How do growing businesses obtain PE or VC investment in 2024?

Current economic turbulence has changed investment sentiment, and investors are, without a doubt, cautious, so obtaining investment in 2024 is difficult, but it’s not impossible.

Through our discussions with investors, we have an up-to-date view of how and where they are currently investing and can answer the following top questions:

How has the investment landscape changed in the last few months?
What does a great investment opportunity look like to an investor?
How has the current climate affected valuations, the process and timelines?
How much cash runway should companies have before launching a funding round?
What are the “must-haves” for your investor discussions?

What’s the difference between Private Equity (PE) and Venture Capital (VC)?

If you want to obtain investment in 2023, the first thing to clarify is the difference between PE and VC funding requirements and styles.

VC firms focus on early to mid-stage companies, typically loss-making and fast-growing.

The VC sector has capital across many different fund structures and sources, from tax-incentivised funds like EIS and VCT to private LP funds and prominent US players like Tiger Global and Level Equity, who have institutional money to spend.

Whereas PE firms like LDC, BGF and Foresight work with high-growth, established and profitable businesses, usually with EBITDA in excess of £0.5M.

What does the investment landscape look like right now?

During 2021 VC and PE firms raised record amounts of cash, so coming into 2022, the investment world was sitting on a lot of money. When we emerged from COVID, there was a mini-boom in investment.

However, resource shortages, disrupted supply chains, instability in energy prices created by Russia’s invasion of Ukraine, inflation at 11%, Liz Truss ,interest rate increases, and a looming recession changed the investment sentiment. With this level of uncertainty, PE and VC investors have become more selective and discerning.

A PE firm typically leverages the companies it invests in, so increasing interest rates and increases in debt obligations impact its returns.

In early-stage businesses, valuations have reduced for fast-growing companies that lose money. In Public Markets, which many investors look to for valuation comparables, valuations have come off, particularly for technology assets. This has created a headwind for what investors can invest, how they can invest, and at what valuation.

Capital is being deployed because investors still have capital they have to deploy. However, it will be deployed more prevalently into existing portfolio assets where PE and VCs know the company and then into ‘the best of’ the businesses they see. Without a doubt, the bar has gone up, and it will stay up for some time.

What does a great investment opportunity look like to an investor?

Great management teams

First and foremost, investors look for great management teams: breadth and depth of the team, capability, ambition and demonstrable track record. Great management teams get good companies through good and bad times.

High-quality earnings

Companies with high-quality earnings are more likely to obtain investment in 2023 successfully:

Do you have contractual relationships with clients that give you good visibility of earnings into the future?
Do you have good margins? With good operating headroom leverage for future headwinds, such as increased costs.

Good forward visibility of earnings

This is a slightly different metric from high-quality earnings.

If you were to look forward twelve (12) months, how much of the forecast or previous year’s revenue is already, or nearly, in the bank? This will be a combination of existing contracts, a weighted sales pipeline, and other business-specific factors.

Have you got high-quality earnings, high contractual revenue, and high forward visibility of your earnings? If so, the business’ resilience, robust processes and high-quality data will give investors comfort in future cash flow and the reassurance that the business has time to weather what is to come

Access to high-quality data is more important than ever

Access to high-quality data used daily in decision-making gives investors confidence.

A business that can:

demonstrate the quality of individual competencies within its management team through data;
show its future earnings potential through data;
and prove a robust future cash flow through data;

will reassure an investor that it is a good investment opportunity.

What has happened to valuations?

The challenge in talking about what has happened to valuations is that high-quality assets will be resilient on valuations and may not be impacted because there is a higher amount of capital chasing a smaller volume of high-quality deals. Sometimes investors overpay to acquire a business and try to create value on the other side to compensate for the overpayment.

However, there has been a significant reduction in valuations in software and technology companies. In February 2022, good quality technology stocks, on average, were trading at around 6-8x multiples of ARR (annual recurring revenue). This has reduced to 4-5x ARR, sometimes lower depending on the growth profile of the business.

The valuations for businesses with lower-quality earnings will have been reduced by a further couple of points.

How much cash runway should companies have before launching a funding round?

In the current climate, when talking to investors, companies should aim for a cash runway of 18-24 months, so they have time to deliver and perform before needing to secure another round.

As a general guide, companies should be ready for another funding round six months before they run out of cash. More specifically, this means being prepared and ready to go with materials ready and investors identified, not just starting preparations.

Timing a funding round is crucial as investors have funding cycles. LDC is an evergreen, so it has a steady flow of cash and is always in the market. However, many investors have a funding cycle: raising funds, deploying funds, and generating returns. Competition for deals (and the availability of funds) ebbs and flows depending on the volume of cash investors have and where they are in their funding cycle. Therefore, companies looking to fundraise need to understand this.

In terms of current appetite, venture capital is more constrained than private equity as they have portfolios that need cash and support, so they are less focused on new deals.

What does a great CFO look like?

Great CFOs do not have to be ex-Big 4 with multiple transactions under their belt.
However, they do need to know the company inside out, understand the data, have a voice at the boardroom table and can influence the board.
A great CFO must be able to have a healthy professional debate with the board and investors.
A CFO with a track record is a bonus; someone who has built a business, sold a business and been part of a successful business before.

What are the must-haves for your investor discussions

Finally, here are our top tips for companies looking to obtain investment in 2023 for their Teaser, IM, or Pitch Deck and presentations.

Have a realistic valuation expectation

Do your research and get a feel for current valuations for comparable companies. Keep your expectations realistic and let the investor form their own view. Potential investors appreciate intelligent discussions with boards who know their market, and you may be able to steer them towards a valuation.

Get on top of the risks that face the business

All business owners believe in the business plan and the forecast, but a seasoned management team can demonstrate an appreciation of the risks to their plan.

Look at your plan from the investor’s perspective and be prepared to discuss the risks and what could be done to mitigate them. Have a few models: an optimistic, a pessimistic, and a middle-of-the-road view.

The best teams have a live view of their data and use it in their decision-making.

Inaccurate financial statements will cost you the deal!

If you have an early-stage business, investors can accept that your financials might not be as polished as they would like and can take a view. However, all other investment opportunities will require professional financial statements.

The due diligence process will uncover deficiencies or inaccuracies in financial statements, so ensure you have professional financial support.

Don’t forget to think about your exit strategy

Every time an investor puts money into a company, they will want to know how they will extract and obtain their return, so ensure you have a well-thought-out exit strategy or exit scenarios. Obviously, things could change, but investors need confidence in the management team’s commitment to building a successful business.

Try to find some comparables of businesses that have made this journey to assess their strategy, why they were successful and the multiples they achieved.

Don’t forget the qualitative side. What does an attractive business look like? How will that come out during the investor’s journey with you?

Need help with a fundraise?

If you need help obtaining investment please get in touch with us