Reasonable ROI for Business Investment?

IrishIrish

Hi there,

Not sure if this is the right forum or not, maybe Investment forum would be better suited, but we'll see....

A close friend has recently opened a new business around 6 months ago. Its been a very successful launch and the company is already showing a profit with room for massive growth in the coming years. The owner has used up all of their own money and borrowings from the bank and is now looking for outside investment for rapid expansion. The problem is, he is unsure what is a reasonable return to offer potential investors.

The business is almost risk free due to the contacts he has made from past jobs and he is not willing to give away any equity in the company. He is looking for €100,000 and was thinking of offering 10% return each year for either 3 or 5 years and then the return of the full €100,000 at the end of the term. So its basically a 30% return over 3 years or 50% over 5 years. The investment model would be very flexible and could allow for the return of principal with 6 months notice or other covenants.

The question is, would investors see this as an attractive offer or what sort of return would be expected by the average investor?

Thanks.

Dont think thats attractive at all to be honest. He's not asking for an investor he's asking for a loan. And if the bank isn't going to give him anymore money then the 'no risk' is out the window because obviously the bank won't finance it (at a lower rate then 10%) because its either too risky or he's too highly leveraged already. If all was perfect the bank would give him more money for sure.

If I was presented with such a case I would be tearing it to shreds given theres no equity offered. The owner of the business is either naive himself or banking on the naivety of his potential targets especially with the percentages quoted, and the way they've been quoted to you.

jimmii

Unless the loan is secured against something I can't see it being that attractive no matter how safe the owner considers it there is always an element of risk attached. If it is such a safe bet then the banks would jump at the chance to make the loan and probably at a lower rate. People who are looking to invest in a business are looking to invest in that business not just give it a loan. Without being willing to give up any equity then the bank is definitely the place to go.

elastico

IrishIrish wrote: »

The business is almost risk free due to the contacts he has made from past jobs and he is not willing to give away any equity in the company.

And if he gets hit by the proverbial bus in the morning what good are his contacts and how risk free does my money become?

You'd need to get an investor, who would probably want to be a director and have to be on bank accounts for cash sign off and have full access to how the business is doing, complete due diligence on all the guys finances etc. before they would invest.

jimmii

Also consider thats it not just how secure your friends business appears but also those of the ones they has the contracts with that they depend on for all your friend knows those companies might not be in such a good state.

sconhome

Why not offer equity reducing on a sliding scale based on the amount of debt?

Your friend may be surprised at the ideas that can come from inclusion of a fresh outside pair of eyes too. They don't have to cede any decision making or control but adding someone to the board gives them security in having some oversight of the day to day operations of the business too. Swings and roundabouts.

IrishIrish

Thanks for the replies guys. The business 'should' grow organically over the next couple of years and then be in a position where no outside investment is needed and would be well positioned for a foreign buy out. That's why he is unwilling at the moment to give up any equity for just €100,000, although he had mentioned that he would be willing to give up equity for larger amounts of investment. It would obviously just accelerate growth if the money was available right now as he is turning down tens of thousands worth of sales from past customers.

Further bank funding may be a possibility when a list of potential orders is compiled and the end of year 1 financials are done.

IrishIrish

IrishIrish wrote: »

Thanks for the replies guys. The business 'should' grow organically over the next couple of years and then be in a position where no outside investment is needed and would be well positioned for a foreign buy out. That's why he is unwilling at the moment to give up any equity for just €100,000, although he had mentioned that he would be willing to give up equity for larger amounts of investment. It would obviously just accelerate growth if the money was available right now as he is turning down tens of thousands worth of sales from past customers.

Further bank funding may be a possibility when a list of potential orders is compiled and the end of year 1 financials are done.

Well there are hundreds of people that have gone into the dragons den and shark tank saying similar things like this above and they get torn to shreds. Entrepreneurs always exaggerate forecasts and future revenues like everything is going to be wonderful.
Theres a lot of other factors that come into play in a growing business, he could have huge sales and terrible margins, he might struggle with the right growth strategy, a multitude of factors that could screw things up.

I see no upside investment 100K as a loan. You get zero stake in the business and if it takes off you won't enjoy any of that success. But you'll enjoy all the pain if there is a problem. I would push hard for equity if you really believe in it, otherwise knock it on the head unless you want to get into the banking or money lending business.

Duckett

this is basically a quasi unsecured bond against to a trading entity that has not got a investment grade from a respected independent party. The concept of a "mini bond market" is compelling but Ireland does not have one. Trials are underway in Europe but it is early days.

In the meantime, asking an investor to stump up the money on a "so called certainty" without having any skin in the game is simply a bridge to far in my view.

pedroeibar1

On the basis of the information provided I view this as is a start-up, not a “business”. It has just six months trading, is highly dependent on the input and contacts of one person, has used up its cash / borrowings, needs more and is pi$$ing off customers by turning down their orders. Classic “over-trading” situation. Bad management, poor understanding of business reality and no idea of cash-flow or debt management. The only positive is that the guy is on to something good as he is profitable after 6 months!

You say (The investment model would be very flexible and could allow for the return of principal with 6 months notice or other covenants) From where would this cash miraculously appear? What other covenants? Breaking one would obviously be a negative and would make it harder to raise the cash to repay.

He is looking for a loan when the market does not ‘do’ loans, it does ‘equity’. Even if offered, with the type of thinking shown I would not take an equity position (e.g. preference shares) as I would want to take a board seat to manage what was going on and would be uncomfortable in doing that on the info as stated.

Calling it a bond issue shows the guy has notions above his station; also having a bond issue rated does not change the fundamentals – a crock of $# sprayed with deodorant remains what it is!

If he cannot get investment he should look at other forms of raising cash - trade finance for e.g. supplier finance or invoice discounting.

Blunt, but that’s how investors think.:)

jcon1913

IrishIrish wrote: »

Hi there,

Not sure if this is the right forum or not, maybe Investment forum would be better suited, but we'll see....

A close friend has recently opened a new business around 6 months ago. Its been a very successful launch and the company is already showing a profit with room for massive growth in the coming years. The owner has used up all of their own money and borrowings from the bank and is now looking for outside investment for rapid expansion. The problem is, he is unsure what is a reasonable return to offer potential investors.

The business is almost risk free due to the contacts he has made from past jobs and he is not willing to give away any equity in the company. He is looking for €100,000 and was thinking of offering 10% return each year for either 3 or 5 years and then the return of the full €100,000 at the end of the term. So its basically a 30% return over 3 years or 50% over 5 years. The investment model would be very flexible and could allow for the return of principal with 6 months notice or other covenants.

The question is, would investors see this as an attractive offer or what sort of return would be expected by the average investor?

Thanks.

So many questions.

What sector is he in? How reliable are his figures? How come profit has not shown up in the bank?

pedroeibar1

Duckett wrote: »

this is basically a quasi unsecured bond against to a trading entity that has not got a investment grade from a respected independent party. The concept of a "mini bond market" is compelling but Ireland does not have one. Trials are underway in Europe but it is early days.

Rating agencies are like prostitutes but provide poorer bang for the buck!

The best analysts work in industry, the failures of the lower tiers work in the agencies for a pittance. Look at the way the pre-collapse Irish banks were rated by Moody’s, S&P, Fitch. How successfully were Lehmans, LTC, countless CDO issues and other derivatives rated? Aside from the fact that a rating costs north of $100k p.a., the trend is away from ratings and several high-ticket bond issues have and continue to be placed without one.

All rating agencies are American and fly the flag of their own self-interest closely followed by what is good for their US clients. Their shoddy work has provoked several crises, both in companies and in economies. These in turn force debtors, both commercial and government, to sell off their assets under distress conditions for a fraction of their worth. Who wins? Is it still necessary for me to say that I have a very poor opinion of them?

pedronomix

If the business has the potential suggested, he might be able to raise the cash by issuing preference shares with say a 10% coupon but I expect that any investor will seek that they become convertible if any default on the coupon or failure to pay on maturity. The vital element that makes his proposition little more than unsecured lending, with everyone ahead of him in the queue, is the total lack of success upside for the investor.The promoter gets it all..they will all walk away. He might have a chance at 20+% per annum coupon but will be a tough sell even at that.
Has he looked at Enterprise Ireland prefs?

delahuntv

Have a look at the EIIS scheme run by Revenue - this way you can invest in the business and get immediate 30% tax rebate + a potential 11% extra in 3 years if the company has added employees.

But that would mean him giving some equity away - but there can be an agreement for him to purchase back the shares from you in three years at a price not below the purchase price (the company can't do this though) and pay you a dividend each year.

It means 30% of the investment is "safe" as its a tax rebate and make the investment far more attractive.



Why he would not be willing to give away any equity is very puzzling - without the investment, his company will not grow. Does he want 100% of a small company or 70% of a larger company? Even better, having investors / shareholders on boards will give him access to better and independent advice.

antoinolachtnai

There is good advice there.

10 percent is just too low a price to expect to pay for money for an organization with no collateral and stringy enough cashflows. Even the paperwork on the loan that is being described is going to a couple of thousand euros in legal fees, so that in itself pushes up the real cost of the funds. And if the papers are not right, and he misses even one payment, a tough investor could foreclose on him and take the business off him.

What is this talk of being able to return the money at 6 months notice? How is he so sure he can refinance?

The debt is going to be subordinate to the bank debt. The bank is going to have to be paid back first.

On the other side, there is a certain amount of sense to not wanting to get equity investors involved. Has he looked at any other possibilities? The best chance, I'd say, is to get either suppliers (through giving credit or goods on consignment) or customers (through prepayments) to finance the business.

It is important for him to figure out how much finance he actually needs.