Category: Uncategorized

Let me apologise up front because this might not be one of the most upbeat of topics that I could have chosen to write about.

However, when not just one, but three opportunities came across my desk in quick succession recently all facing similar challenges, I thought there might be something worth exploring.

The companies in question were all looking to raise their next round of funding and looking for corporate finance advisers. Great! I’m a corporate finance adviser.

 On the face of it, they were attractive propositions – strong technologies tackling big problems and with some great investors already on board but in each case there was something troubling me. Casting an elephant shaped shadow over the opportunities was that I felt each company’s valuation was already too high.

Whether it was their last round price or this round’s expectation, warning lights were flickering and pointing to me that valuation was set to be a major issue – big enough to ultimately frustrate a process or at the very least necessitate some painful and protracted discussions before being resolved.

Valuations too high?

How can valuations be too high? Surely it is better to raise as much money as possible, at as high a price possible to minimise dilution?

In theory, yes but in practice….hmmm, you may be storing up problems.

A high valuation can have many causes – it might be a hangover from having raised money in a bull market and therefore different market conditions or the company having been too aggressive in fundraising and raising too much money too early. Maybe the company’s valuation today is too high relative to its commercial progress – having failed to deliver on its promise and not adequately commercialised the technology since the last round. In practice it might be a blend of them all.

Whatever the diagnosis, the treatment might be very painful.….

Securing funding at an excessively high valuation early on can introduce significant risks to a business so an awareness of how to mitigate them is essential for founders looking to navigate the venture capital world.

1. Pressure to Perform

Raising capital at a high valuation sets the bar for future performance. Investors will expect growth and returns that justify the valuation creating intense pressure on the founders and management team to achieve ambitious milestones. Failure to meet these expectations will drive intense scrutiny, and the likelihood of a down round increases eroding confidence among investors, employees, and customers.

AI-chip company Graphcore was recently sold to Softbank for a reported $500m, which might have been considered a success in normal times, until you realise that $700m had been raised and at its peak at the end of 2020 was valued at $2.8bn. Graphcore failed to adequately commercialise its technology despite this huge investment and revenues in 2022 were $2.7m!

2. Down Round Dangers

Down rounds are damaging in a number of ways – as well as existing management and smaller shareholders feeling the brunt of dilution, employee morale can also be impacted if share options lose value. A down round can create a negative perception in the market, making it harder to attract future investors or customers who may view the company as unstable or on a downward trajectory.

3. Challenges with Exit Strategies

A high early valuation can limit exit options as acquirers are unwilling to pay a premium that matches the inflated valuation, leading to fewer acquisition offers. Alternatively, if the company eventually decides to go public, it may face significant hurdles in justifying its valuation to public market investors, leading to disappointing IPO performance.

So, what can entrepreneurs do to mitigate these risks and help me as a corporate finance adviser do my job or to quote Jerry Maguire, to “Help me, help you”.

1. Set Realistic Milestones

It’s crucial to set realistic milestones and be transparent with investors about potential risks. By aligning on achievable goals, you can build trust and avoid the shock of unmet expectations. It’s better to under promise and overdeliver than to face the fallout of under-delivery.

2. Raise in Tranches

Consider structuring the funding in tranches, where additional capital is released upon achieving specific milestones. However, if you do this then any milestone need to be objectively defined with no wriggle room for delays or investment being withheld.

3. Focus on Sustainable Growth

Rather than chasing hyper-growth to justify a lofty valuation, concentrate on building a sustainable business with solid fundamentals. This includes having a clear path to profitability and positive cashflow, strong focus on customer retention, and a scalable business model.

Like Graphcore, on-line car marketplace Cazoo raised significant levels of investment, but successfully managed to generate significant revenues of £1.25b. However, rampant spending and widening losses of £700m could only be sustained for so long and a series of painful cost-cutting exercises precipitated its administration.  It has just been sold for £5m, three years since being valued at £6billion.

4. Manage Expectations

Transparent communication with your investors is key. Regular updates, both good and bad, help manage expectations and build a strong relationship with investors based on trust. If you anticipate falling short of projections, communicate this early and work together to adjust the strategy.

So, what happened with these opportunities on my desk? Although not afraid of a challenge, I nonetheless passed flagging that difficult internal conversations needed to be had before we would even contemplate getting involved.

If the company and investors had not already taken off the blindfold to see Nellie was not so much in the room but had also left them a nasty mess to clear up, then that would make for one frustrating process for all concerned.

Remember, a strong, sustainable business is the ultimate goal—not just a high valuation.

Let me apologise up front because this might not be one of the most upbeat of topics that I could have chosen to write about.

However, when not just one, but three opportunities came across my desk in quick succession recently all facing similar challenges, I thought there might be something worth exploring.

The companies in question were all looking to raise their next round of funding and looking for corporate finance advisers. Great! I’m a corporate finance adviser.

 On the face of it, they were attractive propositions – strong technologies tackling big problems and with some great investors already on board but in each case there was something troubling me. Casting an elephant shaped shadow over the opportunities was that I felt each company’s valuation was already too high.

Whether it was their last round price or this round’s expectation, warning lights were flickering and pointing to me that valuation was set to be a major issue – big enough to ultimately frustrate a process or at the very least necessitate some painful and protracted discussions before being resolved.

Valuations too high?

How can valuations be too high? Surely it is better to raise as much money as possible, at as high a price possible to minimise dilution?

In theory, yes but in practice….hmmm, you may be storing up problems.

A high valuation can have many causes – it might be a hangover from having raised money in a bull market and therefore different market conditions or the company having been too aggressive in fundraising and raising too much money too early. Maybe the company’s valuation today is too high relative to its commercial progress – having failed to deliver on its promise and not adequately commercialised the technology since the last round. In practice it might be a blend of them all.

Whatever the diagnosis, the treatment might be very painful.….

Securing funding at an excessively high valuation early on can introduce significant risks to a business so an awareness of how to mitigate them is essential for founders looking to navigate the venture capital world.

1. Pressure to Perform

Raising capital at a high valuation sets the bar for future performance. Investors will expect growth and returns that justify the valuation creating intense pressure on the founders and management team to achieve ambitious milestones. Failure to meet these expectations will drive intense scrutiny, and the likelihood of a down round increases eroding confidence among investors, employees, and customers.

AI-chip company Graphcore was recently sold to Softbank for a reported $500m, which might have been considered a success in normal times, until you realise that $700m had been raised and at its peak at the end of 2020 was valued at $2.8bn. Graphcore failed to adequately commercialise its technology despite this huge investment and revenues in 2022 were $2.7m!

2. Down Round Dangers

Down rounds are damaging in a number of ways – as well as existing management and smaller shareholders feeling the brunt of dilution, employee morale can also be impacted if share options lose value. A down round can create a negative perception in the market, making it harder to attract future investors or customers who may view the company as unstable or on a downward trajectory.

3. Challenges with Exit Strategies

A high early valuation can limit exit options as acquirers are unwilling to pay a premium that matches the inflated valuation, leading to fewer acquisition offers. Alternatively, if the company eventually decides to go public, it may face significant hurdles in justifying its valuation to public market investors, leading to disappointing IPO performance.

So, what can entrepreneurs do to mitigate these risks and help me as a corporate finance adviser do my job or to quote Jerry Maguire, to “Help me, help you”.

1. Set Realistic Milestones

It’s crucial to set realistic milestones and be transparent with investors about potential risks. By aligning on achievable goals, you can build trust and avoid the shock of unmet expectations. It’s better to under promise and overdeliver than to face the fallout of under-delivery.

2. Raise in Tranches

Consider structuring the funding in tranches, where additional capital is released upon achieving specific milestones. However, if you do this then any milestone need to be objectively defined with no wriggle room for delays or investment being withheld.

3. Focus on Sustainable Growth

Rather than chasing hyper-growth to justify a lofty valuation, concentrate on building a sustainable business with solid fundamentals. This includes having a clear path to profitability and positive cashflow, strong focus on customer retention, and a scalable business model.

Like Graphcore, on-line car marketplace Cazoo raised significant levels of investment, but successfully managed to generate significant revenues of £1.25b. However, rampant spending and widening losses of £700m could only be sustained for so long and a series of painful cost-cutting exercises precipitated its administration.  It has just been sold for £5m, three years since being valued at £6billion.

4. Manage Expectations

Transparent communication with your investors is key. Regular updates, both good and bad, help manage expectations and build a strong relationship with investors based on trust. If you anticipate falling short of projections, communicate this early and work together to adjust the strategy.

So, what happened with these opportunities on my desk? Although not afraid of a challenge, I nonetheless passed flagging that difficult internal conversations needed to be had before we would even contemplate getting involved.

If the company and investors had not already taken off the blindfold to see Nellie was not so much in the room but had also left them a nasty mess to clear up, then that would make for one frustrating process for all concerned.

Remember, a strong, sustainable business is the ultimate goal—not just a high valuation.

When entrepreneurs and their advisors consider the options available for a full or partial exit of their business, potential buyers will broadly fall into two buckets – private equity or trade. In terms of private equity, this may prove problematic where the business is over reliant on the exiting shareholder(s) (often the founding management team) and/or, there is no clear management succession plan. However, in these circumstances, Search Funds have emerged as an alternative buyer group in the lower mid-market.

A Search Fund is an investment vehicles formed by aspiring entrepreneurs to acquire and operate a single privately-held company. Unlike traditional private equity, search funds focus specifically on acquiring and actively managing a single business rather than investing in a portfolio of companies. Search Funds are either funded (i.e the Searcher raises capital from a mix of high net worth investors, family offices and institutional investors on the formation of the fund and the investors have pre-emption rights to follow their money when the acquisition is found) or they are more informal and unfunded with the Searcher having commitment from investors in principal to invest at the point of the acquisition.

We have recently completed a sale of PCB fabrication and assembly business, Garner Osborne. We concluded early in the process that a sale to a Search Fund best met the objectives of the major stakeholders. The founder and principal shareholder, who was in his early 60s and still CEO, was looking to retire from his business and the Operations Director, who was a minority shareholder, had ambitions to take the business forward. The founder was attracted at the idea of his legacy continuing, however, there was no succession solution for his retirement and a CEO with strong sales credentials was required to compliment the skills of the remaining management team. We spoke to an institutional investor who has supported circa 20 Searcher Funds and asked if they had any Searchers with specific experience in this sector, which they did. The relationship between the remaining management team and the Searcher (who is  looking to take on the role of the running the business) is key to the success of any Search Fund investment, and after a number of meetings both the Searcher and the remaining management team were comfortable they could work with one another going forward and the Search Fund made an offer for the business which was successfully completed, with the Searcher stepping into the business as CEO.

Whilst it is dangerous to generalise, it would appear from our experience that the funded searchers are typically accomplished business operators (with first hand knowledge of running a business, or division of a larger organisation) looking to own their first business and many of the unfunded searchers are accomplished investors (maybe with a private equity background) looking to personally lead their own investment. Whilst in these circumstances, the funded searcher will typically provide the neater solution to management succession, given the likely lack of deal experience, it is essential that they have strong corporate finance and other advisors particularly where they need to navigate through a competitive auction. In these circumstances, they really are offering the best of both worlds.

When entrepreneurs and their advisors consider the options available for a full or partial exit of their business, potential buyers will broadly fall into two buckets – private equity or trade. In terms of private equity, this may prove problematic where the business is over reliant on the exiting shareholder(s) (often the founding management team) and/or, there is no clear management succession plan. However, in these circumstances, Search Funds have emerged as an alternative buyer group in the lower mid-market.

A Search Fund is an investment vehicles formed by aspiring entrepreneurs to acquire and operate a single privately-held company. Unlike traditional private equity, search funds focus specifically on acquiring and actively managing a single business rather than investing in a portfolio of companies. Search Funds are either funded (i.e the Searcher raises capital from a mix of high net worth investors, family offices and institutional investors on the formation of the fund and the investors have pre-emption rights to follow their money when the acquisition is found) or they are more informal and unfunded with the Searcher having commitment from investors in principal to invest at the point of the acquisition.

We have recently completed a sale of PCB fabrication and assembly business, Garner Osborne. We concluded early in the process that a sale to a Search Fund best met the objectives of the major stakeholders. The founder and principal shareholder, who was in his early 60s and still CEO, was looking to retire from his business and the Operations Director, who was a minority shareholder, had ambitions to take the business forward. The founder was attracted at the idea of his legacy continuing, however, there was no succession solution for his retirement and a CEO with strong sales credentials was required to compliment the skills of the remaining management team. We spoke to an institutional investor who has supported circa 20 Searcher Funds and asked if they had any Searchers with specific experience in this sector, which they did. The relationship between the remaining management team and the Searcher (who is  looking to take on the role of the running the business) is key to the success of any Search Fund investment, and after a number of meetings both the Searcher and the remaining management team were comfortable they could work with one another going forward and the Search Fund made an offer for the business which was successfully completed, with the Searcher stepping into the business as CEO.

Whilst it is dangerous to generalise, it would appear from our experience that the funded searchers are typically accomplished business operators (with first hand knowledge of running a business, or division of a larger organisation) looking to own their first business and many of the unfunded searchers are accomplished investors (maybe with a private equity background) looking to personally lead their own investment. Whilst in these circumstances, the funded searcher will typically provide the neater solution to management succession, given the likely lack of deal experience, it is essential that they have strong corporate finance and other advisors particularly where they need to navigate through a competitive auction. In these circumstances, they really are offering the best of both worlds.