Not every SME is going to look great on paper, and certainly can’t sit back and wait for the phone to ring if they need a capital injection or want to sell. EMILY ROSS finds our how to maximise your chances of finding a great investor for your business.

Chief executive of the Photon Group, Matthew Bailey, has been on an acquisition trail, announcing two more acquisitions for the year this week – Sydney-based communications company Bellamy Hayden and London-based firm Corporate Edge.

“There are lots of good people and great businesses out there,” Bailey says. He receives business pitches every week from SMEs looking for funding to expand their businesses, however the majority of businesses Photon invests in are not for sale. “They are focused on what they are doing and making money,” says Bailey.

Photon Group director Siimon Reynolds called Sydney business owner Ro Markson in June 2007, asking her to come and chat to Photon’s chairman Tim Hughes, Bailey and himself about her communications business. “It was out of the blue,” says Markson. “I was not looking for an investor,” she says.

Just weeks later on 1 August 2007, a $3 million deal was announced. Photon bought the business with Markson staying on as a salaried CEO. Markson will run one of 33 businesses that make up the rapidly expanding Photon Group, which has made nine acquisitions so far this year and is worth more than $465 million.

The sale process involved a review of Markson’s business, which was only 12-months old, a new incarnation of the Markson Sparks business following her split from husband Mark Markson and their business that was established in 1982.

Ro Markson says that critical to the deal only taking a matter of weeks was the fact that she was legally and financially well organised. She also passed what she calls Photon’s “emotional due diligence” by demonstrating her drive and commitment to the business. (Photon likes to keep established management at the helm after the sale.)

Markson did her own due diligence on Photon too. Before making the decision, she spoke to other members of the Photon stable (mainly marketing companies) which, according to Markson, share a drive and like-minded approach. “They are looking for highly motivated business owners, people who want to grow,” she says. Markson wants to protect what she calls the “magic” of her company. “The deal is about being supported and having resources that we wouldn’t normally have,” she says.

After her whirlwind experience, Markson says that things went so well because “I have my house in order”, both legally and financially. “If they weren’t in impeccable order, it couldn’t have happened.” Now she has cash, new infrastructure and an expanded network to help to build her business.

Markson has a fast-growing business (staff numbers have doubled in 12 months), clear plans for the future, a portfolio of blue-chip clients, an industry profile and more than 25 years experience in the sector. Not every SME is going to look that good on paper, and certainly can’t sit back and wait for the phone to ring if they need a capital injection or want to sell up.

Big plans, and not much else

Corey Lavinsky, CEO of Los Angeles-based venture capital research firm Growthink Research, says that often entrepreneurs who start looking for first and second round investment have all these big plans for their businesses, but nothing on paper. Their business plans are patchy and they don’t know how to pitch their businesses to investors. In this case, even if an investor came knocking on their door, their business wouldn’t be prepared for the process.

Managing director of Tooronga Corporate Finance, David Lightfoot, works with a range of Australian SMEs wanting to expand their businesses and has been working in mergers and acquisitions in Melbourne for the past 11 years.

A former PwC director, Lightfoot is currently working on capital raising options for a pharmacy group, a health and safety software company, an IPO for a technology business, and planning the next financial step for an environmental business. Clients come to see Lightfoot often have businesses worth developing with good market positions, however they don’t really understand the true value of their businesses. “You need to get to the fundamentals,” he says.

Lightfoot looks at logical ways for the businesses to grow faster, such as raising cash to invest in infrastructure and expansion, and capital for more resources and new financial systems. Lightfoot comes across businesses that need a lot more than capital if they want to grow – for example, the start-up run by the technically brilliant founder that has no clue how to run a business. “They are so protective, they never let anyone near the business,” he says.

In these situations, passive investment is not going to help the business. New management has to come in for the business to survive. (No founder wants to hear that do they?) Other companies need new sales channels, to build strategic alliances and find ways to reach a critical mass.

For some clients, Lightfoot works with them only to prepare an information memorandum for an agreed fee that the business then uses to find funding. With other clients Lightfoot is hands-on in finding the capital and making the deal. For his services, he receives a finder’s fee, typically a small percentage of the funds raised.

It’s in the details

Nothing turns a deal cold like people not telling the truth. When it comes to detailed business plans, entrepreneurs often make unrealistic financial projections. “Plans that show penetration, operating margin and revenues per employee figures that are poorly reasoned, internally inconsistent, or simply unrealistic greatly damage the credibility of the entire business plan,” says Corey Lavinsky.

Lavinsky says the biggest mistake entrepreneurs make when seeking capital is to over-expose their business plans, sending them indiscriminately to any venture capitalist they can find, “figuring that the odds are in their favour that a small percentage will be interested”. He warns against asking potential investors to sign non-disclosure agreements as well. “If a concept and/or strategy must remain confidential, this often implies that there are no barriers to competitive entry,” he says.

The venture capital process is time consuming, stressful and risky for SMEs, however capital raised allows businesses with new technology, great products, services and brands take their businesses to the next level.

It is never easy to make a decision, but for Levinsky the deciding factor is always the same: “The entrepreneur should do what he or she believes is best for his or her business.” Matthew Bailey simplifies things even further: “If it feels right – do it.”

For more information go to www.growthink.com and australianventurecapital.com

The capital-raising reality checklist

1. Do not underestimate the time it takes for the capital-raising process – think hundreds of work hours.
2. Expect an INTENSE level of scrutiny.
3. Have your finances and legal affairs in perfect order.
4. Have a succinct, realistic business plan ready and ensure someone in your team can present it brilliantly.
5. Be able to answer the questions: ‘How much money do you need?’ and ‘Why?’ (Sounds easy? Try it.)
6. Choose your investment banker or adviser wisely. Rigorous reference checks are in order to ensure they have a good track record. There are lots of dodgy, expensive capital raisers out there.
7. Write up (with or without the help of lawyers/VCs) a detailed information memorandum for potential investors.
8. Don’t oversell the business. A wildly ambitious forecast with poor research can turn off an investor instantly.
9. Always opt for introductions to prospective investors rather than cold-calling.
10. Do your due diligence on prospective investors and make sure they have the right cultural fit with your business.

Emily Ross is the co-author of 50 Great e-Businesses and the Minds Behind Them, Random House, September 2007.