Merchant Banking Q&A

First you must pick your exchange. Stock markets vary massively around the world but can be categorised according to two attributes: geographic focus and customer size.

Geographic focus: Some markets are principally (or exclusively) focused on trading the stocks and shares of local companies while others concentrate on the equities of international businesses. For example, Mumbai’s Exchange caters mainly for Indian companies while New York’s Nasdaq trades global equities.

Customer size: Some markets are targeted at only very large companies while others deliberately set out to attract smaller, younger listings. In the UK, the London Stock Exchange’s Main Market is appropriate for larger companies with relatively stable risk profiles while AIM styles itself is “one of the world’s leading growth markets” attractive to smaller, younger, riskier companies with high potential. London’s Plus market competes with AIM for the best European small/mid cap companies with a high potential.

Having chosen your market you must choose your advisors. You will need an Accountancy firm, a Lawyer, a Broker and an Investor Relations/PR firm.

Armed with that expertise you will set about creating your Prospectus (the document that tells potential investors all about you) and a presentation that sells your company to those potential investors.

The accountant will makes sure your numbers are accurate, the lawyer will ensure that everything you say is true and the broker will get you in front of as many investors as they can.

All of this can take anything from 4 months to achieve through to infinity. Sadly, although many succeed, the process is by no means guaranteed and many IPOs (initial public offerings or floats) are abandoned (or “pulled”).

If it does succeed and you accumulate enough people wanting to invest in you, at a price acceptable to the existing shareholders, then your shares are admitted to the exchange for trading. And your life as a public company begins, with cash in the bank and a new public profile to maintain.

There are only two – debt or equity – although the world of Corporate Finance does its best to make them seem much more complicated than that!

Debt means that the company is borrowing money which it will pay back subject to the terms and conditions of the loan. Equity means selling shares in the company to investors.

The complexity comes in two dimensions: the actual terms of either a loan or investment and/or a merging of the two forms of funding.

Terms & Conditions: For example a company might be lent £1m at an interest rate of 5% above the prevailing bank rate in a method analogous to getting a mortgage on your house. However, the lender may choose to impose some extra conditions, not normally found in domestic mortgages. These exist on a wide range, but one common example is a Liquidation Preference. This is expressed in multiples of the outstanding loan and might be 1x, or 2x or even 10x depending on how risky the lenders feels the transaction to be. Or rather how vulnerable they believe the borrower is. A Liquidation Preference of 2x means that if the borrowing company is sold, the lender gets their original investment back plus a bonus equal to two times (2x) their original loan. So if a company borrows £1m as in the above example and is sold some years later when the Liquidation Preference is still in place, the lender will receive their original £1m back plus a further £2m giving them £3m in total.

Debt/Equity merge: a common form of debt is what is known as convertible. This means that although it is a loan (carrying interest and possibly Liquidation Preferences as above) it can be converted into shares based on conditions. And, as ever, the devil is in the detail – for example little things like – what price the debt converts at and under what conditions can lead to massive fights between investors and investees!

Settling this question requires you to reconcile the ability to service the loan (i.e. pay interest and repay the principal) and a desire to give up the minimal amount of your business. So, if a company needs £1m to grow substantially over a year after which it will be generating millions in cash it should try to negotiate a loan of £1m with an interest holiday (i.e. payments are due but postponed) for a year by when it should be able to repay the monies due. On the other hand, if the company expects it to take five years before it is generating significant cash, it should sell shares for £1m and not have the strain of adding the weight of interest payments to its cash flow pressures.

Yes. If you own or control 100% of a company’s shares you can decide everything that it does subject only to the law. This means everything from setting strategy through to selling the business or its assets. Big actions, such as changing the company’s rules (Memorandum and Articles of Association – “Mem & Arts”) or issuing new shares require a “Special Resolution” to be passed by the shareholders and these need 75% or more of the shares voted to be in favour. Other, simpler decisions such as selling core assets require the approval of only a simple majority of shareholders, namely 50% plus one share. Finally, blocking Special Resolutions can sometimes be very important, especially to founders who don’t want to see their power diluted by changes in the Mem & Arts; blocking requires 25% of the shares to vote against a Special Resolution.

So 100%, 75%, 50% and 25% are all “magic” numbers in this context.

Companies’ funders are often faced with a familiar scenario. They have “bootstrapped” their business using money scraped together from savings, bank loans and credit cards and now they need more to be able to grow to the next level. Unfortunately, when they approach institutional investors – venture capitalists, etc – they are often told that they are too small, to early stage, pre-revenue and other dismissive stories. So where do they go for that vital £250,000 which will launch them into orbit? The answer is Friends & Family. Asking people close to you can be embarrassing, but it also has advantages. First, it’s a test. If you are embarrassed to ask people who know you for favours you are probably not going to hack it as an entrepreneur! Secondly because they know and trust you, you can avoid the hard work of persuading strangers of your bona fides. Finally, because they are partly investing as a favour to a mate or relative, their greed is likely to be less than that of strangers and so the price that they will demand of you will be lower.

Yes! Apart from one day at the height of the dotcom boom it is always difficult to raise money for exciting, high-potential but unproven businesses. So the geography is immaterial. It is true that there are many more sources of growth and development capital in the USA than the UK; but a natural consequence of this is that there are therefore many more businesses chasing it.

The simple fact is that it is only easy to raise money when a compelling proposition is offered to an investor. And that can happen anywhere.

A brand is the corporate or product equivalent of a personality and reputation. And the great thing about brands is that they work for you even when you’re not aware of it. So, in stark contrast to making a face to face sales pitch, or running an ad in a magazine, having people talk about you positively when you’re not there generates business without your direct involvement. And if the mention of your company triggers a positive response in the audience, it amplifies the effect. Think of how the MP3 market looked before the Apple iPod!

Yes. Intuitively we know that’s true for judging individuals – “he’s a good guy” or “he’s a complete plonker.” The Four Pillars methodology establishes a slightly more scientific method for measuring the contribution made by teams, looking at factors such as reputation, skill balance and so on. Measuring leadership teams in high-potential businesses is important because it provides investors (and others) with a way of assessing the chances of the top management pulling off their ambitious plans and so delivering a satisfactory return on investment.