The Quality of Money


Posted by MalcolmEvans on Saturday 9th of July 2011 | 0 Comment(s)

Much of the debate around earlier stage investment revolves around the so-called "funding gap".

There is, indeed, a shortage of funds in certain areas, although the issue is much more subtle than any shortage of capital per se.

A related issue, which we feel is almost completely overlooked, is that of the quality of money, whether investment carries with it benefits over and above the raw monetary value of the sum invested.

How can one tranche of £250K investment be different from another tranche of £250K? A friend asked me this a couple of days ago as he considered which of two offered packages to accept into his fast growing business.

I told him about our theory of The Quality of Money and I am sharing it with you, too, as it has grown through many live funding scenarios into a useful and unique tool to assess the optimum possibilities within investments.

As with all our research work, it is designed neither to prioritise the interests of financiers, nor those of investee businesses and projects. As ever, the focus is on value creation itself.

The Quality of Money evaluates seven dimensions to investment packages -

Evaluation:

Can your potential funder bring knowledge and expertise to the table? Do they seem to be asking the right questions? Are they challenging you? Don’t for one minute think that a potential funder who knows too little, asks too little and over whose eyes you feel you can pull the wool is any way a good funder.

Businesses need funders who can evaluate propositions thoroughly, helping you spot things you may not have fully explored.

Money which is poor at evaluation may help condemn you to several exhausting and unproductive years chasing a dream which is simply not viable.

Network:

Is your potential funder bringing new connections? Are they capable of extending your horizons over new marketplaces, new potential partners and new sources of complementary competence?

Support:

Can your potential funder quickly establish a constructive relationship with you (and your key people) which brings significant motivational and management support? Are these people who you would talk to about your fears and your dreams anyway? Do they bring not only general business acumen but also expertise specific to your own domain of operations?

Quantum:

Does the figure which your potential funder is prepared to invest seem about right? Too little and you might be left nowhere, having not achieved anything particularly significant and thus placed in a very poor position with regards to any possible further funding. Too much and you might be both taking unnecessarily high dilution and also possibly storing up future problems concerning future funding once the initial hype around your company subsides and you have to settle in for the hard grind and hard-won growth that is the normal.

Have you worked closely together to come up with a figure which gives strong prospects for growth but which also recognises the ongoing realities of funding and sustainable value creation?

Mix:

Is your potential funder offering you an investment package which fits in with what you have discussed together is in the best interests of sustained value creation? Or should there be a much greater degree of equity than there is debt, given that the company is going to be engaged in R&D for quite some time and will struggle to meet repayments on top of its business building activities? Or is the company growing very quickly through sales and, with the short term requirement of some of the funding, is there too high an equity component and would it be better to have more debt?

Conditions:

Is your potential funder taking reasonable steps to protect their investment, or are you being tied in knots, with every possibility of losing all autonomy over your affairs?

Funders are absolutely entitled to seek to strike a good deal. So long as the valuation at which an investment is made is within a bandwidth which does not limit the ongoing potential for good value creation, we are not overly concerned about valuation alone.

However, overly intrusive or limiting conditions can create damaging friction, or in worse case scenarios, can lead to relationship breakdown and total project collapse.

There is little point in tying a project in such knots that the life is strangled out of it. A consideration of conditions leads on naturally into:

Follow-on:

What happens, if you expect that you will need to raise more money in the short to medium term, once the potential funder’s money runs out? It is amazing how little thought is given to this vital issue.

Follow-on needs to be addressed up front. Where might it come from? How will this work in relation to control of the process and agreements between the promoters and this first funder?

Bad funders will either not consider it, or, worse, exploit follow-on requirements to gain total control over a project.

Bad promoters may be hopelessly over-optimistic in what they purport to achieve through a funding round, or may simply forget to think ahead in their over-excitement at landing some much-needed monetary support.

In summary:

Funders – your prospective investee should be thoroughly assessing what you can bring to the party as well as the money. If they are not, then maybe they are not the best candidates for you money. And if you have little to offer beyond your money, then perhaps you shouldn’t be in the direct investment business.

Funding seekers – if you are not exploring the seven dimensions of The Quality of Money as you seek investment, then you are dramatically limiting your chances of future success. In fact, if all you doing is looking for money, then the best thing a competent funder could do is to tell you either to reconsider, or even just to stop doing what you are doing.

Malcolm Evans is the founder of Funding Enterprise, the North West's leading authority on earlier stage corporate finance.