For most investment companies and funds, investing in a non-core business for them is a form of direct investment. In fact, they buy not only and not so much in order to receive a part of the current income from owning a block of shares in the company, but in order to then resell it. Such investments can provide returns of up to 50% per annum. Of course, provided that the object for investment is chosen adequately.
Direct investments traditionally belong to the alternative category. Meanwhile, for many developing economies, such as China, they act as the leading source of income, the annual "capacity" of which amounts to hundreds of billions of dollars (here we are talking, first of all, about foreign direct investment). Recently, direct investments are becoming more and more popular in our country. According to our data, almost 40% of company owners are ready to cede a share in a business to a direct investor.
Direct investments can be used to develop a business, regardless of the level of development of a particular company. Now they are perhaps the most accessible investment tool for most domestic firms. It is worth noting that here we do not consider venture funds, the strategy of which is somewhat different from that which is oriented towards classical private equity funds.
Pros and cons of direct investment
The main advantage of direct investment is the ability to obtain the funds necessary for the implementation of a project aimed at business development. At the same time, not only money is invested in the company, but also intangible resources - advice from the investor, his connections, knowledge and authority. Information that a well-known private equity fund has invested in a business has a positive effect on the image of the recipient of funds as a business partner.
Direct investment involves some significant restrictions. First, the investor who has invested in the company expects to return them, having received a certain income. Moreover, the return on investment should be at least 30-40% per annum, for some projects higher requirements may be imposed. The return of funds can occur through the sale of the received share to a strategic investor, its repurchase by management (co-owners of the company) or its sale on the stock market as a result of an IPO.
Secondly, a company that attracts a direct investor must be prepared for significant changes in the management system. We can talk about the transition to international financial reporting standards, changing the structure of the company in order to increase its transparency, changing some of the managers (the investor’s representative or a specialist approved by him often takes the post of financial director), restrictions on strategic decision-making (major transactions can be made only with the consent of investors).
Thirdly, when working with a direct investor, a company must be ready to undergo a comprehensive procedure of legal, financial, technological, and marketing due diligence.
Ready for investment
If the owners of the company decide to attract a direct investor, they must assess how ready the company is to start looking for it. The following points are important here.
Business plan. A direct investor most often invests not in a start-up, but in a growing business that needs additional funds to move to a new stage of development or to implement a promising project. The description of the direction of investing the funds raised does not always have to have the canonical form of a detailed business plan, sometimes a brief description of the idea is enough. The investor will still calculate for himself the prospects of the project.
Availability of qualified management with obvious professional achievements. This is an important point for many direct investors. Still, they do not buy the whole business and do not seek to participate in the operational management of it. They must be sure that the specialists available to the company will be able to successfully implement the project for which the money is allocated.
The state and dynamics of the business - investors prefer to invest in growing companies. Only in rare cases can they be interested in the result of overcoming stagnation or recession.
The state of the industry. This factor is not fundamental for all investors, but many of them prefer to invest in growing markets that have not yet approached saturation.
Owners must immediately decide what share in the business they are ready to cede to a direct investor. Many investors invest in a company only if they receive a controlling or blocking stake.
The size of the company is not critical to attracting direct investment. Many participants in this market invest in small firms whose annual revenue does not exceed several million dollars. It is desirable that the company does not have debts and other encumbrances, has a document
cops confirming ownership of assets, necessary patents and licenses. Investors most often negatively assess the presence among the owners of companies of the state or criminal structures, the participation of the company in corporate conflicts. It is clear that a claim against an enterprise by the tax authorities or lawsuits by third parties practically exclude the possibility of successfully attracting investments.
An investor is unlikely to come to the company himself - this happens extremely rarely. It is necessary to take active steps to reach a potential acquirer of a share in the enterprise.
Before starting the search for an investor, you need:
Optimize the company's financial flows by making them as transparent as possible. This is important for a positive outcome of the due diligence procedure. For the same purposes, it is necessary to prepare consolidated financial statements, conduct audits and obtain an audit opinion, prepare the necessary legal documents (charter, contracts with counterparties, necessary licenses and permits, existing agreements with the labor collective and trade unions), optimize the personnel structure of the company, as well as its debt structure.
Prepare a description of the company - an investment memorandum containing general information about the business, information about the share capital structure, information about the property status and obligations of the enterprise, financial statements, a description of the proposed areas for investing the funds raised.
Decide how exactly the investor will be attracted - whether the shares of the current owners will be assigned to him or whether an additional issue of shares will be the best option.
To carry out these activities, it is most often advisable to involve an external consultant, who, as a rule, has not only qualified specialists capable of preparing the company for the arrival of direct investors, but also good contacts with them.
It makes sense to consider two main groups of direct investors - private and institutional. The former include private individuals (often top managers of large companies) who are looking for an opportunity for a profitable investment of free funds, while the latter include investment groups and private equity funds. They can be formal (positioning themselves as funds, such as Baring Vostok Capital Partners) or informal (actually operating as private equity funds, such as Alfa-Eco).
An intermediate position is occupied by holdings and groups of companies diversifying their investment portfolios. On the one hand, such players differ from individuals in terms of capabilities and priorities, on the other hand, direct investments are not their main activity and are one-time projects.
Working with each of these groups of investors has its own advantages and disadvantages. By definition, there are more private investors than funds, and they often impose less stringent requirements on the object of direct investment. However, the benefits from cooperation with individuals are not so great - most often they give only money without additional resources in the form of knowledge and experience. Institutional investors impose more stringent requirements on a company that attracts investments, but they also give incomparably more. If we talk about companies that from time to time act as direct investors, then their requirements and opportunities are individual.
Each private equity fund has its own requirements. For example, Baring Vostok Capital Partners, among other things, assumes that the company must be break-even, the internal rate of return on investment must be at least 40% per year, and the growth in the value of the enterprise must be at least 300%. The direct investment fund of the investment holding "FINAM" is considering proposals for investing in the sector of high-tech companies, in companies related to the entertainment industry, in industries characterized by low asset consolidation and high growth rates, as well as in retail trading companies, primarily operating in the consumer market and having a developed sales network. Almost all investment funds pay attention to such indicators as company management, profitability, revenue and profitability.
Search strategy and tactics
If a company has not attracted interest from private equity funds, and raising funds is an urgent business need, it becomes necessary to find an investor in the person of a corporation or an individual.
In the most general form, the procedure for searching for a direct investor is as follows: determining the possibility and prospects for attracting a direct investor, identifying all possible options for working with a direct investor and choosing the most suitable one, determining the optimal moment to start searching for an investor (changes in market conditions and the state of a particular company are taken into account) , carrying out preparatory measures aimed at maximizing the value of the object being sold and minimizing the risks of parties participating in the direct investment project
n, drawing up a search plan for a direct investor, preparing an investment memorandum containing the most complete description of the business (including market analysis, operational analysis, financial and economic analysis, business development prospects), searching and identifying potential investors, negotiating with potential investors, obtaining, clarification, comparison of final offers and selection of a preferred investor, agreement on investment conditions, implementation of investments.
The most difficult tasks for an entrepreneur who does not have much experience in attracting investors are the selection of priority groups of investors and their immediate exit. Our experience has shown that a three-tiered analysis model has proven to work well for identifying potential investors. At the first stage, the main players interested in direct or strategic investments in a particular industry are identified. For this, information from industry associations, catalogs, media reviews, and specialized marketing research is used. Further, an analysis is made of other investors who have sufficient free funds to participate in the project. The main mechanism here is the study of publications in the media, primarily the statements of the top officials of companies about their plans and strategies for further development, and a survey of experts. The ideal option is if the firm's salesperson or his consultant has their own staff of analysts. This significantly reduces the time of work and their cost.
The third stage is the compilation of a short list of potential investors. Here, open sources are also studied, experts are interviewed, the balances of participants are studied. Players who most likely do not have enough free funds to complete a transaction are eliminated, as well as companies that are seen to be involved in corporate conflicts or unfair competition. It is worth noting that the company's competitors may well act as a direct investor - they know the industry well and understand its prospects, they can expect to eventually move from the category of direct investors to the category of strategic ones. Players are also eliminated, with whom the owner of the company, for one reason or another, prefers not to work. As a result, a list of solvent companies is formed, communication with which is not associated with excessive risks.
After that, it is necessary to establish contact with the first persons of companies-potential investors. It is clear that they can send a simple investment proposal (summary of the investment memorandum). If it is correctly drawn up (clear positioning and unambiguous addressing to one of the top managers), then, most likely, it will be able to reach the manager who makes the decision to start negotiations. However, the risk that the message will remain lying on the desk of a middle manager or personal assistant to the head of the company remains quite large. Access to the first persons is simplified if the seller is represented by an intermediary or consultant who is well known in the investment business.
After a potential investor declares his intention to invest in the company, the parties come to an agreement on the main investment parameters. Here an important role is played by: the order of receipt of investments. It is necessary to determine whether the investments will come at a time or in parts, whether the amount of investments will depend on the success of the implementation of the declared business project; the powers received by the investor, his rights to withdraw from investments. It is necessary to immediately specify how this process will be carried out: whether the owner of the company will receive priority rights to buy out the investor's package, whether a strategic investor will be attracted, whether an IPO is planned; proposed mechanisms for monitoring the use of invested funds. It is necessary to decide what kind of additional reporting should be provided to the investor, how the distribution of the company's profit will take place - what part the owner will receive, which investor. Often the best option is to reinvest the profits in business development - this approach will allow you to get the maximum income after a public offering of shares or a sale of the company to a strategic investor.
There are many other mechanisms for direct receipt of direct investment. This includes the purchase of shares in companies (stakes in LLCs) and “mezzanine” financing (the use of financial instruments that have the characteristics of both debt and equity, usually a combination of subordinated debt with options to acquire a block of shares). Sometimes private equity funds invest in acquiring stakes in mature companies that are not growing at a high rate. The acquisition is often leveraged (LBO). The funds can be invested not by one fund, but by several - in this case, each of the investors can agree to receive a relatively small block of shares - 10-15%. There are cases when direct investments took the form of a commodity loan. In any case, if and the company is of interest to direct investors, they will be able to find the best way to invest.