There are several ways to finance a scaleup. You can re-invest profits, borrow from yourself, your connections, or your bank, or sell equity in your company by finding people who are willing to exchange their cash for a percentage of equity.
Most companies grow by re-investing profits, but sometimes profits cannot fund the magnitude of the investment needed to grow rapidly and you may want to consider taking “other people’s money” (OPM) in exchange for equity. The trick is to find individuals or corporations that are willing to exchange their cash for your equity because they believe an investment in your company is likely to return a multiple of that investment in the foreseeable future.
Since it’s often difficult to find these people, you may need to work with an intermediary—a company whose business is to raise money for other companies. Depending on whether they are preparing documents, making introductions, raising money, or all three, they will expect to be paid a fee, generally 3-5 per cent of any money raised, plus equity, and probably a monthly retainer, which can be deducted from their fee pay-out. That may seem like a lot of money, but if they are able to raise the money quickly, it is worth giving them a fair share of what they raise. Here are four tips when considering using an intermediary to find OPM.
1. Do Due Diligence on Several Intermediaries
The criteria to use when selecting an intermediary include the size of the firm, their connections and credibility with high net worth investors, their track record, and how quickly they can round up the money you’ll need.
Be sure to check references with other CEOs for whom the intermediary has raised money. Get a sense of the time frame required to raise various amounts, and the total amounts the intermediary was able to raise. It’s also important to determine how much you personally will need to be involved in the process.
I have seen companies choose intermediaries who couldn’t get potential investors to commit. They did not have enough contacts, or did not work them well, weren’t viewed as credible to the potential investors they approached, or could not close the deal. Typically, the fund-raising dragged on for months, while the company ran out of money and their valuation headed south.
2. Put it in Writing
Develop a written agreement and limit it to a certain segment of the market, such as high net worth individuals in a certain location. Make sure you do not sign a blanket agreement which gives the intermediary a percentage of funds raised from anyone, such as people you have already approached (or your mother!). Set requirements for progress reports, and a date by which the funds need to be raised or the contract ends. You can always write an addendum to the contract with an extension if the intermediary is working hard and about to close some deals.
3. Manage the Process
Don’t think you can turn your fund-raising over to an intermediary. You will need to manage the process and answer their questions. Expect to be available by phone 24/7 and provide whatever company information they need. And be prepared to go with them to close some deals. Potential investors often want to meet the CEO, in person.
4. Understand the Risks
When using an intermediary, there are two big risks. The first risk is that you have chosen the wrong one and they will not be able to raise the funds you need in the time required. The other is that the terms of the various deals they negotiate will not be acceptable to you and you will not want to take the money under those conditions. In either case, the outcome is the same: $0 funds raised. Have an early conversation with the intermediary about any individuals or sources of funding that would be “off limits”, how much a single person or company would need to invest in order to have a seat on the board, and any other terms and conditions which could be “deal breakers”.
There are good reasons an intermediary wants an exclusive, but what happens if they don’t deliver funding within the timeframe you require? They forgo a fee, but your company is seriously compromised. Build in measures, metrics and contract break points if certain milestones are not reached so you aren’t tied up for too long with an intermediary who, for whatever reason, is not able to deliver the funding your company needs to survive.
Meanwhile, keep ramping sales and being profitable. Not only will you have more money to re-invest, your valuation will increase, and external investors will be even more interested in investing in your company.
Professor Jana Matthews is the ANZ Chair in Business Growth and Director of the Centre for Business Growth (CBG) at the University of South Australia’s Business School. Professor Matthews helps CEOs, executives and directors unlock their organisation’s growth potential, develop and execute plans for growth, attract and retain talent, develop products and services that meet customer’s needs, and improve their leadership effectiveness.
This article was first published by Entrprepeneur.com