14 June, 2011

The pros and cons of external investors

Some years ago, I worked with the board and owners of a mid-size business which had the opportunity to expand, and had several funding options available. At the same time, we also considered the implications of outright exit. Adding to the issues was the realisation that the status quo wasn’t a long-term survival option.

This table summarises the discussion of the pros and cons of the options:

Investment stage
Expansion
Exit
Investor type
Pro
Con
Pro
Con
Self-funding
No transaction cost
You’re still involved
Miss rapid growth opportunity
Too small for long term viability
You’re still involved
NA
NA
Trade investor
Access to markets, channels, know-how
Patience
Grows the pie faster
You’re still involved
Exclusive distribution
Limits on additional investors
Pre-emptive rights diminish exit choices and value
You’re still involved.
They want a future strategy - often 100% acquisition
Highest potential exit value
Loss of your baby and what you’ve built
Financial investor
You’re still in charge – if you perform
Ability to bring in additional investors
You’re still involved
No access to channels, markets, know-how
Impatience
They can sell their stake to a competitor
You’re still involved
They will want an exit strategy - often 100% sale within 5 years
Your baby keeps going
Unless you’re a stable business, not the top value
IPO
Access to bigger capital pool
Freedom of action (within public co limits)
Retained control (as manager and major shareholder)
You’re still involved
Public scrutiny before you’re really ready
A competitor can build up a stake
Cost of servicing many investors
Transaction cost
Fickle investors
You’re still involved
Good potential for value
Your baby keeps going
You will still be locked in
Transaction cost
Less viable for smaller businesses

Obviously this is a gross over-simplification of the alternatives, and was in the context of the structure and behaviours of their industry.

We explored each alternative in terms of complexity, risk, growth, the impact on shareholder value, and perhaps most importantly, the appetite of the owners for the next stage of the journey. This led to the conclusion for these owners that their first preference was to seek a financial investor for expansion, with an exit strategy based on a 100% trade sale within 5 years. If no acceptable financial investor could be found within 12 months, then the business would be put up for 100% trade sale, while it still had the market expansion opportunity.

Now that wouldn’t necessarily be the conclusion for every business, e.g. Xero went for an IPO as its primary expansion capital funding mechanism. The point is that you shouldn’t make a quick assumption about how you should fund your business expansion or, indeed, if you should expand at all.

First posted February 26th, 2008

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