Guide for entrepreneurs to find right equity partner

Cape Town - Entrepreneurs looking for a cash injection often turn to private equity to give them the boost they need to grow their business.
However, if the business owner is not thoroughly prepared, this route could turn into an exercise in futility.

Gary Palmer, CEO of independent lender Paragon Lending Solutions singles out nine crucial issues entrepreneurs should be aware of before they begin the process of finding equity investors.

When entrepreneurs look for funding they should ideally be looking for debt funding, in his view. However, banks will require at least a 25% equity quotient before they consider further funding. If the entrepreneur has no cash of his own, he would need to find a partner who can bring both equity and expertise to the table.

Palmer shares his views:

What makes an attractive deal?

Investors are always on the lookout for the next great idea. But even the best idea will fail if it’s not driven by a person or team who knows their game and knows how to make business fly. Some of the most successful investments have come from equity partners who have taken a risk on a person they believe in, rather than simply backing a great idea. Essentially, they are looking for a person to back "where their competence exceeds their capital".

A private equity funder will look at four things: Firstly, the opportunity. What are the merits of the idea? Is it unique, will it fill a gap in the market?

Then they will closely assess the individual and if they are comfortable backing them. Do they have the competence to see the deal to fruition?
The third requirement is "skin in the game". What does the entrepreneur have to lose if the deal goes south and just how invested are they in the success of the deal?

Finally, they will look at focus. No investor wants to back someone who is not wholly focused on the venture or is distracted by other business dealings.

Horses for courses

Most entrepreneurs will turn to their own networks first when looking for growth funding. However, family lending has a far greater chance of failure.

Family and friends may be your biggest fans, but they are not in the money lending business. What’s more, their own circumstances may change over time and they may suddenly need their money back, leaving your business high and dry.

"It’s been our experience that entrepreneurs look for funding in all the wrong places. Successful businesses choose their partners carefully, spending time to find a backer who is not only willing, but who understands the business and the sector in which you operate," explains Palmer.

"Working with partners, who don’t understand your sector and your business, ends up adding more stress to transactions and could become a future liability."

There’s no such thing as cheap money

Many entrepreneurs will look for the cheapest funding they can find. Unfortunately, banks don’t always have experience in particular industries and so don’t understand the peculiarities associated with running a business in that sector, in Palmer's view.

"Entrepreneurs need to weigh up the premium they would pay for being with a non-traditional funder, against the experience that funder may have in understanding their business," he says.

"Entrepreneurs need to put a factor on the ease of doing business. The ease of doing business with an alternate lender far outweighs the rate you will pay and paying a premium may just be worth it in the end."

Deal paralysis

Entrepreneurs need to spend time and effort when looking for the right partner. They need to meet often, take time to understand their partners’ needs and wants, look at their culture and find out if there is a meeting of the minds in terms of the common objectives.

"That said, spending too much time agonising over the potential partnership could lead to a deal paralysis, which could permanently stall any future opportunity. A balanced and realistic approach is required," says Palmer.

Manage your expectations

Entrepreneurs look for different things when choosing a partner. Some of those who approach us are simply looking for a money investment and don’t want the investor to be overly involved. Others are looking for a big brother, someone who will guide and nurture them through the deal and into operations.

"Many big brothers are happy to perform the mentorship role, but they may not bring in new deals. We find that some entrepreneurs expect a golden key from their partner, and think they will pave the way for their new venture. This seldom happens and entrepreneurs should manage their expectations when it comes to what their funders can do for them," says Palmer.

You only get one chance

When it comes to negotiating the deal, entrepreneurs need to do their homework and be absolutely clear about what they want out of the deal, what shares they are willing to part with, what they are looking for from their partners, and what they expect from them on a day-to-day basis.

"You get one crack at negotiating a deal. Finding yourself 12 or 18 months down the line realising that you could have gotten a better deal may lead to a growing dissatisfaction, resentment, attempts at re-negotiation, and the businesses falling apart," says Palmer.

Deal momentum

Negotiating a deal is a complex process. Sometimes the negotiations are so intense, with so many parties involved, that many aspects of the deal structure are changed. By the end of the process, the deal looks nothing like it did at the beginning and this can pose a significant risk for the entrepreneur.

"They need to pause and step out of the minutiae of the deal and take a helicopter view of where it is going. For this reason, an independent financier can be exceptionally valuable. They are not emotionally invested in the outcome and have a much clearer head when deal momentum creeps in," says Palmer.

Deal fatigue – set some boundaries

Deal fatigue can also be dangerous. If you can agree that the partners have a common vision, a common set of values, and the deal looks good, then set some firm cut-offs. This may be a limit to the number of versions of the loan documents or a certain timeframe in which the deal must be agreed.

Find a partner who has a network of partners

"Independent lenders look at the details of the deal, based on realities. They can guide the entrepreneur and help find the right equity partner who will not only understand the deal, but also their industry," says Palmer.

"More than that, since an independent, alternate lender may also have a sizeable capital base, they could finance the deal, or part of the deal, themselves."