An Insider's Guide to Securing Private Equity and Venture Credit
Securing equity or debt and debt-like investment from institutional providers involves a multi-stage process, over many weeks and sometimes months. The level of due diligence (DD) varies and each team has its own preferred approach. However as a general rule, you can expect most if not all of the following stages in the process:
Cold Call
Some firms will accept email applications for investment from completely unknown founders and entrepreneurs. Applying through on-line portals with pre-set questionnaires is fairly common, for example Mainstream investments (part of CSIRO) follows this approach. Other firms insist upon a formal pitchbook being emailed to a dedicated inbox. However, many will only engage with start-ups or growth businesses that have been introduced to them through a mutual, trusted contact. In truth, all investors would prefer this latter type of introduction. This is mainly due to time constraints on the investors, meaning the firm must trim down potential investee companies to those with a closer connection and thus a degree of pre-vetting.
Warm Introduction
The preferred approach of all early-stage investors. A mutual trusted contact, perhaps an existing sponsored company or a representative at a previous investee firm, will introduce a founder to the investors.
The “Sniff Test” - Initial Screening
With a set of introductory materials, before any face-to-face or teleconference meeting, an investment professional at the relevant firm will screen the opportunity. The criteria varies widely between investment groups, but some common themes include: the specific sector - is it in favour? The size of the “ask” for capital - too big/small? The maturity of the business - too young or too mature? The addressable market for the product or service - is it big enough? The uniqueness of the product/service/business model - has it been seen many times before? The likely “moats” around the business - how defensible is the product/service? The complementarity with other portfolio investments - can this business earn synergistic benefits from others? The founders’ experience and technical knowledge - do they have what it takes on paper? This process can take a number of weeks or more, depending upon the resources of the firm and the volume of inbound pitches. Compiling your introductory materials is a critical stage. It is your only chance to make a positive first impression. Remember, you know a lot more about your business than anybody else. But this does not mean all that detail will make for a compelling proposition. You must simply, succinctly, outline what your business does, why this is valuable, why you are well equipped to do it, and why you are requesting capital investment or lending.
Initial Meeting, Teleconference or Video Call
Simply making it this far in the process is encouraging. It means the investors have found enough interesting aspects of your business to spend time meeting in person, or assembling team members for a video call or teleconference. The subject of these calls and meetings is generally higher level, but will involve your leadership and management, your product or service, the specific market place and USP within it, and a clear vision statement or “moonshot” which shows the founders’ long term goals. If your business does not make it past this stage, do not lose heart. Most businesses will not, and for very sensible reasons. If the investing firm has a long-term ethos, it should give you recommendations for alternative capital providers and/or constructive feedback. You may not be ready now, but you could be a perfect investment in 12-24 months for example.
Preliminary Due Diligence
This is the part where it gets more intense. The investor will need to know a lot of detail about the business, the founders, the staff, the product and the marketplace in which you compete. How is your sector regulated? How do you protect your IP? What financial metrics can be demonstrated? Can the product/service be scaled, nationally or globally? This part can be the most time-consuming in the process, involving multiple meetings over a number of weeks, both on-site at your business and meeting a wider set of team members at the investor’s premises.
Investment Terms
If the prelim DD is promising, the investor will usually move onto a draft investment proposal or “term sheet”, which contains the key commercial terms of the equity, debt or hybrid investment. These terms should be analysed and considered very carefully, with external advice, as they will form the basis of your relationship with your new investor or lender. This can be the most highly charged part of the process, where external advice and counsel is especially useful. Some of the terms may be “square-bracketed” (literally written in square brackets), meaning they are proposed but not set in stone. There should be scope for negotiating these terms, although the speed and complexity of the “ask” from founders may limit negotiating power. Some terms may be set in stone and non-negotiable, as they form part of the investment mandate for the fund or pool of money from which the investment firm is sourcing capital.
Investment Committee Meeting
Most firms operate a structure with a group of partners or directors, plus analysts, who are involved in tasks such as sourcing new deals, day to day management of the portfolio, and the management or oversight of investee companies or borrowers. There is a separate and independent Investment Committee (or IC), which can have a mixture of staff and external advisors, making the final decision on whether to invest / lend, or not. It does so after considering detailed written proposals and financial models from the analysts and managers, normally contained in an Investment Memorandum, or IM. The IC may sit a number of times to discuss the investment, potentially with a presentation from the founder/s and a Q&A session. Coaching of business founders prior to these meetings is especially useful, from an external advisor or trusted counsel. After these meetings, the preliminary term sheet may be amended on instruction from the IC, to address either concerns or discrepancies. If approved, the final term sheet will be issued to the founder/s.
Confirmatory Due Diligence
This stage marks the home stretch in the process, as it shows that the investor is fully behind the business and the investment parameters, as contained in the agreed term sheet. There will be clauses which mean that any items uncovered at this detailed stage, can still lead to the term sheet being withdrawn. However, this is likely to be issues around misleading items or forecast errors not discovered in earlier stages. Or, it can be due to external expert opinion which contradicts the views of the IC. A large amount of documented material will be requested, often to be housed in a “data room”, or secure on-line file. There will be meetings with most of the staff in your business and some of your customers too. The general goal is to independently verify things such as: technical information for your product/service, financial projections, market verification, founder assumptions, regulatory compliance. Generally, external parties such as “big four” accounting and consulting firms are engaged in order to perform Commercial DD, and legal firms are engaged to perform Legal DD. These costs are generally borne by the investor not the investee, and can amount to hundreds of thousands of dollars for complex or larger transactions.
Legal Documentation and Execution
Assuming the confirmatory DD is satisfactory, the long-form legal documents will be drafted to detail every aspect of the investment and the relationship between the investor/lender and the investee/borrower. There could be final DD occurring during this process too. This is where both parties will need to rely heavily on their own legal counsel. When the documentation is complete and the executed by both parties, funds will be transferred from the sponsor’s bank accounts to the investee/borrower bank accounts.
How Barraclough + Co Can Help
The process we have described here can be arduous, stressful and time-consuming. All of which can distract you from the core passion of running your business. Barraclough + Co can assist with all stages of this process, not least as our staff have been involved in this process themselves, either as business founders or as investors. Get in touch with us to discuss how we can help you secure the investment you need to take on the world.
