Paul McPadden: It's wise to seek out investors before you need capital

There's a multitude of different financing alternatives over and above bank debt. Photo / Janna Dixon

Get professional help to determine what type of finance is appropriate, writes Paul McPadden.

At what stage does an SME generally seek a new shareholder or some form of external finance?

SMEs have often grown in a relatively orderly fashion over time using retained profits and modest bank debt secured over the business and other assets of the owner. Business owners are generally good at managing growth without the need for large "demanding" capital investments.

However, when a significant growth opportunity or need arises, like new plant or the acquisition of a competitor, the owners want to raise capital. It is sometimes too late at this stage. Investors and financiers need time to evaluate the business, the industry and the investment opportunity. Start discussions before the need arises.

What process should an SME go through before approaching potential parties?

Be clear and concise in outlining your existing business and the opportunity available to the company. You should then seek professional help to determine what type of finance is appropriate and what return is necessary for investors/financiers.

What other money-raising avenues are available to SMEs?

There's a multitude of different financing alternatives over and above bank debt including trade finance, equipment finance, mezzanine debt, high net-worth investment, private equity and even a public offering. All of these financing sources have their place but it is unlikely that all sources would be appropriate or practical for all SMEs.

When does a stock exchange listing suit?

A listing on the stock exchange is possible if the business and the opportunities are suited to listing on the stock market. Often business size is a barrier to a public listing because of the cost and ongoing compliance involved in a public listing. Companies with high growth projections and hence high capital needs are likely to be better suited to public listing. Companies such as Charlie's and Diligent were relatively small listings that had high growth plans and the potential need for capital.

What are SME attitudes towards taking on new shareholders?

Control is the key concern of SME owners. Obviously apprehension and caution also prevail, especially if the owner has not already developed mature existing relationships with potential shareholders or financiers.

Dilution of the owner's shareholding goes hand-in-hand with the control concern. My advice is to focus on what additional benefits you can access from the investor, over and above the money, to help balance the inevitable dilution with the issue of new share capital. The reason private equity firms like Direct Capital and Waterman Capital have been successful is because they have brought more than money to SMEs to help them grow - things like governance, reporting and discipline, industry connections, acquisition capability, banking relationships, overseas networks and simply outside support for the management team.

How do you protect your company if things go wrong with new shareholders?

At the outset, the rules and procedures should be laid down in a detailed shareholder's agreement, to deal with the common issues that can arise - a bit like a prenuptial agreement. You don't intend to ever use it but if it is needed it clearly sets out the rules. Ensure the investment is structured in a way to ensure the investor's objectives are 100 per cent aligned with those of the owner.

Paul McPadden is business advisory national managing partner at KPMG