by Dr Zita Stone
Since our last B I G Network session, where we explored ‘reaching beyond strategic financial management: identifying what really drives performance and growth’, we’ve been translating some of the work and outputs into a series of blogs.
This first blog looks at the area of ‘investment readiness’. What does it mean to be ‘investment ready’? Why do entrepreneurs have insufficient knowledge about strategic finance? What are the most common reasons for seeking investment? Why do SMEs fail to secure strategic finance? All important questions that business owner-managers participating in the B I G Network set out to explore together with Dr Zita Stone Lecturer in Strategy and International Business at Kent Business School, University of Kent, and the B I G delivery team.
Are you investment ready?
The discussion started with the most basic yet imperative question for any entrepreneur considering approaching external providers of finance: ‘are you investment ready?’ Those participants who felt that the answer was ‘yes’ argued that: their businesses are running low on cash and therefore they are in need of an ‘investment injection’; that their businesses have a well-defined strategy; and/or that they have the relevant track record and experience in securing various types of investments.
These answers, however, were in a sharp contrast to the ‘No’ group of participants who claimed that: their business systems and relevant documentation are not ready; that their business models are ‘not quite there yet’; and/or, that they simply felt they did not need any form of investment.
According to findings by the European Commission [1] the three most apparent needs of entrepreneurs for making them and their businesses ‘investment ready’ are:
- mentoring in sources of finance;
- developing skills for successfully leading a dialogue with, and understanding the needs of investors, and;
- finding business angels.
Indeed, becoming ‘investment ready’ encompasses a whole set of considerations, from the assessment of your business strategy , to clearly defining your business mission and objectives, demonstrating the presence of a sustainable business model, understanding of various sources of financing with a particular focus on the advantages and disadvantages of equity finance, and corporate structure implications, to name a few.
SME owner-managers lack knowledge in finance, and fear losing control
The next focus of the ‘investment readiness’ debate was exploring the barriers stopping entrepreneurs from securing finance. The B I G Network participants commented that the understanding of finance is ‘not taught in school’ and that specific knowledge on finance is typically gained via specialised higher education courses; an educational path which many entrepreneurs do not choose to follow. Another group of participants raised the aspect of ‘strategic finance’ and the understanding of it being of a lower priority than perhaps the day-to-day running of their businesses; the realities of passion for their business (idea) before profit, was highlighted by many. In addition, many participants commented on the need for a forward looking business model and its link to a forward looking investment-focused financing such as equity finance via business angels or venture capitalists.
Crucially, according to findings by the OECD [2], there seem to be two other key reasons contributing to the lack of investment readiness, which the group of the B I G Network participants did not comment on. First, surveyed businesses felt that their fear of losing (strategic decision-making and operational) control over their businesses and second, the threat of information asymmetries, both stemming from the investor presence in the business, were simply undesirable negative side-effects of strategic finance for SMEs
Where to find the money!?
The group also discussed various sources of finance, starting with the debate on internal financing and its constraining impact on growth. Next, the implications of bank financing were explored with a particular focus given to the subject of a collateral requirement by lenders, the development of a trustworthy relationship between the lender and the business, as well as the expectations of lenders on an SME’s management team, the realism and feasibility of their business plan, and their business’s financial performance. This was followed by a discussion on equity finance. The latest research [5] was confirmed by those participating in the Network session with business owner-managers recognising the need for understanding their potential investors, such as business angels and venture capitalists.
Although the capital business angels inject into high-growth businesses is of strategic importance, a number of SMEs report struggling to access these wealthy individuals or identify ‘gatekeepers’ who would make the business-to-investor introductions [4]. Further, business angels are perceived by businesses as wanting high levels of control and in many cases representing high transaction costs in the eyes of ‘investment-needy’ businesses. It has also been noted (for example see [3]) that in many instances the requested capital businesses seek are too large for business angels.
Venture capital is an equity-based alternative to the investment offered by business angels. Venture capitalists seek low risks and quick returns and are therefore often interested in SMEs with foreign investments, as international operations indicate the presence of economies of scale and potentially also economies of scope. However, many entrepreneurs feel that these profit-driven investors require too much control and monitoring, employ aggressive investment contracts and seek quick exits [4]. SMEs also fear that venture capitalists sell off their stakes without prior warning and leave the entrepreneurs unable to buy back their shares and thus protect their business model from dilution or even destruction [5].
A way forward? Taking a strategic ‘pick and mix’ approach to financing
Having discussed the various investment options and their constraints the B I G Network participants completed their discussion by considering two major findings. According to research conducted by the European Commission [6], the vast majority of SMEs taking a strategic approach to seeking finance tend to adopt a mixed funding product approach to fuel their growth. The same report also found that many SMEs express an interest in equity finance, however do not succeed in securing it, or in many cases opt out from the transaction cost-heavy process of finding, contractually securing and managing an equity investor.
About us
The B I G Network provides a space for ambitious owner-managers to explore, challenge and resolve issues that are central to the sustainable success of their organisations. The Network is led by its members and is prefaced on openness and honesty, mutual respect and confidentiality.
For further information contact Dr Simon Raby on 01227 824740 or S.O.Raby@kent.ac.uk
References
[1] European Commission. 2005. Best Practices of Public Support for Early-stage Equity Finance, European Commission, Brussels.
[2] OECD. 2004. Venture Capital: Trends and Policy Recommendations, Science Technology Industry, Organization for Economic Co-operation and Development, Paris.
[3] Cumming D.J., Johan S. 2010. Venture capital investment duration, Journal of Small Business Management, 48 (2) (2010), pp. 228–257.
[4] Dimov D., De Holan M., Milanov, H. 2012. Learning patterns in venture capital investing in new industries, Industrial and Corporate Change, 21 (6) (2012), pp. 1389–1426.
[5] Rosenbusch N., Brinckmann J., Muller, V. 2013. Does acquiring venture capital pay off for the funded firms? A meta-analysis on the relationship between venture capital investment and funded firm financial performance, Journal of Business Venturing, 28 (3) (2013), pp. 335–353.
[6] European Commission .2006. The PAXIS Manual for Innovation Policy Makers and Practitioners, European Commission, Brussels