When is it right to tap up potential private investment, what types are out there and how do they differ, how do you know if you and your business are ready, what are private investors looking for and, most importantly, how can you ensure you close that vital deal?
It is apt the last segment of our foray into the fickle world of financing is focused on private investment. Unless your hotel, restaurant or pub business is ready to attract second round funding or float an initial public offering (IPO) the chances are your final step on the path to getting backing after banks and specialist lenders will probably be private investors.
“We all know the reality of the situation in the economy we are in at the moment – the banks won’t fund it all. Private equity comes in to complete the deal,” Mauro Biagioni, director at NVM Private Equity, tells BigHospitality.
With responsibility for the investment activity in the North East, Biagioni was part of the team that invested in Wear Inns to fund its expansion plans. He says private investment is the only option for many hospitality businesses.
“There are sub-sectors in the market that just aren’t bank fundable at all – it is either private equity or nothing,” he argues.
What options are there?
However any serious business owner knows just because the recession is putting a halt on bank lending it doesn’t make getting funded privately any easier. If you thought putting that attractive proposition to the bank together was difficult – convincing a private backer their money can grow in your company is even trickier.
The most important first step is to identify the different private investment options. Put simply where a bank can make its money back through interest any private investor is someone, or a group of people, that take a share of the business with a view to seeing a capital gain when the company profits grow as a result of the investment.
At the far end of the scale can be friends or family parting with their hard-earned cash to support a business led by someone they care about. So-called ‘love money’ is increasingly common. Angel investors, or high-net-worth individuals often with knowledge of the industry they invest in, are also an option.
Finally ahead of advanced second round funding or company flotation, the other viable private investment option for hospitality businesses is private equity (PE) houses. While PE is essentially money from an investor, or investors, set of funds decided by the firm’s investment management team there are various strategies the houses will use.
Generally an investment of this kind will be on a 3-5 year deal with a view to making around a 30 per cent gain in the initial investment. However strategies can differ from full leveraged buyouts to minority investment growth capital in generally mature businesses or venture capital which is high capital and high risk and tends to happen at the start of a company’s history.
Exits from PE deals, when the investor gets his or her return, can be mergers, acquisitions, recapitalizations or an IPO.
What is right for me?
For a business owner grounded in the day-to-day operations side of a hospitality business the world of private investment can seem a daunting prospect. However the reality is the type of investment that is open to you will narrow depending on the development of your company and what you need the cash for.
Biagioni describes the type of investments NVM Private Equity is making: “We are at the exciting end of the market. It is not a start-up so you are not taking that risk but it is a small model that has been proven and you have a small team that want to accelerate that growth.”
If you are looking for start-up funds then unless you have a long, solid background in the hospitality industry already and have a full business plan the likelihood is many small-mid size PE houses will not give you a second look. Most of these firms will be looking to invest in an established business looking to make the next step in terms of expansion, acquisition, change of ownership or concept rollout.
If however you can show an investment in your idea could drive significant profits then venture capital may be an option open to you. If not, friends and family and angel investors are your likely targets.
That was the conclusion Ben Fordham, co-founder of restaurant chain Benito’s Hat, made when he was starting-up.
“In the early days we didn’t have a lot of contacts in the restaurant world at all so didn’t really look for what people could add to the business it was just ‘how are we going to get together money full stop’. Now with a bit of hindsight when we now look for money we don’t just look for someone who can come in with cash but someone who can add value, experience or knowledge.”
At the outset Benito's Hat was founded by friends and family, including Fordham's Dad, and a wealthy individual known to the founders. They then moved into bank financing and most recently an angel investor with sector experience.
"I felt much more comfortable with investors," Rohit Chugh, founder of Roti Chai (former Cinnamon Club MD), tells BigHospitality. Like Fordham he was looking for someone who could add more to the business than cash alone.
"I think we do have a good relationship with one of the banks and they are involved in a small part of the business. Because I come from finance, I know the area really well and I left it because I’m not that way inclined, I’m much more about passion."
"The people that have invested in my restaurant have walked in and congratulated me on it all, which is an incredible feeling – they’re not just coming in and asking to see the balance sheet and look at the numbers," he adds.
Whatever type of private investment you feel is right for your business needs it is important to remember you don't have to put all your eggs in one basket as Fordham explains. "You don’t want to have to give away equity if you don’t have too so a combination of bank and equity would probably be the way we look to go for the next round."
How does it start?
Like many deals those with private investors come about for a variety of reasons but are predominantly led by a meeting of people and personalities.
Fordham is now embarking on his latest round of financing looking at a number of options to raise £1-1.5m with private equity groups making the approach and showing interest in the Benito's Hat business.
Until your business has a similar reputation direct approaches from an investor will be rare. In the same way businesses tend not to make direct approaches to private equity houses but contacting friends and family or potential angel investors direct happens more.
For PE using who you know and working through known lawyers and bankers in the region and community is the way to go.
As Biagioni points out this is still a personality fit - investors are making a deal with people not numbers.
“Wear Inns was a direct approach. The difference with it was it had quite a sophisticated management team. In the managing director you had an individual that knows that market very, very well, has worked in it all his life and has managed hundreds of pubs across the UK.”
Established personal relationships with friends and family may make this an attractive proposition but Fordham points out it should not significantly change how the deal comes about.
“It certainly does differ but I hope it doesn’t too much – we were fully aware that when we were setting things up, albeit with friends and family, we wanted to do it in the right way and we had to repay their trust. What we put together in terms of a business plan on day one was a pretty comprehensive 40-page document with investment highlights and risk assessments.”
What closes the deal?
Once an approach has been made and a relationship developed business owners should be prepared for significant due diligence (DD) processes. Know your market, competitors and your business inside out.
“I like to keep things simple so I have a tick box," Biagioni says. "Firstly, what is your management team like? The key guy who is going to drive the value – where does he sit in the business, who is he? Obviously we want to spend a lot of time with him and understand his plans. Secondly, in terms of the plan, is there a key business plan in place? Is there a financial, strategic plan to the point where we can commercially understand the market and where it is going?”
Fordham concurs: “It was a lot of work but not a bad exercise for us at all. The questions he was asking were the ones that needed to be asked in order for us to take the step up.”
As well as being prepared for financial, management, legal and commercial DD, to secure private equity investment you need to be prepared to show an exit strategy - how you can deliver a 30 per cent return in three to five years for example. Also be prepared for possible management changes - perhaps a chairman appointment.
Private investment checklist: Is your business ready and what do you need to do?
- Decide what stage your business is at and what you need the cash for. This will decide if you need private investment and if so what type.
- Do you have a detailed business plan with projections, reasons for forecasts and any holes in the document explained? This needs to be a totally robust document that is true to the market you operate in.
- Develop a good personal relationship with any potential investor before you make a deal.
- Know the risk and return of investing in your business.
- Surround yourself with good advice - lawyers, bankers etc.
- Does your business have gross profit margin of around 70 per cent, can it get there and will it deliver a three times investment return?
- Know your exit strategy.