WHAT’S THE DEAL? 247
What’s the deal?
If you are going cap-in-hand to your bankers, you will be telling them that you want a
$10,000 increase in working capital … or a $25 million loan for the specific purpose of
acquiring the following assets, with repayment proposed … They will mumble some
incantations and arrive at an interest rate that they want to charge you. (But do not
accept it – negotiate.) It is not quite so simple if you are looking for equity funding.
In theory, you value the business (we will do this in a moment), see what proportion
you will raise, and allocate a chunk of shares accordingly. The business is worth $10 mil-
lion today, you are raising $1 million; therefore, you will swap 10% of the equity capital
for the cash. Sometimes it works in much this way, especially for an established business
with a known price for existing shares. Of course, you have to take perceptions of risk and
reward into account.
Frequently, you will work backwards. You place a value of $10 million on the company
(stock market listing or trade sale) at the likely exit point, say, three years hence. You need
$2 million now, your investors’ required overall return is 100%. This means that the inves-
tor wants $4 million back in three years’ time, equivalent to 40% of the equity at that
point. So you issue 40% equity today in return for $2 million.
Sometimes, it is entirely down to supply and demand. You need restructuring capital.
There is only one offer. Take it or leave it. As a point of interest, 40% is a magic figure. I have
shown potential backers varying profits and cash flow projections with the same business
proposal, and they have all tried to negotiate for 40% equity. Maybe it sounds to them as if
it is the largest proportion that they can get away with? It is not always like this. Capital pro-
viders will come in for anything between 1% and 100% depending on the proposition.
What do you want it for?
Seed, venture, start-up, adventure, risk or injection capital are various names
for the cash needed to get a business off the ground.
Working capital is money used to pay for inventory, salaries and other production/
Fixed capital is money locked up in fixed assets such as buildings and equipment.
Growth capital is cash targeted specifically to fund expansion.