Two questions every growth company management should ask themselves

6th October 2017

Email a Friend

This article attempts to help management of small growth companies consider one of the crucial aspects of their role - the need to raise equity capital. It is hard to over-stress the importance of this role. Many brilliant business ideas fail for the simple reason that they run out of cash. Failure to raise sufficient capital is one of the major reasons that half of all start-ups fail within five years.

There are some simple lessons that should reduce the failure rate significantly. However, running the business on a day-to-day basis while communicating clearly with an increasingly diverse and demanding shareholder base can be challenging. Failure to appreciate and address the significance of both aspects can have a material negative impact on a company’s valuation.

I will try to address some issues around what we call ‘the capital cycle of a growth company’. By this we mean the process that all companies go through to raise capital from the appropriate sources as they grow and mature towards a point at which they generate, rather than consume, capital. Every company goes through a series of different stages in this life-cycle. Consideration must be given to how capital needs can be met, and the need to think about who is the natural investor in a company at various stages in its life must be highlighted.

A start-up is typically an idea in the mind of a founder or founders, and funded - at least initially - by little more than the financial resources of those founders. Contrast that company with a multi-national like Vodafone that is able to access both equity and debt capital markets in numerous geographies. Clearly these are companies at different stages of their capital life-cycle.

It is important to Hardman & Co to determine where a company is in its growth cycle in order to identify the natural owners of the company and the most appropriate sources of capital. The natural owners of equity in a very early stage company, where high risk and high potential return investment go hand-in-hand, are different from those owners with a lower risk tolerance keen to fund a more established business knowing that they have probably missed the most exciting returns. Put simply, investors in more mature businesses are attracted by characteristics such as stability and dividend payments – characteristics that have been of little interest to equity investors in prior periods in the life of the same company.

Our significant experience working with small growth companies has shown us how important it is for a company to identify the type of investors they are seeking before spending valuable management time on a capital raise. While this might seem to be a statement of the obvious, it is not always clear that this exercise is sufficiently thought through by companies in advance. The shareholder register will inevitably change character as a company matures, and there is often a lack of understanding of how to identify and communicate with new investors.

We consider there to be five stages of a company's life:

  • Stage 1 (market value up to £1m): Clearly a start-up has little to show potential investors apart from a business plan and some founding individuals. An investor must have, at the very least, a high tolerance of risk and is very likely to be familiar with the individuals that have founded the company. At this stage we are talking about raising equity capital from friends and family with little professional advice beyond a lawyer and perhaps an accountant.
  • Stage 2 (market value between £1m and £5m): Once a start-up has begun to establish a track record, the opportunities to raise further tranches of growth capital from a wider investor base begin to open up. Perhaps the venture-capital or private equity world is now the place to look. Alternatively, private individuals/business angels or funds able to capture the advantages of the Enterprise Investment Scheme (EIS) could be approached. One thing is sure, the management team are likely to be in need of a fresh approach to selling themselves, and so should obtain advice from well-informed capital market advisors.
  • Stage 3 (market value between £10m and £25m): As illustrated in our table, we have a more established private company that is still in need of additional funding to grow and take full advantage of the business opportunity. The company is probably profitable and has a relatively low valuation. The investor base interested in providing capital has grown as the business model has been proven, and the track record has extended. The management needs to be adept at presenting to large groups of potential investors as they reach out to a wider audience.
  • Stage 4 (market value between £25m and £250m): By now our growth company can consider the option of seeking a public listing. At this stage there is an argument that the management team need new skills, or perhaps the company needs some new management. It is now a very different business with a broad base of shareholders, and the Board carries the additional responsibility that goes with being a public company. Perhaps it is not so surprising that by this stage so many company founders have sold out in a trade sale. For those that persevere the rewards can be considerable, but the hunt for the new investor base is just as challenging and time consuming as ever. Typically, the company will now have a full array of advisors and will be looking to bring in a NOMAD and broker if heading to AIM, along with a Public Relations or Investor Relations firm.

    Stage 4 can be a very challenging period. There is the risk that successful companies start to become complacent when it comes to interaction with investors. It is crucial that every management team does not forget or neglect the need to continue to seek out new investors. Long-term supporters of the company will become natural sellers as the company grows and matures; there is always a need to find the next natural source of investors. The company needs to consider that as the growth rate slows and the size of the company reaches new higher levels they might see their long-term (and previously very supportive) investors move on to new and more exciting investment opportunities.
  • Stage 5 (market value over £250m): At this point, management should be relatively comfortable with communicating with the capital markets and in particular how to relate to their shareholders. The management needs to continue to devote some time to attracting new shareholders even if there is no need for additional capital as, over time, the initial investors in the company will look to exit.

This article was written by Anthony Gifford, Business Development Consultant at Hardman & Co. For more information, please contact Anthony at ag@hardmanandco.com.

Join Now

  • Gain access to investors
  • Benefit from our campaigns on key policy issues
  • Receive discounts on best practice guides
  • Connect with other members of the sector at our events
  • Stay ahead of the issues with up-to-date news and information
Join now

Newsround

Newsround is the QCA's monthly newsletter produced for the small and mid-cap community.

Sign up