Escolar Documentos
Profissional Documentos
Cultura Documentos
This version – a scanned copy of the original – has been made available
primarily as a reference for SME researchers, although others may find
the content of interest.
Much has changed since it was first published. For instance, the
government’s Small Firms Service (p.210) subsequently evolved into the
Small Business Service, although it, too, was later replaced.
To avoid an overly large file, the publication has been split into two
Acrobat documents, namely:
David Purdy
Visiting Fellow, Kingston University
http://business.kingston.ac.uk/sbrc
January 2011
Preface iv
Acknowledgements vii
Introduction ix
Chapter
INDEX
- Liability Disclaimer -
Due care and attention has been paid to the collection and
selection of the information and advice contained herein, and
as such, this information and advice is offered in good faith.
The Small Business Research Trust regrets, however, that
neither the Trust, the project sponsors, the author, nor any
contributors to this publication, are able to accept any liability
for losses or damages which could arise for those who choose to
act upon the advice or information contained herein.
The Trust would be pleased to receive any comments or
suggestions for improvements for future consideration. A
'tear-out' page for this purpose is included at the rear of
the book.
TO THE READER:
This guidebook and source directory is intended for the owner(s), or
prospective owner(s), of businesses in need of an injection of up to &50,000
in equity capital to help hislherltheir respective business to:-
i) commence trading (with a lower than average risk of early
failure);
ii) expand; or,
iii) prevent cessation of trading - with due regard to potential
viability.
It is anticipated that the guidebook should be of greatest benefit to those
owners who wish to retain control via a majority shareholding, and it
should be appreciated that the figure of £50,000 is, to a certain extent,
arbitrary. Indeed, much of the information contained within the guide also
relates to investment activity above this figure.
Any such business should be of the type which would be permitted by its
own articles and statutory legislation to raise external share capital. In most
circumstances this is likely to be a limited liability private company. An
incorporated partnership is also allowed to raise such capital, although the
possibility of a liability which extends beyond the investor's subscribed
share capital may render it unattractive to an outside investor.
Terminology:
In this book, the words 'risk' and 'equity' are intended to be synonymous
with the word 'share' (although some would refer to 'equity' in the
sometimes narrower context of 'ordinary shares'; and some understand
'risk capital' to include unsecured borrowing). 'Venture capital' is a broader
term which can include both share and loan-based finance, but, again, it
may be open to different interpretation. A glossary of various terms is
included as an appendix.
Objectiues:
The aim of this guidebook was to provide such information as would allow
readers to: -
1) Explore all or most of the main benefits that additional (external) equity
capital could bring to their business;
2) Improve the likelihood of any viable business in successfully finding
and ultimately raising amounts of up to £50,000 by:-
a) drawing attention to ihe main criteria by which different types of
prospective investors are likely to evaluate investment proposals,
b) suggesting practical methods to help develop a suitable business
plan which would satisfy likely investment criteria,
c) identifying the main sources of risk capital or potential 'linkages' to
such sources, and,
d) illustrating a possible strategy, which, if followed, could help
minimise any delays in finding and raising external risk capital.
The guidebook and directory should also be of assistance to small firms'
advisors in general e'g. bank managers, Small Firms Service counsellors,
accountants, local enterprise agency directors and counselIors, solicitors,
etc.
In certain regions of the U.K., the existence of risk capital sources andlor
effective and efficient 'linking mechanisms' to potential investors are
relatively undeveloped. For any area where this condition prevails, the
guidebook a i d directory should illustrate what has been possible elsewhere,
and it is sincerely hoped that it will provide some encouragement to those
who are well placed to develop and implement, with the support of others,
suitable plans to improve the flow of risk capital into viable businesses
within their own locality.
A WORD OF CAUTION
Some readers will be motivated at the present time by a sense of urgency and
perhaps by a general feeling that the injection of some extra capital could
represent an immediate panacea for today's (and tomorrow's) problems.
However, the issues which affect a smaller business in need of finance are
rarely capable of being reduced to a single factor for consideration; nor are
they usually best resolved after only a brief deliberation.
Given, also, that any subsequent decisions could result in very profound
- -
consequences either one way or the other it is strongly recommended
that professional advice be sought to assist with a fulI investigation of the
advantages and disadvantages of any proposed plan IN THE LIGHT OF
YOUR OWN BUSINESS CIRCUMSTANCES. Similarly, it is also
recommended that some time be spent in exploring the possibilities for
alternative and contingent plans.
Moreover, readers should be aware that the tremendously diverse nature of
business owners, their businesses, and their markets, make it impractical
for a guide of this nature to accommodate every different set of
circumstances or eventualities.
Notwithstanding these problems, this guidebook and directory should
enable the reader to familiarise him or herself with the main principles
concerning the raising of external equity capital. It is hoped that it will
engender realistic expectations, allowing an increased measure of
confidence when discussing the subject with:-
* a professional adviser,
a business counsellor, and,
a potential investor.
The process of raising venture capital has been described as 'imperfect',
and, given the absence of a readily accessible and well-defined market at the
lower end of the financial spectrum, such sentiment is probably well placed.
But having said this, the businesses used as case studies- not to mention the
several hundred companies each year which successfully take advantage of
the Business Expansion Scheme - demonstrate that the task for a smaller
business need not necessarily be insurmountable.
Thus, by helping to save a greater amount of time and money (and
frustration and discouragement) than would have been possible without the
benefit of this guidebook, it is hoped that its acquisition will represent a
worthwhile investment in its own right.
Barclays Bank plc, Small Business Group, for project sponsorship and
printing costs; the Small Business Research Trust for project support
(especially Gillian Barker); Peter Love11 (Barnet Enterprise Trust) and Paul
Duffin (Smith Cooper & Partners) for t h e i ~assistance and suggestions
during the preparation of drafts.
For the supply of case study information: - Colin Barrow (Cranfield School
of Management); Venture Capital Report; London Enterprise Agency
(LEntA); David Boult and Ron Halford (Community of St. Helens Trust);
Clive Lewis & Kenneth Roy (re. Transit Publications); Peter Brown (re.
Tripos R & D); Derek Brooks and Edward Wilson (re. Fibre Composites);
Arthur Young & Co. (re. Microdisk); Michael Downey (re. Comic Arts);
Steve Parsloe (re. Motaplas).
And also: Leslie Livens (Moores & Rowland) for his piece on share
valuation; Ray Horner and Patsy Smith (Kent Economic Development
Board) for general assistance and the supply of information for the Motaplas
case study and the sample investment offer letter; Peter Quine (Businessin
the Community) regarding Chapter 7; Ian Menzies (Investorsin Industry),
Tony Wilson (Welsh Development Agency) and Paul Beard (Business in
the Community) for their general assistance. Peter Clark (Barclays Bank
plc, Small Business Group) and his Secretary, Mrs Alison Barot, for the
considerable work involved in preparing the final drafts and providing
general advice.
Clive Lewis - for permission to reproduce the item on LEntA's Investors'
Meeting; Brian Warnes (Business Dynamics Ltd.) - for permission to
reproduce extracts from 'The Genghis Khan Guide to Business', 'Cash
Flow Notes' and for the supply of suggestions and his personal notes; Tony
Lorenz (Equity Capital for Industry) - for permission to reproduce an
extract from 'Venture Cgpital Today'; Andrew Davison - for permission to
adapt his article on the venture capitalist's viewpoint; the Confederation of
British Industry - for perfission to extract terms from 'A share in the
action'; Kogan Page - for permission to extract terms from 'International
Dictionary of Management'; Macclesfield Business Ventures - for
permission to extract tables from 'The Small Business Action Kit';
Investors in Industry - for permission to extract terms from 'An a-y of
venturespeak'; Venture Economics - for permission to reproduce research
data.
Keith Hayton (Planning Exchange) - for help with the distribution of an
enquiry letter via their Local Economic Development Information Service
and for permission to reproduce the LEDIS review of Yorkshire
Enterprise; Peat Marwick McLintock - for the supply of details from their
venture capital database; National Economic Development Office - for
general permission to use extracts from several reports; the Bank of
England - for general permission to use extracts; the Institute of Chartered
vii
Accountants in England & Wales - for general assistance; the Department
of Employment - for suggested improvements; the Inland Revenue - for
the supply of statistical information.
Professor Kevin Allen (Strathclyde University) and Keith Isles (Bank of
Scotland) - for permission to reproduce information from the GAINS
database; Prelude Technology Investments - for permission to reproduce
portfolio details; the Centre for Product Development, Nottingham - for
the supply of the sample non-disclosure agreement; Bexley Venture Capital
- for the supply of board details; the Welsh Development Agency and
Coopers & Lybrand for permission to reproduce the extract on BES
advantagesldisadvantages;and the many others - especially the sources of
equity capital - who supplied various information.
The rate at which money flows in to and out of any business - in relation to
its capital base -governs the extent to which that business will, or will not,
flourish.
On a day-to-day basis, the actual proportion of money tied up in running a
business will vary from firm to firm; but, as Brian Warnes emphasised in
....
'The Genghis Khan Guide to Business', " a typical, tightly controlled,
manufacturing company will need to arrange funding of around £27,000
for every £100,000 of annual turnover, just to finance that turnover
itself". That is, an amount greater than a quarter of a year's sales. Note, too,
the qualification "tightly controlled".
So, whilst the opening quotation from the Loan Guarantee Scheme report
may, at first sight, seem a little negative, it is intended to foreshadow the
notion that the raising of risk capital should be considered as part of a
broader issue, and one of paramount importance: namely, the subject of
business fmancing (or under-financing)in general.
SOURCES OF FINANCE:
Owners' funds, borrowed money, trade credit, and retained profits (if any)
are the normal ways of financing the smaller business; yet there exists
another form of finance which would appear to be significantly
underexploited.
The limited liability private company is a very common form of business -
in genera1 terms, there are around 1,000,000 registered companies in the
UK - and one of the major benefits of this type of business is an entitlement
allowing its owners to raise share capital. Share (or 'equity' or 'risk') capital
confers upon its owners the potential benefit of almost an unlimited return
on investment, but, in the event of investment failure, restricts their
maximum liability to the extent of the money they have agreed to
subscribe.
This share capital may be supplied from the founders' own funds and from
outside sources - that is, from friends or other contacts, business owners,
investment funds or other companies.
Needless to say, these investors will be seeking something in exchange, and
this would usually be any combination of:-
* a regular income - via dividend payments on profits, fees, or (in the
case of a private investor) a salary or management charge;
0 capital gains - realisable when selling the shareholding for a profit;
or ,
a say in the running of the business - to a greater or lesser extent,
via voting rights related to the respective investment in some
way.
The shareholders, as owners of the business, also have a certain entitlement
to the company's assets in the event of liquidation, and the exact provisions
associated with each type or 'class' of share can be almost as simple or as
complex as the shareholders desire. The different types of shares and the
relationship between shareholders and directors are outlined in Chapter 1
('Equity Capital - What is it?'), whilst the general constraints imposed by
shareholders' funds on bank borrowing are covered in Chapter 2 ('External
Finance - Equity vs. Loan Capital').
The apparent underexploitation of raising external equity capital - though
some might argue against such an idea - is difficult to describe in a precise
manner, but the recent experience of the Business Expansion Scheme
(BES) may help to support this view.
This scheme was introduced in 1983 to help improve the flow of external
capital into smaller UK businesses by offering investors tax relief when
taking minority shareholdings in BES-qualifying companies. Although
about half of the BES investments in any one tax year (around 400
companies) are for amounts below £50,000, debate has continued
regarding:-
a) the perceived lack of availability of smaller amounts of venturelrisk
capital - from any source;
b) the effectiveness of the scheme - with reference to the absolute
number of recipient companies and the capital requirements of a
million or so registered companies; and,
c) the apparent 'overlunder' supply (or demand) in somkegions.
MAINTAINING CONTROL:
'Institutional' investors (those managing some form of investment fund), in
the main, tend to seek minority shareholdings in investee companies, and
from a general standpoint, therefore, the day-to-day control of the business
rests in the hands of the holders of the majority of the voting rights (subject
to the conditions governed by any statutory legislation or company
articles).
'Loss of control' is frequently cited as a reason why many businessmen steer
clear of selling a stake in their business: their desire for independence being
a powerful countervailing force. Nevertheless, several studies touching on
the subject of outside investors have reported that the fear of loss of control
often proves to be unfounded in practice. Indeed, some investors have
actually been criticised by business owners for a lack of involvement after
having once made their investment. This topic is broached on several
occasions; notably in Chapters 2 ('External Finance - Equity vs. Loan
Capital'), 3 ('Equity Finance - More than just money?') and 5 ('The
Investor's Standpoint'), and also in the various case studies.
VENTURE CAPITAL:
'Venture capital' and 'risk capital' are terms which have both enjoyed a
certain degree of popularity in the business press during the 1980's. But for
those to whom such a term is unfamiliar, it might be helpful if venture
capital is thought of as a certain type of investment finance - share and
loan-based - which is seeking a considerable appreciation in value over an
investment period of several years.
Considerable appreciation' means a growth of, say, 25% to 50% a year, and
the venture capitalist seeks to make his money by selling his shareholding,
at a profit, some 5 to 10 years after first placing each investment. The extent
of any involvement in the management of the investee business will be
governed by the fund managers' preferred mode of operation. Venture
capital has been described as 'patient money', and while the public sector
sources are seeking to help viable and growing businesses too, their
priorities differ from those of the private sector.
Risk capital, in a similar fashion, may be taken to represent money invested
and looking for significant gains, and also, with some real risk of loss -
unlike, for example, a secured loan. Some would also include unsecured
loans in this category, but in the context of this book, 'risk capital' is taken
to mean share capital. The different types of risk capital sources are
described in Chapter 4 ('Alternative Sources'), and the accompanying
directory contains a Iisting of those having indicated an interest in placing
smaller investments.
xiv
CHAPTER ONE
"To be alive at all involves some risk."
HAROLD MACMILLAN
Equity Capital - What is it?
In the context of an incorporated limited liability company, a 'share' is
an indivisible unit of capital, often having a face (or 'par' or 'nominal') value
of £1. And, in general terms, the total share or 'equity' capital represents
that money which has been subscribed or promised by the shareholders
(known as the 'members'). In exchange, each shareholder will enjoy an
entitlement to a number of rights and privileges, including some
combination of:-
1) a corresponding proportion of that business's distributed profits -
usually paid, as and when declared, in the form of a dividend
(calculated as a percentage of the nominal share value);
2) a corresponding proportion of the voting rights in connection with
major decisions of principle on the size, shape and scope of the business
(i.e. an element of control)- sometimesallocated in direct proportion to
each shareholder's contribution towards the total amount of money
subscribed or promised, but not necessarily so; and,
3) a corresponding proportion of that business' net assets (i.e. the total
assets less any liabilities) in the event of it being liquidated, voluntarily
or otherwise.
For any given company, the specific entitlements conferred upon the
shareholders are described in its Articles of Associatjon and Memorandum
of Association.
DIRECTORISHAREHOLDER RELATIONSHIP:
The longer-term strategic control of a company is vested in a board of
directors who will normally exercise this prerogative through resolutions
passed at duly convened board meetings. For the smaller company, the
directors (or director) will also be responsible for much, if not all, of the
shorter-term operational management, i.e. the daily running of the
business.
Although shareholders have the power to vote directors on and off the
board, the directors of a business are responsible for the control of policy
and management, and they act as representatives, rather than delegates, of
the shareholders- in much the same way as members of parliament do for
the general public. I
A shareholder (or shareholders) with more than 50% of the voting rights
has the day-to-day control of the company; whereas a holder of 75% of the
voting shares has sufficient power to pass a special resolution to put the
company i ~ t liquidation
o or to sell the business as a going concern.
If the directors control a majority of the voting rights, then they have a duty
not to discriminate against the remaining minority interests. The subject of
voting rights is discussed in further detail in the appendix entitled 'Share
valuation - the ground rules'.
SHARE CLASSES:
However, not all potential shareholders may have identical sets of
preferences: some, for example, may prefer to forgo the prospect of large,
but unpredictable, gains, if a lower, but more certain, annual return is
available.
Hence, shares are categorised - in 'classes' - according to their respective
entitlement to distributable profits and voting power. Usually, their names
provide some clue as to their role e.g. 'redeemable', 'preference',
'non-voting' and so on. The profit and voting entitlements often vary
inversely, i.e. the higher the priority of their claim to any profits, the weaker
the voting power.
In general, the main types are designated as ordinary or preference
shares, and instead of being a rather general term for share capital or
shareholders' funds, 'equity' may take on a narrower meaning to cover only
the 'ordinary' class of shareholdersor shareholders' funds.
ORDINARY SHARES
The usual class for a single-share class company.
Voting Rights - usually one vote per share, but these can be varied.
For example, a company could have 2 classes of
ordinary shares: with 1votelshare for one class, and
the other - with no voting rights at all - designated
'A' Non-voting Shares. Alternatively, the 'A' shares
could carry a 5 voteslshare entitlement (in
comparison with the 1 votelshare of the other
ordinary class).
The following prefixes may be used singly, or sometimesin combination, to
denote the different entitlement features (and constraints) associated with
the basic ordinary share.
'Redeemable' - ordinary shares are traditionally considered as a
permanent feature of the capital structure of a
business, however, redeemable ordinary shares can
be issued and repaid later allowing the original
owner(s) to regain full control. In limited
circumstances, a business may buy back and cancel
a proportion of its standard ordinary shares, but on
such occasions, professional guidance should be
sought.
'Deferred' - similar to ordinary shares except that they are not
entitled to a dividend (or a vote, in some instances)
until some future date or until the company's profits
or dividends on its ordinarv shares have reached a
certain level.
- Comparison of Different Types ofSkares -
Reward Degree of Wao buys Whoissues
hvestment Earned Risk them them
F
'Equal share' of Carry the main risk (a)WeIl-to-do Pkivare and pubk
profits - hence investors who wam companies
'Equity Shares' goodrenuns;
(b) Institutional
investors, for a
balanced
portfolio;
(C) People interested
in capital gains, rather
than revenue profits
Defemd Shareof profits after Sameas Ordinary They axe taken by the Public companies
Ordinary Ordinary Shareshave Shares vendor of a business ChiefFyrbut also
had some proft when he sellsit pnvafe
(Founder'- (W 10%) to a company, -m
as a tokeaof
goodwirr
Preference Deffite rate of Lower than Ordinary Investors see- Private and public
dividend (say 7%), but Shares as they d l y security rather companies
onlv if ~rofits have a ~riorright than large
aknkde I torepaym& I dividends
PREFERENCE SHARES
These shares rank first in their claim upon profits and provide a fmed
percentage return out of taxed profits. This return (dividend) is usually
limited to a specified percentage e.g. 8% of their nominal value - even if the
profits increase tenfold.
Voting rights - none usually, unless the company has fallen into
arrears in its dividend payments.
Variants on the basic preference share include:-
RAISING FINANCE:
Company shares, with their various entitlements to dividends, voting rights
and business assets, are a potentially marketable commodity. And in
principle - subject to any constraints dictated by statutory legislation or the
company's Articles of Association - shares can be sold to outsiders for the
benefit of:-
1) the shareholder or shareholders concerned - for direct personal
.gain, or,
2) the business itself (and, ultimately, the remaining shareholders) -
to strengthen the company balance sheet.
Finally:
"This fundamental gearing concept, which is necessary to
protect depositors, is simple and straightfortzard. Yet problems
arise, which can have most damaging consequences, if
company managements and their professional advisers fail to
understand the forces at work. Most people think the concept
k W the full value of the assets - they
means that the b a ~ will
don't realise that very different principles are at work. It is
not the full value of the asset which is regarded as the cover,
but the value after deducting the lendings. "
"Thus a company can only grow a t the rate a which its
equity base is growing [our emphasis again] - through
retained profits and external injections of share capital."
Though having said all this, the 1:l capital gearing ratio represents an
idealised state of affairs. In practice, however, a branch manager may
choose to exercise a degree of discretion and allow a higher gearing limit
under favourable circumstances.
Given less critical conditions, as in the case of an established business, it
may be possible to agree a ratio of, say, 1.5 to 1 (loans to equity). But for a
start-up business, having secured a loan using personally-pledged assets,
this ratio could even exceed 5: 1 (though borrowers and lenders alike should
always be mindful of the maxim: "Security never made a bad proposition
good").
Company 'A' has been wholly financed out of shareholders' funds, whereas
company 'B' has obtained half of the necessary finance in the form of a loan
requiring 10% interest. As you can see from the above calculation, company
'B' produces a significantly greater return for its shareholders on their
investment - half as much again - than company 'A'.
Of course, it might be possible to achieve an even better return (60%) if the
equity element were to be reduced to £10,000 and the borrowing increased
to £40,000 (assuming that anyone would lend under such conditions). In
this instance, the interest as a proportion of profit, has become greater -
£4,000 interest compared with £10,000 profit - but since the interest has to
be paid irrespective of whether there is any profit, the business is now more
vulnerable to changing circumstances eg. lower profits or rising interest
rates.
Hence, as the level of borrowing increases - in relation to the shareholders'
funds (the equity) - so too does the risk to both lenders AND
shareholders.
From the standpoint of borrower and lender alike, another consideration
concerns the ability of a business to service the interest element of a loan,
and this falls under the heading of 'income gearing'.
INCOME GEARING:
This is a measure of the extent to which a firm's liability to interest
repayments relates to its profit level (pre-tax and pre-interest). It is used as a
guide to the risk dlending and proiides a measure of a business's exposure ,'
to changing interest rates and its ability to pay interest charges when profits'
fall. 'Interest cover' is another name, and reflects the number of times the
interest charge is 'covered'. It improves, from the lender's standpoint, as
the 'cover' increases, i.e. as the profit becomes larger in relation to the
interest. A generally acceptable limit allowing sufficient lee-way for
shareholders' dividends (if any) and deteriorating profits would be a ratio of
3:l.
Further details on capital and income gearing (plus other management
ratios) are described in the appendix entitled 'Key ratios'.
l
'The Genghis Khan Guide to Business'
Wames B.
Osmosis Pubtications 1984
I0
EXPANSION:
Many people running a small company have a not unnatural desire to
'strengthen' their business, and correspondingly, the solution is
represented by a simple increase in turnover. However, this apparently
justifiable desire can easily prove a means to an end, but perhaps more often
than not, the terminal type of 'end'.
In accepting the generalisation that a significant proportion of a
manufacturing business's annual turnover (around a quarter or more) is
needed to finance its day-to-dayactivities, then a growing low profit-margin
business will not be automatically 'self-financing'.
For example: contrast the 2 possible outcomes for the same hypothetical
business after the coming 12 months:-
'C' 'D'
Turnover £100,000 £200,000
Fixed Assets £10,000 £15,000
Net Current Assets £27,000 £54,000
(27% TIO)
Finance Needed -
- £37,000 £69,000
The bank will finance HALF the requirement, provided that the other half
is present in the form of equity (i.e. shareholders' capital + retained profits
less intangibles like research & development).
Assuming the present owner has supplied £5,000 in share capital, and that
the after-tax profit margin is £6,500 for turnover of £100,000, increasing to
£16,500 at £200,000, then:-
Possible solutions:
Each of the following solutions need to be evaluated - prior to any adoption
-for their immediate and longer-term suitability. The list is not intended to
be exhaustive.
Increase the share capital via an outside investor. An external
source may be prepared to supply several times the present 'share
capital, whilst holding a minority share of the voting rights.
a) Preference shares offer one possibility.
For example: a business which presently has £15,000 in ordinary
share capital, may be able to persuade a fund to provide a further
£45,000 in preference share capital (or in loans, either
interest-bearing or interest-free) such that the voting rights would
be:-
Votes
Existing owner £15,000 Ordinary Shares
New investor £45,000 Preference Shares 30%
b) External investors may be prepared to pay a premium - that is,
an amount over and above an agreed purchase price for shares
which would not unduly dilute the original owner's control.
Eg. Each '£1' share purchased by a new investor could carry a
premium of £2.
Votes
Existing owner £15,000 Ordinary Shares (£1) 60%
New investor £10,000 Ordinary Shares (£1) 40%
£20,000 Premium (Mlshare)
Increase prices to reduce the growth in turnover but increase the
profit margin and, in turn, the retained profits. The ultimate aim
would be to ensure that at least half of any additional asset need is
being met by additional retained profits.
[Relatively small price increases on low margin goods or services
can produce disproportionately larger increases in profit margins.
E.g. for a given number of items retailing at £10 each, and with
each producing a profit of £1; the overall profit will double to £2
per item when the price is increased by lP/o to £1 1 - assuming the
same total number of items. Even when such an increase causes the
overall volume of sales to fall, they usually need to fall much
further than you might imagine before this possibility can be ruled
out.]
Introduce better controls to reduce the relative size of net current
assets.
Find a source of loan capital which does not require security to the
same extent as your usual source e.g. consider the suitability of a
loan under the 'Loan Guarantee Scheme'. A source providing a
loan of what would appear to be 'last resort' may encourage another
source to help as well.
Consider the suitability of factoring (which results in up to 80% of
debtors being financed, rather than 50%). N.B. This may be
uneconomic for some smaller businesses.
Evaluate national and local schemes for grant-aid support.
CHAPTER THREE
"There is only one way of seeing things
rightly, and that is, seeing- the whole of
them."
JOHN RUSKIN
ADDITIONAL SKILLS:
The founder of Dorset-based Membrain (manufacturers of
computer-controlled test equipment, now trading under the Factron
banner) and who now controls a &30m turnover computers and
communications systems business was asked: 'to what did he owe his own
relative success ?'. In reply, a mixture of ingredients were cited,
including:
"...a willingness to give up total control of his companies
(owning only about 35% of his existing business) as a way of
gaining new sources of investment and of management
skills".
Financial Times 11/6/86
Explaining to the owner of a small business (or, for that matter, to the
manager in a larger firm) that he or she is likely to have one or perhaps
several weaknesses in his or her managerial skills is, of course, a subject
requiring a measure of tact (or armour plating). But if, for example,
someone is running a small business and the general managerial functions
may be broken down into, say, the following main areas:-
Marketing & Selling
Financial Control
Personnel management
Production .
And they then care to contrast (frankly) their own knowledge and
experience (e.g. training, qualifications, work experience - scope and
duration) against those of someone they know (or know of), and whom they
consider to be a skilled practitioner in an area listed above, it will be highly
probable that, unless their background and training have been specifically
tailored to cover each subject to some reasonablestandard, the skillsin some
areas will be appreciably stronger than in others. (N.B. No assumption is
made here about the level of competence needed to carry out satisfactorily
any of these functions in a small business; the exercise is suggested simply to
help explore the argument).
As a business grows, many a small business owner will appreciate that it is
physically impossible to do everything himlherself, and so certain functions
will be delegated to others. But having recognised this need, it still can be
difficult to assemble (or afford) a balanced management team.
Accordingiy, this fundamental difficulty wilI be recognised by most
investors - investment funds especially - and as a condition of investment,
they may wish to appoint a non-executive director to help complement the
existing management team.
NON-EXECUTIVE DIRECTORS:
A board of directors may comprise both fuI1-time and part-time directors.
The former usually act as executive directors and will be responsible for the
following primary functions:-
* representation (regarding shareholders' interests);
* policy-making; and,
management
In contrast, the latter - where appointed - would normally act as
non-executive directors and would be involved mainly in the representation
and policy-making aspects, although such directors may be charged with
special assignments too.
For the smaller company, a non-executive director should possess one or
more of the following attributes:-
A more detached and independent standpoint
Full-time directors, by definition, spend virtually all of their
available time and energy on the company's business, so when a
company begins to expand, an increasinglynarrow personal view is
likely to develop as each director concentrates on his or her limited
areas of responsibility e.g. production, sales &c. Moreover, the
development of a business will depend upon a proper recognition
of the varied interests of many different groups, including: -
shareholders, customers, suppliers, lenders, employees and so on.
Thus a non-executive director should be able provide a more
balanced view to help compensate for any bias.
Special skills
A move into an area of business for which the limited experience of
the existing director(s) would have significant implications could,
again, be compensated by a non-executive director having certain
knowledge and experience e.g. as an engineer, accountant, lawyer
or banker.
New contacts
These could include:-
new sources of finance (whereby, for example, the standing of
the non-executive director might be able to influence more
favourably an important outsider's view of the company - such
as its bank);
potential customers or suppliers;
central or local government departments; and,
professional sources of advice.
An investigation which included a detailed survey of 120 companies having
received investments under the Business Expansion Scheme reported on
the role of the non-executive director. [The BES is a special scheme which
was introduced to encourage equity investment in smaller businesses by
offering tax relief to investors - this scheme is covered in further detail in
Chapter 4 and in the appendix entitled 'The Business Expansion Scheme'.]
It found:
"The ability of the companies surveyed to survive and prosper
in the future depends primarily upon the exercise of good
commercialjudgement in the day to day management of their
businesses. Typically the companies surveyed were at an early
stage in their development, i f not start-ups, and such
companies generally did not have the balanced, experienced
management teams which the more mature companies and the
management buy-outs possessed."
"Typically the young companies would have been founded by
one or two entrepreneurs who had developed the business,
largely on their own, to the stage at which B E S finance was
raised. B y this stage in the company's development it had often
become clear that the ffounders' were being very stretched in
performing the functional role which they had in the company,
as well as managing the business. The process of raising
finance in particular placed additional strains on the
management of the business, in view of the time required to
produce and discuss business plans with outside sources of
finance ."
"In producing and discussing their business plans with outside
sources of finance it often became clear that changes in or
expansion of the management team would be necessary i f the
business was to be able to function efficiently at new levels of
activity which the outsidefinancing would support. Most often
the deficiency was in the finance area, but attention was also
drawn in a number of cases to deficiencies in marketing or other
areas."
"In many cases a weakness in the management team was
resolved through employing a replacement or additional
member of staff. In other cases, particularly where the BES
Funds were involved, an attempt was made to ensure that the
non-executive director who would monitor the BES Fund's
involvement also had exaerience and skills relevant to the
particular company. Individuals investing directly have rarely
provided support in this way. [* see thefollmingparagraph]
The extent to which non-executive directors became involved
in each company varied considerably. Some simply attended
board meetings, others were almost constantly involved and
ofen visited the company concerned, while others were called
upon for specific advice as required."
'The Peat Marwick Report on the Business Expansion Scheme'
Inland Revenue 1985
(*) It should be noted that BES investors are not allowed to receive
remuneration in connection with any services supplied to their own
investee companies (although they may claim expenses and still enjoy
the benefit of full tax relief). It seems likely, therefore, that this feature
would discourage some BES investors from pursuing any significant
involvement with their own companies.
With reference to the annual fee paid to them, the study also indicated that
some non-executive directors were not viewed as good value for money.
Alternative Sources
Share capital investments can be sought and placed by individuals, and
similarly, by workaday manufacturing or service sector companies seeking
to further their shareholders' interests, Such investmentscan also be sought
by financial institutions (whether of the long-established types such as the
merchant or other banks, investment trusts, or the more recently
established specialist venture capital organisations), and by organisations
operating on behalf of central or local government - such as the Welsh
Development Agency or any of the various enterprise boards.
The aim of this chapter is, therefore, to provide an overview of the main
sources which would be interested in providing smaller amounts of risk
capital (below &50,000),and also, to give some indication of the scope and
activity for each type of investor. The key areas of this segment of the risk
capital market have been sub-divided into the following sections:-
Private sector:
(1) Venture capital funds
(2) The Business Expansion Scheme (BES)
(3) Corporate venturing
(4) Private individuals (non-BES)
Public sector:
(5) Central government
(6) Local government
(7) European Community (EEC)
( I ) VENTURE CAPITAL FUNDS:
The term 'venture capital' has been used to cover various modes of
investment in unlisted companies, but a useful description would include:
'an input of money (in the form of share andlor loan capital) - usually in
conjunction with business skills - for the purpose of achieving longer-term
capital gains'. Frequently, such investment is introduced at a very early
stage in a company's development, and while the capital growth sought may
be loosely described as "substantial", it will probably be somewhere
between 20% and 50% p.a. over a period of 5 to 10 years.
Investing what NEDO has described as 'patient money', a venture capitalist
may supply a financial package consisting of ordinary and preferred shares,
together with convertible loan stocks and loans. Normally, the investment
stake offered would represent a minor portion of the post-investment equity
capital -often between 5% to 49% -though a few funds will consider taking
larger shareholdings. In return, they will take an active interest in the
running of investee firms; a single manager sometimes handling only 10
accounts. Successfulventure capital investment depends upon the ability of
a fund to establish an expert in-house management team which possesses
the appropriate combinations of financial, technical and managerial flair.
Over a term of 5 years, the previously-quoted annual rates of 20% to 50%
would represent an approximate growth of between 2% and 7% times the
original investment. These sort of target growth rates may seem high, but it
should be borne in mind that each fund will have a range,of investments- a
'portfolio' - to help spread the risk. Out of this portfolio, some businesses
may fail completely, a sizeable proportion will not achieve their target
growth, and only a small minority will achieve (or exceed) the original
expectations. Consequently, the combined annual growth rate of a portfolio
of investments will fall short of the individual target growth rates.
An example of a porfolio of venture capital investments is shown in
summary form below. The information refers to the Prelude Technology
fund (as at May 1987) and 'Holding' refers to equity held in the given
company (i.e. the % ownership of the business assets; the voting rights do
not necessarily correspond directly), and '&'000' indicates the cost of the
investment (the total portfolio cost was £3.0m). Prelude Technology uses
various types of securities in varying combinations; these include:-
ordinary shares; preferred ordinary shares; preference shares - the latter
being cumulative (with regard to dividend payments), participating (in
profits), redeemable, or convertible (into ordinary shares) - and loan
stock.
NATURE OF
COMPANY BUSINESS HOLDING E000
Arun Technology Portable alloy analysis 48.0% 300
Ltd equipment
Recent growth:
In earlier years, such bodies as the former Industrial and Commercial
Finance Corporation (created in 1945, but now part of Investors in Industry
- '3i') and the National Enterprise Board (formed in 1975, but merged with
the National Research & Development Corporation in 1980 to become the
British Technology Group - 'BTG') were set up with official or institutional
encouragement and backing, but it is only in the last decade that the venture
capital industry has started to establish itself on a wider basis.
In terms of professionally managed UK venture capital organisations, for
example, there were fewer than 20 in 1979, yet now, some 10 years later,
there are well over 100. The money raised by these amounted to &30m
during 1979, and to nearly &940m in 1987 (the latest figure refers to
members of the British Venture Capital Association and includes 3i). These
figures, however, should be treated with caution; to obtain a truer reflection
of this type of activity, some &70m- &loommay need to be added to the
1979 estimate to allow for the investment by 33s predecessor. Also, having
invested &537mduring 1987188, 3i still represents a significant proportion
of this investment activity.
Although the venture capital industry covers a wide range of organisations,
2 types predominate: a) the 'captive' funds which are owned and financed
by the major banks and long term investment institutions (such as those
managed by Barclays Development Capital, Citicorp Venture Capital and
Rothschild Ventures), and, b) the independent funds which invite
subscriptions from a wide variety of sources (such as Advent and ECI
Ventures).
According to figures published by Venture Economics, the sources of
capital for the private independent funds in 1986were: - UK pension funds
41%; private individuals 15%; UK insurance companies 15%; foreign
institutions 12%; UK banks 6%; UK fund management groups 5%;
industrial corporations 4%; academic institutions 2%; and, others 1%.
Venture capital growth:
The reasons for the recent growth of venture capital in the UK would
appear to be several-fold. In the case of the Business Expansion Scheme,
this has been as a direct result of a central government initiative; on the
other hand, a change in Stock Exchange requirements in 1981 enabled
publicly listed investment companies to take part in venture capital
provision, where, previously, they had been restricted in the amounts they
could invest in unquoted companies.
In the past, shares in a private company have generally been an unattractive
investment because of their unmarketability. Thus the creation of 'junior
stock-markets' for smaller companies (smaller that is, than the usual Stock
Exchange-quoted businesses), notably the Unlisted Securities Market
(known as the USM, launched 1980), and more recently, the Third Market
(1987), have helped create 'exit routes', thus allowing investors to realise
their investments via an established share-dealingmarket-place sooner than
would have been cost-effective via a Full Listing. Furthermore, the
Companies Act of 1981 allowed both private and public companies to buy
back their own shares on a less restrictive basis than before.
Regional investment:
Attention has been focussed on the apparent bias of BES investments
favouring businesses in the South East of the country. However, the high
concentration of business activity in this particular region should also be
borne in mind: approximately 32% of all VAT-registered businesses reside
in the South East - see Table A.
ENGLAND:
South East
East Anglia
South West
West Midlands
East Midlands
Yorkshire & Humberside
North & North West
WALES
SCOTLAND
NORTHERN IRELAND
Unknown
TOTAL
Although the process has not established itself to the same extent as in the
USA, there have been a number of examples in the UK. A better-known
example would be Pilkington Brothers of St. Helens: as well as placing
direct investments in smaller companies, it also runs its own in-house fund,
Rainford Venture Capital, which has &2Sm invested in some 10
companies.
The National Economic Development Office has recently studied the
subject and reported (in 'Corporate Venturing: A strategy for innovation
and growth' 1987) that a third of the 350 large companies responding to
their survey claimed experience of corporate venturing. Their 'experience'
covers a broad range of activities and may create an exaggerated impression
of the extent of corporate venturing if taken at only face value.
Indirect corporate venturing appears to have gained a foothold in the USA
(reports suggest that some $400m was invested by 245 companiesin venture
capital funds during 1986, compared with &10min the UK), but reliable
information describing the overall picture in the UK seems to be wanting -
save to say that it is not very advanced in its development. NEDO has been
investigating the possibilities for helping its growth, and one suggested area
which has since come to fruition includes a 'marriage bureau' service to help
link interested parties together (there is more about this in the directory).
PUBLIC SECTOR:
The public sector sources can be sub-divided into 2 main groups:
those promoted and funded by central government; and,
those promoted and funded by local government.
These types of sources usually place great importance on investment for job
savinglcreation and on their ability to attract larger amounts of private
sector financial support alongside their own investments; this is termed
'leverage'. For example, the Scottish Development Agency quotes a ratio of
3: 1 (private sector funds:SDA investments) for small business investments
made during 1986187.
Enterprise boards:
A higher profile alternative is the 'enterprise board' or 'economic
development board'. These have been developed to help counter the
centralised growth of venture capital in the UK.
NEDO estimated that in 1985 the total UK investment level was in the
region of £18m, and an example of an enterprise board which has sought
broad local support would be the Yorkshire Enterprise (formerly the West
Yorkshire Enterprise Board). Yorkshire Enterprise would normally fund
about 25 firms a year, and by April 1986, the average loan was a little over
£100,000 and the average equity investment just under £60,000.
Some boards, like many private-sector venture capital sources, seek larger
investments only of, say, over £100,000, though others have tried to
accommodate lower levels of investments. Examples would include the
West Yorkshire Small Firms Fund with a maxiumum investment of
£15,000 (associated with Yorkshire Enterprise), and also the North West
Regional Fund with a range from £25,000 to £200,000 (associated with
Lancashire Enterprises).
(7) EUROPEAN COMMUNITY (EEC):
In recent times, the European Commission has displayed a growing interest
in what it terms 'SMEs'- small and medium-sizedenterprises. This rests on
the argument that in a time when large businesses are shedding labour, then
any employment expansion will depend, in the main, upon the growth of
smaller firms.
Its policy has been targeted at regions suffering from declining industries -
e.g. coal-mining, steel-making, and shipbuilding - however, there are a
small number of EEC schemes which have, or will have, a greater degree of
importance for smaller equity investments.
The Commission appears to be less keen on simply supplying cheap finance
for projects rather than looking at ways of helping create more favourable
business conditions. However, a 'Venture Consort' pilot scheme has been
launched to encourage cross-frontier venture capital syndication (being
supported by funds from at least two member states), but, judging by
reports on the scheme's first 18 months, the average investment level (over
£100,000/business into 15 syndicated deals) suggests that it will probably be
biased towards slightly larger investments.
Another equity capital scheme geared to assist with the cost of appraising
small equity investments (usually those below £100,000), is their 'Business
Improvement Services' scheme. This can provide limited assistance -
normally up to £1,500 - in grant form to financial institutions or
intermediaries considering making such an investment in a qualifying
company. Support is limited to manufacturing companies based in certain
regions, but it has been found to be useful by some; the St. Helens BES
Syndicates, for example, have used it to help keep the costs of their
operation to an absolute minimum. (See the Fibre Composites Ltd case
studies for further details).
These schemes, by definition, find limited application, although the
Commission had plans to investigate during 1987-88what further support it
could usefully offer to stimulate the supply and demand of risk capital
throughout its member states.
CHAPTER FIVE
CONFUCIUS
VARYING INTERESTS:
Risk capital sources display varying degrees of specialisation, and the extent
to which the respective investment preferences or exclusions vary from
fund to fund, or individual to individual, can be quite marked.
In the case of a fund, the process of evaluation will usually be much more
formalised than that of the private investor. On the other hand, a private
individual might seek a greater degree of involvement with the investee
company - in the vein, perhaps, of 'buying a job'. (See the note on
'hands-on' and 'hands-off participation, p. 60).
In many aspects of investment selectivity, the public sector sources should
bear some close resemblance to those of the private sector, although their
priorities may differ in certain areas. For example, such considerations as
job-creation or job-saving will rank higher in the public sector.
The following section has been presented from the viewpoint of the private
sector funds. However, many of the points also apply in the general context
of the public sector sources and can be taken to refer to these too. Any
significant distinctions have been noted.
INVESTMENT CRITERIA -FUNDS:
Most investment criteria will have evolved in the light of the experience
gained by the fund management team. Usually, the team will be relatively
small, and its members will have a range of contrasting backgrounds -
including perhaps chartered accountants, management consultants,
chartered engineers, managing directors of their own companies,
stockbrokers, non-executive directors etc.. They will have been selected to
ensure a complementary breadth and depth of skills (in terms of knowledge
and experience) and to ensure a satisfactory standard of appraisal and
monitoring on behalf of the fund.
The public sector funds often recruit individuals having an extensive
background in the private sector, and sometimes their services may be
utilised by the fund on a part-time basis to help keep the overhead costs
down. An example of the board of one public sector source has been
included as an appendix (Bexley Venture Capital).
In addition to the capital growth target - which some managers are reluctant
to be too precise about - the main criteria may be categorised as shown
below (some feeling for the actual range of investment criteria can be gained
by inspecting the details of the various funds listed in the directory
section):-
Investment range, maximum & minimum - £000'~
Equity range - % of capital
Industry preferences and exclusions
Stage of company development (start-up, development &C.)
Extent of participation - 'hands-on' or 'hands-off
Realisation term - years
Geographical preferences
These criteria act as a preliminary filter, helping to eliminate the obviously
incompatible or unsuitable businesses (which, for private sector funds at
least, can represent as many as 95% of all applications), and allowing more
time to concentrate on the better prospeqts.
The satisfactory outcome of any investment appraisal will rest heavily upon
the evaluation of the contents of its associated business plan.
Business plan:
In short, the fund managers will be looking for a realistic estimate of the
business's performance over the foreseeable future.
This estimate will be in the form of a business plan, and this plan should also
take into consideration any major problems which are likely to occur. If any
of these do materialise, the plan will help the company's management to
steer round the problems, thus improving the probability of reaching their
original targets.
A business plan is usually sub-divided into several sections, and while there
is no exact format to suit every type of business, the following example will
help to illustrate the general principle.
'The Peat Marwick Report on the Business Expansion Scheme' Inland Revenue 1986
Presentation
A well-presented business plan is essential. More than half of
the opportunities that come to my company come without a
professional intermediary. They are none the worsefor this and
while their business plans may not always be as skilfully
presented, they are true reflections of the entrepreneuJs view of
his own project: too beautiful a business plan may hide heavy
cosmetic work on the figures.
N o matter how the proposal fist reaches the venture capitalist,
one of the initial impressions will be its visual presentation and
the speed with which the essence of the proposal can be
assimilated. The clarity of the description of the project is a
reflection of the presenter's own objectiveness and leaves a
strong initial impression on the reader, which can be either
corrected, heightened or embroidered by a detailed
consumption of the main plan.
Further investigation
The venture capitalist's initial decision is whether he wishes to
investigate the project further or not. I f the business plan has
portrayed a sure-fire project then it is more likely that the
venture capitalist will commit a sizeable amount of time in
viewing the project 'on the ground'; ifthere is still doubt, then a
venture capitalist may prefer to devote his time more sparingly
by asking for a discussion on the business plan at his own
office.
I n summary, a business plan should be, as far as possible, an
accurate representation of the project, giving a flavour of the
proposal, and, more particularly, the management. The plan
should be effectively summarised with a clear index and it will
probably be viewed as a sample of the quality of thought and
expression that can be produced by the entrepreneur.
First impressionsare important; it will be thefirst time that the
entrepreneur has seen the venture capitalist and vice versa.
Management evaluation
The consensus of venture capital investors is that the
management of their client's business is the key to its success or
failure and most effort will be centred on assessing the key
person or people in the management team.
All sorts of unpredictableevents will occur to blow a project off
course and the venture capitalist will be attempting to gauge,
within the comparatively short period available to him, how
the entrepreneurmight react in unfamiliar circumstances:what
would happen i f a supplier failed or the markets shifted ? Will
additional burdens crush the management team who may
already be at full stretch? Will the management team stick
together in difficult circumstances? What is the motivation of
the management team and, particularly, the leader? Can the
team set and achieve realistic objectives? Do they seem to be
able to trust one another? Can they be trusted? How flexible
are they? How pragmatic are they? How well can they assess
and respond to their own weaknesses? Is the team complete or
will it need supplementing?
Teamwork
To some extent the venture capitalist will become part of the
team and both parties should consider whether they can live
and succeed together. Both should communicate what they
expect j?om the other, under what circumstances and within
what limits.
The entrepreneur will probably be invited to describe his
business plan and to highlight the most relevant points. This
preamble will relax both parties and also identib areas for
further probing. The entrepreneur should take this as an
opportunity to accentuate the positive aspects and to highlight
what is needed from the venture capitalist and what is not.
Time will be important and it is sensible to agree beforehand
how long everybody has - there could be nothing more
frustrating than to have an interesting discussion
foreshortened.
This initial preamble will be a first important sample of the
entrepreneur's ability to express himself and to engage people's
enthusiasm. The leading management group member should
also recruit other important members of his team to contribute
their views. The interaction among the team will be a
demonstrationof how they work together, which team members
are strongest or which can contribute least.
Disclosure
The investor will certainly look for full disclosure from the
outset. It is frustrating to hear that information cannot be
entrusted to him, particularly until he has promised to put up
money, or even worse, never.
The venture capitalist will be attempting to check information
given during the interview and in the business plan against
yardsticks in which he already has confidence.
These third-party checks may be made in thef m of industrial
research, or, should he know the entrepreneur's company or
industry well, may be against detailed knowledge. It is
possible that the entrepreneur may view some of the questions as
being misconceptions; however they may well be popular and
therefore worth dispersing.
Investigation
The process of checking may be a forerunner to more detailed
investigations, market research and technical assessments. The
completeness and the accuracy of answers given are important
and indicative of the entrepreneur's grasp of his business.
The venture capitalist will wish to check what the entrepreneur
has told him, perhaps through mutually agreed parties whom
both entrepreneur and venture capitalist know and trust
already, such as suppliers, customers, and even competitors or
colleagues.
This inev;:ac!~process of checking can be helpful not only to
the venture capitalist but also to the entrepreneur. The
weakness of the technique is of course that the venture capitalist
may only be directed towards a satisfed referee. Although the
entrepreneur may feel that inquiries within his markets could
create suspicion, this fear is very seldom realised. O n the
contrary, enquiries by a venture capitalist are generally viewed
as a precursor to future strength and expansion. I t would
appear reasonablefor the venture capitalist to report any major
findings which appear to threaten thefuture business while still
honouring the confidentiality of his informants.
Further enquiries
As the relationship develops between the entrepreneur and
venture capitalist so the depth of investigation will increase. If
the discussion at the venture capitalist's office is successful and
it is agreed to carry the discussions further, then a reciprocal
visit will be essential. A t this stage the venture capitalist will
probably want to see as much as possible within a rather
restricted time allocation.
It is helpful to talk to other members of the management team
and key people on the staff and workforce to get a feel for the
corporate culture and management effectiveness. The venture
capitalist will hope to see the business working and as result the
visit should be made at a suitable time.
Practical demonstrations of unique manufacturing methods
are important and the visit is also an ideal time to demonstrate
the business product. O n occasions there will be areas of a
secret nature, but ifthey are important they should be shown to
your proposed partner i f you intend to take him znto your
confidence and future plans.
It is not unreasonable to hope that a venture capitalist will be
enthusiastic about the business and just as he has tested the
entrepreneur's motivation there is no reason why the
entrepreneur should not judge the venture capitalist's support
for his business and way of conducting it.
Heads of terms
Ajier further discussions the venture capitalist will be prepared
to give some heads of terms on the type of deal that he expects to
be able to deliver. These will of course be indicative and
non-contractual but should give the entrepreneur time to
consider whether he wishes to continue to negotiate and spend
the inevitable costs of third party investigations that probably
will follow in the next steps.
The investigations may cover a simple accountant's report,
market surveys, technical analyses, product investigations
and, quite likely, property valuations.
Appraisal costs
Although it is possible that investigation expenses can be
reduced by making contingent promises, the costs will in the
end have to be paid and even work done by in-house experts
will generally be charged.
A final question
Both sides will have learnt about each other's business and
both should be sympathetic to one another's demands. On the
assumption that the deal is to be consummated, then the final
question which the venture capitalist asks, is: how can I
communicate with you in the future as the project progresses
and as our investment matures ?
Appraisal:
In summary, the key areas for investigation are likely to cover:
track record of the entrepreneur and his management team
technical performance assumptions about the product1
process/service
market size, growth and penetration (market share and
distribution effectiveness) assumptions
pricelcost assumptions, particularly with regard to competition
staff resources assumption, with special attention to the mix,
source and cost of essential skills
overall timescale and important milestones along the business's
anticipated path
'Venture Capital Today' Lorenz T. Woodhead-Faulkner l985
Funds will use their own check lists and the main purpose will be to test the
assumptions behind the forecasts, determining whether or not they are
sound.
Techniques for evaluation:
In evaluating an investment proposal, a venture capitalist will want to
satisfy himself that the business proposal will still be sufficiently profitable
under 'worst case' circumstances (also called a 'downside assessment'). All
forecasts are subject to some degree of uncertainty, but the usual
consequence of a variation from a cash-flow forecast is an increased demand
for finance.
Also, some businesses are highly vulnerable to small changes in
circumstances. To determine whether this would be the case for any given
business, it is possible to vary certain figures by a set amount (such as
projected turnover levels in a cash flow forecast) and then gauge the extent
to which key factors are adversely affected. This process of sensitivity
testing may fall under the heading of 'risk assessment7.
The general method for testing such forecasts is to apply a series of 'what-if
questions to the business plan. For example:-
What would be the effect upon cash flow if the projected sales for
the first year fell by 10% - or even 25% - short of target?
If the demand for working capital is estimated as being, say, 25% of
annual turnover, how would the cash-flow be affected if it
increased to 30%?
What would be the effect on profitability and cash-flow if major
contracts materialised later (or sooner) than expected; or, likewise,
if an important approval (from, say, a major customer or a
government department) to supply or manufacture goods were to
be delayed by 12 months?
Risk Assessment:
'Risk', in a general sense, means: "hazard; chance of bad consequences,
loss", and in the evaluation of investment proposals, investors place
considerable importance on the risks inherent in these businesses and the
ability of management to identify and minimise them.
One of the larger accountancy firms (Peat Marwick McLintock) advises:
"The venture capitalist will normally make up his own mind
on the risk factors, but will take note of the company's own
assessment. To determine these you should consider which of
the business plan assumptions or potential problem areas are
most critical to the success of the business. Highlight these
factors, explaining how it is planned to minimise the impact of
unfavourable developments in each risk area."
"Having determined these factors it will also help to provide a
sensitivity analysis of the projected results, possibly by showing
a best, worst and median position."
'Venture Capital and The Growing Business' 1985
It may be helpful to think of the areas of 'risk' as those which would be
subject to an appreciable degree of variation or uncertainty and which
would bring about some significant adverse consequence. These can be
tested by the 'what-if process (mentioned in the previous section
'Techniques for evaluation').
When dealing with the subject of risk in a business plan, it has been
suggested that the following two points should be borne in mind:
[l] " I f a specific section is devoted to risk assessment, it must
be complete, not selective. I f it is obvious that only those risks
which can be adequately countered have been included in the
plan, the mutual trust between investor and investee, so
essential throughout the financing process, will prove
significantly harder to establish."
[Z] " I f the question of risk is not dealt with directly as outlined
above, it must be done indirectly, at the appropriate place in
the plan. For example, i f a manufacturing company has to rely
significantly on one or more components whose ready
availability at reasonable prices may be a potential problem
for the business, the plan should discuss alternative sources of
supply and projectedcosts."
'Business plans and financing proposals'
Arthur AndersenlBritish Venture Capital Association 1985
Bwak-even sensitivity:
If the break-even trading level is taken to be that condition whereby the
business is making neither a profit nor a loss, then a low gross profit margin
business (e.g. 20%) may soon become loss-making if the actual sales level
falls only a little below the target level. Thus a firm having an ultimately
high ratio of fured to variable costs will be thought 'fragile' i.e. more
sensitive to small changes in sales, and such a business will not represent an
attractive proposhion for investment.
To illustrate the point: consider the (deliberately simplified) circumstances
of two businesses which are seeking finance and have identical projected
sales figures for their first year's trading, but have different break-even
levels.
Both sell the same item at £100 each, both buy the item at the same price and
both have the same direct ('variable') costs of £50 per item. However, one-
Business 'A' - has much higher annual overheads ('fixed' costs), amounting
to £40,000, whereas the other - Business 'B' - has a lower overhead of only
£30,000.
Business Business
'A' 'B'
Business 'A', with the higher fixed costs, and the lower profit margin, will
find itself making a loss much sooner when sales begin to fall. For further
information, see the appendix entitled 'Key Ratios'.
Exit routes:
Another important consideration would be the investor's opportunity to sell
his or her shareholding and realise the investment at some later date.
'Voluntary realisation' may be achieved via any of 3 main exit routes,
namely:-
a repurchase by the original owner(s) of hislherltheir company
a flotation on a public stock market
a 'trade sale' of the business to another company
A voluntary realisation may sometimes represent a preferable alternative to
an involuntary realisation; losses to the venture capitalist may be minimised
if liquidation or receivership can be avoided.
Control vs. external investment:
Generally, a venture capital fund would not be seeking to take over the full
day-to-day running of a business, though it would be looking to supplement
the firm's existing strengths with complementary management skills (the
latter to a varying extent, depending upon a given fund's philosophy). The
point being that such sources (both private and public sector) will be
seeking a minor share of the total voting rights.
However, the control of the company rests, in essence, with those
shareholders who command a majority of the voting rights, i.e. over 50% -
though the voting rights for a given business need not necessarily
correspond in direct proportion to the total share capital. For a more
detailed appreciation, see the appendix on share valuation, entitled 'Share
valuation - the ground rules'.
Thus, if a business having a relatively small base of founders' capital is able
to re-structure the share capital by issuing a suitable combination of, say,
ordinary and preference shares, then it may be able to raise an external
amount which would be several-fold the current share capital - while still
holding a majority of the voting rights.
For example:-
Voting Voting
Present shareholding: Rights Proposed shareholding: Rights
$ Founders' equity
Participative style:
Venture capital funds fall into 2 general categories, namely: 'hands-on' (also
called 'pro-active'), or, 'hands-off ('passive'),
'Hands-on': such an investor will appoint a non-executivedirector who
will have reasonably frequent contact with the investee
company (perhaps 314 days a month); the intention being
to offer advice as a positive contribution to the better
running of the business. The fund's representative will be
interested in receiving details of the regular management
accounts and usually will be remunerated by the investee
company.
'H~nds-off:seen as the traditional style of participation whereby the
investing fund has relatively infrequent personal contact
but will reserve the right to appoint a director if things
start to wander too far off course. The fund may still
require some form of reporting on a fairly regular basis.
The non-executivedirector's fees and costs are usually borne by the investee
company (the role of the non-executive director is discussed in Chapter 3,
entitled 'Equity Finance - More than just money ?').
Negotiation:
Most funds have a standardised package of documentation to govern
relations between them and any prospective investee businesses. The 'heads
of agreement' (or 'heads of terms') will set out the main details in outline
form and are usually used as a basis for negotiations. They indicate the
liability for legal and other fees likely to be incurred during investigation,
and when they have been agreed by the two parties, they can be signed and
passed to legal advisers to determine the exact detail of the proposed
agreement.
A shareholders agreement will usually give the investor some say in:-
the involvement of further outsiders
the borrowings of the company
the composition of the board of directors
the payments of dividends
This agreement will also contain warranties which cover the scope for any
liabilities should the agreement be broken.
An example of an investment offer letter is shown in the appendix entitled
'Sample Non-disclosure Agreement'
Valuation
An issue as likely as any to divide both parties will be the value set by the
entrepreneur on the portion of the business being placed on offer - i.e. what
equity at what cost?
Entrepreneurs have been criticised for sometimes expecting too much for
too little. Clearly, a professional valuation will strengthen hislher hand, but
if the investigation of the business plan reveals, for example, some evidence
of higher risk and a need for an increased level of financing, then the venture
capitalist will seek compensation, more likely than not, by way of an
increase in the potential rewards.
Under such circumstances, the venture capitalist may offer the argument
that, say, 55% of a £1 million business should be more attractive to the
entrepreneur than 70% of a &!h million business or even 90% of a failed
business - though not all entrepreneurs are susceptible to this argument.
The subject of share valuation is described more fully in the appendix
'Share valuation - the ground rules'.
Public sector sources
Most public sector sources are likely to have job saving or job creating
criteria as high priorities, but another criterion, certainly at local
government level, could include an insistence that investee companiesmust
have 'good employer' policies.
"Enterprise Boards also take into account the need for good
employment practices, including recognition of trade union
rights and compliance with employment legislation and best
industrial relations practice. These are regarded as essential to
the long-term success of the firm and its contribution to the
economy . of
. the region."
The Peat Marwick study of the Business Expansion Scheme produced some
interesting findings about BES 'direct' investors (those investing directly in
a business rather than those investing via an approved fund). Their
observations refer to the BES and although some are bound to be useful in
the broader view of all private investors, the original context must be borne
in mind.
In a survey of 500 investors (both indirect and direct), 71% of investors
indicated that the primary reason for selecting the BES was the 'tax relief,
followed by 'potential capital appreciation' (12%).
When asked to indicate their principal sources of information on potential
BES investments, the most common source was the 'media' (for half of the
respondents - with the Financial Times, and the Daily and Sunday
Telegraphs receiving the most frequent mentions). This source was
followed by a general classification: 'financial advisers' (45% of the
respondents, with stockbrokers and accountants prominent). Colleagues
and other personal contacts were also important.
A sub-sample of investors was interviewed and asked what factors were
considered important when assessing the risk associated with a prospective
investment. The response for the direct investors is shown in Table B (more
than one response per investor was allowed).
Investment risk assessment- BES direct investors
Percent of interviewees %
. . . . . . . . . . . . . . . . . . .W
Asset-backing . 42
. . . . . . . . . . . . .D. . . . . .
Product/sector
Company track record
Quality of management
Marketabilitylilliquidity W.....
Results to date ....B...W..21
Returns expected B
.. 5
'Nature.of. .H
small
. . . companies'
.............
Other H
.. 5
'Non-BES' investors
It should be remembered that BES investors are not allowed to receive any
remuneration in return for services rendered to any company in which they
choose to invest (under the scheme), and so the exact producthector
compatability may be more critical in the case of a non-BES investor seeking
some form of part of full-time involvement. This latter situation may also
mean that the investor would be looking for an opportunity based within a
limited radius of his home.
The viewpoints of various different investors are described in a number of
the case studies e.g. 'Tripos R & D Ltd.'
CHAPTER SIX
WINSTON CHURCHILL
(continued on
next page)
Use general matching criteria, such as:-
1) investor investment preferences1
dentif; I list exclusions e.g. geographical
potential investors 2) investment range e.g. min. £
+ 'links' to same 3) extentlmode of participation
plus others as appropriate -
SOURCES: Guidebook directory;
Local enterprise agency
(continued on
next page)
Legal advice should be sought in
Offer made & connection with contractual matters
I negotiation I -fees to be paid shortly after conclusion,
(and likewise to other advisers)
Scope:
The aforementioned sources offer:
information
advice and counselling
The government-funded Small Firms Service (SFS) provides:
". ... free information on a wide variety of management
questions both to existing businesses and people who wish to
start one. And, if you need advice, the Service's business
counsellors (themselves experienced businessmen - not civil
servants) will give sound practical, impartial and confidential
advice on your project, whether you are developing a going
concern M just starting."
"In particular the Service can help you to draw up a business
plan, raise money, choose the right premises, plan your
marketing M re-jig your production. They can give you an
impartial second opinion on your plans ifyou wish to check
their viability."
'How to make your business grow!' DTIIHMSO 1985
It is well-placed to provide information about the current range of
government schemes, and also general guidelines on eligibility. Their
advisory service was formerly known as a counselling service, but was
re-packaged mid- 1987 under the title 'Business Development Service'.
On the other hand, if we take a typical local enterprise agency (Derby &
Derbyshire Business Venture - like all local enterprise agencies, a joint
publiclprivate sector supported initiative), it offers advice on most aspects
of setting up and running a small business including:
"0 Help with assessment ofyour business idea
0 Help in the fqrmulation and presentation of your proposals
Advice in marketing, accountancy, legislation. finance, taxation,
personnel matters
Advice on obtaining premises, land, planning permission &c.
Advice on grants"
These services are strictly confidential and free of charge. Some local
Enterprise Agencies have access to small business finance.
The Government-funded Rural Development Commission is charged
with revitalising "... country areas by helping small ruralfirms to become more
prosperous" and the service relies upon a number of regional organisers who
are supported by professional and technical officers.
Services on offer include 'Business Management Advice', for example:
"Accountancy - book-keeping, profit planning, cash flow fore- casting,
costing, applications for loans and overdraft facilities.
Marketing - market research, product planning, pricing and
distribution, advertising and sales, export, exhibitions."
Another feature worthy of mention would be the Rural Development
Commission's limited loan fund which could be relevant for those trying to
raise combined equity and loan-based finance.
Regarding local authority assistance, this, as mentioned earlier, varies
quite considerably. As an indication of the potential scope for assistance,
the table below lists the following activitieslinterests based oh a near-total
sample for the London area. (The Manpower Services Commission- 'MSC'
in the table - is now known as The Training Agency).
Local Authority Support for Small Business
.................................................
\
Equal Opportunities
Premises Register
Number of Authorities
m w ~ m m m ~ m m m m m m m m17
m r n m r n m m m m ~ m ~ m ~ m17
~m
Co-operatives m m m m m m m m ~ m ~ m . m 16
Loans & Loan Guarantees m m m m m m ~ m m m 13
Premises Improvements
Training Courses
Rent Grants
Setting Up Grants
Firms Directory
Which service ?:
At first sight, it may be difficult to differentiate between the various
services. The following simple guidelines may help:
costs:
Regarding initial costs, tbe first discussion would usually be free - whoever
you decide to contact (an appointment can be arranged by telephone) - so
this shouldn't be an important consideration.
Inasmuch as one recommendation could ever be suitable for such a diverse
range of business interests, it is suggested that your local enterprise agency
would in most cases represent the best port of call for initial business
advice.
However, if for whatever reason the service first contacted isn't able to fulfil
your requirements or expectations, do not hesitate in making contact with
an alternative source.
INDEX
1 Introduction to the Business
2 ProductKervices
3 TheMarket
4 Pricing Policy
5 Plan of Action
6 The Marketing Budget
7 Record System
8 Management
9 Premises
10 Objectives
11 Finance Required
12 Financial Information
The notes which follow are intended to cover the salient factors in an
organisation for the benefit of a reviewer who is not familiar with that
organisation. If you were discussing the situation with your bank manager,
he or she would normally already have much of the information.
3. THE MARKET
You should show an assessment of the market you propose to enter to prove
viability, product potential etc.
Prove the need; this section should include sub-headings such as:-
a) Competition
b) Statistics and research information to support your proposal
c) Packaging
d) Distribution
e) Advertising
f) Brochures, literature, sales aids etc.
g) Contacts
h) for Products - show supply channels
i) any other sub-headingsrelating to the proposal
j) Sales estimates as appendices
k) Sales methods - direct/salesmen/van sales etc.
4 . PRICING P O L I C Y
Show how this has been arrived at e.g. basic costings and margins
5. P L A N O F ACTION
The steps taken to actual launch of the product/service with appropriate
dates.
6. THEMARKETING BUDGET
Do not forget to show marketing under its own heading in the cashflow
forecast and not just as a miscellaneous expense.
NB For Budget and Cashflow information together with relevant financial
information, see separate guidelines. [These follow shortly.]
7. R E C O R D SYSTEM
At the centre of every successful operation there is an efficient record
system, whether by simple cards or computer. [The system should be used to
keep a record of quotations, sales, customers, suppliers etc. for subsequent analysis
- this will enable future plans to be implemented with maximum efficiency and
cost-effectiveness.]
8. MANAGEMENT
Include fairly brief but concise notes on the person or persons who are or
will be running the business, and of any key employees, highlighting if
possible why they should be successful.
Include full curricula vitae as an appendix.
9. PREMISES
You should state the following details about your premises:-
- Whether existing or sought
- The size, tenure (i.e. details of lease, licence etc.), rent and rates
payable, when the next rent review is due
- Whether local authority permission for 'change of use' is
necessary
- The maximum possible production and staffing
- How long before bigger premises are needed
NB If you are taking on a 'full repairing lease', you should be aware that this
imposes significant obligations upon you and your business.
10. OBJECTIVES
Outline the key areas of the business over the next five years or so, dividing
these into:-
- Short term (next 6 months)
- Medium term (6 months to 2 years)
- Long term (2 years to 5 years)
Your long t m objectives can have a particular bearing on how an outsider
will look at your plan, particularly if you are looking for investment (as
opposed to borrowing) to finance your business.
l l . FINANCE REQUIRED
a) Amount required, including breakdown and timing of proposed
expenditure.
b) Contribution available from shareholders/promoters.
c) Preference for i) institutional source, or, ii) private investor(s).
12. FINANCIAL INFORMA TION
a) Audited accounts - up to 5 years (if available).
b) Selling prices and product/service costings.
c) Budget for forthcomingyear broken down into 12 months.
d) Cashflow for next 12 months.
e) Outline budgets and cashflow for the following 2 years.
Examples illustrating c), d) and e) follow the Notes on Preparation of Budget
and Cashflow.
-Basic Market Assessment -
[This ia a general questionnaire used by LEntA counsellors to help them when
advising clients - it may serve as a useful checklist when consideringyour own
circumstances. A more detailed approach to marketing can be found in 'The
Small Business Action K i t - as described in the appendix entitled 'Further
Reading'. ]
Type of Business:
How would you describe the market you are in or propose to enter:
Strengths: Weaknesses:
[g] Do you have factual evidence that would support your answers to
Question 7?
[l31 How do you propose to make available the product or service? (e.g.
mail order, direct, retailer, wholesaler, van sales, dealers, franchises
&C.):
[l41 Which of the following more closely describes the market strategy you
will be adopting? Tick as appropriate.
[l61 What is the estimated value/volume of the total market, or the sales
value in the area you are considering entering?:
BUDGET
A budget is the management's plans for a business expressed in financial
terms. It should show the sales value of the products or services against both
the total costs of making the product or providing the service, and the costs
of overheads (including the cost of promoting the business and bringing in
orders) needed to support these activities.
The budget records the monthly sales invoices and estimated cost of
running the operation for the month. Seasonal variations in the level of
activity are revealed as are the costs of an expanding operation which tend to
increase in steps rather than in a straight line. Some months may therefore
show a loss although the overall picture for the year is a profit.
CASHFLOW
This forecast anticipates cash movements from: - sales, outgoings costs,
details of capital expenditure; and it indicates the level of financing required
by the business. Where audited accounts are not available for the period
immediately preceding the period covered by the budget and cashflow it is
important to provide a note of debtors, creditors, stock and capital and
reserves at the opening date.
Some points to be considered when preparing the cashflows:-
Cash sales, cash purchases, salaries and wages will be reflected in
the current month.
Debtors and creditors should be entered according to the terms of
trade - or experience where this is more relevant i.e. 30 days net
often becomes 6 weeks, 2 months, or even longer.
Rent and rates may be paid quarterly or half-yearly in advance.
Insurance is usually paid for a year in advance.
Light, heat and telephone are likely to be paid quarterly in arrears,
whereas postage may be an immediate cash payment, as also will be
the case for most travelling and entertainment.
Hire-purchase charges are usually monthly while bank interest is
usually charged quarterly in arrears.
Capital expenditure may incur a deposit with order. Details should
be supplied.
Marketing costs should include such costs as: - Selling costs other
than salaries included elsewhere; Packaging; Design; Brochures;
Market Research; Advertising; Customer Liaison; all Sales Aids,
samples etc.
h) Capital inflows will arise from sale of plant, vehicles etc. and from
cash introduced by shareholders/promoters. Details should be
supplied.
i) Outline budgets and cashflows for the following 2 years should
reflect the objectives set out in 6 above. These shortform
documents can be produced on a quarterly basis to the nearest £100
or £1000 as appropriate.
j) VAT must be included where applicable.
These notes are intended as a guide to the elements that should be thought
through when compiling budgets and cashflows. They are not meant to be
all-inclusive.
Assumptions
Budget Example:
1) £12,000 equipment purchased with Directors' initial capital
injection.
2) Materials comprise 50% of invoiced sales throughout.
Cashflow Example:
Credit taken - 3 months
Credit given - 2 months
Reserve stock - £5,000 (at cost)
Rent - £6,000 per annum (paid quarterly in advance)
Rates - £1,200 per annum (paid half yearly)
Insurance - £600 per annum (paid annually)
25% of budgeted wages and salaries is PAYE and National Insurance
(30 days credit).
p - P - p-p
BUDGET EXAMPLE
MONTH = 1 2 3 4 5 6 7 8 9 10 11 12 TOTAL
SALES 7000 7000 7000 8000 8000 9000 9000 9000 l0000 l0000 l1000 l1000 106000
Less COST OF SALES:
Materials Used 3500 3500 3500 4000 4000 4500 4500 4500 5000 5000 5500 5500 53000
Wages 1300 1300 1300 1300 1300 1800 1800 1800 1800 3500 2500 2500 22200
GROSS PROFIT [A] 2200 2200 2200 2700 2700 2700 2700 2700 3200 1500 3000 3000 30800
OVERHEADS:
Salaries 400 400 400 400 400 400 400 400 400 400 400 400 4800
Telephone 80 80 80 80 80 80 80 80 100 100 100 100 1040
Travel 100 100 100 100 100 100 100 100 120 120 120 120 1280
Rent,Rates&Insurance 650 650 650 650 650 650 650 650 650 650 650 650 7800
Light & Heat 50 50 50 50 50 50 50 50 60 60 60 60 640
Miscellaneous- inc.
MarketingIAdvenising 270 270 270 370 370 370 470 470 470 550 550 550 4980
Repairs & Renewals
Finance Costs: Bank, HP
Depreciation @ 20% p.a.
(straight-linemethod) 200 200 200 200 200 2d0 200 200 200 200 200 200 2400
TOTAL COST OF
OVERHEADS [B] 1750 1750 1750 1850 1850 1850 1950 1950 2000 2080 2080 2080 22940
PROFITl(L0SS)
IAl
- - minus -[B1- 450 450 450 850 850 850 750 750 1200 (580) 920 920
CUMULATIVE
PROFITI(L0SS) 450 900 1350 2200 3050 3900 4650 5400 6600 6020 6940 7860 7860
Source: LEntA
CASHFLOW EXAMPLE Owing at
MONTH = 1 2 3 4 5 6 7 8 9 10 11 12 TOTAL Year End
SALES RECEIPTS
IAl t
OUTGOINGS:
Materials t 9775 4025 4025 4600 4600 5175 5175 5175 5750 48300 18400
Wages 975 975 975 975 975 1350 1350 1350 1350 2625 1875 1875 16650
Salaries 300 300 300 300 300 300 300 300 300 300 300 300 3600
Telephones t 276 276 299 345 1196
Travel 100 100 100 100 100 100 100 100 120 120 120 120 1280
Rent, Rates, Ins. 2700 l500 2100 l500 7800
Light & Heat 150 150 160 180 640
Miscellaneous inc. t
Marketing1
Advertising 310 310 310 426 426 426 540 540 540 633 633 633 5727
Repairs and Renewals
-
TOTAL
OUTGOINGS[B] 4385 2110 2536 14169 6251 7052 11212 7440 8494 12753 9078 9928 95408
p --
Change in month
[A]-[B]or[B]-[A] (4385) (2110) 5514 (6119) 1799 2148 (2012) 2910 1856 (2403) 2422 1572
Opening Bank
Position [C] NIL (4385) (6495) (981) (7100) (5301) (3153) (5165) (2255) (399) (2802) (380)
Closing Bank
Position [C] (4385) (6495) (981) (7100) (5301) (3153) (5165) (2255) (399) (2802) (380) 1192
+I- Change in I
Month
-SPECIMEN BALANCE SHEET AS AT YEAR-END -
FIXED ASSETS
less Depreciation
CURRENT ASSETS
Stock 5000
Debtors 25300
Cash in hand +l192 =31492
Represented by:
CAPITAL
NET PROFIT
Source: LEntA
-BUDGET FOR 2nd &3rd YEARS -
YEAR 2 YEAR 3
Quarter = 1st 2nd 3rd 4th TOTAL 1st 2nd 3rd 4th TOTAL
SALES
Less Cost of Sales
(materials & labour)
Gross Profit
TOTAL COSTS
Profit or (Loss)
Cumulative Profit
or (Loss)
Source: LEntA
- CASHFLOW FOR 2nd t3 3rd YEARS -
YEAR 2 YEAR 3
Quarter = I 1st
SALES
RECEIPTS t
Materials t
Wages
Overheads t
Interest
Loan Repayments
Capital Expenditure
or (Inflow)
Tax
Dividends
TOTAL
OUTGOINGS
Change in Quarter
Opening Bank
Position
Closing Bank
Position
RISK ASSESSMENT & SENSITIVITYANALYSIS:
How far should you go in preparing different sets of figures ? Guidelines
jointly published by the British Venture Capital Association and
accountancy firm Arthur Andersen ('Business plans and financing
proposals') advise:
"The availability and popularity of microcomputer-based
spreadsheet packages has given many businessmen the facility
to perform extensive senstivity analysis with minimum effort -
but it can be overdone."
"The figures derived from sensitivity analysis are meaningless
in isolation, and must be analysed to have any point. I n this
context, too much sensitivity analysis can be as bad as too little,
if the assumptions used have little chance of happening in real
life.
7y
For businesses seeking investments in the region below £50,000 (under the
Business Expansion Scheme), research suggests that the average initial
costs were 3% of the finance raised for direct investments, and similarly 9%
for fund investments. A specific example indicated that the total cost to a
small service sector company raising £30,000 was £750 (£300 stamp duty
plus £450 legal fees), i.e. 2?h%.
It was also found that the typical charge for non-executive and monitoring
support was in the range of £2,500 to £7,000 per year, although one example
was found to be as low as £500 per year. (These figures are possibly biased
towards larger investments.)
'The Peat Marwick Report on the Business Expansion Scheme' Inland Revenue 1986
These features were seen by the BES funds as being positive or negative
when included in a proposal for finance. Any single factor may be relatively
unimportant by itself (indeed, some may be less significant for investments
below £50,000), but collectively, a picture will emerge which should help to
provide beforehand an indication of your chances of success.
CHAPTER SEVEN
MIGUEL CERVANTES
ADVERTISING:
If a business owner places a small advertisement in, say, the business
columns of a national newspaper, announcing - without drawing reference
to equity or share capital: "Business seeks finance for ...... (expansionlto
exploit new market &C.)", then, generally speaking, it would not be seen as
offering securities to the general public. But if the advertisement were to
state: "Business seeks finance for ....-equity offered", then it would almost
certainly be in breach of the law.
'Linking' services:
As one way round this difficulty, it is possible to provide a service which
links together the two groups (formerly, by gaining general permission
under the Prevention of Fraud (Investments) Act; but more recently, by
complying with exemptions under the Financial Services Act, or by acting
as an authorised investment business). These specialised services act as an
information channel between small businesses wishing to raise external
finance and investors looking for investment opportunities.
Examples of such services include the London Enterprise Agency's
(LEntA) 'Marriage Bureau' and the Henley-based 'Venture Capital Report'
(VCR).
LEntA, for example, distributes to subscribing investors a monthly bulletin
of very brief 'pen pictures' describing such businesses (their operation has
since joined forces with a nationwide operation called 'LINC'). Fuller
information on specific opportunities can be made available to interested
subscribers upon request. In contrast, VCR is a monthly magazine showing
fuller details, though of fewer opportunities, which is circulated to a
network of subscribing investors. Both services have a cross-section of
several hundred private and corporate investors as subscribers.
Organisations complying with exemptions under the Financial Services
Act, such as local enterprise agency 'marriage bureaux', are obliged to
prominently display in each publication:
"Investment in new businesses carries high risks, as well as the
possibility of high rewards. I t is highly speculative and
potential investors should be aware that no established market
exists for the trading of shares in private companies.
Before investing in aproject about which information is given,
potential investors are strongly advised to to take advice from a
person authorised under the Financial Services Act 1986 who
specialises in advising on investments of this kind. The persons
responsible for using this advertisement have taken reasonable
steps to ensure that the information it contains concerning
proposals requiring capital is neither inaccurate nor
misleading. "
Inevitably, the need to take "reasonable steps" involves some degree of
vetting of proposals by the publishers. This takes time (usually to interview
the individual or individuals behind the proposal, and to help with certain
aspects of content or presentation), and since 'time equals money', there are
associated costs which have to be borne by someone.
Costs:
Further information about these and other services can be found in the
directory section; but for immediate reference, LINC charges £50 to
businesses seeking finance, and £50 to subscribing investors (for 12 issues).
Correspondingly, VCR charges £100 to start-up businesses (£200 to
expanding businesses) plus a small percentage fee for any risk capital
successfully raised, and £200 to investors. The former is subsidised by the
enterprise agency in which the service is based (as tends to be the case with
any enterprise agency operating such a service), whereas the latter must
stand or fall as a profit-making commercial venture.
ALTERNATIVES:
When looking for a suitable investor, you might think: "Surely my
accountant (or solicitor, bank manager, stock broker, etc.) must know of
one or two local businessmen who would wish to invest in my business ?"
Of course, this could well be the case, but in making such introductions, the
professional adviser, acting as an intermediary, runs the risk of a conflict of
interests between himself and the other two parties. A reputable
accountancy firm, for example, would find it impossible to be able to give
advice which could represent simultaneously the best interests of both seller
and buyer.
Another view of the problem of making introductions was expressed in the
Small Business Research Trust's report (1985) on the Business Expansion
Scheme, where a senior partner in one of the largest accountancy firms was
reported as saying:
" I f we give a proposal for funds to our private clients, the
suggestion is that we think it is a good idea even i f we make no
recommendations. I f our client makes the investment we will
gain no praise if it & su~cessful,but stand to get criticised if it
fails."
In addition, accountants, as a profession, probably take the view that
investment in private companies is a very risky activity - especially
start-ups. And in spite of the fundamental attraction of the Business
Expansion Scheme as a useful tax shelter (especially to higher-rate
tax-payers), a sizeable proportion may be much more likely to recommend
an investment in a pension plan with a guaranteed return for the investor
(and a commission paid to the practice), in preference to, say, £15,000 for a
20% stake in a new business.
Stockbrokers, who, also, should have a useful range of contacts, may be
reluctant to draw their clients' attention to an investment which will yield
them no commission and see a significant amount locked up for a
considerable time, when it could be moving in and out of quoted stocks and
shares and gilt-edged securities.
This basic type of problem can be extended to include other people who
appear well placed to effect introductions between potential investors and
small business owners seeking finance (those working within say the banks
or accountancy firms would fall into this category). Whilst in principle such
people may have opportunities to perform useful introductions, the
potential losses tend to outweigh the rewards- especiallywhere no charge is
made and where, for some reason, an investment ultimately goes wrong. To
some, this might seem like a rather narrow commercial view, but before
passing judgement, perhaps we should speculate as to how you or I might
act if we were to find ourselves in a similar position.
High Street banks:
A recent NEDO report on lending to small firms touched on the situation
which can occur when an applicant's request for a loan has been turned
down by his or her bank, which then necessitates a search for sources of
equity finance. It was felt that:
"Some (but not all) banks take the view that it is not their
responsibility to advise their customers on who to approach nor
do they appear to collect or disseminate appropriate
information. Branch managers in these banks suggested that
the accountants were likely to be the best source of advice."
"For the small customer this means an additional visit,
perhaps to a bigger accountancy practice than he cun-ently
uses, to explain his position. He may be uncertain as to which
firms in his locality can provide the information, he may be
reluctant to attend for reasons of time, cost, or even pride; he
may even feel that the financial community has given him the
brush off. I n short there is a real possibility that his business
plan will not be implemented because of inefficiencies in the
communicationprocess linking the providers of external equity
with small businesses via intermediaries of the banks and
accountants."
So, whilst advisers may seem well-placed to act as intermediaries between
businesses seeking equity capital and potential investors, there are, in
practice, several reasons why they may prefer to decline the opportunity.
However, this is not to say that the chance of finding a private investor via
this route is non-existent, but that it could be lower than you might
expect.
%OF
FINANCINGS
25
These costs can include legal expenses and charges made for accountancy
work and technical evaluation. As an indication of the charges which would
be incurred for fund investments falling within the range £100,000 to
£500,000 the National Economic Development Council reported in 1986
published by NEDO that the professional fees would usually be £20,000 to
£25,000 (as a 'one-off cost), and that the non-executive directors' fees
associated with the subsequent monitoring - and which are charged to the
investee company - could be £6,000 to £10,000 p.a.
Of course, venture capitalists are seeking high capital returns to compensate
for the high level of risk, but since a significant number of investments may
grow more slowly than first predicted, or even fail (and failures tend to
appear relatively early), smaller investments are frequently considered not
worthwhile.
In addition to these considerations, some funds have claimed insufficient
levels of staff to enable them to monitor large numbers of small
investments.
PROBLEMS WITH THE BUSINESS EXPANSION SCHEME:
Around half of the companies receiving BES investments have been below
£50,000, and the dominant type of source has been the direct investor - in
contrast to the BES funds, which, due to the relatively large costs of
appraising and monitoring of investments, have made only a limited
contribution at the lowest end of the spectrum. The situation is well
illustrated by Table E (below).
Disadvantages:
Whilst the BES has a number of distinct benefits to small businesses and
investors alike (see also the Appendix entitled 'Business Expansion Scheme'
for a review of its primary advantages and disadvantages), it also has a
number of features which, depending upon the circumstances of the
business and its BES investors, can turn into disadvantages.
% OF
FINANCINGS
AIF
/ ONLY
New investors:
Having once grown past the difficult 'start-up' phase, a company may have
some form of track record with which to attract new investors: there are
likely to be more institutions interested in taking equity in businesses
having a reasonable past performance as well as a promising future.
Again, professional advice should be sought, but the main suppliers of
relatively larger amounts of equity capital (£100,000 plus) are summarised
below. Further introductory information and addresses can be found in the
Bank of England's 'Money for Business' (see the appendix entitled 'Further
Reading').
Comments
SHARE MARKETS:
There are a number of markets for selling shares to the public, of which, 3
are governed by the Stock Exchange. With centres in Belfast, Birmingham,
Dublin, Glasgow, Leeds, London, Manchester and Newcastle, the Stock
Exchange operates a main market of securities in 'listed' companies; it also
controls two smaller markets - the Unlisted Securities Market (USM) and
the Third Market.
'Full listing':
To become listed, a company has to satisfy the various requirements of the
Stock Exchange. These are intended to protect investors and relate to the
way in which securities may be issued and to the disclosure of information
by the company.
Whi1.e this is one method of raising additional capital, it may also represent
an opportunity for existing shareholders to realise their investments. This
can be achieved by one of 4 routes, i.e.:-
Key Ratios
Two of the businesses - Comic Arts and Transit Publications - started life as
publishing-type ventures, and although they may seem similar at a first
glance, their cases reveal some significant differences.
Each case study has a brief introductory section which indicates: - the type
of business; where it was based; how much was raised (at the outset, more
may have been forthcoming later); the purpose for which the external
finance was required; the type of investor; and the method used to contact
the investor.
Case Study A
BACKGROUND:
Comic Arts was managed in 1985 by its two founder directors, Chris
Reynolds and Colin Brett, and their main line of business involved the
design and supply of Christmas cards to in-house benevolent funds such as
those associated with the Fire and Ambulance services. Other activities
included the marketing of specially-designed products (mugs, badges &C.)
to the Fire Service.
Chris, a full-time London fireman with 15 years' service, was a natural artist
with an extraordinary talent for cartoon work, and he acted as the originator
of most of their designs. His skills were usefully complemented by those of
his co-director, Colin Brett, whose experience of working within the print
industry was extensive - he had worked on all aspects of origination,
printing and finishing, and had also covered estimating, costing,
production management and print sales.
THE PROPOSAL:
After much research, it had been discovered that there existed no national
publication for firefighters - particularly to carry advertisements of new
products on a regular basis. The directors felt that they had the contacts, the
knowledge and the skills to produce such a publication, and so they formed
Fireline Publications Ltd. to exploit this opportunity.
Under Fireline Publications, they planned to attack 2 main markets:-
1) A free monthly newspaper - 'The National Firefighter' -which would be
a 16-page publication with a print run of 35,000 copies and distributed
to every fire station in the country. It would be financed by advertising
and would contain news and photographs of major fires, road accidents
and many other special problems faced by firefighters. Stories of
outstanding bravery and personal achievement would also be included,
as would lighter items touching on sports news, general interest and
humour.
2) 'Characterisation' - that is, the creation of characters for a book or film
theme and then further developing them into a wide range of related
products aimed at a mass market. At this stage, they had originated
several characters for a series of children's books called 'Trotters
Bottom Fire Station'. Each book carried a different safety message and
they were judged to be of value as a schools' teaching aid on both fire
safety and the Fire Service. Other products were also in the pipeline.
THE MARKET:
In terms of competition for 'The National Firefighter', the only other
nationally-circulated publication was 'Fire', a technical journal aimed at
officers, rather than firemen. Chris and Colin had established that there
were over 75,000 Fire Service employees in Great Britain and Ireland, and
taking into account possible interest overseas and in industry, another
25,000 could be added to the potential readership.
Secondly; although the Fire Service represented an initial market for their
'characterisation' products (Comic Arts then had over 60 established outlets
within the Service), both Colin Brett and Chris Reynolds felt that the scope
elsewhere would be much greater. The main market would lie not only in
schools and book clubs, but also in multiple outlets such as W.H. Smith and
Woolco. They also planned to approach various television companies with a
view to making a children's programme (in a similar vein to 'Postman Pat',
or 'Camberwick Green').
PLANNZNG:
On the basis of personal guarantees, the directors were able to obtain an
overdraft of £5,000 from their bank, but since they were advised that a
larger amount of finance would be needed to support such a venture (part,
at least, in the form of equity capital), they started work on a business plan
which would help them to raise such finance.
By mid- 1985, they estimated that £5,000 had been spent on the project:
that is, to pay for the existing premises and office equipment, to cover their
research, and also on the development of artwork and prototypes. To enable
them to employ a general managerial person on the newspaper, and to get
into production with the books and other products, it was estimated that
another £15,000 would be required immediately, plus a further £10,000
some 5 months later.
THE SEARCH:
The original business plan was prepared by Colin Brett, who found it
time-consuming and difficult afterwards to find suitable sources of finance.
'Suitable sources7 included a number of city institutions, but they soon
became 'unsuitable' when it was discovered that the level of finance being
sought was considered too small to warrant any further interest in Fireline
Publications.
However, one of the funds, Investors in Industry (3i), suggested as an
alternative that they try to find an investor via LEntA - the London
Enterprise Agency. LEntA offered not only the usual enterprise agency
business counselling service, but also a 'marriage bureau' which acted as a
"business introduction service designed especially to help small businesses find
capital and management help".
After a preliminary meeting with a LEntA counsellor, Comic Arts (Fireline
Publications) were accepted as a bonafide proposition and were allowed to
register their requirements with the agency's marriage bureau.
The marriage bureau publishes and distributes a monthly bulletin
containing brief descriptions of various businesses seeking finance, and if
an investor subscriber is attracted to any of the propositions, further details,
in the form of a 2-page business plan summary, can be supplied upon
request.
For Comic Arts, their 'advertisement7 announced:
New Fire Service Newspaper Publishers (London)
£25,000 working capital required to assistlexpand national
newspaper for the Fire Service and to allow producation of a
series of childrens books, as the basis to the highly lucrative
characterisation of the Fire Service. Excellent return on
investment.
This appeared in the October and November (1985) issues of the bulletin,
but soon after the preliminary counselling discussion at LEntA, Colin and
Chris were invited to make a presentation at the September meeting of the
LEntA 'Investors' Club7.
Investors' Club meetings are held most months, and business promoters
seeking finance via the LentA bulletin can present their plans and ideas to
an audience of twenty or so potential investors. Each of the 4 or 5 presenters
are allowed 20130 minutes to explain, demonstrate or display hislherltheir
venture in whichever way they feel is appropriate. Usually, there is a little
time after each presentation to allow for questions from the floor, though
any interested parties have a better chance to introduce themselves and
learn more over the informal buffet which is held at the end of the
afternoon's session.
INTERESTED INVESTORS:
At the September meeting were Simon Rogers and Michael Downey, joint
Managing Directors of Inventure Ltd., and although they had serious
doubts about the ongoing viability of the activities and plans as presented,
they felt that Comic Arts would offer the seeds for profitable growth if the
strategy was revised. In particular, they recognised the niche that they
created for specially-targetted artistic products in support of specific
charities.
Chris and Colin made initial contact with the Inventure directors during the
informal session which followed the final presentation, but after further
discussions, and in spite of an interest expressed by other prospective
investors, they felt that Simon Rogers and Michael Downey had more to
offer.
Simon had earlier helped to form Applied Holographics - a business
exploiting commercial opportunities using holography - and had
successfully floated the company on the Unlisted Securities Market only 16
months after its launch whereas Mike, a qualified accountant and graduate
of Harvard Business School, had been the Finance Director at
Willcinson-Sword prior to the Inventure formation in 1985. It was felt that
this type of background experience could only enhance Comic Arts' future
prospects.
A DEAL:
By late October 1985, it had been agreed that Inventure would invest
£10,000 in exchange for a 33% shareholding in Comic Arts - with the
prospect of a further £40,000 to be invested during the coming year.
"As part of the deal," Mike Downey explains, "it was
decided that the free newspaper and 'fire brigade
paraphernalia' would be dropped in favour of re-focussing on
niche-marketing of Christmas cards, childrens' books and
charity support activities."
"One of the problems with the owners of smaller businesses, is
that they find it difficult to differentiate between what it is that
they are good at, and conversely, where it is that their
weaknesses lie - and the free newspaper seemed tofall into the
latter categoy ."
"Clearly, the main strength of Comic Arts lay in their ability to
produce purpose-designed items - of high quality - which
would combine a general theme with some specific aspect of the
customer's interests or activities."
"For example: instead of offering a standard 'Santa Claus'
type of motif for a benevolent fund's Christmas card, they
would incorporate a design which would identify much more
strongly with the client -for the Fire Service, the scene would
include fire engines, firemen and so on."
"This we felt was an archetypal 'niche' type of market, and
one which at that time was relatively unexploited."
96
It was realised shortly afterwards, however, that their initial plans were
likely to be under-financed, and so the deal was re-structured so that
Inventure would increase their holding from 33% to 50% upon the
successful raising of a £65,000 loan under the government's Loan
Guarantee Scheme.
POS TSCRZPT:
As a result of concentrating on the company's strengths and developing
niche positions, the turnover rose from £60,000 in 1985 to £280,000 the
following year. The target for 1987 was &1.4m.
This progress has not been without problems and Inventure had to supply a
further £45,000 as a temporary loan to help overcome a cash-flow problem
caused by over-stocking in 1986.
Colin Brett, as co-founder of Comic Arts, says:
"Much of the original businessplan was undertaken by myself,
and while this helped to reduce our external costs, the exercise
was v e y time-consuming. One particular problem lay in the
difficulty of actually finding suitable sources offinance - and
one which was not helped when few accountants at that time
appeared to know of services like the LEntA Marriage
Bureau."
"Our business has grown rapidly from small beginnings: the
children? stoy books were initially sold by the book-sellers W .
' H . Smith and Menzies with ISplcopy zoing to the BBC's
'Children I n Need' campaign - and now we act as the sole
merchandising agentsfor this campaign."
"Our association with Inventure has brought about a total
change of attitude - obviously, small businesses must be
adaptable to survive in a volatile market, but looking back, we
used to be reluctant to change. Now, when complete changes of
strategy become necessary, we can adapt much more quickly
than before."
Case Study B
PURPOSE: Expansion
LINKAGE: NIA
Adapted from a case study first published by Arthur YoungiBusiness in the
Community 1985 and reproduced by kind permission.
BACKGROUND:
In 1986, Microdisk Ltd., manufacturers of a disk drive suitable for most
micro-computers, had been trading for 18 months from a small industrial
unit in Cheshire. After initial losses, the company had built up a significant
market share in the North West, and by mid-1986, its reserves stood at
£15,000. These were as a result of the company's net trading position which
had recently been improved by a 100% increase in turnover during the
previous 6 months.
The company was owned in equal proportions by 2 working directors, and
the issued share capital was £5,000 (issued at par value - i.e. with each share
at a nominal value of £ 1).
A further 10 staff were employed by the business, and most were in
manufacturing.
EXPANSION:
Due to an increased demand, the company had outgrown its existing
premises but had been able to identify a suitable new unit in the Manchester
Science Park. This unit would also provide additional space for the
commercial development of a new hard disk drive unit which was the
brainchild of one of the directors.
Technical trials of the new product had proved satisfactory and the results
of market research appeared to justify production on a viable basis.
FUNDING REQUIREMENT:
In the course of their regular business planning, the company's directors
had compiled financial projections for the coming 3 years. During this
period, the market for the existing disk drive would continue to be
exploited, and the new product would be introduced.
After a rigorous analysis of future operations, including an analysis of
financial sensitivity to the key critical factors - sales volume and gross
margin - the most likely requirement for finance had been calculated as
shown below (detailed cash flow estimates have not been included):
PLUS:
Plant for new production line £50,000
Additional net cash requirement £30,000
at peak (early in year 2)
Maximum likely requirement £140,000
FINANCIAL STRUCTURE:
At that time, Microdisk's only borrowing was a bank overdraft of £20,000
secured by a fixed and floating charge on the stock, debtors and plant (total
book value £95,000). The company was also financed by directors' loans of
£30,000 split equally between the two shareholder/directors, and their
projected Profit and Loss Accounts and Balance Sheets looked like:-
PROFZT AND LOSS ACCOUNT
P R O J E C T E D
Latest Year Year 1 Year 2 Year 3
£ £ £ 6:
Sales - existing product 250,000 300,000 50,000
- new product 100,000 495,000 670,000
LESS:
Development materials 20,000
Overheads 113,000
p 201,000 250,000 300,000
PROFIT (LOSS) before tax 25,000 (1,000) 50,000 100,000
LESS tax 30,000
CURRENT LIABILITIES
Creditors
Directors' loans
Bank overdraft
Represented by:
Share Capital
Profit and Loss Account
The directors did not have any further funds of their own to finance the
expansion, and although they were open-minded about the introduction of
outside equity, they wished to retain control of the company. A friend who
had made money on the commodity markets had said that he was prepared
to invest £10,000 but did not wish to take part in the running of the
company.
LONG-TERM PLANS:
At that time, the directors were seeking to expand the business on a sound
base for the next 5 to 10 years. But afterwards, it was their intention to
obtain further finance for continuing expansion - realising also the
enhanced value of some of their own shares - by flotation on the USM, or
alternatively, by sale to a larger business.
PROFESSIONAL GUIDANCE:
Having sought professional advice on the development of their business
plans - prior to talking to a selected number of venture capital funds - the
Microdisk directors were then able to present a case for investment based on
the following considerations.
Company Valuation:
In general, the valuation of a company may reflect its:-
* past dividend record,
asset base,
future earnings.
But, in the case of Microdisk, the 'past dividend' method was not
applicable, and since the 'asset base' approach showed a less favourable
valuation, it was felt that a 'future earnings' assessment represented the
most appropriate basis ['earnings' = profits available to ordinary
shareholders].
However, the directors were advised that, beyond a preliminary
orientation, there were no hard and fast rules, and in practice, the
determination of a fair valuation is a matter for negotiation between a
willing buyer and a willing seller of the shares in question.
Accordingly, it had been assumed - based on the following calculations -
that a fair valuation for the company would be £225,000. Namely:-
Sustainable future earnings, say: £50,000
PriceIEarnings (PIE) ratio for an unquoted
company in this industrial sector, say: 9 and
discounted by 50% to allow for the
accompanying risk of reduced earnings and
lack of marketability of private company
shares: 4.5
Therefore Valuation: £50,000 X 4.5 = £225,000
capital Structure:
Given that Microdisk needed £140,000, the principal factors were:-
1) The shareholder/directors wanted to retain control.
2) It had been assumed that the debt:equity gearing ratio would be
about 1.3: 1 - this seemed conservative to the Microdisk directors,
but they were advised of the inherently high risk in their business,
and that additional short-term borrowing might be needed at short
notice. Second round financing could be sought by selling further
shares 2 or 3 years hence.
3) A private investor was interested in an investment of £10,000
which could be suitable for tax relief (for the investor) under the
Business Expansion Scheme. £10,000 would represent 17% of a
company valued at £225,000.
4) There were directors' loans of £30,000, which were, in effect,
long-term and represented their commitment to the business. It
was recommended that they be capitalised by an issue of new
shares as part of re-structuring the balance sheet.
On further investigation, it seemed likely that the company would
qualify for a government grant under the 'Support for Innovation'
scheme. A maximum rate of 25% applied to the planned
development costs of £60,000 would produce a potential grant
worth & 15,000. (This particular scheme was replaced in l988 but this
aspect illustrates the principle of raising a 'package' offinance by using
several different sources).
To enable a venture capital fund to invest a substantial sum
without acquiring a majority of the ordinary shares and a
corresponding proportion of the voting rights, a proportion of the
investment could take the form of preference shares. These would
offer a reasonable dividend yield, say 10°h, with rights to convert
into ordinary shares at a later date if certain conditions - perhaps
linked to profit performance - were met.
Taking into account each of the above factors, the restructured funding of
the company was calculated as follows (with % of voting rights shown in
right-hand column):-
E % of
ShareholderslDirectors Ordinay
Original holding of 5,000 shares @ £ 1 Shares
5,000
New shares issued on capitalisationof
directors' loans: 30,000 @ £1 30,000
BES Investor
New shares issued: 10,000 @ £1
- preference shares
TOTAL BORROWING:
Medium term loadhire purchase facility
Existing overdraft
Additional overdraft (of which, £15,000 will be
repaid from the 'Support for Innovation' grant)
Case Study C
BACKGROUND:
By mid-1985, Derek Brooks had worked for 5 years as a sales and marketing
manager for a manufacturer of reinforced plastic equipment used in
industrial applications. He felt that although the company was hoping for
an upturn in sales, it was not faring sufficiently well for it to be able to
sustain its manufacturing capacity into the medium-term future. In Derek's
mind, this could spell problems sooner or later and so he decided that he
would prefer to exercise greater control over his own destiny and would
explore the possibilities for setting up his own business.
He was familiar with the markets for process vessels in the effluent,
chemical and food processing industries and was convinced that there was a
niche for a small, but profitable and growth-orientated, manufacturer of
standard and purpose-designed reinforced plastic tanks, pipework and
ducting. Based on what minimum level of income he felt he needed, he then
drew up a simple plan, and started talking to some of the local banks.
Derek soon discovered that they would lend him a proportion of the money
needed, but that their contribution would be limited 'pount for pound' to
match Derek's contribution, and then only if it was fully secured. However,
in the process of looking for suitable premises, the local industrial
development officer (at the St Helens' Town Hall) suggested that he talked
to the local enterprise agency because they had access to an alternative
source of finance for smaller businesses.
And so, in July 1985, he approached the local enterprise agency, the
Community of St Helens Trust, to discover how they could help.
B USZNESS ASSISTANCE:
Lauliched in 1979, as one of the first enterprise agencies in the UK (q.v. the
directory), the Community of St Helens Trust was set up to provide a range
of free advice and counselling to help those thinking of starting in business.
But, being progressive in its approach towards small business support, it
also helped to establish the first of several local Business Expansion Scheme
(BES) syndicates to act as a source of that relatively rare commodity for
small firms - risk capital.
ST HELENS BES SYNDICATES:
When the BES was first established in 1983, it was created to encourage
external equity investment in smaller firms. Much of the money raised
under the scheme was, and still is, placed through special BES funds,
though these funds have tended to favour larger-sized investments (ie. those
businesses seeking over £100,000); mainly for cost considerations
associated with investment appraisal and monitoring. Recognising that this
situation was of little benefit to start-ups or very small businesses, the Trust
endeavoured to rectify matters locally by sponsoring a local BES fund
(technically a 'syndicate' and not an 'approved investment fund') which
would provide firms based in or around St Helens with an accessible source
of relatively small amounts of equity capital.
From the potential investor's standpoint, the intention was that the
inherent risk of investment in small firms would be reduced by:-
a) spreading the investment across a portfolio of several firms, so that
a loss of one or two firms would not wipe out all the original
investment, and
b) improving the investee companies' prospects for survival by
offering access to the business skills and experience of Trust staff
and non-executive directors.
The general philosophy is perhaps best conveyed by David Boult, former
full-time Director of the Trust and still involved on a part-time basis, when
he says:
" I n thefirstyear when the business is most dij~ficultto manage,
the entrepreneur is likely to be least experienced. Thus, apart
from help in planning the business and ensuring provision of
sufficientfinance, a new start-up needs a considerable amount
of after-care."
" I t often happens that an entrepreneurplanning a new start-up
has both a good idea and a deep knowledge of the business he is
entering, but a poor plan which does not give the necessary
confidence to a would-be-investor. More time, more research
and the introduction of a more balanced management team can
often result in the plan revealing a real business opportunity.
The cost of preparing this plan may be daunting to the
entrepreneur. I t may require 100 or so hours of professional
help which he can ill afford. Most of the longer established
enterprise agencies are able to provide this help."
SYNDICATE OPERATION AND COSTS:
A first syndicate invited investors' subscriptions for investment during
1984185, but this was followed by further syndicates - one per tax year - for
the purpose of placing investments in subsequent years. Each syndicate has
around 18 investors and the total money raised each year for investment has
been in the range of £200,000 to £250,000.
The responsibility for syndicate management rests in the hands of a
management committee (comprising a chairman plus 3 members, including
the chairman of a six-strong appraisal committee) and the members - who
offer their services free,of charge to the syndicate - are drawn largely from
the corresponding syndicate's investors.
The members of the committee usually are businessmen having an
appreciable depth of managerial experience and responsibility, and
additional support comes in the form of stockbroking, audit, legal,
investment monitoring (via appointed part-time non-executive directors or,
latterly, non-executive chairmen) and investment appraisal services.
As part of a deliberate policy, the syndicates have been able to keep the costs
to investee companies relatively low (usually 2Y2% of the sum invested, in
contrast to anything ranging from 4% to 11% for most BES funds) as a result
of the investors agreeing to waive any rights to deposit account interest prior
to investment. The syndicates are also in receipt of grant-aid of from the
European Regional Development Fund to help cover appraisal costs. (As a
result of job losses in steel, shipbuilding, textile and clothing industries, St
Helens falls within an EEC-designated area for support and can receive help
under a special 'Business Improvement Services' Scheme).
INVESTMENT CRITERIA:
The syndicates are interested in existing or new businesses which are or
could be: -
1) locally-based, ie. within a 10-mile radius of St Helens
2) operating BES-qualifying trades
3) seeking risk capital within the range of £25,000 to £60,000
4) prepared to offer a minority equity shareholding - typically 25% to
45%
5) able to offer longer-term capital growth (dividend payments are
discouraged)
6) prepared to accept board-level representation - usually a part-time
chairman who receives a small fee from the investee company
A meeting was then arranged with Ron Halford, the Trust's Director, to
discuss Derek's sales and cash-flow forecast, which had been drawn up to
cover the first year of trading. In the ensuing discussion, it became apparent
that although there seemed to be basis for a viable business, the plan
required additional information in several respects. For example, the costs
for certain items had not been anticipated and his plan would therefore
require further work before it could be presented to potential backers.
FORECASTING:
Established businesses can rely on historical data to help predict with
greater confidence what lies in store over the next 12 or 24 months - a luxury
that new businesses usually do not enjoy. Thus, the absence of a track
record can deter even the most enthusiastic investor.
This fundamental problem of uncertainity goes hand in glove with a very
real risk of running short of money and these difficulties were recognised
from the outset at the St Helens Trust.
David Boult says:
" I t is crucial that enoughfinance is made available in order to
ensure that the business is not prevented from becoming viable
because, predictably, there are deviations from the forecasts in
the plan."
"The early months are dangerous times for a new business. I n
the first year, variations from the sales forecast may be great,
perhaps as much as 50% either way. I t is probably only in the
third year, when the business has an established place in the
market, that variationsfrornforecast come within a more easily
manageable bracket."
"Entrepreneurs are naturally optimistic -perhaps they would
not be entrepreneurs otherwise - and allowances must be made
for over-optimism. I t is possible to deal with this problem by
ensuring the plan is fully tested using financial modelling
techniques on a computer. Variousparameters can be flexed on
the computer and their impact on profit and cash-flow readily
assessed. Judgement of the financial resources can then be
made so as to reduce either the risk of failure or the need to
search for extra finance at a later date."
" I t is always difficult to obtain second stage finance. Bank
managers are not over-sympathetic with those whose
performance is below forecast and who are short of cash, even
if the order book has by then become healthy and success
appears to be just round the corner."
Although the Trust's business advisers were only too willing to help in
developing a sound business plan for consideration by the active syndicate's
management committee, it was made clear to Derek that the decision
whether to place an investment, or not, rested solely with the syndicate.
This 'arm's length' approach is intended to avoid a conflict of interests
which might adversely affect either party - namely, the investors or any
prospective investee company.
EXIT ROUTES:
Another point brought out was the ultimate need for an 'exit route' -that is,
an opportunity for the investors to sell their shareholding and realise the
increased value of their investment. This is important, because, otherwise,
the investors could easily find themselves holding an investment in an
unquoted company with no ready market for their shares. There are several
possibilities, and these include:-
the outright sale of the investee company;
the sale of shares to other shareholders in the company or to a third
party;
by selling the shares back to the investee company itself; or,
via a listing on a stock market, such as the USM.
APPRAISAL:
After some 200 hours of research and planning by Derek (but with only
negligible out of pocket expenses), it was felt that he was in a position to put
his plan to the St Helens syndicate. Although the basic business concept
remained largely unchanged, the discussions with St Helens Trust
highlighted certain weaknesses and showed where supplementary
information was needed if it was to stand a chance of finding support from
the BES syndicate. Proposals from businesses seeking backing tend to
arrive in various stages of development and this sometimes necessitates a
certain amount of toing and froing between the Trust and the Syndicate; a
generalised appraisal route for St Helens is shown overleaf.
- Appraisal Route -
Proposal or
enquiry
l
I
I
Refer to Trust Business plan
to help presented I
develop plan
l
, Testing of plan on
4
Trust's computer
First response
to client by
Committee Chairman
t
Submit plan to
Reporting
Accountants
T
Committee reviews
+ I
and reaches
-
decision
Return for
+
'No'
I
I
'Yes'
- -
modification
of plan
REJECT INVEST
SHAREHOLDERS' CONTROL:
In these circumstances, the voting rights are apportioned according to the
equity owned, and this meant that Derek held a majority, and thus
controlling, shareholding and that the syndicate held 35% (what the Inland
Revenue would term an 'influential minority shareholding'). A shareholder
having 25% or more of the shares can block a special resolution for the
liquidation or disposal of the company and this arrangement was to help
protect the interests of the BES investors.
The board of directors would comprise:- Derek Brooks as Managing
Director, Jean Brooks (Derek's wife) as Directorlsecretary, plus Edward
Wilson (on behalf of the syndicate), as non-executive Chairman.
Fibre Composites Limited, then, were ready for a flying start - or so they
thought.
EARLY PROBLEMS:
The predictions for their anticipated sales were felt to be somewhat
optimistic by the Trust's counsellor, although Derek didn't feel so at the
time. Turnover levels for each of the three years following start-up had been
forecast and a figure of £240,000 had been confidently predicted for the first
year. However, due to an active trading period which did not manage a full
12 months, the first year's turnover fell significantly short of expectations.
The reasons for the slow build-up were several-fold.
Premises:
They had identified suitable premises and planned to move into them at the
beginning of May 1986. However, they were dealing not with the landlord
directly, but with another business which was sub-letting the premises. As
is usual when leasing property, the terms of the lease required the occupier
to accept ~ e r t a i nconditions. In this instance, the proposed building had
some structural problems and Derek felt that any potential liability for
repair should not rest upon Fibre composites. It proved impossible to
persuade the (sub-)lessor to vary the conditions and because of these
contractual difficulties (which were more complicated than has been
indicated here) the search for suitable premises had to start again. This
meant that Derek then had to spend time looking for alternative premises -
at the expense of other time that had been set aside for a concerted
marketing and selling campaign.
Not everything was against them though. In his previous search, Derek had
identified one building as being almost ideal for his requirements. At that
time the building was already occupied by another business but when he
encountered his subsequent difficulties, Derek discovered that the
ococupiers had since been asked to vacate the premises, which rendered
them available for occupation. The new building still needed some
modification to make it suitable for their needs - telephones had to be
installed, stationery reprinted, and so on- and by the time they were able to
concentrate on selling, the holiday period was upon them and it was then
proving difficult to make contact with prospective customers. In their
experience, they had discovered that sub-leasing appears fraught with
problems, and these problems, inevitably, had delayed the start-up date.
Edward Wilson, Fibre Composites' chairman, thinks the problems of
finding business accommodation - even in an area where there seems to be
ample choice - are sometimes underestimated:
"Finding premises for any small business, let alone one in
manufacturing with special requirements, can entail much
more than you might atfirst imagine. The legalities have to be
considered, and the lead time before the selected premises
become available for occupation can be as long as a year".
Another opportunity for introducing a delay would be where difficulties
arise with compliance with local authority planning regulations. A lapse of
several months is not unusual before approval is received.
" T o get all the people concerned -your solicitor, the landlord and his solicitor, the
local authority, the fire seruice - to meet a set deadline," says Derek, "is virtually
impossible".
Track record, lack of:
After two years' trading, Fibre Composites has managed to win a number of
better-known companies as customers - including ICI, United Biscuits and
the Wellcome Foundation. The business's turnover is now running at &4m,
it produces a range of standard and customer-designed products, and it
enjoys the relative comfort of having work in hand. However, the initial
demand, and therefore the workload, proved intermittent. Nevertheless,
this is the sort of problem that any manufacturing start-up can encounter
and one which should be considered beforehand.
In the absence of some sort of a track record, a new business may have to
rely upon selling products which, to date, exist only on paper. This is not to
be treated lightly: after all, why should a company which is used to buying
goods or services from proven suppliers suddenly switch to someone who
claims they can offer the same (or better), but who has no proof to
demonstrate that he actually could 'deliver the goods'? This is potentially a
'Catch 22' problem: you can only develop a track record after having sold
and manufactured the products, but you are unable to sell the products
(especially with larger value items where the manufacture of samples would
be prohibitively expensive) until you have established an acceptable track
record.
Derek was aware of this pitfall and has managed to obtain a written
intention from a prospective customer who also intimated that the company
would probably buy tanks from Fibre Composites at a rate equivalent to
60% of the first year's projected turnover. This expression of intent was
given (and taken) in good faith, but, for reasons which Derek has still not
been able to fully ascertain to this day, the anticipated business from this
potential customer just never materialised.
Government Aid:
At the time of Fibre Composites' start-up, the Government operated a job
creation initiative, through the Department of Trade and Industry, in the
form of Regional Development Grants. (RDGs have since been phased out
as part of the 1988 'Enterprise Initiative'). These were available to
qualifying businesses based iin selected areas of the country, such as St
Helens, and provided grants which helped towards the outlay on elilgible
items of capital expenditure. The application procedure was intended to be
straight-forward (the DTI has described these as 'automatic grants'), but in
this case, the company encountered significant delays in the receipt of their
grant.
Their application was submitted in April 1986 and the original premises
were registered as the location of the business. They were intending to claim
for the capitalised value of the lease (on the replacement premises) in the
grant application but, as a condition of grant-aid, a copy of the full
agreement needed to be submitted before any grant could be paid. As it
transpired, Fibre Composites were unable to acquire and submit this
information until November 1987, some 18months later. Final grant claims
needed to be submitted within 12 months of project start-up, and so the
DTI determined that the project fell outside the terms of the RDG scheme
and, initially, rejected their application.
Fortunately, the problem of ineligibility has since been resolved and they
have received £27,000 to date; a useful contribution which Derek and
Edward readily acknowledge has helped to restore the capital base of the
company. However, the delay has been reflected in increased borrowing
charges from the bank (as a result of the overdraft being extended to
£48,000) and meant that expenditure on items which could have helped
with the business's earlier expansion - such as on a new brochure - had to be
shelved for some time.
Bank borrowing:
At the outset, an overdraft facility had been agreed at a small branch of one
of the clearing banks (the then manager offered to waive a fee of £500 for
setting up the new facility), but the slow start-up and low initial turnover
meant that the overdraft needed to be extended. As the delay in receipt of
the grant increased, the bank's confidence in the business waned, and since
the overdraft had reached £14,000, the business was asked to reduce its level
of borrowing to £3,000. Although the manager had recently retired and had
been succeeded by a younger and personable replacement at the branch, it
was felt that the account had been identified as a problem account by the
branch's regional office and that pressure was being applied for the lending
to be cut, even though a personal guarantee of a greater amount had been
taken by the bank as security.
After reviewing the situation internally and feeling the bank was indicating
to Fibre Composites that they didn't want the business, they decided to find
another bank. Edward Wilson knew the manager at the branch of one of the
larger clearing banks, at which the manager had a higher level of lending
authority*, and a facility of £24,000 was agreed (£14,000 being secured
against Derek's house, with the balance unsecured).
[* The managers at branches of the clearing banks have discretionary limits
for secured and unsecured lending, and approval must be sought from a
higher internal authority before a borrowing application for loan above these
limits can be sanctioned. The limits tend to vaty according to the size of the
branch and are also dependent upon the status and experience of the
individual manager. For example, a smaller branch could have a 'secured'
lending limit of say £50,000, whereas a larger branch might be £500,000.
The 'unsecured' limit is usually much lower.]
With the benefit of hindsight, Derek says:
"There is a tendency to accept the bartk manager's view almost
as gospel, especially where the language of banking and
finance is not as familiar as one might prefer. However,
cheapest is not necessarily best, and it can be important to find
a manager who understands and appreciates the nature of the
businessyou are in. Some bank managers understand the more
commonplace types of business - such as retailing or running a
local pub - but a good number would appear to have a limited
appreciation of the complexities associated with higher
technology manufacturing businesses. This limitation may be
critical when the business falls on dgficult times."
MONITORING:
For any business, especially for one in the process of starting up, where
circumstances canchange very rapidly, it is important to keep a constant
watch on the business's day-to-day performance. Thus the St Helens
syndicates require, as a condition of placing any investment, a quarterly
report covering the following points:-
1. Financial a) Profit performance and comparison
with budgeted figures
b) Liquidity
2. Operational a) Sales and marketing including
comments on margins
b) Costs and overheads
c) Other related issues as appropriate
3. Forecast a) Short-term sales, profit and cash
b) Forecast to year-end
4. Other key issues
From the outset therefore a "simple, but effective" management accounting
system was implemented to help them exercise close control over the
business. The format for their systems are shown on the following pages.
(1) Monthly Operating Statement (Profit & Loss Account)
THIS MONTH YEAR TO DATE
Budget Actual Budget Actual
& % & % & % E %
Invoiced Sales
Variation in Work-in-
Progress
Materials Used
Direct Labour & NHI
MANUFACTURING
PROFIT: [A] - [B]
(Materials & Labour Capitalised)
Total [C]
OPERATING PROFIT:
[AI - [B1- [Cl
TOTAL [l]
CURRENT ASSETS:
Materials, Tools & Stores
Finished Goods and
Work-in-Progress
Debtors
Prepayments
Cash at Bank
TOTAL [2]
CURRENT LIABILITIES:
Creditors
VAT, Tax & NI
Accruals
Overdraft
TOTAL [3]
NET CURRENT
ASSETS: [2] - [3]
NET WORTH:
[l1 + 121 - 131
SHAREHOLDERS'
FUNDS:
Issued Capital
Share Premium
Profit (Loss)
The monthly figures are usually completed and ready for internal use within 7 days
of each month-end, and a set is also duly supplied to the company's bank.
NON-EXECUTIVE SUPPORT:
Based on the early experience with the St Helens BES syndicates, there
appeared to be a number of potential problems arising from representation
via a non-executive director. For example, such a representative:-
* may not spend enough time with the business;
may be seen as a hindrance by taking-up too much time;
may have no involvement in most of the important decisions;
and,
may be unable to create disciplined management of the
company.
In the light of this experience, the representative's role was subsequently
enhanced to that of a non-executive chairman. NOW,he:-
* has direct access to whoever does the accounts;
organises monthly control information;
takes part in major decisions;
checks important quotations submitted by the company;
can instil disciplined management of the company.
In Derek's experience at Fibre Composites, he has found that another
perspective is invaluable in what can be a lonely existence. Like line
managers at most other larger businesses, he never had to deal with the
company's bank in his normal day-to-day business. Whereas Edward
Wilson (the non-executive chairman), originally had been trained as an
accountant and was, until his retirement three years earlier, the Managing
Director of Lantor (UK) Ltd, in Bolton - part of a manufacturer of
non-woven materials (jointly owned by Tootal Group plc and West Point
Pepperell Inc). His experience and contact at the new bank proved to be of
almost immeasurable value when the business needed a solution to the
overdraft problem, and he also helped to set up a financial monitoring
system for the business.
Under the rules of the Business Expansion Scheme, investors claiming tax
relief are not allowed to receive remuneration from the investee company,
but, as a representative of the syndicate, Edward spends around half a day a
week at Fibre Composites to check how things are progressing and to see
whether he can help in any way.
External investors:
Did Derek Brooks have any sense of foreboding before actually getting
involved with external investors?
"Not really. A t m y previous company we had non-executive
directors and I was already aware of the type of involvement
that they had. Also, I belong to a school of thought that
believes that it you didn't have the necessary skills and
wherewithal yourself, then you went out and acquired
them."
Under the BES, any single investor is not allowed to acquire more than 30%
of the ordinary shares in any case, but as a member of a BES syndicate and
an investor in Fibre Composites himself, Edward Wilson says:
"The larger share of the business should go to the entrepreneur
himself, the person who is doing all the work; that is only
right. "
Also, the syndicates, comprising a number of small business investors, have
the potential - where further investment is felt appropriate - to provide
extra finance for investee companies.
Case Study D
INVESTMENT CRITERIA:
KEDB's investment fund - a wholly-owned subsidiary called Kent
Investments Ltd. - had been established: "... for the purpose of promoting
economic growth in Kent by way of equity investments" within the range of
£20,000 to £100,000. The fund seeks a return described as "usually low
initially, higher long termJ',and, like many other public sector sources, it will
not subscribe to a controlling equity stake (no more than 30% of a
company's equity). Investee companies are encouraged to buy back the
investment stake within 5 to 7 years, and whilst the fund's management are
interested in most industrial sectors, "special circumstances would be
required in the case of retailing, building and construction, farming and
transport ".
As a condition of investment, they usually require a monthly progress
report and quarterly management accounts, and selected companies are
required to pay an arrangement fee of typically £500 to £1,000 (or more for
particularly complex cases).
Examples of the fund's equity investments include (each, coincidentally,
£25,000):- a distance learning company providing study modules for
science technicians; a manufacturer of soft toys; and, a manufacturer of
enclosures for the electronics and defence industries. For businesses
requiring larger investments, it will consider joining an investment
consortium. Examples of such collaboration include: - an investment of
£27,000 (as part of a total of £807,000) in a company manufacturing
scientific and analytical equipment, and £200,000, including a rights issue
(as part of an equity and loan package totalling £4.2m for a rough terrain
vehicle manufacturer).
Applications for finance
Having once approached Kent Investments in the latter part of 1986, Steve
found that they (like all investment funds) required some preliminary
details to help them assess whether or not the business fell within their broad
investment criteria. A standard form is typically used to gather such
information, and it took Steve approximately six weeks to provide the
necessary details - which, in his case, were expanded to include a business
plan.
-BUSINESS QUESTIONAIRE -
GENERAL
NAME: ....
COMPANY NAME AND ADDRESS ....
BRIEF DESCRIPTION OF BUSINESS ....
HISTORICAL INFORMATION
DATE & FORM OF INCORPORATION:. ...
(OR INDICATE: SOLE TRADEWPARTNERSHIPIOTHER~
FINANCIAL REQUIREMENTS
1. SUM REQUIRED: ....
2. PURPOSE O F FUNDING (PLEASE DEFINE CLEARLY): ....
3. DETAILS OF OTHER FUNDING CURRENTLY BEING UTILISED (E.G. OVERDRAFT.
LOANS, HIRE PURCHASE):. ...
4. WHAT IS THE EXTENT OF YOUR OWN, AND YOUR FELLOW DIRECTORS'
FINANCIAL COMMITMENT:. ....
5. HAVE YOU APPROACHED ANYOTHER SOURCES OF FINANCE?: ...(PLEASE DETAIL)
-1- Continued
MARKET
1. WHO ARE YOUR COMPETITORS?:. ...
2. DO YOU INTEND TO INCREASE YOURMARKET SHARE?: ....
I F SO HOW?: ....
3. DO YOU EXPECT COMPETITORS T O RESPOND T O ANY INCREASED ACTIVITY?:. ...
MANAGEMENT
PLEASE PROVIDE THE FOLLOWING INFORMATION ABOUT THE MANAGEMENT
TEAM, INCLUDING YOURSELF:
EMPLOYMENT RECORD:
- DATE - -COMPANY - - POSITION(S)HELD -
A): ....
B): ....
&c ....
LENGTH OF SERVICE WITH APPLICANT COMPANY?:
N.B. PLEASE PROVIDE THE ABOVE INFORMATION FOR EACH TEAM MEMBER
IN ADDITION
Case Study E
[In two previous issues of 'The Journalists Handbook', 1l new magazines had
been reviewed. Of these, 2 ('Best of Health' and 'Review') had already died, and
a third ('Woman's Review') was looking urgently for a saviour. A recent
remarkable level of start-ups in the magazine business had its inevitablefi7ip side:
thefatality rate was high.
Of the remaining 8 new titles reviewed, nearly all were protected, for the time
being at least, by having big-company strength around them. The notable
exception, and still above ground, is 'On The Move', a magazine for public
transport users published by the unknown Transit Publications. Launched in the
winter of 198SI86, the bi-monthly 'On The Move' is now into its eighth issue.]
Transit, operating from a single room in the South Bank Business Centre,
Battersea, turns out to be Clive Lewis, a former features sub-editor on 'The
Times', who is 'On The Move's founder, publisher, editor, telephonist and,
for the time being, advertising manager. For Lewis, the notion of running a
magazine took shape as one of those "nice warming ideas" most journalists
have from time to time, but then discard in the cold light. In Lewis's case,
the idea wouldn't go away.
BACKGROUND:
It first struck him about 15 years ago, when he joined the long-suffering
crowd of suburban commuters into London, that no one seemed to care
how travellers were treated. How about a magazine about the world of
public transport - but aimed firmly at the consumer? Lewis reasorled that it
would offer detailed information about when to travel, where to get the best
buys, how to connect, a sort of Which? of the booking office.
"I didn't think of the idea in commercial terms", he admits. "It sprang from
a purely social concern. Then Mr Murdoch arrived at The Times, and I
thought it might be the time to clear the furniture in my mind and see if the
idea would stand up."
He resigned, took up freelancing to make ends meet, but spent most of his
tirnw working out a way to get his magazine launched. It was three years'
hard labour ("If you are going to do your work properly, you'll have to be
prepared to wait a long time").
PROBLEMS:
Did the inaugural issue sell as well as he had expected? "No," Lewis says
flatly. "We had a large order from the trade because it had been hyped. But
the returns were disappointing. The magazine was not right
presentationally. It looked too much like a trade magazine, and I found I
had been relying too heavily on my previous experience in journalism,
applying newspaper logic. It was all too stiff looking. Instead, it had to be
spectacularly different. Also, I had very little money to spend on publicity,
and I did suffer from that."
A trade magazine, however boring to look at, would have been an easier
proposition for a new, independent publisher with severely limited
resources. It would have been simpler to identify the market and cheaper to
reach it. Instead, 'On The Move' was aimed at the amorphous mass of the
country's public transport users, and expected to sell on the news stands
already groaning with titles.
After the launch, Clive Lewis took off on a tour of the nation's points of sale.
This was not particularly encouraging. In Birmingham, he found 'On The
Move' in the gardening section. Sometimes, it was just visible, peeping out
behind the stacks of 'Good Housekeeping'. Occasionally, it was not to be
seen at all.
"We are not competing against other transport magazines, but against all
other magazines," he says cheerfully.
REDUCING OVERHEADS:
He would like to go monthly, "it's a natural monthly, really", but is worried
that there might not be the advertising to sustain 12 issues a year. Against
that, however, greater frequency of publication would allow him to spread
overhead costs. It is all part of the delicate balancing act of the small
publisher, a role with which Clive Lewis is now very familiar.
"You start as a journalist and you end up as a businessman," he says. But
there is still in his character and outlook a strong element of the social
concern which gave birth to 'On The Move'.
"The magazine is basically about information, but views give an edge to it.
It is also about the quality of life. We are a small island. The logic is that if
we let market forces dictate transport requirements, we will end up with
spaghetti junctions all over the place."
'On The Move' deserves to win. It is bright, well-researched, admirably
written, authoritative on its subject. But, even after 15 years, Clive Lewis
has still to find out for sure whether social concern can be married to
commercial reality. "The going is tough," he says. "We're still not making
money, but we're getting close to it now. And with every issue, the
magazine finds a clearer way of getting its messsage across."
POSTSCRIPT:
The start of 1988 saw signs that the hours and years of endeavour were
beginning to pay off. Plans were laid to make 'On The Move' monthly from
May and the listings heart of the magazine, called 'Fare Check' was being
developed as a separate, three-times-a-year magazine available from
newsagents. As a further boost to confidence, the British Tourist Authority
is to make 'Fare Check' freely available at its 26 enquiry offices around the
world.
Case Study F
BACKGROUND:
In 1982, Laurence Abbott, who is an architect and sports car enthuasiast,
decided that he would build himself an equivalent of the Caterham 7 kit car
(perhaps better known as the Lotus 7), but using the most up-to-date
technology for running gear and suspension, and packaged in a superbly
elegant body. At that time he worked as a partner (and consultant) in a
3-man architectural practice, Tripos Architects, but recent experience
included two year's work with Fiat's IDEA team in Italy designing an
all-plastic car-of-the-future. Once his idea had been discussed with the
other Tripos partners, Rodney Gordon and Ray Baum, they warmed to the
project and quickly became involved too. At the time, they reckoned that a
prototype would cost about £15,000 to build.
Having raced cars of all sorts himself for 30 years, Laurence Abbott knew
many experts to whom he could turn for specialist advice (as well as being a
considerable expert himself, he has a collection of sports cars which he
rebuilds and races, including two Aston Martins and two Jaguar E-Types).
For example, the current chassis and suspension was designed by Mr.
Abbott and Bob Egginton, whose company, Automotive Systems
Development, a specialist supplier to the motor racing industry with a
reputation for producing the highest quality work, and with its own
Formula Ford racing team.
THE PRODUCT:
Throughout, the intention was to produce a no-frills, but elegant,
high-performance sports car with adjustable suspension so that the car
could be raced or used on the road. The body would be moulded from
self-coloured glass reinforced plastic ('GRP' - which meant no painting or
finishing) by Protoco, a specialist moulder in London, and the moulds
would be built to produce 100 to 200 body shells before replacement would
be necessary.
" I t took us six months of burning the midnight oil, of draft and
re-draft, in which all three of us (Rodney Gordon, Laurence
Abbott and R a y Baum) were involved, each undertaking an
aspect that was our individual forte, each listening to the
criticism of the others, and all of us obeying the word of the
Oracle (our accountant)."
COMPETITION:
Their research showed that while there were over 100 component or kit cars
made in the UK, the promoters believed that only about 10 were even
remotely comparable to Tripos. Of these, the nearest was the Caterham 7. It
was planned to sell the Tripos R81 in component form only, since this
avoided the need to obtain Type Approval, and the intention was to offer 3
kits in varying degrees of completion, ranging from £2,500 to £6,000.
The R81 standard kit was to be sold at £4,500, the same price as the
Caterham 7, of which, the promoters believed that about 200 to 250 per year
were being sold.
FINANCIAL DATA:
By autumn 1984, they had prepared a 43-page business plan, and the first 3
years' profit and loss projections are summarised in the Table overleaf.
YEAR 1 2 3
£ £ £
Sales
Mini-kits @ £2,500 - 6 15,000 18 45,000
Standard kits @ £4,500 5 22,500 40 180,000 84 378,000
Maxi-kits @ £6,000 6 36,000 23 138,000
Spares - 1,200 6,700
Less
Fees to directors (1)
Other overheads
(1) The directors were prepared to link their salaries to the financial
performance of the business.
In view of the positive flow resulting from deposits and prepayments, the
cash-flow estimates suggested that £23,000 would be required to finance the
anticipated operation. However, the directors preferred to raise £40,000;
not only to cover the costs of developing two production cars
simultaneously, but also to allow for contingencies.
FINANCIAL STRUCTURE:
Tripos R & D Ltd. had been formed to develop the car, and each of the
Tripos partners held a 33% directors' shareholding in the company. When
an investor had been found, a new company, Tripos Motors Ltd., would be
formed to take over Tripos R & D with Rodney Gordon acting as Managing
Director.
The Tripos team preferred to raise all £40,000 as equity (under the Business
Expansion Scheme), but they were also prepared to consider an alternative
equity structure such as the one shown below:-
The loan would be interest-free and would be repaid before the salaries to
the existing directors could rise above £500 per month each, or £1500
combined.
APPROACH:
They first approached the Small Firms Service in London. The directors
received some helpful advice - including "an impressive list of
organisations" in the business of arranging investment in projects up to the
order of several millions. But after "much letter writing and inumerable
phone calls", Rodney Gordon and his fellow directors felt that it was "far
easier to raise £4m than the paltry £40,000 that we needed".
The Small Firms Service also suggested that they contact the London
Enterprise Agency's (LEntA) 'Marriage Bureau' to help find a prospective
investor. In addition, the directors became aware of the existence of the
Greater London Enterprise Board (GLEB, now Greater London
Enterprise) - as another source a investment finance - from television
advertising placed by the former Greater London Council.
Simultaneously attacking what they called "both ends of the political
spectrum" [in simple terms, local enterprise agencies are generally
considered as a government-inspired initiative to help smaller businesses,
whereas enterprise boards tend to find greater favour among certain local
authorities], and after a meeting with several representatives of GLEB, they
came to the conclusion that a "bright red two-seater out and out sports-car"
was not really at home with the philosophy of their own region's enterprise
board.
After making a presentation at one of LEntA's Investors Club meetings,
everyone socialised "as anxious brides and potential spouses", and although
their particular presentation didn't ultimately lead to a successful business
consummation, a representative of LEntA did suggest that they also try
Venture Capital Report (VCR) as another possible way of finding an
investor.
Accordingly, a copy of their much-travelled business plan was duly
despatched to VCR, and following a day-long meeting with Lucius Cary (of
VCR) - which took in the London-based design office, the mouldings
supplier, and the workshop in Kent - a draft article was received and
approved by Tripos for publication in December 1984.
A FIRM OFFER:
Within a matter of weeks, the Tripos directors were talking to a couple of
potential investors, and after yet another visit to the workshop, one of the
investors, Peter Brown, expressed a desire to invest in Tripos as a whole,
rather than in just the car project alone.
As an accountant himself, Peter felt that the business should be
re-structured to form Tripos Ltd. as a holding company managing both the
car project (as Tripos Research & Development) and the architectural
practice. He, and another friend of long standing, Martin Bunting (also
with accountancy training and ex-Managing Director of Courage Ltd.),
would then:- jointly provide the capital needed to develop the car;
introduce an enhanced standard of financial management; and, exploit their
existing business contacts for the benefit of the architectural side.
A N INVESTOR'S VIEW:
As Chairman of Synergy Holdings, Peter Brown's involvement with a
variety of business ventures has included investments in:- computer
software, sports equipment, specialist publishing and yacht building.
After reading their article in VCR, he felt that the Tripos presentation was
well-produced and merited an initial meeting, even though the project
smacked of self-indulgence and "middle-aged fantasy fuelled by early
hero-worship of Colin Chapman".
Coming away from this meeting, he believed that the Tripos team had the
collective skills to develop the car to the production stage, but had
"negligible'' knowledge of the type of organisation which would be needed
to produce it to strict cost and time deadlines. Moreover, he discovered that
the practice had borrowed heavily from their bank - due to a drop in
architectural commissions since 1982.
Private investigations with the specialist car trade and media indicated that
a niche market for the Tripos car did exist, but that their cash plans were
probably over-optimistic, and that at least £50,000 would be needed to: - 1)
complete the development programme, 2) help the architects' practice to
provide income support during this period, and, 3) invest in the limited
infrastructure which would produce a viable production and sales unit.
Synergy's experience in the specialist car trade was somewhat limited, and
so Martin Bunting (an "old friend, car buff and experienced businessman")
agreed to invest 40% of the £50,000 needed.
Having decided to invest in Tripos, the contractual terms and conditions
associated with the investment deal needed to be tied down. Peter Brown
now says:
"Structuring the actual investment was extremely complicated
but worth the effort. I used City solicitors, as we needed an
arrangement that provided security and incentivefor the Tripos
team, but also offered flexibility for the seconda ry funding that
would obviously be necessary".
Two companies were formed, namely:-
1) Tripos Ltd. - with 50% of the equity being owned in equal shares by
Rodney Gordon and Ray Baum (equivalent to £30,000 in time and
money), and the other 50% being shared equally by Synergy Holdings
and Martin Bunting in the form of a £30,000 investment in low interest
convertible loan stock [Business Expansion Scheme investment was not
applicable because only ordinary shares are eligible for tax-relief.]. 75%
of Tripos R & D (below) was owned by Tripos Ltd.
2) Tripos R & D Ltd. - with 25% of the equity being held by Laurence
Abbott and the balance by Tripos Ltd.
The whole deal, from the initial meeting to the completion of contractual
details, took around 6 weeks to complete, and the legal costs (including the
filing of forms with the Registrar of Companies, registration of VAT details
with the Customs & Excise, payment of stamp duty &C.)were in the region
of £2,500.
Having once committed his money and around 3 or 4 days a month to
Tripos, Peter Brown didn't see himself as an investor, but rather more as a
"fellow entrepreneur" to the original team.
However, his advice to other investors/entrepreneurs when seeking
opportunities would be:
l ) "Check the gross margins that could be achieved with the
proposedproduct or service. You must see the possibility of
40%, and for comfort, SO%."
2 ) "Always allow for secondary funding at least equal to the
initial investment within two years. Zfyou cannot raise it
yourself, be sure who can, and what their terms will
be. "
3) "You must like your entrepreneur partners. Y o u will face
rough, tough times together. Trust is essential and is more
likely to be engendered $all your wives have met as well,
so that everyone knows who is providing support or
criticism, when things get fraught."
4) "Feel proud of the product or service the company offers.
This does not just relate to quality, but to the product area.
Enthusiasm is infectious, and you must get an emotional
as well as a financial returnfrom helping a provider of the
particular speciality."
5 ) "Do not, however, feelyou must have previous experience
in an industy to make a good investor: unless you are a
v e y slow learner, the problems associated with start-up
companies in most industries are very similar. You should,
though, t y tofind investment opportunities selling at least
part of their output directly to the public, or, contrariwise,
a unique industrial product or additive which adds less
than 2% to the cost of the product into which it is
incorporated by your immediate clients."
THE AFTERMATH:
By the end of 1985, Tripos R & D had spent £70,000 on development and
had sold the original car for £3,500. In the following year, they budgeted for
a loss of £9,000 on a turnover of £370,000 (from the sale of 70 kits and
completed cars). For 1987and 1988the projected turnover [and profits] was
set at £570,000 [£50,000] and £860,000 [£90,000] respectively.
However, the architectural side of Tripos started to pick up, and the time
spent on the car was cut back to such an extent that, by the end of their first
trading period (14 months to the end of March 1986), their sales amounted
to a little over £6,000, producing a loss of some £18,000.
Since then, two Americans have been brought in as new directors with
investments of £10,000 each; namely, Scott MacMillan (as Managing
Director of Tripos R & D - with Rodney Gordon still acting as a director,
but committed in the main towards the architectural practice), and Steve
Walker. The present total investment stands at £100,000- with the two new
directors each owning 16.7% of the car business - and following the
acquisition of the American-based Hunter kit car company in September
1986, the Tripos car is now under manufacture in both the UK and the
United States.
Apart from bringing the initial finance - now standing at £50,000 from
Brown and Bunting - and also the anticipated general business skills to
Tripos, Ray Baum and Rodney Gordon feel that the outside investors have
successfully helped to find further finance (and skills) for the car project.
And even though it has taken much longer to develop than was first
envisaged, the business probably has been set on a much firmer footing than
otherwise would have been possible.
From the viewpoint of an outside investor, Peter Brown has been able to
help the mainstream business in several ways. Tangible examples
include: - assuring the bank that Tripos would not be dissipating too much
money into the car development; introducing a higher degree of selectivity
when seeking architectural commissions; and reducing clients' average
payment period from 12 weeks down to 6 weeks.
1990 could hold the prospect of a flotation on the Third Market or the OTC,
although this may be delayed until 1992 if they choose to merge beforehand
with, for example, a motor dealer specialising in classic cars.
2) PROFILE - A PUBLIC SECTOR FUND
Reproduced by kind permission of the Planning Exchange, Glasgow. First
published in September 1986 as LEDIS Initiative A281 (Local Economic
Development Information Service).
Yorkshire Enterprise
[Formerly West Yorkshire Enterprise Board]
Origins:
In the late 1970s, the recession and decline in industries such as textiles and
coal mining produced rapid increases in unemployment in West Yorkshire.
In their 1981 West Yorkshire Metropolitan County Council (WYMCC)
election manifesto the local Labour party had a commitment to set up an
enterprise board to provide finance for viable local businesses, thereby
helping stem rising unemployment. In November 1982 the West Yorkshire
Enterprise Board (WYEB) was set up.
Objectives:
WYEB provides an additional source of finance for viable local businesses.
It aims to meet the demand from small or medium-sized companies,
particularly those with insufficient collateral to gain further clearing bank
finance and which are unable to offer a sufficiently rapid investment
realisation to interest the 'City'.
The Board considers it vital that the private financial sector appreciates that
it is market oriented, supporting viable businesses which have good growth
prospects. This is important for 2 reasons:-
a) it will enable WYEB to attract major funds which can then be invested
in local business,
b) it will encourage the private sector to make joint investments with the
Board in major projects.
Activities:
Financial support is of 3 main types:
A) Loan and Lease Capital is usually medium term finance in the £15,000
to £500,000 range, lent at commercially competitive rates (around 3%
over bank base rate) but with lower collateral than private sector
funders would require.
B) Equity Capital is in the form of ordinary or preference shares, again in
the £15,000 to £500,000 range. Minority holdings of around 25% are
the norm. Combined loan and equity packages are available.
C) The Guaranteed Industrial Mortgage Scheme enables a district
council (within the Yorkshire and Humberside Region) which wishes
to support a firm in its area, to offer a 90% mortgage loan. The loan is
based upon the district's valuation of the property involved and a
guarantee of repayment to WYEB. As WYEB provides the money to
the firm, local authorities are able to use their own credit power (rather
than ratepayers' funds) to promote local investment. The scheme offers
a higher percentage mortgage than is generally available and is
particularly helpful for businesses needing larger premises. As the
security can be readily refinancied, WYEB does not need to tie up a
substantial proportion of its own funds. Finance available ranges from
£25,000 to £250,000.
Examples of WYEB investments include: a half stake in an £800,000 loan
and equity investment in a firm of loudspeaker manufacturers; a £175,000
mortgage loan (guaranteed by Bradford City Council) for the purchase and
development of new premises by a manufacturer of specialist air handling
equipment; and a £100,000 loan and equity package for a fabrication
engineering company jointly supported by a loan from British Coal
(Enterprise) Ltd. [LEDIS A2601.
Investment criteria:
Before April 1986, WYEB only helped companies based in West Yorkshire.
An amendment to its Articles of Association means that it can invest
antwhere in the Yorkshire and Humberside Region. A business is eligible
for support if:-
a) it is not retailing direct to the public;
b) it is not a subsidiary of a larger business;
c) the proprietors and shareholders are contributing a reasonable
proportion of the total capital;
d) the investment will ensure good long term prospects of
profitability;
e) the investment will be saving or creating jobs;
f) it has 'good employer' policies.
Performance:
WYEB receives some 300 enquiries a year, of which, about 25 gain funding.
Urgent proposals may receive a decision within 2 weeks, although 2 months
is more normal.
By April 1986, investments had been made in 60 companies, with the
average loan being £113,000; the average shareholding £58,000. Equity
investments represent about 15% of the investment portfolio. To date, only
5 client companies have failed. WYEB is prohibited from paying dividends,
and therefore, in 1985186, it retained net profits of almost £lm. The
investments are estimated to have safeguarded or created 4,000 plus jobs,
with an average investment per job of £2,500, and have achieved a leverage
ratio of 1 to 4.
Developments
Initially, WYEB had to generate income. It therefore concentrated upon
giving loans. However, as one of its main roles is providing risk capital,
more is now to be placed in equity investments. Whilst these are far from
risk-free, WYEB feels that its strengths in investment appraisal and
aftercare should result in lower losses than experienced by most other
investment institutions.
It is felt that there is a scope for local authorities in the region to set up joint
companies with WYEB to channel investments into their areas. The first
such joint venture, Bradford Metropolitan Enterprise Ltd., was set up in
July 1986 in conjunction with Bradford District Council.
In the longer term, WYEB may wish to re-cycle funds committed to equity
holdings in investee companies. However, for a number of reasons, WYEB
investee companies may not be suitable for an independent listing on the
Stock Exchange and there is no ready market for shares in unquoted
companies. Accordingly, in June 1986, in conjunction with the
Leeds-based merchant bank, York Trust, WYEB bought a 29.9% stake in
the Unlisted Securities Market quoted property investment and printing
business, the York Mount Group. This will become an industrial holding
company able to acquire interests in WYEB-financed companies. Thus it
will provide an 'exit route' enabling WYEB to realise its equity
investments.
Investors' meetings
And LEntA has the added attraction that its list of private investors
numbers many with management skills which are on offer as part of a
"hands on" financial package for fund seekers. The investors' meeting
devised by Mr. Lovell is tailored for the entrepreneur with a well-developed
business plan which is ready to go into action.
This talking shop in which entrepreneurs can show off their wares to
investors works like this: Six bidders for cash are invited to participate.
Each prepares a resume of his or her project, with the emphasis on financial
performance forecast - profits, turnover and value, etc. - which are then
presented as a session portfolio before the start of the meeting to the
investors.
Peter Lovell's guidance notes for presenters continues:
"Zdeally your presentation should last from between 15 to 20
minutes" (exceptions can be madefor the inclusion of a video or
slide programme which takes the whole presentation beyond
the agreed limit).
"Allowing five minutes for questions, your overall time will
therefore be somewhere between 20 and 3 0 minutes. I n our
experience, this is ample to put over most cases."
"The use of slides, video, flip charts and other visual aids will
always help your case. D o not expect to be able to turn up on
the afternoon of the meeting, make a few off-the-cuff remarks
and get your money ."
The six presenters are expected to have completed their submissions within
three hours, and this includes a short tea break. The session is rounded off
with a buffet at which eyeball-to-eyeball contact is made between the
hunters and their quarry.
Negotiation:
The LEntA notes conclude:
"Investment money will only be forthcoming after fairly
extensive investigation by the prospective investor, and
perhaps a good deal of bargaining relating to the actual terms
upon which money is made available."
Any hardened fund seeker will join amen to that. So what banana skins lie in
the path of the entrepreneur who wants to present his or her project to a
group of investors?
If like me, you are caught in the trap of being the first to present, devise a
method of coolly coping with late arrivals. Avoid sandwiching slides into a
running script. Unless you bring a team of assistants along with you it can be
a hit and miss affair and wipe out the benefits that such aids are supposed to
add.
Learn your script. Prompt cards are always preferable to reading from close
writing or typing on A4 sheets. Those fellow presenters who topped my
score card - and we all sat in on each others' presentation - included one
who adopted the "come here I have a tale to tell you" approach. He had the
money men eating out of his hand. Another, aggressive and confident to his
fingertips, prevailed by his sheer professionalism.
The dreams that come alive for 30 minutes in that 6th floor room in the City
of London once a month are already showing encouraging returns. Half the
36 entrepreneurs who have played to LEntA investors at the six meetings so
far held, have got their money.
Postscript Clive Lewis had been seeking backers for a magazine aimed at
public transport (the coach, train, plane and ferry) travellers -
entitled ' O n The Move' - and although he was unable to find an
investor via the L E n t A Marriage Bureau, he achieved his aim
almost by accident.
A s it transpired, his landlord (of his business premises) was afirm
of accountants. Unbeknown to him at the start, a number of the
partners belonged to a syndicate of B E S investors on the look-out
for suitable investment opportunities. I t wasn't long before this
connection became known, and, after the usual appraisal and
negotiations, the syndicate decided to invest in the project. ' O n the
Move' was launched by Transit Publications at the end of 1985.
His story is described in case study E (Transit Publications).
5) THE BUSINESS EXPANSION SCHEME (BES)
a) A SYNOPSIS
Reproduced by kind permission of the Bank of Scotland from their Government
Assistance Information Service ('GAINS' database). The information was
correct as at June 1988 (database updated 31/3/88) but is subject to review (the
Chancellor of the Exchequer's March-time budget speech will usually announce
any major changes to the scheme).
I . Summary
Under the Business Expansion Scheme (BES) tax relief is available to
individual taxpayers who invest in the new ordinary shares of a new
company starting up a new trade or in a qualifying established unquoted
trading company. Relief from income tax is given at the individual
investor's highest rate of tax on up to £40,000 invested in BES approved
companies in any one year.
In addition, BES shares issued after 18th March 1986 are exempt from
Capital Gains Tax on their first disposal provided BES relief is not wholly
withdrawn from the shareholders (see 9).
The aim of the scheme is to encourage investment in unquoted companies
which are engaged in higher risk businesses and have difficulties raising
equity finance. Investment in certain specified low risk trades or in
companies with a secure asset backing is therefore excluded from the tax
benefits offered under the scheme (see 4).
2. Awarding Body
The Board of Inland Revenue.
3. Location Restrictions
BES approved shares must be issued by companies whose trading activities
are carried out wholly or mainly in the UK. This includes groups with
subsidiaries which are resident or incorporated overseas provided that the
trading activities of the group as a whole are carried out wholly or mainly in
the UK.
To be eligible for tax relief, the individual investor must be resident and
ordinarily resident in the UK at the time of the share issue. From 6th April
1986, Crown employees serving overseas, whose salaries are taxed in the
UK, are also eligible.
4. Zndusty Restrictions
The company invested in may be any unquoted company (i.e. those not
quoted on the Stock Exchange or the Unlisted Securities Market [USM]).
BES companies may not issue shares on the Stock Market or USM within 3
years of the BES issue. Over-the-counter flotations (i.e. outside the Stock
Exchange's official control) are eligible.
Eligible business may be in almost any trading sector, including
manufacturing, construction and service industries (including ordinary
retail and wholsesale trades). A company is also eligible if it carries out
research and development (or oil exploration) 'with a view to carrying on a
qualifying trade.
Ship chartering companies (except those chartering oil rigs or pleasure
craft) qualify provided the company's ships are all UK registered and are
owned, navigated and managed by it, and the charter period does not
exceed one year.
Film production companies qualify provided they are engaged, throughout
the three year qualifying period, either in film production or in the
distribution of films produced during the period.
The following are excluded from BES relief: companies carrying on
financial activities; dealers in shares and land; most leasing and hiring
companies; dealers in investment commodities (eg., gold, whisky);
wholesalers or retailers trading in goods of a kind which are collected or held
as investments (eg. antiques) unless the company is actively trying to sell
them; the provision of legal or accountancy services.
Relief will become available (after the 1988 Finance Bill receives Royal
Assent) for investment in companies which specialise in letting residential
property on new-style assured tenancy terms over a period of at least four
years from the date BES shares are issued.
5. Size Restrictions
The investor must normally invest at least £500 in any one company (unless
he invests through an approved investment fund). The investor cannot have
relief on more than £40,000 in total in any one tax year.
More than one investor may invest in any one company.
It was announced in the 1988 budget that, with effect from 15th March
1988, a ceiling of £500,000 has been imposed on the total amount of
investment in a company which can qualify for tax relief in any 12 month
period, except in the case of companies raising money.for ship chartering or
private rented housing, when the limit is £5,000,000.
6. Application Deadlines
There is no set terminal date for this scheme.
7. Timing of Application
Relief cannot be claimed until after the company has traded for 4 months (or
completed four months' research and development or oil exploration).
9. Eligible Expenditure
The tax relief relates to investment in the ordinary shares of eligible
companies. The shares must be held for at least 5 years, otherwise some or
all of the relief is withdrawn. Exemption from Capital Gains Tax is only due
in respect of the first disposal of shares issued after 18th March 1986
provided that relief has not been wholly withdrawn.
Beneficial terms:
One of the major considerations for investors using the BES is the
availability of income tax relief. As a result, investors may be less likely to
drive a hard bargain over the percentage of equity acquired in return for the
finance provided.
Other benefits:
BES finance can often be raised quickly, particularly if finance is being
sought towards the end of the fiscal year when BES investment funds can
find themselves under some pressure to invest the funds at their disposal
before the year-end. Also, some companies find that association with a
'City' institution - the funds at their disposal before the year-end. Also,
some companies find that association with a 'City' institution - such as a
BES investment fund - can improve their corporate image. Companies can
also benefit from the advice and contacts provided by fund managers.
DISADVANTAGES
Raising additionalfinance:
A company which has raised funds through the BES may find it difficult to
raise additional finance. If the company looks to its existing shareholders for
such finance, it may find that those who originally invested through the
BES are unable, or reluctant due to changes in their tax status, to reinvest in
the company. Also, the company will have to satisfy the BES legislation
over 3 or more years. This may, in certain circumstances, jeopardise its
ability to raise additional finance from more conventional sources, which
may be unwilling to accept conditions which are necessary to preserve the
BES status of the company.
A company cannot obtain a quotation on the USM or a full listing on the
Stock Exchange until at least three years after an issue of shares under the
BES, without losing its BES status. However, it can enter the Third Market
or one of the Over-the-Counter (OTC) markets.
Overseas business:
The requirement that the trading activities of the group as a whole must be
carried out wholly or mainly in the UK may be a limiting factor on some
companies which are rapidly expanding into overseas markets. The Inland
Revenue's usual practice is that BES companies should have at least half of
their assets, sales and profits in the UK.
Complex legislation:
The legislation relating to the BES is complex and includes many
constraints and restrictions which can prove to be a barrier to both investor
and company.
Exit route:
In order to be attracted to a company, investors will need to be satisfied that
there is a reasonable chance that they will be able to realise their investment
after the 5-year retention period has elapsed.
Tax relief:
The major advantage that the BES offers the investor is relief from income
tax at his top rates of tax in respect of his investment. In addition, BES
shares issued after 18th March 1986 are wholly exempt from capital gains
tax on their first disposal, provided that BES relief has not been withdrawn
by the date of disposal. However, with the reduction in the highest rates of
income tax from 75% to 60%, and the prospect of further reductions (the
upper rate was reduced to 40% by the 1988 Budget), there is inevitably a
corresgonding reduction in the tax saving to the BES investor.
Approved funds:
Investment may be made through BES approved funds. These funds will
choose suitable unquoted companies and spread the investor's risk over a
portfolio of investments. The minimum investment limit, currently £500,
does not apply to subscriptions made through such funds.
DISADVANTAGES
Lack of control:
Relief can be withdrawn from an investor for reasons outside his control.
For example, where a company ceases to carry on a qualifying trade within 3
years of issuing the shares, relief is withdrawn.
Value received:
An investor who receives value from the company during the period from
the date of incorporation (or if later 2 years before the shares were issued) to
5 years after the share issue will suffer a withdrawal of relief equal to the
value recevied. A wide variey of circumstances constitutes the receipt of
value.
Connected persons:
The purpose of BES is to encourage genuine outside investment. As a
result, individuals connected with the company are not entitled to claim
relief. For these purposes, the normal tax definition of connected persons
has been considerably extended.
Locked-in capital:
To obtain tax relief, the investor must hold the shares for at least 5 years.
6) FINANCE - MATCHING APPLICATIONS TO
TYPES & SOURCES
The sources of finance are basically few in number. The followinglist (Fig. 1
taken from 'The Small Business Action Kit', and reproduced by kind
permission of Macclesfield Business Ventures) is properly headed by: self,
family and friends.
FIGURE 1.
- Sources of Finance -
1) SELF, FAMILY & FRIENDS
Loans and equity
4) CLEARING BANKS
Overdraft, short-, medium- and long-term loans
Loan Guarantee Scheme
Also some start-up and equity packages
(some building societies will provide long-term business
development loans)
5) SECOND-TIER FINANCE
Hire purchase, leasing, contract hire, sale and leaseback,
factoring and invoice discounting
6) SPECIALIST FINANCIAL INSTITUTIONS
Merchant banks and Investors in Industry Group
('3i7, formerly ICFC)
British Technology Group
Pension Funds
Investment Trusts
Insurance companies
Plus:
Banks other than clearing banks
Some local authorities, development corporations and enterprise
boards
9) GRANTS
Government and local authority
Trusts: Prince's, Royal Jubilee, Youth Enterprise Scheme
FIGURE 2.
- Matching Finance -
Equity funding
PURPOSE: Core finance
Permanent capital
PROFZTABZLITY
Gross ProfitMargin = Sales Revenue - Variable Costs
Sales Revenue
(multiply by 100 to convert to %)
'Capital employed' means loans and equity - this ratio indicates the
overall return on all capital employed. Apart from any short-term
deterioration, no company is able to survive for very long unless its
return on capital exceeds the cost of borrowing. More profitable
companies can produce a return on capital in excess of 20%.
LIQUIDITY
'Quick assets' are only those available very quickly such as debtors and
cash (but not stock or work in progress). Current liabilities includes
overdrafts, creditors and provisions (such as taxation, dividends
&C.).
Considered by some the ultimate test of liquidity; traditionally, a figure
of 1, or above, is felt acceptable.
The current ratio is a less stringent version of the above; the assets
element now includes raw materials and work in progress. A figure of
around 2 is generally acceptable - but a greater figure of 2 could be
indicative of too high a stockholding.
WORKING CAPITAL
As above, it produces a result in terms of weeks (the '1.15' allows for the
inclusion of VAT). In the real world, an average payment expectation
of "30 days" is not realistic. A period of 8 or 9 weeks is more common:
anything over 10 weeks warrants a review.
'Stock Turn' - Stocks X 52
Sales Revenue p.a.
STRUCTURE
ProprietoJs assessment:
It is true to say that business proprietors often have a "feel" for the value of
their business. This may be acquired intuitively by assessing the
remuneration and rewards that have been earned from the business, or by
noting the price that competitors may have obtained from disposing of
businesses or shares.
The latter is probably a better measure of the likely value of the company's
shares, but, of course, that information is rather difficult to obtain.
An intuitive value may well be accurate, and certainly many valuations start
off by wetting one's finger and putting it in the air to see which way the
financial wind is blowing, yet at the end of the day, the important thing to
remember is that the seller of the shares is not on his own, but that there is a
purchaser who has his own views; not only about the worth of the company
in absolute terms, but also about the total amount that he is prepared to
Pay.
Prelimina y valuation:
In valuing shares one must understand that a share is not a sum of money
and, usually, that no shareholder has a right to any specific assets belonging
to the company's property.
He is entitled to a share of the company's capital and profits, and therefore
the procedure in share valuation is first to assess the net value of the
company's business and activities, and having done that, to estimate what
proportion of that net value is reflected, through expectation of future
income and capital, in the shares held by the individual shareholder.
Because there are a number of different types of share that a company can
issue, the valuer would first ascertain what type of share is in issue (usually
ordinary shares issued at 'par' value of E l or lop or something in between).
The valuer would ascertain whether there were any peculiar rights attaching
to those shares, or whether they are simply entitled, according to the
number of shares held, to dividends and a proportion of the company's
assets on a winding-up of the company.
Having identified the character of the shareholdings and the rights, the
value attributable to the shares will depend very much on the percentage of
the shareholding owned by the individual shareholder.
Owners of large shareholdings:
The holder of 90% or more of the shares in the company has an unfettered
right to sell his shares and can also give the purchaser of the shares
compulsory powers to purchase any remaining shares of the company held
by minority shareholders who may not wish to sell. He has total control of
the direction of the company and over its dividend policies.
The holder of 75% or more of the shares has power to pass a special
resolution to put the company into liquidation or to sell the business as a
going concern. He cannot force the sale of shares by other shareliolders, but
he has effective control over the company. When selling such a
shareholding, a 'nuisance' value may exist in the shares held by the other
shareholders, particularly if they are all held by one individual, and the
purchaser of the shares may not be prepared to pay as much as 75% of the
estimated value of the business as a going concern and may look to negotiate
some discount from that value. This is very dependent upon the facts of the
case and may well be influenced by the number and identity of the other
shareholders.
Smaller shareholdings:
Although a shareholder with 50% or more of the company's shares has the
day-to-day control over the company, he may have the problem of other
shareholders interfering and similar principles apply here as to the 75%
shareholder. Clearly, if one is selling a minority shareholding, it is
important to clarify, before a deal is completed, the extent to which the
prospective shareholder would wish to be involved in the running of the
business, and whether this is likely to be compatible with one's own
preferences.
A shareholder with exactly 50% of the shares in a company does not have
control, but then, no-one else has control either (unless there is some
additional factor such as casting votes being given to Chairmen of
meetings).
In the event of real control accompanying an exact 50% shareholding, then
the same principles apply as to a 50%+ shareholder. Although real control
is absent, there may be effective control if all the other shareholders have
minority interests such that the 50% shareholder has only to secure the
agreement of one other shareholder to obtain control. But, without real
control, the holder of 50% of a company's shares cannot force a liquidation
and his expectations of profit would be dependent upon the future earnings
of the company and the translation of those earnings into dividends.
If there is no likelihood of the company being wound-up, and if there is no
likelihood of sufficient earnings being made to declare dividends, then the
owner of 50% or less may not be able to identify great value in his
shareholding. This problem is intensified for the smaller shareholdings so
that, for example, a 10% shareholder would in the normal course of events
have no influence over the conduct of the business, and it is quite unlikely
that in an open market sale this shareholding would be able to achieve
anything like 10% of the underlying value of the company.
Valuation:
As mentioned previously, a valuation of the shares will depend upon a
number of factors.
In the case of a trading company being sold as a going concern, the valuer
would seek to establish what level of future maintainable profits can be
expected. Usually, these would be the profits after the deduction of
corporation tax. Apart from any particularly valuable assets that may be
owned the company, it is the level of future maintainable profits that the
purchaser will be interested in, for that is in reality what he is
purchasing.
There are questions of growth expectancy, management expertise,
know-how and exploitation possibilities that may all have an influence and
the purchaser may see (or perceive) potential that he can develop using his
own available resources.
In any arm's length negotiation, a knowledge of such a perception will be of
considerable value in negotiating a high price, but, essentially, the
purchaser is acquiring what is currently in the company, and if the existing
management does not have the ability or intention to develop the business
beyond its obvious potential, then the risk attaching to the purchaser's
development of that business must lie with the purchaser and may not have
an effect on the current value of the shares.
On a total disposal of 100% of the shares in the open market, it is unlikely
that minority shareholders would receive less than the full pro-rata value of
their shareholding because what is being acquired would be 100% of the
company.
Minority shareholdings:
What has been said in relation to the percentage of shareholdings applies in
respect of individual disposals of that percentage.
In the case of minority shareholdings, an entitlement to dividends has
tended to be more relevant than the profit expectations of the company,
although in recent years, a greater emphasis has been placed on investment
growth (via retained earnings) rather than on shorter-term income
considerations.
It is often assumed - mistakenly - that the value of a company is its net asset
value as shown in the annual balance sheet. This can be most misleading and
the real value of the company may be greater or less.
It is necessary first to distinguish between business assets and investment
assets.
The company's business assets are all those that contribute to creating the
profit that the company makes. These will include premises, fixed plant and
machinery, cash at bank and even cash reserves that are required for
business liquidity.
Earnings valuation:
A company's valuation by reference to its earnings - future maintainable
profits -will in most cases reflect the value of such assets because when the
future maintainable earnings have been ascertained, they would then be
'capitalised' by applying a factor which is usually regarded as a number of
years' purchase of those earnings.
To determine what this factor should be requires some considerable
experience.
It may be with reference to current price-to-earnings ratios of quoted
companies (and discounted to reflect the fact that the subject company does
not have the strength nor the market for its shares available to public
companies). If the valuer discovers that the profits derived from the assets
are unacceptably low, he may look at the net asset value to see what could be
realised on a sale of those assets after losses on realisation, sales costs etc.,
and if that 'break-up' value is greater than the capitalised value of
maintainable earnings, then that is where the main value of the company
would lie. In most cases of healthy going-concern businesses, the net asset
value would not displace the earnings value.
Investment assets:
If the company owns assets which are not used directly in the business or for
the purposes of the business, then the value of those assets may be brought
in as additional value to be added to the capitalised value of earnings. But if
the business assets are of very considerable value themselves, then even
though they are reflected in the earnings, the capitalisation factor that the
valuer would use may be higher than if the assets were the bare value
necessary to generate the earnings.
In ascertaining the future maintainable earnings of the company, the valuer
will probably start with the historical profits to see whether there is a
discernable trend. He will also look at the management projections and
profit forecasts, if any, and will require reasonable evidence of their
accuracy.
Management review:
Very important is the question of working directors and the personnel
because it has been proved time and again that a company's fortunes are
largely dicatated by the efficiency of its management. Therefore to some
extent a management review of the business may be necessary.
Additional considerations:
Other factors which would be considered would be contingent liabilities
such as leasehold obligations, any current litigation, research expenditure
commitments and so on; the current state of the company's order book may
have a bearing on substantiating any management projections; the
relationship with suppliers and customers can have a considerable impact
on a business and, for example, a single customer would probably indicate
that there is very great goodwill as between an individual in the company
and that customer and a disposal of shares without a commitment of that
individual may mean that tthe shares themselves have little value; the
company's history of bad debts and debt collection may also be of
relevance.
Apart from the internal factors, the valuer will wish to identify the
company's place in the market and to gain a view as to the general economic
outlook for the sector in which the company trades.
At the end of the day, the deal will be done by a willing buyer and a willing
seller and despite the formal estimate of the company's worth, other factors
may intervene such as a vendor's personal requirements to raise finance
very quickly or the purchasers desire to invest very quickly. But these,
external matters fall not within the realm of share valuation but within the
realm of negotiation - and that is a different kettle of fish.
Tax implications:
Finally, with any disposal of shares there is likely to be some tax
consequence and special valuation rules and principles apply for these
purposes if a disposal of shares takes place between parties who are
connected with each other for tax purposes. It is always important to have
the tax implications in mind in any proposed transactions and these
implications can include corporation tax, capital gains tax, income tax,
inheritance tax, and value added tax. Tax consequences could also dictate
that instead of shares being disposed of the company disposes of its assets.
Obviously, it makes good sense to take timely and professional advice.
9) SAMPLE NON-DISCLOSURE AGREEMENT
: inventor's
: address :
WHEREAS
1 The purpose of communication between the Parties to this Agreement
is to explore co-operation with a view to establishing a further
Agreement covering development and exploitation to the mutual
benefit of both parties.
2 The information to be communicated in strict confidence between the
Parties to this Agreement includes demonstrations, commercial and
technical information, all forms of intellectual property and includes
material for which patent or similar registration may have been filed.
FOURTH Any information which either Party can prove was in his
possession prior to disclosure hereunder and was not acquired
from the other Party or his representatives is excepted from
this Agreement.
Position: Position:
The correct names of companies must be used in this Agreement and the
Managing Director or his equivalent must sign for and on behalf of a
Company.
10) SAMPLE INVESTMENT OFFER LETTER
Reproduced by kind permission of the Kent Economic Development Board,
Maidstone.
1.
I am pleased to tell you that Kent Economic Development Board
through its wholly owned subsidiary Kent Investments Limited
("the Investor") is prepared to make available ..........to purchase
shares to the value of.. ........in ..........This offer is subject to:
(i) Our being satisfied on the affairs of the Company;
(ii) A formal Contract between the Investor the Company and its
Shareholders which sets out in detail the terms and proposals
contained in this letter;
(iii) The Memorandum and Articles of the Company being altered
to reflect the proposals;
(iv) Confirmation that .......... will grant the Company an
overdraft facility of &. .........;
(v) Our receiving written acceptance from you by ...........
The Company is to use the funds provided by the Investor for the
purpose of the fixed and working capital requirements of the
Company and for no other purpose.
2. Shares
Cumulative Participating Preferred Ordinary Shares to be
subscribed for & ..........
2.1
The Investor is willing to subscribe & .......... for new
Cumulative Participating Preferred Ordinary Shares of £1
each (representing .......... per cent of the equity share capital
after subscription), having the rights as set out in the attached
Rider I.
3. Other Terms
While the Investor is a shareholder:
(a) The Investor may appoint a Nominee Director to the Board of
the Company. His fees shall be ..........per annum, subject to
the annual revision by agreement, and he shall be reimbursed
for all expenses properly incurred by him on the Company's
business. This Director may not be required to retire by
rotation.
(b) The Company is to supply any financial or other information
regarding the Company as the Investor may request. In
particular, the Company will provide the following:-
(i) monthly financial and progress reports within 3 weeks of
the end of each period;
(ii) budgets and cash forecasts for each financial year, by the
beginning of that financial year;
(iii) Balance Sheets and Profit & Loss Accounts covering
operations for each quarter within 4 weeks of the end of
such period, and revised and up-dated cash forecasts
when so requested;
(iv) the annual audited Profit & Loss Account and Balance
Sheet for each financial year within 3 calendar months of
the end of that financial year.
The Investor may appoint an Accountant of its choice to
prepare the above information if the Company does not
produce the above information when due. The Accountant's
fee will be the Company's responsibility.
The Investor is to have the right to obtain information from the
Company as if it were a Director regardless of whether it has
appointed a Director to the Board.
(d) The Investor's legal costs arising from these proposals are to be
paid by the Company. In addition, an investment fee of
& ........... will be paid to the Investor by the Company for
services prior to investment.
(e) The aggregate of the salaries of the Directors is not to exceed
& ........... in the year ended ............ and & .......... in any
subsequent financial year without the written agreement of the
Investor. Other benefits including company car are subject to
the Investors agreement.
(f) The Company will maintain 'Key Man' policies for the benefit
of the Company as hereunder:-
(i) No Director of the Company is to be engaged or
concerned with any commercial undertaking other than
the Company;
(ii) If the Directors who are shareholders whish to sell or
otherwise dispose of all or any part of their shares, they
shall first notify the Investor who shall have the right to
require its shares to be purchased at a price acceptable to
the Investor as a condition for giving its consent to such
sale or disposal.
Rider I
Rights Attaching To The Cumulative
Participating Preferred Ordinary Shares As
A Class
l . Dividend
1.1 Fixed
A cumulative annual dividend each year of ......... per cent,
payable half-yearly on and commencing with the year beginning
l .2 Participating
A cumulative dividend payable in relation to each year from 1st
January .......... of such sum (if any) as represents the greater of
.......... per cent of the "Net Profit" of the Company or the
dividend paid on the ordinary shares.
The participating dividend is to be paid within 14 days after the
Annual General Meeting at which the Accounts for the relevant
year are adopted.
The "Net Profit" means the Audited Consolidated Net Profit for
the relevant year, but;
(a) before charging exceptional or non-trading items;
(b) before making provision for any dividends other than the fixed
dividend referred to at 1.1 or any transfers to reserves;
(c) after payment of Corporation Tax on profits earned.
Thereafter, dividends are to be payable on both the Preferred Ordinary
and Ordinary Shares as if they were all shares of the same class.
2. Rights on Widing Up
The Shares will carry the right in a winding up to a repayment at the
issue price plus any arrears and accruals of dividend in priority to the
Ordinary Shareholders. Thereafter, subject to the repayment of each
Ordinary Share of an amount paid on each Preferred Ordinary Share,
any surplus is to be distributed to both the Preferred Ordinary Shares as
if they were all shares of the same class.
3. Voting
The Shares will carry ......... per cent of the voting rights.
At any General Meeting of the Company where the dividend on any of
the Investor's Shares is in arrears or it is proposed to wind up the
Company or modify the rights attaching to the Preferred Ordinary
Shares, the Investor shall not hold not less than .......... per cent of the
total votes.
171
11) POSSIBLE 'FUND'-TYPE BUSINESS PLAN
The following section was written by Brian Warnes (and also has been used
in 'The Genghis Khan Guide to Business'; and 'The Cash Flow Handbook')
and provides an example of business plan guidelines which have been
offered by a private sector venture capital fund to the owners of small
businesses when approached by them for equity capital. It also includes a
'Procedure for drawing-up forecasts' which explains in detail how the
various figures are derived.
Reproduced by kind permission of Brian WarnesM A F C A (Business Dynamics
Ltd.)
It is recommended that their applicants should submit a brief Proposal (of not
more than say 4 to 5 pages, plus attachments), carefully and accurately covering
all the points set out below. Any other relevant information should be included.
l HISTORY
Date of Incorporation. Date of start of trading. How did the Company
come into being? What identified need in the market-place led to the
setting up of the company and development of its products/services?
Any other significant events. Date of any Inventions or Provisional or
Final Patents.
2 PRODUCT
Description and nature of product or service. Why is it special? What
has the Company got that other companies have not? Please attach
product brochures, if any. Details of Research and Development
Expenditure. To what extent is product fully developed? And fully
tested?
5 PRODUCTION
Brief details of buildings - freehold/leasehold/rented;square footage of
production area, offices, storage, etc.; site acreage; plant -
ownedlleased; vehicles; fixtures; and production methods -
manufacture, assembly only, salesidesign only. Brief details of sources
of raw materials/sub-contract parts.
6 SHAREHOLDERS
Who financed the Company? Brief background of controlling interests
(company or individuals). List shareholdings.
I Estimate Monthly Sales (Line 1) pre VAT, allowing for the fact
that:
1) For starts-ups, build-up is nearly always much slower and
takes longer than expected, and starts later.
2) Holiday months (e.g. JulyIAugust, December) are usually
poor.
3) Seasonality should properly be taken into account (e.g. peak
sales pre-Christmas, poor January etc.).
V1 Insert Opening Stock (4) for month 1, from the 'Opening Balance'
+ +
figures at (32) (33) (34)
V11 Derive Closing Stock (10) for month 1, having summed lines (1) to
(12). Insert as opening stock (4) for month 2. Repeat through to
month 12. Check the above stock figures are approximately correct
as follows (Material and Labour content only):
Raw Material (32) If say 6 weeks' production requirement is
carried, January's Stock should total January's Material Deliveries
(5) plus half December's (5).
Work in Progress (33) If work takes on average one month to pass
through the factory, January's Work in Progress should be
equivalent to January's Cost of Sales (1 1).
Finished Goods (34) If say 2 months stock is carried, January's
Finished Goods should be broadly equivalent to December's plus
January's Cost of Sales (1 1).
+ +
Check Closing Stock (10) = (32) (33) (34) for same month
+ +
Check Opening Stock (4) = ( 3 2 ) (33) (34) for the previous
month
Note 1: If the above vety approximate calculations show the
opening and closing stocks previously inserted at (4) and
(10) are seriously understated, monthly Material
Purchases (Stage IV) and Labour costs (V) should be
increased and the stock figures (Stage VII) reworked.
Note2: Stocks of packing materials, publicity leaflets, etc.
should be included with Finished Goods (34). Any
amounts actually used in the month, in sales at (l),
should be included in Costs of Sales (1 1).
Note 3: The following complexity is not recommended and for
forecasting purposes, should, if possible, be ignored, but
if the company insists on showing an 'overhead' content
in stocks, rather than valuing stocks at just labour and
material cost, the content should be separated out of (33)
and (34) and the total shown at (19), with (20) being the
equivalent for the previous month.
XI1 Other Creditors (38). Include PAYE, VAT, Interest owing and
accrued expenses, etc. Assume, say, equivalent to current month's
overheads (17), or ignore for forecasting purposes.
XI11 Derive Net Current Assets (40) by deducting (39) from (36). (This
figure should approximately equal total sales for the past 3 months,
for a typical manufacturing company).
XIV Moving now on to the Cash Flow as such, derive the Increase or
(Decrease) in Net Current Assets (41). January's (41) will be
January's (40) less December's (40).
XVII Derive (44) = (41) +(42) + (43), giving the gross additional
funding need in the month.
XVIII The contribution from Cash Profits (48) i.e. (22) plus
Depreciation, will reduce the monthly net cash requirement; Cash
Losses (45) on the other hand will of course increase it.
Profits are however reduced by interest charges (16) calculated on
total borrowings (57), which in turn depend upon profits. To break
the vicious circle, assume, initially, that interest (16) is zero and
derive rough profit (loss) figure for month 1 by deducting (13) from
(12). Insert at (45). Add Depreciation (46) and Amortisation (47) to
extent included in Administration Costs (13). Derive (48) and
deduct, if a profit, from (44) to arrive at the rough net cash
requirement (49). Add if a loss.
XIX Insert Opening Balances prior to the start of the 12 month period
at (50) to (56) and total (57). Add to this the rough cash
requirement at (49) for month 1 to arrive at a new total borrowing
figure (57) as at end of month l.
XX Calculate Interest, for one month, on the total (57) and insert at
(16) for month 1. Derive (17), (18) and (22). Insert the more
accurate figure at (45) and rework Total Borrowings (57), derive
Closing Overdraft (56), having inserted the relevant closing
balances for Factoring (54), Loans (51), (52), and Hire Purchase
(53) for month 1.
XXI Work through the same cycle for month 2 and so on to month 12,
which will then show peak funding need and in what month it
occurs.
XXII Calculate Breakeven Point (24) i.e. the level of turnover needed
needed just to cover overheads (17), at the gross margin percentage
in question (23) i.e. (17) X 100 t (23).
At 25% gross margin, every £4000 of sales above breakeven will
produce a profit of £1000; every £4000 below breakeven, a loss of
£1000. The company can be controlled accordingly by comparing
order intake (25) and orders in hand (27) with actual sales (1).
NOTE
If the Gross Margin the company thinks it is achieving (26) and (28)
as worked out from its Costing and Pricing data begins to be
substantially higher than is actually being achieved (23), the
Costing and Pricing assumptions should immediately be rechecked
to bring the two into line. The accuracy of the gross margin
percentage calculated at (23) in turn should be frequently checked,
particularly in the early months of a new company, by basing
closing stock (10) on physical stocktakes (Labour and Materials
only) until broad agreement begins to emerge. The task is often for
a period a tedious one, but any company that does not know its real
gross margins is likely to fail, possibly quite quickly.
MONTHLY
MONITORING
Within 14 days of the end of each month, at least approximate
results for the month should be inserted (January Actual in the
example) for comparison with Budget. Next month, February's
Actuals will over-write January's Budget to give comparison with
February Budget; and so on.
Immediate rebudgeting for the rest of the year should take place if
it becomes apparent from the emerging pattern of Actuals that the
basis on which the Budget has been compiled is inaccurate, in
order to give maximum advance warning of impending
problems.
MONTHLY PROFIT AND LOSS ACCOUNT (f'000)
Actual Budget
Months D T J F M A M J J A S O N D T o t a l
SALES
1 Gross Sales
Direct Sales Costs
NET SALES
MATERIALS AND LABOUR
Opening Stock 22.0 25.0 25.0 27.0 29.0 30.8 32.6 32.7 32.8 31.0 26.8 28.8 35.3 37.8 25.0
Material Deliveries - 7.0 3.0 5.0 6.0 6.0 5.0 5.0 - - 7.0 10.0 10.0 - 57.0
Labour 5.0 4.0 5.0 3.0 3.0 3.0 3.5 3.5 5.0 3.0 4.0 4.5 4.5 5.0 47.0
(R& D)
Closing Stock
COST OF SALES
GROSS MARGIN
AdministrativeCosts
Interest
Sub-Total
NET
Overheads in Closing Stock
(Less in Opening stock)
(Sundry Income)
Actual Budget
Net Current Assets Per Balance Sheet
DEBTORS
Trade
Other
STOCK
Raw Material
Work in Progress
Finished Goods
(Progress payments) - - - - - - - p - - - - - - -
49.0
Sub-Total - 41.5
- 40.0
- 49.0
- 52.8
- 56.6
- 58.7
-60.8
- 53.0
-46.8
- 55.8
-70.3
-77.8
-61.1
--
Creditors Trade 9.0 15.0 3.0 8.0 11.0 12.0 11.0 10.0 5.0 - 7.0 17.0 20.0 10.0
Other -
-
-p------
1.0
------
- - - - - - - - - - -
Sub-Total 9.0 16.0 3.0 8.0 11.0 12.0 11.0 10.0 5.0 - 7.0 17.0 20.0 10.0
- -- - ----- - - ----
NET CURRENT ASSETS - 25.5
- 37.0
40.0
- 41.0
- 41.8
- 44.6
- 47.7
- 50.8
- 48.0
- 46.8
- 48.8
- 53.3
- 57.8
- 51.1
--
Cash Flow Total
CASH OUT
41 Increase (Decrease) NCA
42 Capital Expenditure Assets
43 R&D
44 Sub-Total
CASH IN
45 Profits (Losses)
46 Depreciation Assets
47 Amortisation R & D
48 Sub-Total
49 NET CASH REQUIREMENT
(SURPLUS)
MONTHLY CASH FLOW (S'000) cantinued
Closing Balances per Balance Sheet
Actual Budget
J J F M A M J J A S O N D
New Equity
Debentures
Medium Term Loan
Hire Purchase
Factoring
(Cash in Hand)
Overdraft
TOTAL BORROWINGS
12) 'A' SCORES - QUALITATIVE COMPANY
ASSESSMENT
The 'A' scores were originally developed to help predict company
failure (in conjunction with other techniques such as 'Z' scores and
accountants' ratios) and they are based on the argument that failing
businesses are characterised by the following stages:
Defects -+Mistakes -+ Symptoms.
They have been included as a general guide, indicating which
characteristics could be seen by prospective investors as potential
weaknesses in an investment opportunity.
A company is assessed and marked against the following factors (note
the relative marks awarded to different factors), and a score of 25, or
greater, means that danger signs are evident. This system will have
limitations regarding the assessment of the very smallest businesses,
and so the scores should not necessarily be taken at face value.
DEFECTS: (maximum: - 43)
Management Score
Autocratic chief executive who dominates his company
and will hear no advice 8
The chief executive is also the chairman 4
The skills on the board are unbalanced 2
(e.g. too many engineers)
There is no strong finance director 2
Members of the board do not actively participate in decisions 2
There is no depth of management below the board 1
Accounting
There is no budgetary control system, maybe not even a budget 3
There is no cash flow plan or it is not updated 3
There is no costing system, no one knows what the
product costs
Response to change
There are clear signs of failure to respond to change - an ageing
product, old factory, out of date attitude to employees 15
DANGER SIGNS 3 25
'Predicting Corporate Failure' Argenti J. ICAEW Notes for Businessmen 1984
FIGURE 3
- Bank Manager's Aide Memoire -
1. HOW INTRODUCED
2. OCCUPATION (outline of products/services)
3. CONCLUSIONS
3.1 MANAGEMENT ABILITY
3.1.1 Technical
3.1.2 Financial
3.1.3 Administrative
3.1.4 Marketing
3.2 LABOUR RESOURCES
3.3 PREMISES
3.4 PLANT & MACHINERY
3.5 FINANCIAL PLANNING & CONTROL
3.5.1 Book-keeping system
3.5.2 Profit and loss reporting
3.5.3 Budgets - cash flow forecast (3 years' sales)
3.5.4 Costings and breakeven calculations
3.5.5 Pricing
3.6 CURRENT ASSETILIABILITY MANAGEMENT
3.6.1 Cash
3.6.2 Debtors
3.6.3 Stock
3.6.4 Creditors
3.7 FUTURE PROSPECTS
Capital Gains Tax (CGT) Tax levied on the gains made on the disposal of
goods or assets when their value has increased
from the date of acquisition to the date of
disposal. CGT is levied above a certain
threshold. Some types of gains, such as the
sale of BES shares (when satisfying
appropriate criteria), are exempt from CGT
liability
Certificate of Document confirming that a company has
Incorporation been legally incorporated - issued by the
Registrar of Companies