ordinary equity). When we invest, we fully appreciate equity dilution is a concern for management teams taking on additional capital and so look to tailor our deal structures on a case by case basis.
Many businesses struggle to get their heads around what it means to raise funding from a VCT versus any other growth capital fund, can you tell us a bit more about this?
From an investee company perspective, the main benefit of raising funding from a VCT, as opposed to a limited life growth capital fund, is that VCTs are evergreen, which means we are true patient capital. This fund structure allows us to support portfolio companies in making long term strategic decisions and provide follow on funding where required, rather than being limited by the life of a fund.
How much “value add” should companies expect from their growth investors?
As growth investors, we can provide deep sector advice (we exclusively focus on B2B software) and strategic support (including follow-on investment when required, future exit planning, and generally helping companies avoid common mistakes by using our experience from such a wide portfolio). We can also assist operationally, if that would be helpful to the management teams, with anything from helping to recruit the right people to developing sales strategies. Finally, we can provide access to the wider Octopus network, including supporting internationalisation with offices in both the US and Australia.
What key characteristics or highlights do you look for in potential investee companies?
We look out for businesses which have the following broad characteristics:
How soon should companies begin the conversation with potential investors?
The earlier the better. This way we can develop a relationship and get to know the business and management well ahead of a fundraising process. This helps us learn how you think about your business over time, share expectations and check we are aligned on values, so we can build a productive working relationship.
What common mistakes would you recommend companies take care to avoid when raising growth capital?
Have a clear view on why you need the capital and how much you need versus simply raising as much as possible. We want our cash to be used effectively rather than just sat on the balance sheet or used towards inefficient growth. We recommend companies have a clear and well-thought-out plan on how they will use the funds and ensure it is aligned to their growth ambitions.
And finally, how important do you consider the working dynamic and relationship between management and investor to be?
It is the most important factor, which is why we like to meet management teams as early as possible. Ultimately, we are backing them as a team to deliver growth and this will involve working closely together for a number of years. It you think of it a bit like a marriage, we may both have different perspectives but our interests are fully aligned, and it has to work for both sides to achieve success.