Free advice for SMEs setting out on fund raising

parachute in experts

I do advise the few start-ups on raising initial capital, but it is more by way of a charity donation from me to them and not a business model.

Fortunately, I did it often enough that I was able to condense what I’d learned into a few documents that I can hand out over coffee. Sort of “homework for first-time entrepreneurs”. After 10 years of doing this, I’m finding quite a few of those start-ups coming back as SME businesses with real revenue, but now they’re facing the second fundraising challenge; only this time it’s more complicated as they’re trying to balance new equity, debt, invoice discounting, leasing, and internal capital against their business model and the normal founders desire to optimise control on their board.

But why is it so hard to raise money?

It isn’t that hard to find debt finance for a company that is trading with growing revenues, steady profits, solid underlying assets, and fantastic customers.

Looking at the latest statistics there are about 5.9 million SMEs in the UK, of which 3.2 million are solo consultants, there are about 0.5 million partnerships, and 2.2 million enterprises are limited companies. Of those 2.2 million limited companies about 1 million have more than two employees. Roughly 750,000 new enterprises are born and die each year (it’s been quite steady for a few years now).

Of those 1 million companies with employees, 280,000 of them are get new loan finance every year, roughly 80% of those who apply.

The figures for equity investment are quite a lot lower.

There were roughly 1200 equity investment deals last year investing about £9.4 billion, with an average deal size around £7.5 million. While the average deal size is going up, it seems to be heavily distorted by a very few “megadeals” over £50 million

(Companies House also records the issue of new shares, but an awful lot of that activity is existing shareholders following on or changes in shareholder structure, so forgive me for going with the survey reports).

It looks, therefore, as if obtaining equity investment is about 200 times harder than debt finance. This certainly matches the discussions I’ve had with investors over the last year where they report roughly 1000 approaches leading to 100 pitch decks leading to 10 due diligence efforts and 4 or 5 serious attempts to reach ahead of terms for every deal that is closed and invested in. From the point of view of SMEs, over the last couple of years, they are suggesting that they send out roughly 20 to 40 pitch decks to potential investor contacts to get 10 meetings before they reach a first head of terms.

When you consider that this will absorb at least two or three months of senior executive time, it is a huge burden for companies that should be on rapid growth curves. It sets back their sales, products, and team development while they grapple with fundraising which is absolutely not their core skill set.

The market statistics also mask a deeper truth – those that get investment are those that have been successful in the past with other venture investment. It’s rather like Hollywood – everybody famous is the child of the famous. In growth capital, almost everybody who’s invested in has previously been invested in before and has returned a capital gain to their investors.

It feels to me as if the wrong companies are looking for the wrong sort of money and wasting an awful lot of effort in doing so. Venture capital is simply not the right solution for 90% to 99% of growing companies.

Who wins?

So, if you are fortunate enough to be in possession of the majority of shares in a growing SME in the United Kingdom the first free advice I will give you before you go looking for equity funding is this handy checklist:

Are you 100% able to demonstrate that you

  1. are the right team
  2. with the right level of commitment
  3. to be are seeking the right amount of finance
  4. at the right time
  5. for the right strategic purposes
  6. in the right industrial sector
  7. from the right investors
  8. with the right quantitative evidence (including revenue, cashflow, growth rate, and net CLTV)
  9. presented in the right way
  10. showing the right reasons for investment
  11. and the right returns to the investors
  12. at the right level of risk
  13. where you are willing to pay the right price
  14. and accept investment on the right terms

If you have all those 12 points nailed down, then you won’t need anybody’s help and you probably have a one in 10 chance of landing the amount you need within three months.

If anyone of those 12 points isn’t nailed down, then you probably do need help, because your chances drop to one in a thousand.