Written by David Tebbutt, MicroScope 01/83 item 02 - scanned

IT'S NEVER TOO EARLY TO TALK TO THE CITY (column) - financing business growth

Many businesses reach a critical point when they must decide whether to stay small, providing a modest service, or go for the big-time. And many micro-computer companies don't even have the choice. They have to go for growth or be submerged by the competition.

Although you may believe The City to be rather remote and unapproachable, in fact, it has become increasingly receptive to approaches from fledgling growth companies. Over the past two years especially, City institutions have invested substantial amounts of money in high tech ventures including Torch, Tycom, ACT and Sinclair.

You will need to present your case carefully and thoroughly. You must convince the investors that your team and ideas are worth backing and you must explain to them how you will develop your business over the next few years. In fact, it's not a bad idea to present three or four different scenarios, each based on a different set of assumptions perhaps pessimistic, realistic, optimistic and blue sky would do. Potential investors will be impressed both by your honesty and by the fact that you are capable of planning for a variety of different outcomes.

Before you can present your case, though, you need to find your investors. You will need to know how to convince them that you are best qualified to give them the growth they seek. You will then need to ensure that they don't take too much from you in the process.

First of all, let's look at finding the investors.

Stockbrokers are useful in that they are approachable and they know many investors very well. They can act as middlemen who try to make the best match between your company and the investors. They spend a lot of time getting to know you and your business. They then try to find the investor(s) who will suit you best. There is a lot of merit in this approach because it can save you making false moves or, worse, getting into an inappropriate arrangement. If the broker is successful in obtaining funding, it will take a small percentage (3-5%) of the total amount obtained. If it fails then you will pay nothing but you may have learnt a lot, both about your business and about how to approach investors. You should bear in mind that not all stockbrokers handle corporate finance and, of those who do, few are used to handling high technology companies. It is very important that you deal with people with experience of obtaining funding for businesses in our type of industry.

The same conditions apply to merchant banks. Many of them have a corporate finance department which will do a similar job to the stockbroker. The best use you can make of a clearing bank is to talk to the manager, who may be able to put you on to sources of venture capital.

Your accountant, too, probably knows a number of investors and brokers so he or she, too, may be a handy source of advice.

Going direct to an investor is a bit of a hit and miss affair. If you know them and their way of working, you should be in with a chance. If you don't, you could fall at the first hurdle and not even know why you fell. If you can use someone who is familiar with the various methods then you can at least match your approach to the needs.

This would seem to bring us back to the merchant bank and the stockbroker. In general, the merchant bank will only be interested in the larger fundings, whereas brokers are prepared to consider fundings from as little as 100,000. However you make the approach, the rules of the game are the same. Your overriding aim should be to get the best deal. But this won't necessarily be the same as getting the most money for the least number of shares. The best deal is one which is fair and which makes each company happy. The investing company will be happy if it has confidence in you and your prospects and if it has a reasonable shareholding relative to the amount invested. You should be happy if you've got the money, if you can 'get on' with the investors and if you know you can go back for more. Many companies, Apple is a good example, go back for repeated funding. First estimates are nearly always wrong.

Don't expect the investors to want a controlling interest, they won't. They know that you and your key people are far better qualified to run your business than they ever will be. One or two deals have been struck recently in which performance objectives have been set. If the company fails to meet these targets, then the investors will receive additional shares according to an agreed formula. This is not a case of investors twisting the companies' arms. It was seen by each company as a way of keeping the investors' shareholding down.

When looking for money, you should give investors at least three months warning, so that they have a chance to get to know you and your business. In fact, it's never too early to make contact and talk to The City and potential investors. More than anything else they are going to be investing in the people and the earlier you establish a personal relationship, the better it will be for you. They will look at your short term estimates and forecasts and see how your company measures up to them. They will want to understand the nature of your business and the way it is run. If you use a stockbroker then, rather than having odd investors crawling all over you, you will just see one.

Once the investor or the stockbroker is happy with your company, the money will be made available. With any luck this will enable you to make the company grow, thus rewarding the investors with a substantial increase in the value of their shareholding. You, too, will benefit from your reduced number of shares having a greater value than if you had never sought funding in the first place.

(I would like to thank Michael Bean and Brian Coultas of City Brokers Henderson, Crosthwaite & Co for helping me clear my thoughts for this article.)