When a company’s strategic focus turns to equity raising, it is critical for the company to determine what type of investor will best support the company’s strategic imperatives over the long term. Robert Peché, Corporate Finance Associate at Bravura, an independent investment banking firm specialising in corporate finance and structured solutions services, highlights the key differences between strategic and financial investors and the drivers of their respective investment decisions.
The key steps to a successful equity raising process are a clearly articulated strategy, detailed analysis of the various sources of capital and selecting the right type of equity investor.
Financial equity investors include private equity and other investment funds, usually operating under specific mandates, with highly skilled investment professionals at the helm. A high net-worth individual, family office or listed investment holding company with a permanent capital structure could also be a financial investor.
Strategic investors have an investment strategy that goes beyond purely financial returns. This includes trade players endeavouring to consolidate the market, suppliers or customers attempting to vertically integrate their businesses, or investors aiming to acquire a distribution network for products, specific intellectual property or other business infrastructure.
The focus for financial investors is purely on financial returns and thus emphasis is placed on entry price, dividends during the period of investment (including through debt refinancing) and eventual exit price. Financial investors will usually consider a negative controlling stake as a minimum, with preference for a controlling stake. This is usually motivated by a need to control the cash flows generated by the operations of the business.
Some financial investors have defined investment periods (e.g. certain private equity funds with a seven year life-span) and thus require exit mechanisms (such as put options). Others take advantage of permanent capital structures (e.g. listed investment holding companies where shareholders achieve liquidity through selling their shares rather than winding up the fund) to enable greater flexibility in deal negotiations.
Financial investors usually have minimum internal rates of return that they must achieve in an investment, known as hurdle rates. Private equity funds investing in the current South African market may have geared hurdle rates as high as 30%, which drives a need for such investors to consider a wide variety of potential opportunities in search of the right investment.
Although financial investors will certainly consider the underlying strategy of the business in their assessment, the likelihood of realising synergies as a direct result of the investment is usually lower. The business is thus valued based on its existing prospects. The strategic equity investor is still motivated by a desire to maximise financial returns, but the scope of the analysis is much wider. Instead of analysing and valuing the business purely on a stand-alone basis, such investors would consider other benefits such as access to a distribution network, a highly desirable operating infrastructure or operational synergies.
Prevailing market conditions may significantly impact the analysis and resultant valuation e.g. the largest competitors in any given market may be willing to pay a higher value for small competitors as part of a broader strategy to consolidate the market and remove competition.
Because of this, a strategic investor may well place a higher value on the business than a financial investor.
Both strategic and financial investors will typically require lock-ins of key management, earn-out provisions for existing shareholders and potentially extensive warranties relating to the underlying business. Strategic investors may also require contractual agreements related to collaboration, cross-selling into respective client bases or sharing key platforms.
The ideal strategic partner might provide strong balance sheet support for subsequent acquisitions, or attractive synergistic benefits such as corporate access for new revenue generation, a listed platform providing liquidity or an established distribution network for products.
B-BBEE investors may be strategic or financial investors, or potentially both if the credentials are considered highly strategic. Typically, B-BBEE ownership investments are structured more like a purely passive financial stake. The structuring considerations of such an investment are beyond the scope of the article, but must ultimately be sustainable and fair, particularly in light of the current regulatory environment and the overarching supervision of the B-BBEE Commission.
The key steps to a successful capital raising process are a clearly articulated strategy, detailed analysis of the various sources of capital, preparation of suitable marketing material for the business, creation of a detailed dataroom for due diligence processes and agreement on a set of criteria against which potential bidders will be evaluated. In all of this, the guidance of an independent professional advisor may prove to be invaluable.
Bravura Holdings Limited is an investment banking firm specialising in corporate finance and structured solutions services. Bravura Holdings has a primary listing on the Stock Exchange of Mauritius and a secondary listing on the NSX. It has offices in Mauritius, South Africa, Namibia and Australia.