Back to Basics: Choosing the right investor

Different funding groups will have diverging views on investment and involvement in your business. When starting out, the key is to take a step back. Ask yourself why you need the funds, what you are trying to achieve and what timeframe you are working to. Prepare thorough forecasts that show the strength of the opportunity (and that you understand and have addressed the risks). Then look for funders that match your requirements. Search broadly — do not just turn to the obvious investors that you know. This all seems so simple, but many people who seek property investment skip this critical step. If you are too flexible with your strategy and flex it purely to suit the requirements of a particular funder, you are already on the back foot. This creates an artificial position that could unwind after you receive the funds, leading to a dissatisfied lender and — ultimately — a dissatisfied borrower (you). Debt funding Traditional debt providers like funding property. With an asset to secure against, gaining funding from such providers is relatively straightforward and understood by both lenders and borrowers (thanks to a loan form document with covenants and pre-agreed, regular payments). However, this type of funding is subject to the vagaries of interest rates and fluctuations in property values, which can affect timing and appetite from both sides. While clearing banks traditionally led in this field, there are now a multitude of challenger banks and alternative debt products with the appetite to support such transactions. The more complex funding comes from private equity, family offices and some property-only debt providers. There are an array of private equity and family offices in the UK. Some even specialise in investing in property-related businesses, yet this type of funding is more expensive and complex than the traditional debt route, with various terms that require negotiation. Private equity funding Private equity investment works. While there are many statistics that prove added value — such as businesses that have had private equity investment at some point seeing 3% higher average annual growth in assets — shareholders must make an informed decision and understand the process they are entering into. It is not for the faint of heart. Equity funding is usually preferred where you are making a step change in your business. As equity funders generally want a seat at the table, you will need to think beyond price and look at what else they can offer. As a key stakeholder in your business, an equity funder requires more access and dialogue than a debt provider, acting as a sounding board for key strategic decisions. They should be able to add significant experience across a breadth of sectors. Often, a non-executive will be placed on the board post-funding. This should be a joint appointment from the equity provider and the business to fill a skills gap or fit a requirement to diversify trade. Equity funders will also require shares in the business. The level of shares given will depend on the valuation agreed at entry and future projections. As a rule of thumb, equity funders generally look to be in a business for around three to five years, after which they require an exit to return funds and reinvest in other ventures. Some equity funders are described as “patient capital” and can hold investments for longer periods of time. The agreement on timing to exit should be reached pre-deal so that shareholders are aligned. This does not prevent further transactions outside of this timescale, as markets can change, but funders will have certain thresholds that the investment needs to reach in order to be successful. In any equity deal, much time is spent on agreeing the subscription terms (effectively, the “prenuptial agreement”). These are only referred to in circumstances where the business has moved away from its outturns as presented when the original investment was sourced. High-net-worth funding High-net-worth funding can be a good alternative but the issue here is finding a suitable investor. You will need to tap into the right networks to find the HNW option that suits your requirements. Unlike private equity and most family offices, HNW investment may require involvement in the day-to-day running of your business. This must be understood and tested early on in the process. Similarly, there is no “house style” with HNW funding. This can have both pros (like more flexibility to agree on points that suit both parties) and cons (like the need to negotiate all points, with HNW views potentially being more stringent than equity house rules). As there is no precedent to see how they operate, the HNW investment process can range from the speedy to the tedious. Mezzanine funding Mezzanine funding is effectively a hybrid between debt and equity. It is often used where the funding proposition is too rich for a debt provider but does not hit the hurdles required for an equity investment. Typically, this type of funding would be repaid in regular instalments (similar to a bank loan), with an added redemption premium payable on the final repayment. This premium will be calculated to achieve an agreed return which should be commensurate to the risk taken. Personal contacts Borrowing from family and friends can be easier in the short term, but may lead to problems later on. It is important to agree the terms before investment, so that all parties understand the “rules”. You will also need to ensure that “personal” and “business” are kept separate — this transaction must be properly documented and not be part of an emotional decision. How are your properties held? There is an important correlation between funding and how your properties are held. Looking at the two extremes, a funder could be making an investment into a trading company with an incidental property portfolio (such as a supermarket or high street chain) or a property investment company (where the main trade is in property). If property is incidental, the focus from funders will be predominantly on the trading aspects of the business, with the usual property protections undertaken as part of the process. If the properties are the focus of the trade (for example, with a property lettings business), the funders will focus on the quality, condition and title of the stock, as well as (potentially) wanting some say in the terms of any lettings. Ultimately, while both options will attract funding, they will attract very different funders. A further consideration is to consider how a shareholder could increase value by extracting the property from the business before any investment. This only works where the freehold of the property is incidental to the value of the business. Most businesses subject to a transaction — whether, for example, that is a management buy-out or disposal — hold property either as freehold or leasehold from which the business trades. When valuing a business, the value of the freehold property does not always impact the enterprise value of the business. Quite often, we see the owners extracting the property pre-deal. This can be affected via a sale and leaseback or held with you as the landlord. However, the value of some businesses is intrinsically linked to their enterprise value in that it is helping to generate trade. In such cases, negotiation is required to maximise the funding opportunity to suit both business and shareholder aspirations. Property development The funding options above assume that your properties exist. If there is a degree of development or construction required, this adds another layer of complexity to fundraising as the risks must be factored in. Quite possibly, bridging funders may be required until the development is complete. At this point, the business can be refinanced to provide funding that is suitable and priced to the level of risk taken. Regularly review your funding The final point to note is that there is not usually a structure that suits a business throughout its various growth stages. Businesses should regularly review their funding structure to ensure that they’re maximising all possible avenues. A failure to do so may result in opportunities being missed. Remember, it is easier to raise funds from a position of strength than weakness. Next time Restriction or notice? A comparison of the key differences between restrictions and notices, explaining which should be used and when in land registration Paula McGrath is principal and head of deal advisory at Brabners Image © Scully/imageBROKER/Shutterstock