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Perspective of an Equity Investor in Financing a Private Business

Apohan Corporate Consultants Pvt. Ltd. > Financial Strategy > Perspective of an Equity Investor in Financing a Private Business

Introduction

You (as a businessman) may be thinking that most of the investors putting their money where there is maximum rate of return for highest yield on their investment. To your wonder, you will find that the real world scenario is exactly opposite. Maximum wealth or money in this world is invested in the assets that have hardly any attractive rate of return. You can find many statistics on this on the internet. Then, what are these other aspects that govern the psychology of the investors?

 

Risk of business

 

The first aspect is risk of the business investment opportunity. The word risk in general language is used with a slight negative connotation. The same is not the case in the world of finance. In the world of finance, the word risk has a neutral connotation. The word risk describes both the positive as well as the negative side of attractiveness/threat of investment in a business opportunity. In a layman’s language, it represents the degree of fluctuation, turmoil, wildness, variation, deviation, uncertainty, unpredictability, probability, etc of the return on investment on either side. The measurement is typically made based on what happens in a similar type of investment reference to past instances, if available. It is a statistical term & let’s not go into it.

(The marriage analogy for risk to equity investor

A loan is like an acquaintance, it it easy to make & break. You don’t pay & I will encash security! Also, I don’t bother what happens in your private life (here company!). Relatively, equity funding is like a (traditional Indian) marriage, hence the entry has to be very very careful & diligent. Because there is no recourse later!!! There is no obligation to pay back investment, no interest, no security & no guarantee!!  Exit is difficult & all risks have to be shared. Hence, the transaction study, documentation, time & cost is higher. A businessman must appreciate the requirement of information by the investor & rigour of due diligence. An equity investor may look to be a difficult person till he becomes part of the company, but this is the time to be patient & not spoil the relations right in the beginning. A should use empathy method – what all I would have checked had I had to invest so many crores in an unknown company?)

 

Management quality aspect 

 

Apart from ethics, transparency, competence, quality and intentions of the business’s management, there are many other internal and external factors that govern the ability of a business to generate sufficient returns or to keep the investor capital safe.

 

Liquidity aspect

 

Another aspect is liquidity. A private limited business is the most illiquid asset among all asset categories, even more illiquid than real estate. There is no ready market to sale a private business. Very few people understand buying and running a private business.

 

Term aspect

 

Another aspect is duration of investment. Equity investment cannot have a duration of investment. That is why financial investors are very particular about the exit clause in the investment contract. Strategic investors are least bothered about the duration of investment and their main interest is to keep on growing the business forever.

 

Control aspect

Another important factor that investors Looks for his control of the organisation. Why the original promoters and management is more acquainted with the business and very well network with all the stakeholders, they can’t be done away with for running the business successfully. However, new equity investor may perceive risk of siphoning of the fund by the people who were call controller of the business before his entry. That is why an investor may seek to appoint himself or his nominee directors on the board of the company and monitor the financial and operational activities.

 

Another reason for control is decision making power in case of differences of opinions or frictions among various shareholder groups. They differences could be candid in the direction of what is in the best interest of the company or could be malevolent (company means good company by default, right?) to harm the company or the other shareholders’group.

 

Entry process

 

An equity investor would also require sufficient time to carry out all the due diligence and mobilize all the requisite funds. An investor would expect the business to be flexible enough accept the business structure and capital structure related suggestions. The process is lengthy, rigorous, complex, costly, etc. The business owner must be ready  & available for the process & associated communications, meetings, etc

 

Sector & location aspect

 

Certain investors have inclination for certain sectors or products or geographies. Some other investors are guided by investment philosophies, i.e. no investment in vice businesses such as alcohol or investment only in basic human needs such as food & health.

 

Ticket size aspect

 

Certain institutional equity investors very huge chunks of funds and they are limited by their ability to assess small businesses. Hence, businesses invest only more than a certain minimum investment ticket size. Typically, larger the ticket size, easier the deal from M&A consultant’s perspective!!!

 

Potential/Valuation & Offer aspects

 

Finally comes valuation of the equity. While equity investors are flexible in general and flexible on many of the parameters discussed above, the ultimate objective of an investment is to multiply the capital in the shortest possible time. The value of a business is not based on the market price of the individual assets in the business at the given moment. It is based on the ability of the business to generate additional cash which is many more times the capital infused in the business from time to time.

The sale offer made to the investor should be reasonable, practical, rational & logical.

 

Contractual aspects

First of all, the business and the equity investor need to reach an agreement on what is this value the business can generate in its future lifetime if equity funding is done. Note that we are not discussing share purchase between two individuals which will have no impact on the cash position of the business. Before entering and investment contract, the business and the private investor shall discuss and negotiate the ratio of their monetary and non-monetary contributions towards this value, their rights, obligations, assets, liabilities, risks, relative bargaining powers, alternate options, market trends, etc. Both the parties should feel that the transaction is mutually beneficial. While the business gets all the capital to undertake all those activities that were otherwise beyond its control and the investor gets an opportunity to grow his capital at a much faster pace than it was growing previously.

 

Author

Arun Joshi,

Chairman & Managing Director,

Apohan Corporate Consultants Pvt. Ltd.

Address:              Office No. 11, First Floor, Shriram Complex, Model Colony Road, Shivajinagar, Pune,

Maharashtra, India -411016 (Landmark – Fergusson College)

Landline:             +91 20   25650005, Mobile: +91 9810481325

E-mail:                 arun.joshi@apohanconsultants.com,  Website: www.apohanconsultants.com

Profile:                 https://www.linkedin.com/in/arunjoshiapohan

Company:            https://www.linkedin.com/company/apohanconsultants

Company PPT:   https://www.slideshare.net/ArunJoshi38/apohan-marketing-presentation-v47-02-062020-aj

 



 

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