The Supper Club - Logo

How to recognise smart capital

When it comes to finding funding for the expansion of your business - whether that end up with you at the helm, or via an exit with someone else in charge - not all lenders and investors are equal. All money comes at a cost and with some strings attached, the trick is to recognise the shape your business is in and the stage it is at to make sure you land the right deal. Get it right - find "smart capital" and you'll be off and at the scaling races. Get it wrong - pick the "dumb" choice - and you could knacker the whole enterprise.

The key to making any capital “smart” is to match what your business needs with the style of funding, particularly with an eye to aligning the objectives and interests of the investors or lenders with those of the business. Finance options range from low risk, low return debt (mostly provided by banks) through mezzanine debt (debt where lenders might also seek to take a small slice of equity) and onto venture debt (where money will come with more warrants attached) and then riskier, but potentially higher return models of private equity and venture capital.

At a recent Supper Club digital discussion, Matt Katz and Andy Hodgetts from entrepreneurial advisory specialists Buzzacott, talked members through some of the factors to consider when looking for capital, including the state of the business, the nature of cashflow and revenues, the reason for the extra funding and what impact it will have on growth and future potential.

  • There is no simple magic formula, but it's worth recognising not all finance options are right for all businesses.

  • The smart way to approach funding is to grow your best business and then identify the best value capital – what type and at what cost – that fits with the business you have built.

  • Many people associate the idea of “smart capital” only with the added value business founders can get from private equity investment teams, often through them providing board-level execs or support staff. But it may be smarter to get hold of capital through a simpler route (such as bank debt) and then use it to hire experts with the skills and insight you need, either on a full-time or consultancy basis. It’s much easier to get rid of such people than to get rid of a shareholder.

  • A top tip for assessing investors, especially the larger PE and VC firms is to look at their website and look at what they say in their pitch to their investors. This is a good way to discover their motivations and objectives, which allows you to find investors that are aligned with your ambitions.

  • It always costs more and takes longer to secure capital investment.

  • Keep in mind that while sometimes a small slice of a larger pie is the better outcome, there are situations where a much larger (or entire) share of a smaller pie represents better value.

Hodgetts outlined a two-step approach to help make a better decision."First, think of the organic growth opportunity. What would the best scenario here look like? How would it look with some debt finance to boost growth? Second, think about what a larger investment, in exchange for equity (and a loss of some control), would allow you to finance. How much better off would the business be? Comparing these scenarios can help you divine a course of action, albeit predicated on forecasts, that are never 100% accurate."

It is also worth factoring in sector and type of business and how you need to use any money. "A manufacturer in need of new machinery or a warehouse might bet better with debt as a first option. There are solid assets to offer as security. If you’re a service business that is looking to invest in marketing, for example, or to fund expansion to a new market, you may be better opting for a form of equity finance, where there is a higher tolerance of risk. Smart capital is always, above all else, about matching your risk profile to that of your investors."