This webinar brief has been written by Prayrana Singh from NAVRACHANA UNIVERSITY and has been edited by Oishika Banerji.
GUEST SPEAKER: ARUN JOSHI
DESIGNATION: CMD, APOHAN CORPORATE CONSULTANTS PVT. LTD
HOST: ANUBHAV GARG
ABOUT THE SPEAKER: Mr Joshi is an MBA advisor with professional experience of 22 years across industries, sectors, projects, geographies in the reputed company in India. He has been involved in 240+ worth ISD 2-3 Billion which includes equity funding transactions, financial turnaround, slump sale, Greenfield project funding, financing of acquisitions, PPP projects & many more.
Why is investment in SME better than a start-up or listed company?
In the stock market, any person would only invest in a popular or listed company rather than in a new company, so the valuation of the listed company would be high as compared to the new company with the same turnover. Also, the business external and matrimonial risk would be the same for both the company. The investment in the listed company than the new company could be because of risk perception. And the risk perception is because the ability to engage the SME promoters for equity investment is not there in most of the private or institutional investors.
The process begins with educating them on what is equity, then removing their miss-conception about their equity investments. Most of the SME documents are in the form of minimum documentation required to operate. There is no documentation to communicate to the external stakeholders. What is there in the company?
Why doesn’t the investment happen in SME?
The investors have to borrow the verbal of the SME promoters at face value, which is very difficult for one to do. Secondly, the process of mergers and acquisitions is very lengthy, rigorous, and this rigorous process is not instituted by the SME promoters. So there is a difference between the financial attractiveness and the actual process of investments which requires the existence of documentation, well presentation, and logical rational offer. It requires the evaluation; the investment contract etc. so the SME ran after the clients to sell these products and they actually never interacted with the investors and doesn’t have knowledge about investments.
One’s behaviour or one who offers to the investors is not very logical and rational represented by the perfect people as well. That is why the investment doesn’t happen in SME, so the absence of investment in SME’s is not because of the financial investment worthiness or lack in the SME’s and also not because there is no money with the investors, the investor would invest where there is a fair proposition both the parties, the SME deserves to take equity funding and the investors.
Why is investment in SME is better than in start-up & listed companies?
There is a large fail of consulting the infrastructure on the financial intermediary infrastructure. In a very large company, there are well-educated CFO, elaborated financial departments, dedicated project teams to look out the merger and acquisition activity, in case of SME, there is no second run important finance person to deal with the people so, therefore, the deals don’t happen at all. In any company whether large or small a promoter has to do corporate functions, technical functions, support functions etc, so in a big company there are many people to do all these functions.
In small towns there are few people to do all these activities, most of the time is spent in technical functions. They have very little understanding in producing and making a profit and don’t have basic knowledge of corporate function. Investing in a start-up is as good as investing in the set-up as 99% guarantee of failure, 95% of start-up fails after the investment spent 4% will fail after a couple of years so no investor would like to put money in the start-ups when there is such a great probability of losing the money.
Among all the investors there are some specific investors known as a venture capitalist, is a small one. Purpose of investment and risk appetite is not the mainstream appetite of the merger and acquisition activity. No investment is right or wrong but every investment has its own advantages and disadvantages. If one invests in well-listed companies then there is good security but less growth, if one invest in start-up then there is high risk less growth and if one look at the SME’s then there is a balance of risk and growth is more than normal if we consider that the stock market return is 12 to 15 % then probably the return in SME in which the technical promoter takes care of the technical function, financial promoters take care of the financial corporate strategic functions. The company has a good return but not as wide as the one in the start-up.
Common misconception among SMES regarding equity funding
The specific misconception of SME regarding availing equity funding one of the things is like there is a prolific network of banks and bank funding there is a visible network of investment professional or investors or investing institutions or any people like that so the first misconception SME of equity funding is the where these investors exist. They generally mistake the professional’s chartered accountant or company secretary or lawyers as the MMA consultants who actually connect to the parlance are called referrers. The people who do certain execution of scopes are called brokers.
Mostly the SME engage the chartered accountants for the purpose of equity funding into companies. But most of the chartered accountants are into the accounting, auditing and taxation and they do not have the exposure to the merger and acquisition world and investors. Most of the SME’s are related to these types of chartered accountants and they take them as one of the higher mutual exclusive consultant agreements. This is one of the areas where the SME selects the incorrect consultants.
The second thing is the SME knows the scope of work in the merger and acquisition and they think it’s a very simple process in which one needs only investors and to issue the share in its name but they do not know the types of strategic transactions. They cannot come across the deal structure of their specific transaction. It could be like asset sell, share transfer transaction in which money doesn’t come into the company but it goes to the personal account of the shareholder it could be a corporate transaction with existing stakeholders such as bonus issue, rights issue.
There could be a merger and acquisition or demergers. There could be another strategic transaction, in which nothing happens to the company but a new entity takes care of the plan between two companies so these people cannot conceive the deal structure they just hire one type of professional. There are around 51 steps in the merger and acquisition process and the SME finds that process with too much involvement and decision making of SME.
Another misconception is the dilemma between growth and control. Most of the times people see that partnership fails and there is more media discussion about the partnership than the success of an alliance, and this is seen nowadays, when two individual starts a new activity there is hardly to share or fight or to agree or disagree about so they do not enter into a formal contract and as the business gets more complex lot many assets, risk, liability comes in and since there has nothing agreed with them they can agree when the complexibility is less. Most of the SME things that they would be able to work with another partner with whom they have not worked in the past. They engage without the contract and only see the negative aspects together.
There is very less money available to invest in SME as a number of investors are very less. Money that is associated with the business but there has to be proper communication there. So there are numbers of the platform for the investors where they come together and discuss things.
The brokers as consultant and chain of around 8 to 10 brokers and they take a lot of time and hesitate in connecting the final buyers and sellers in the absence of inter broker agreements of sharing their broker’s fees. Sometimes broker’s fees are mistaken for consulting fees by the SME’s there is a huge misconception around the world.
Step for securing SME fundings
- Appointment phase: – The SME business should ensure that there should be a detailed discussion in first hand which will assess whether they are seeking equity funding or something else. The degree of equity funding is very high and also equity funding is not possible for the business with low revenue. They should sign the NDA so that the confidential information is not passed on by the parties when discussing it. The NDA which is signed in time can circulate documents and make proper decisions. There are three types of NDA one is between the consultant and the SME business, then there is a consultant and the consultant of the counterparty, and there is principle to principle or mutual NDA, then after the acceptance to the proposal and then the consulting contract execution. None of the output is technical. Aggregation should be of good quality, and the scope of work should include all this activity.
- Inception phase: – where the detailing of requirements is done where they discuss why a business is funding and why the existence equity funding is not sufficient. Option available for raising money, what is the cost of the entire transaction in business.
- Identification phase: – where there is a profile of the seller and communicate with them. Study of investor’s communication and then prepare the profile of buyers and study what kind of buyer or investor they are looking for. Collect the buyer’s due diligence information after which they know the expression of interest by investors then shortlist the serious investors.
- Detailing phase: – where one should have the financial model at this stage, there next is the selection of professionals like CA, CS, lawyers, and technical experts are required. Then we should have a business term sheet and business valuation report. One should be the seller’s due-diligence.
- Closure phase: – there is a BTA model, negotiation, signing, fund transfer, success fees and hand-holding at the end.
Process of equity funding of SME in short
As an SME business one’s first activity is to hire a professional consultant with the presentation on the scope of work. One should not hire anyone to understand the process. The second thing is deal structure, so businesses need not worry about loss or compliances as they are secondary. The third is the identification of the party. And the last one is the evaluation and the contract.
Importance and content of an investment contract
In the case of small and medium enterprises, the need for preparation of a financial contract for long-term strategic relationships and transactions is not paid as much serious attention as should be paid. The understanding between the parties is verbal or is written down in a very cursory manner. It has been observed that the requirement of having to prepare a detailed financial contract is seen as a symbol of distrust in many cases between the partner friends in an SME company. Going is good in the beginning, and there is not much to fight for or to fight about, everything sails smooth.
But when the business becomes wealthy and complicated, a lot of new assets, liabilities, rights and obligations, decisions, duties arise which the friends were not aware of before. There is no clear framework between the partner on how to share these positives and negatives. In these circumstances, misunderstandings might get developed and may also ultimately lead to a breakup. When these people approach for dispute resolution, in the absence of a contract, exactly what happened in history is taken as what was contracted.
Importance of financing a contract
Many properly organised institutions and organisations dealing with small and medium enterprises will not work without a written down the formal contract. The businesses think that the terms and conditions of these contracts are non-negotiable including the clauses on the prices. Their contract is very elaborate as they are prepared by the giant financial institutions who have a wide variety of risks. So the business ends up accepting all the standard terms and conditions, completely in the favour of the institutions without a single word of negotiation.
However, when it comes to the relationships between a business (as the legal entity) and the most important stakeholders of the top of the management, or between individuals very close to it or between the other businesses very close to it, elaborate contracts are not prepared even if large value and long-term transactions are being carried out
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