How and why attract investor to business?

Attracting an investor to a business is one of the most crucial decisions that owners of any company can make. Such a decision can be made at various stages of business development, depending on the shareholders’ strategy, growth prospects, and existing needs. The success of both attracting an investor and utilizing the investments greatly depends on the actual readiness of the company itself and its shareholders.

Before initiating the process of searching for an investor and securing investments, it is necessary to determine why the business needs an investor and whether it is needed at all. There are always alternative forms of financing that allow maintaining full control over the business. Nevertheless, there are numerous situations where attracting an investor is justified and a harmonious decision.
 

Reasons for attracting investor

• Obtaining funding for expansion and development

In certain cases, additional share capital may be the only form of long-term financing for the business. This can be associated with both a high level of credit load and the early stage of business development, such as venture investment.

• Enhancing creditworthiness

Additional share capital reduces core indicators of debt burden, automatically improving the entity’s creditworthiness. This can apply to both overall creditworthiness and the ability to finance a specific project. Banks and other creditors typically require mandatory equity participation in a project (ranging from 20% to 50% depending on the risk), and this share can be provided by an investor as part of a broader arrangement.

• Access to new knowledge and experience

Investors often have valuable expertise and knowledge in the business sphere that can be utilized to enhance the efficiency of company management. This can include specialized industry knowledge as well as the best management practices. An investor may provide advice or even take responsibility for aspects such as strategy, marketing, risk management, process optimization, and even R&D or attraction of specific market-related competencies.

• Expanding business network

Investors often have a broad network of contacts within the business environment, which can be leveraged to attract new clients, partners, or even talented professionals with specific expertise.

An example could be the company’s entry into a new market, where the investor becomes not only a source of funding but a reliable partner, enabling the business to grow rapidly due to the investor’s understanding of the market specifics and their existing contacts.

• Risk sharing

Attracting investments allows for the distribution of financial and non-financial risks between founders and investors. This includes potential losses from an unsuccessful project and risks associated with decision-making through the introduction of additional competencies.

• Driver for innovation and development

Investors often focus their efforts on innovation and implementation of cutting-edge technologies, stimulating companies to develop and seek new solutions. This helps businesses stay competitive and align with current market trends. Business owners often articulate this need as a desire to gain a fresh perspective or new ideas for further development.
 

Drawbacks and potential risks in attracting investor

It is important to keep in mind the drawbacks and potential risks of attracting an investor (if it does not involve a full sale of the company). Primarily, this involves significant changes to the rules of the game: the investor will stake a claim on a portion of the value created by the company in the future. Additionally, they may participate in management and demand greater transparency from current shareholders and management.

By and large, this is a significant change that shareholders may not be ready for at the beginning of the process, but it is usually beneficial, as it allows them to streamline not only their relations with the investor but also between existing shareholders, formalizing long-term verbal agreements through a shareholders' agreement.

The risks associated with bringing in a new shareholder can be linked both to the investor's behavior (such as raiding risks) and the potential conflicts of interest in the future. Additionally, commitments to the investor can create additional pressure on the business in the future, leading to a loss of flexibility, the need to buy back shares at a certain valuation, etc.
 

Types of investors

Investors can significantly differ in their motivations, strategies, competencies, and even legal constraints in investing. These can include individual (private) and corporate investors, angels, sovereign funds, international financial organizations, and large groups through their investment departments. However, the most crucial distinction lies in categorizing investors into portfolio and strategic, as their investment strategies vary significantly. Understanding these differences is crucial when selecting a potential partner.

• Portfolio investors

As part of a portfolio strategy, a portfolio investor invests in various companies to diversify risks. Therefore, they do not seek to acquire a controlling stake in the company or take direct involvement in operational management. Such an investor plans to profit from the growth in the company’s value over a limited period, acting as a minority shareholder with limited control over the company.

One of the most popular types of portfolio investors is investment funds, which typically invest 15-30% in companies and actively participate in business development. These funds traditionally have an investment horizon of up to 5 years (although in different situations, the term may be much longer), after which they will either attempt to sell their stake (including to a majority shareholder according to defined rules and valuation) or sell the company together with the majority shareholder to a strategic investor.

• Strategic investors

A strategic investor differs from a portfolio investor in that they seek to take direct involvement in managing the company, bearing primary risks, and reaping primary benefits from the growth of the business.
Typically, these are companies operating in the same industry as the business in which they invest, seeking to increase their market share, enter new markets, or improve their own efficiency through such deals.

Strategic investors often aim to acquire 100% of the company but may choose to retain current shareholders and management for a certain period to oversee the company, and optionally — leave them with a minority stake for greater motivation. Such a structure, for example, may be considered when an international group acquires assets in a country where it is not yet present, and understanding the market from the perspective of former shareholders and management is critically important in the initial stages of integrating the business into its structure.
 

How to attract investor to your business?

Certainly, there are no universal rules for attracting an investor, but in general, we can outline some general recommendations that will help determine the format and process of seeking investment.

• Defining the purpose and reasons for attracting an investor

Initial self-analysis would be very useful. Shareholders should determine the current state of the company and the market in which it operates, as well as the purpose of attracting an investor. The most understandable for any investor would be raising funds for business development or a complete exit from the company, while resolving corporate conflict by involving a third party may be perceived as a ticket to war.

One of the points of analysis should be the appropriateness of attracting equity capital rather than debt capital, as equity capital is typically more expensive in the long term. 

The choice between a strategic or portfolio investor can also be made at this stage: a portfolio investor would be a beneficial partner if shareholders seek rapid development and are not willing to compromise control in the short to medium term, whereas if the desire is for a complete exit from the business, a strategic investor would be the right choice.

• Engaging a financial consultant

Typically, expertise in investment attraction is specific, and most companies do not fully possess it. A professional financial consultant (often specializing even further in M&A advisory) can provide a range of services that allow for the best outcome:
 

•    Assessment of the company's readiness for investment and providing recommendations for improving its current state (typically, the consultant also assists with implementing these changes).
•    Business or project valuation, financial modeling, and business planning (it is important to communicate with potential investors using the language of numbers).
•    Development of a strategy for raising additional capital, as capital raising often involves a combination of investments, debt capital, and other forms of financing (such as export financing for equipment). A separate option is the development of a capitalization and exit strategy.
•    Searching for potential investors, conducting negotiations, and if necessary, conducting a tender to obtain the best terms for shareholders. 
•       Due diligence support and deal negotiation process. 
•    Further support in implementing the agreement if necessary.

Engaging a financial consultant is not just about gaining specific expertise but also an opportunity to facilitate communication between shareholders and potential investors, which creates competition in the process and allows for better results for current owners. Additionally, as a result of the financial consultant's work and analysis, a new capital-raising strategy may emerge, significantly different from the initial vision of the owners.

Expanding the circle of potential investors always benefits the end result. Therefore, even if someone from potential investors independently approaches the business owners, it is always worth discussing this possibility with a consultant and, if necessary, involving other investors in the negotiations.

• Discussion of the terms of investor attraction

After determining the basic structure of the deal (full sale, partial sale, attracting a portfolio investor) and a shortlist of priority investors (or even a single winner), the most critical stage is agreeing on the terms of investment. Typically, these terms include:
 

•         Business valuation, investor's share and investment volume, deal realization timeline. 
•    Investment directions, other sources of capital. 
•    Investment horizon, projected returns, responsibilities regarding joint exit or buyout of the portfolio investor. 
•    Investor's participation in business management, access to information, investor rights protection. 
•    Rights of the initial business owners (if they remain minority shareholders along with the strategic investor).

The role of a professional consultant (both financial and legal) at this stage can be decisive, as it involves not only securing the best terms at the time of the agreement but also anticipating risks and potential future liabilities. Therefore, it is important to fully leverage the expertise of advisors possible.

In conclusion, it’s worth noting that investments can be attracted by almost any promising company at various stages of development. However, the effectiveness of such a step will depend on a multitude of factors. Therefore, thorough initial analysis of alternatives remains the primary recommendation before embarking on any process of seeking potential business partners.

If you have any additional questions about investing and a new investor, financial advisory, business valuation, etc., please contact BDO in Ukraine.

The material was prepared by Andriy Borenkov, Head of Advisory at BDO in Ukraine, at the request of Liga Zakon