Get ready to venture forth

Companies looking to expand should think about equity capital before they even need it, writes Sandra O'Connell

AFTER a mere three years in business, Sean Fitzgerald's Sentenial employs 12 staff and is set to double the number within six months.

The payment-technology specialist firm spotted a global niche for a direct debit product and has already attracted clients in Ireland, Australia and America. "We made a product the market wanted and, because we got cash-flow pretty quickly, we were able to reinvest to grow the business," he said.

Fitzgerald set up Sentenial with savings of E100,000. He went on to win funding from Enterprise Ireland. The next stage will require "serious money" from venture capitalists. "My next round will require E2m to E3m," he said. "After that, it will be in multiples of E10m."

Companies that enjoy rapid growth are prime venture capitalist (VC) targets, according to Diane Mulcahy, a former venture capitalist and author of Venturing Forward -A Practical Guide to Raising Equity Capital in Ireland.

Equity investors, particularly VCs, want "rapidly growing companies, led by strong management teams, with the potential to capture significant market share in large and emerging markets, before realising a timely and profitable exit," she writes.

The best time to raise capital is before you need it, says Mulcahy. "It is a lengthy process to identify and interest investors, schedule meetings and other presentations, conduct due diligence, negotiate and close the transaction and receive the money," she said.

It pays to prepare early. Investors are rarely in a rush to complete a deal "and their patience affords them negotiating leverage if the company is in desperate circumstances and requires an urgent injection of capital".

Fitzgerald is ahead of the game in this aspect too. "You need to be looking two funding stages ahead every time," said Fitzgerald. "You need to think in terms of stages. So you don't end up giving all your equity away too soon. But you also need smart money, someone who will bring you added value such as market share."

To secure it, the business must first be attractive to prospective suitors. "Build your credibility first. The key is having proof of concept, bringing good clients with you," said Fitzgerald. "Then you have value when you go to the market."

Don't be greedy either. "Don't look for too much. It can make you lazy," said Fitzgerald. "(If you) get E10m when you need only E2m, you end up going out to dinner. When building a business, you need to be disciplined."

Finally, as any Jane Austen heroine might put it, save yourself until you have found the right match.

"When it comes to equity just don't give away too much too soon," said Fitzgerald.

To get the best valuation for your business, know your sector, know your figures, develop a valuation range and then build your case, said Mulcahy.

Attributes likely to result in a higher valuation include a strong and experienced management team and the existence of other investors who are interested in the deal.

Being in a "hot" sector or market helps, as well as being in strong flotation or trade-sale markets with high valuations, having paying customers and a strong sales pipeline and intellectual property ownership.

Those prepared to take that step must first be "investor ready". "Investors have a habit of evaluating the structure and governance of potential investments and classifying them as either 'clean' or 'hairy'," says Mulcahy.

With clean deals, the financials are up to date, employment, share options and shareholder agreements are signed and organised, and intellectual property ownership is documented. Tax and corporate filings are up to date and in order.

Hairy deals arise where "poor record-keeping and documentation make the company's capital structure or financials opaque" or the "board is composed of inappropriate, unsophisticated or poorly performing directors that must be restructured," she says.

A business angel is a better option for many small firms than getting involved with VCs too soon, according to Fergal McCann, lead adviser at InterTrade Ireland, a business development body, promoting north-south trade.

"It is very difficult for most companies in Ireland to scale up in size to suit venture capitalists, who are typically looking for rapid growth," said McCann "The business angel network is more likely to be applicable to most Irish companies seeking equity investment," he said.

Last year the Business Angel Partnership was launched, bringing together the private investor networks of Enterprise Ireland, the Dublin Business Innovation Centre and InterTrade Ireland to form a national business angel network with particular interest in start-up and early stage small firms.

InterTrade Ireland's Equity Network provides an advisory service to help small firms understand the benefits of private equity and ensure they are investor-ready.

That is the stage at which Diarmuid Crowley and John O'Keefe find themselves. The pair founded Wild Orchard Natural Beverages in April 2001, having spent the previous six months perfecting recipes for their fresh-fruit smoothies and juices in Crowley's kitchen.

Having succeeded in tickling the taste buds of family and friends, they amassed E110,000 in savings and bank loans and went into commercial production at their factory in Hospital, Co Limerick.

Today the company, which employs nine people, sells in excess of 20,000 bottles a week across Ireland and moved into profit last year.

Having cracked the domestic market, the next stage in the plan is to take on Britain and Northern Europe.

Such a move would require significant investment, however. So far their strategy of ploughing all earnings back into the business has been enough to allow them to develop. "The kind of money we needed to keep moving was never massive," said Crowley. "But to ramp up to the next stage requires us to expand the factory and invest in automation. It's a big step and we have to revisit our funding strategy."

They may finally be ready to relinquish a portion of their firm. "While we're still very small to be giving away equity, we can see the advantages of having a smaller piece of a bigger pie," said Crowley.

"We can also see the advantage of having an investor who brings not just money to the table but who adds value, whether in terms of knowledge of new markets, distribution networks or products."

Equity capital comes without the burden and cash-flow drain of the monthly repayments required by debt, according to Mulcahy.

"External investors can bring a new and higher level of financial discipline, as well as greater requirements for good governance," she said. "An equity investment can meaningfully improve the reputation and status of a company. The downside is a big one: a reduction of control and decision-making over your business."

HELP DESKS

THE Business Expansion Scheme (BES) allows start-ups to obtain up to E1m of equity capital from a BES fund or BES investors.

BES investors can receive up to E31,750 in annual tax relief for their participation in BES and could invest directly in the company or via a BES designated fund, holding on for a minimum of five years to get full tax relief.

For more details see Revenue.ie.

The government's Seed Capital Scheme allows entrepreneurs who invest their own capital in a qualifying firm in which they are a full-time employee to claim back their own previously paid income tax for the past six years, up to the amount they have invested in their company. Details are on Revenue.ie.

County and City Enterprise Boards focus on very early-stage companies with less than 10 employees, with equity financing typically offered for redeemable preference shares, which are more like loans. See Enterpriseboards.ie for more.

Enterprise Ireland makes equity investments but demands that its investment is matched or exceeded by private equity investors. For information see Enterprise-ireland.com.

Business Angels Partnership is at businessangels.ie and the Equity Network can be contacted via IntertradeIreland.com.

Venturing Forward is published by Oak Tree Press. Visit Dianemulcahy.com or Oaktreepress.com for further information.