CandidCapital

Aim of the Chapter

To explain: the possible roles of advisers in an externally funded project; how to select, brief and work with the right advisers for a particular project; and how to negotiate the right fee structure with an adviser.

Key concepts described in the chapter

Lead adviser
Specialist advisers
Contingency and hours-based fees

Introduction

Starting or buying into a business is something that a manager is likely to do once in a business career. Even raising finance for developing an existing business or acquiring another business is a rarity with which many otherwise experienced managers will not be very familiar. Under any of these circumstances, therefore, it is essential that a management team is properly advised.

The choice of adviser is legion; stockbrokers, merchant bankers, lawyers, accountants, management consultants to name but the most obvious; and all of them will be more than happy to tell a management team why their skills and advice are essential to a venture capital project, especially one with the prospect of predictable and large fees. It is the predictability of the fees, and their size, which drives the enthusiasm of all advisers.

Since the buy out of a mature business with every prospect of sustaining its profitability and cashflow will be an attractive prospect for an investor, it will also, not surprisingly, be attractive to advisers who see the near certainty of a large fee based on successful funding of the deal. In contrast, it can be very difficult to find an adviser who is prepared to work on an innovative start up where there may be a need for the project to go through a tightly funded seedcorn phase with little certainty of attracting a main round of finance.

This chapter is intended to give an overview of the issues involved in selecting and using an adviser and of the fee structure which a management team can negotiate with the adviser. Following chapters look at the specific use of advisers in deals involving different externally financed projects.

When to take on an adviser

There is a considerable amount of preliminary advice which a management team can and ought to take before appointing a professional adviser. Reading a book like this is a good way of gaining an overview of the uses and implications of external finance and the process of raising it. There are other sources of free advice which are well worth considering:

Enterprise Agencies The Enterprise Agencies offer advice to the management of smaller businesses about all aspects of business planning: from identifying a strategy, through preparing a plan to presenting it to a source of external finance (typically a clearing bank). Their experience of larger deals and of venture capital is limited but they are excellent advisers on the practical issues involved in starting and then managing a smaller business.

Clearing Banks A clearing banker will normally be prepared to comment, without prejudice, on the feasibility of a lending proposal. It is worth pushing him on the drawbacks he sees in the proposal and how he will view the company if things do not go as well as the plan forecasts. Keeping the business going will be much harder with a disenchanted lender than ever they will be with a disenchanted equity investor.

Venture Capitalists Most venture capitalists will be prepared to give you a little time to spell out what they are looking for, and what they expect from an attractive proposal. They may not be prepared to arrange a meeting on spec, so a management team should have prepared a brief (say two or three page) summary of what they are looking to do, which can be the basis of a worthwhile discussion.

It makes sense to select a professional adviser when the management team have had an opportunity to consider the options for funding their project, and once they have gleaned as much informed free advice as they can get (in a time critical buy out or acquisition this may not be possible). Having been through the exercise, they will have acquired a fair idea of the strengths and weaknesses of different advisers and can make a more informed choice since, inevitably, professional advisers do have their own prejudices and areas of particular expertise. Moreover, advisers function better when they are taking instructions form an informed client who has taken the trouble to gain a reasonable overview of the issues involved in raising external finance.

It is worth asking prospective advisers for the names of other management teams which they have advised on similar deals and taking the trouble to ask those teams about the quality of the advice and how the relationship worked in practice.

Choosing an adviser

Any external financing deal, but especially an equity deal, will require financial and legal advice. It may also require specialist advice in areas such as intellectual property, taxation or land and building survey. However, the management team must also select a lead adviser who is responsible for advising them on the project as a whole, who is committed to the project's success and who has a stake in that success.

Lead adviser

Many management teams use accountants as their sole adviser and for a small, relatively predictable development capital deal a firm of accountants is a good one stop source of advice. However, it is worth checking that they have experience of fund-raising if they are advising on anything but the most straightforward lending deal. As an alternative, and especially for seeking external finance from venture capitalists, there are now a number of management consultancies which specialise in advising on venture fund-raising.

The more complex the deal, the more care the management need to take in choosing both the right lead adviser for the deal and through him, the right specialist advisers. The management team in a more complex deal, such as a buy out, buy in or a large start up, should normally look for specialist corporate finance advisers, who have had wide experience of venture and development capital, as the primary source of advice on the deal. The large accountancy firms, stockbrokers and, for the larger deals, merchant banks all operate specialist corporate finance departments (a number are listed in Appendix ).

The lead adviser must ensure that all aspects of the project are monitored and are given the attention they need by the management team and by other advisers. In particular, he must be capable of providing, or arranging, three separate categories of advice:

Developing a strategy He must help the management develop a workable strategy for the business which is capable of achieving its financial objectives with no unnecessary risk and which, more importantly, will be credible to potential investors. He must ensure that this strategy is expressed in a comprehensive but readable plan.

Identifying, presenting to and negotiating with the right potential investors He must help the management team identify and approach the right potential investors, or lenders, and attend any meetings with them. After each meeting he must ensure that any necessary lessons are learnt and the plan, or its presentation, modified if appropriate. He must help the management negotiate the terms of the deal with the potential investor or lender, before and after a formal offer, and facilitate the process of investigation and due diligence.

Specialist advice He must ensure that the management team receives the right specialist advice, including legal, taxation and accountancy advice, prior to entering into any commitments on the deal.

Legal adviser

The legal advice should come from a competent commercial lawyer who has had experience of the type of loan or share agreements on which the deal is going to be based. The lawyer will advise the management on the terms and conditions of the agreements, especially those terms which the management should seek to amend, and should review every commitment which they are being asked to make. He should be especially vigilant over any warranties which the management are being asked to give the investors.

Other advisers

It may be necessary to take specialist advice on aspects of the project. These may include tax advice, especially in an acquisition, buy out or buy in, where the actual cash proceeds to the vendors may be critically affected by the tax efficiency of the deal. The project may include the acquisition or use of some technology, process or product which is protected (or allegedly protected) by patent or copyright. Under these circumstances, the management team should consider taking the advice of a patent attorney or other intellectual property expert, whose advice can be of benefit to both them and a lender or investor.

Negotiating the adviser's fees

It is worth looking at the issue of fees from the adviser's point of view. A properly motivated adviser will expect to recover his profit from a success based fee (ie a contingency fee) but he will also expect to have his reasonable expenses, including basic overheads, paid irrespective of success. It is tempting for the management to try to erode this base fee but to succeed in so doing is self defeating. An adviser who cannot afford to give sufficient time and attention to a proposal is likely to give hasty, ill considered and, potentially, flawed advice. However, this can only apply to a financial adviser who is taking the anchor role. Specialist advisers will not have the same central role in the success of the project and will expect to be paid at a straightforward hourly rate for the time which they have used to research and provide their advice.

Therefore, in appointing their lead, and probably financial, adviser, a management team should never agree to a fixed price or hours based contract which bears no relation to success. They should also make sure that there is a written agreement with all advisers which specifies exactly what they are required to pay under any feasible circumstance. In particular, they should ensure that there is clear arrangement for what each side's obligations are should either party seek to withdraw (or the management sack the adviser) from the negotiations.

Summary

Experienced professional advice is essential for any externally financed deal. A good lead adviser will esnure that the management have a credible plan which is described in a well-presented but pithy plan; will help them identify the right investors and lenders; will support them through the negotiation and completion process; and will ensure that they get the right specialist advice when they need it. An adviser msut have a stake in the success of funding the project, through a performance based fee, but he must have his reasonable basic costs met in any event, if he is to function effectively.

Glossary