In this feature, Business Leader looks into the challenges scale-up businesses are finding around funding and acquiring later stage growth capital. The feature also looks at tips for leaders who may be looking to raise later stage growth capital.
Associate Director, finnCap
Principal and Founder, Acuity Associates
Principal, Frog Capital
Interview with Hugo Lough, finnCap
What are the challenges scale-up businesses are finding around funding and later stage growth capital?
Many scale-ups will find that, while it is much easier to double sales (and impress investors) when their revenue base is only in the low millions, maintaining a good growth rate becomes significantly more challenging as the business scales. The quality of revenue can also change.
For example, many B2B companies, especially in the software industry, find as they grow that they pivot from selling smaller size packages to SMEs, say, towards selling to much bigger organisations where there is a different style of sale, generally taking longer to complete.
Another challenge is visibility of profitability. Companies at growth stage have to contend with not just showing continuing top line growth, but demonstrating that they have a clear path to profitability in the near term. Investors need to be able to see clearly how there is a path to self-sustainable business. Funding growth versus funding losses is nuanced, but important.
Last, and certainly not least, it is important to consider the timing around when to raise – what is the current traction? How does the current cash situation look, and should you delay by a few months to reap the rewards of the incremental growth, or would that leave you at risk if the process drags?
Can you share any tips for leaders who may be looking to raise later stage growth capital?
It is important that companies start thinking about the timings and when to raise growth capital at the earliest possible stage. They should be identifying potential funders and creating a plan that outlines a timeline of activity and considers all parties they could be targeting.
On the hiring front, companies should start thinking as soon as possible about who they need on their team to help scale up the business. Are there any gaps? Perhaps there are skill sets that are missing? What might the business need to address soon?
Thinking clearly about what is next for the business, and what growth capital will be used for, is also critical. Funds may be used to pivot a business towards a different type of customer, to ramp up sales or marketing, and often at the growth capital stage internationalisation is a goal.
Finally, a company should never lose sight of ensuring the highest quality of products and services with all that they do. At growth stage, investors will be scrutinising product market fit and looking at metrics that are indicative of quality of service such as customer churn or the number of new customers – it is vital to demonstrate a first-class product.
Are there any emerging trends around later stage growth capital?
One trend that has emerged, and one thing scale-ups should be aware of, is that there have been some very fast transitions between Series A and Series B funding. There is clearly a willingness from many funds to provide additional capital early on after a raise, which may come as a surprise to some businesses and should be something to bear in mind. Indeed, there could be a level of backlog deployment occurring as many funds have found it difficult to find the right businesses to invest in or struggled to get comfortable deploying during Covid-19 given the lack of face-to- face interaction – there may be some pent-up demand.
Another trend is that, particularly in the UK, there is now a greater focus among investors on the underlying profitability of businesses. Previously, money has often gone into businesses where the business model has required very high levels of cash, and many investors now want to be assured that businesses can demonstrate a clear route to profitability. Some of the larger EU and UK venture capital funds are of course still happy to back highly cash consumptive companies given the right potential, but we have seen a general trend towards increased scrutiny of profitability
Preparing to pitch for scale-up funding
Article by Giovanni Nani, Frog Capital
For entrepreneurs looking to raise an early stage round of funding (i.e. seed and Series A), there is plenty of good advice available on how to pitch and position a start-up. But, when it comes to pitching a scale-up business to raise later stage growth capital, the resources publicly available to CEOs to help you prepare for that process are somewhat scarce.
Pitching for late stage funding is different. The company is at a different stage of development, and late stage Investors look for different signs of potential. Understanding the process and getting the pitch right (e.g. the narrative, the metrics, the deck, etc.) is critical. These need to be tailored from stage to stage to factor in the specific audience requirements. That does not mean writing a pitch that over-caters to investors, rather adjusting it to ensure it speaks their language with the appropriate tone of voice and focus on key topics.
Some elements of a good pitch are universal, but zoom in on the later stage fundraising and you’ll see there are some key pitfalls to avoid. The following six considerations will help ensure your pitch resonates with growth investors:
Ask yourself, ‘How can I make it easy for them to make an investment decision?’
Growth stage investors will be listening for different things than early stage investors. While their equation for building conviction around an investment may have the same variables (i.e. team, market, traction, etc.), their coefficients are often different. A pitch that reflects the growth stage investor’s mindset will make it easier for that investor to assess the opportunity.
Often later stage investors have a corporate finance/professional investing background, whereas earlier stage investors are more likely to have operational/start-up experience. Their diverse backgrounds will likely influence their expectations and investment mindset.
Don’t just update a Series A deck
In an interview, Bill Reichert, Managing Director at Garage Technology Ventures, says the fundamental difference between early stage and late stage pitching is this: selling a dream vs. selling an operating company and your ability to execute your plans.
The experience gained in raising seed and Series A rounds is certainly valuable, but the differences of what is expected at Series B or later must be well understood.
The set of numbers, metrics and evidence that a later stage investor will want to see is greater. History and track record are key to demonstrating sustainable growth potential.
Expect more data driven discussions and more ‘difficult’, forensic questions. Late stage investors will look to be convinced by data at a more granular level, not just by the bigger picture vision.
Demonstrating a keen handle of KPI monitoring helps create a sense of control. Investors will want to see that you have got the discipline of having a metrics dashboard in place for several quarters and they will expect you to be tracking against specific performance metrics.
If you are raising a later stage funding round, most likely you will have an existing set of investors onboard already. Leverage their knowledge and experience, A/B test with them, get input and feedback.
For a company at the scale-up phase, you are typically expected to have senior management team in place (or at least an initial form of it). Carefully choose the team around you that will support you in the presentations and will attend meetings. That should typically reflect the way that the company is run day-to-day.
Scale-up businesses demand agile funding
By Ben Mekie, Acuity Associates
The CFO’s role has never been more critical
More than 5,000 unquoted companies in the UK qualify as high-growth businesses according to The ScaleUp Index, a joint research study published by the market analyst Beauhurst and The ScaleUp Institute.
Scale-up businesses constitute a very different cohort to many ‘steady state’ SMEs and mid-tier businesses and the individual pressures they face require a close and detailed understanding. These are amplified as they make the transition from thinking tactically to strategically and strive to build new capabilities and resources.
Fast-growth businesses face critical cash flow challenges
For any fast-growth business, cash flow seldom takes a straight-line trajectory. Spikes in demand, the need to alternately consolidate and build, as well as handle seasonal trading fluctuations, serve to underline the need for more agile solutions
Why the ‘obvious’ solution may not be the optimal solution
There have never been so many choices of funding options available to businesses. Unfortunately, for many time-poor entrepreneurs, the plethora of offerings can prove bewildering. As such, businesses often gravitate towards taking out a term loan via their existing clearing banks or by searching for bank loans on Google, without considering whether there are more appropriate and flexible alternatives in the market.
Private Equity – ‘Dry Powder’
Private Equity houses are currently sitting on substantial levels of ‘dry powder’ for investment in businesses looking to scale-up. We will inevitably see the phrase ‘patient capital’ being used more and more, as PE Houses are prepared to wait longer to see exits on both their existing and recently acquired portfolios.
Asset-Based Lending – ‘Delivering Headroom’
We will also see asset-based lending playing a growing part in event-driven M&A activity, particularly in tandem with PE sponsored buy and build transactions, where lenders not only fund the purchase consideration of the target but also provide significant additional headroom to drive further growth for the enlarged group. In addition to providing funding against assets such as accounts receivable, inventory, plant & machinery and property, some asset-based lenders will also provide supplementary cash flow loans, subject to EBITDA.
Medical business looking for growth capital
When they pitched for scale-up funding (later stage growth capital) – how did they find the process?
The business had previously found that asset finance was an excellent way of acquiring equipment (very useful in an asset heavy medical business) and was used extensively to build the business organically and add revenue streams. However, the FD recognised that this was never going to allow a step change in the way the business operated.
What were the options?
In this particular case, where the business had a clear exit strategy and time horizon in mind, the main option considered was to approach minority investing private equity houses to accelerate growth. Once the strategy had been documented and honed as an investable proposition, the process of meeting potential PE investors commenced in earnest.
Details of the raise
The PE house, which was a minority investor, agreed to acquire 30% of the business for £5m. The business at the time was turning over £3.5-£4m and the valuation was agreed based on the performance of the expanded group post investment.
Tips for other business owners or leaders or who may be looking to raise later stage growth capital
Prepare, plan and prepare some more. Start sorting out finances, legals, health and safety and operational issues way before you start going for finance. Make sure your strategy is a) coherent and flows naturally from your current business, and b) is comprehensively documented. This will make your presentation to investors flow and be far more compelling as a proposition and will make the end of the process much cleaner and easier.