UK: Raising Capital: Alternatives To Flotation

Last Updated: 7 November 2006
Article by Kevin McCarthy

Whether a business is planning to grow through acquisition opportunities or by developing organically, expansion will require capital to support and sustain the growth strategy. For many companies the buoyancy of the UK market means that flotation is being considered as the next step in development - a means of accessing capital investment. For those not ready to face the strict regulatory requirements for entry on the main market, listing on London's junior market (AIM) provides a viable alternative. In the first seven months of 2006 alone, £17.8 billion has been raised by companies floating on AIM.

However, there may be more appropriate means of raising capital than an Initial Public Offering (IPO). The flotation process may be too expensive, problematic issues might be raised through due diligence, the management team may not yet be ready for life in a quoted company, the company might still have greater potential as a private entity, or the markets themselves might be unfavourable at a given point in time.

What alternatives to flotation are on offer in order to access capital?

1. Venture Capital/Private Equity

Private equity financing is a medium to long-term source of financing by investors in return for an equity stake in high-growth unquoted companies and is therefore ideally (though not exclusively) suited to start-up and developing businesses of small to medium size. The British private equity industry is the largest in Europe and, worldwide is second only to the USA. It is a multi-billion pound industry and the pool of cash available for investment is growing at a phenomenal rate; the British Venture Capital Association reports that in excess of £27 billion of funds were raised in 2005 (more than double the previous year).

Investors look for a well-researched, documented and supported business plan, good financial forecasts and a strong management team. In return a company benefits from the expertise gained from the funder's experience with previous ventures. Being associated with a private equity fund may also help secure funding from other sources. The private equity route will mean diluting equity of the founders and investors will seek to exert significant control over the investee company in order to gain maximum profits, but on balance many owner/managers consider a diluted position in a faster-growing business as an acceptable trade-off for this type and size of investment.

2. Debt Finance

Debt financing is an alternative source of capital. Products available are varied and the interest rate on the loan reflects the level of risk that the lender is willing to accept. This will vary depending on a company's financial status, credit rating and financial history. Loans are commonly secured by way of fixed and floating charges on the company's assets and/or guaranteed by a third party. This secured lending is considered relatively low risk and may therefore be more accessible than equity finance.

A company should ensure it achieves a proper balance between its debt and equity so that it is not left too highly geared. Too much debt and a company will be exposed to fluctuations in cash flow and/or adverse changes in its trading conditions, which would affect its ability to meet repayment obligations. Significant breaches of such obligations result in damage both to the company's credit rating and additional charges or penalties for default.

The main advantage of debt over equity financing is that it allows shareholders to retain undiluted ownership and control of the company. On repayment of the loan, the lender has no further claim.

3. Private Placings and/or Pre-emptive Offers

A private placing is an issue of new shares to a restricted group of persons, such as institutions or high net worth private investors rather than the general public. A pre-emptive offer (or rights issue) is where a company offers its existing shareholders the right to buy newly-issued shares or other securities in proportion to the shares that are already held by them.

Private placings and rights issues are a means of accessing capital for unquoted companies as well as publicly- quoted companies. The mechanics of both these routes can be complicated but the lower costs involved, relative to a flotation, make them attractive alternatives.

The pool of funds which may be available by these means will be less than if the company were to access the publicly-traded capital markets, but in many cases it is sufficient and the process certainly affords the company more control over the diversification of its shareholder base.

A company may carry out a private placing either directly with investors or with the help of a broker. The company prepares a private placing memorandum with a description of the terms of the offering, the company's business and risks attached to it and other material terms. The target placees are then invited to subscribe under the terms of the offer.

Conclusion

The equity capital markets provide companies with a potentially rich source of funding. However, a market listing brings with it regulatory constraints and requirements which might outweigh the perceived benefits. A company needing to raise capital to promote its strategic development should, therefore, consider all options available and its current stage of development before deciding which is the most appropriate course of action.

This article is only intended as a general statement and no action should be taken in reliance on it without specific legal advice.

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