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Can Europe Grow Unicorns?

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In a recent cover story on the Age of Unicorns, Fortune Magazine, recently commented, “the billion dollar start-up was once a thing of myth, now they seem to be everywhere”   The question is where are Europe’s unicorns?

On one hand, European tech firms haven’t done so badly –an influential study last year from GP Bloudhouse reported that between 2003-2013, Europe founded 30 unicorns (firms that raised at a $1 billion valuation in either public or private markets) compared to 39 in the US. Yes, European firms were slightly smaller and slightly older, but not so bad.

However, one has to look at the recent wall of money in the US;  according to PItchBook, US late stage venture capital received ~$42 billion last year with a record 62 firms raising money at more than $ 1 billion dollar valuations.   Some have argued that that there is a valuation bubble, similar to the dot-com era of the 2000s.  Leaving aside the specifics of the valuation issue (is UBER really worth $40 billion) it does allow later stage US companies the ability to raise large amounts of cash to execute on their business plans.

Which brings us back to the original question, where are the European unicorns?  Firstly, they do exist –as I write this, Spotify (UK based) is reportedly seeking new financing at an $8.4 billion valuation.  However, European start-ups may want to keep their valuation expectations for some of the following reasons:

 Lack of serial entrepreneurs

A number of studies has shown that 80% of billion dollar companies come from serial entrepreneurs.  Europe’s start-up eco system is still young.  We are creating them, look at Nikkals Zennstrom of Skype as an example of a serial entrepreneur but it will take time to nurture and develop them.

Europe’s pool of capital is more limited and more risk averse

The European venture capital market is quite simply, more shallow and less diverse than the US. We simply don’t have the myriad of firms (sector, stage, etc.) that the US system (which is in turn is supported by a very large base of public & private pension plans alongside with foundations and endowments) has; this leads not only to less overall capital but less competition for deals (which in part drives those unicorn valuations).  In addition, Europe does not yet have the peripheral actors such as conventional mutual funds and hedge funds providing late stage capital.

Lack of support from European corporations

We don´t have as many tech giants in Europe, with some prominent ones such as Nokia having fallen by the wayside. Particularly on the enterprise front, most of the really big players remain in the US, and thus most often, so does their check book.


Europe has a tendency to copy the best ideas that are being funded in the US and create localized clones.  The investment strategy is not necessarily unsound, however, Europe is not nearly as homogenous of a market as the US, which results in firms that have much smaller markets and therefore much smaller potential.  That in turn makes it much harder to justify big valuations.

Ambition vs risk

At the risk of sounding like a broken record, there seems to be a European tendency for risk aversion.   European entrepreneurs (and their backers) seem happier for a nice pay-out and a decent return. For European unicorns to truly develop we will need more people –founders, CTO’s, investors, aiming to be the next Mark Zuckerberg, Sergey Brin or Peter Thiel.

Author: Ashok Parekh – Director, Investment Services, White Lake

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Can Europe Grow Unicorns?

The Start-Up Fundraising Advisor: The how-to guide

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You have raised angel funding – made good progress and now you need a larger cheque to supercharge your growth. You also need the expertise and professional experienced Board a VC investor will bring. Brokers and their terms of engagement are many and varied – so what to do? And are their cheaper alternatives? We recently ran a beauty parade for an early stage company to run a fundraising with VCs so have considered this area carefully.

Do you need a broker? NO if:

  1. You have a CFO who has run fundraisings before – who can build a quality financial model and prepare materials and also is adept in deal-making and negotiation AND
  2. You have a Board with deep and high-level contacts into many VCs AND
  3. Your exec team has the time and expertise to run a fundraising project WHILST keeping the business on its growth trajectory.

If you cannot say “Yes” to those three questions then most likely you need an advisor/broker in one form or another.

What criteria am I looking out for when picking a broker?

  1. A track record of raising capital in your sector at the size you wish. It goes without saying – no point using a broker who has a history of £2-3m capital raisings for cleantech if you are looking for £10m for a SAAS business. Investment bankers are by their nature chameleons and can change sectors quickly (and will talk a good game around doing this –  a good banker is a good salesperson) – however past performance is often indicative of future success. Hence pick a broker with deep sectoral expertise in your area.
  2. Ability to sell – you will be able to gauge from meeting a broker whether they are good salesfolks or not. Raising capital is a sophisticated sales job – simply put. Perseverance, charm, knowing what the other side is thinking, making a process competitive – all attributes which a good banker has. If they can sell you to hire them – maybe they can sell your company.
  3. Ability to present well - I always ask to look at examples of previous financial modelling work and presentations they have made. Most likely under NDA.

What sort of deal to strike?

  • Retainer – any broker who values themselves will charge a retainer and I would advise paying one. Here’s why:  If you don’t – you will get commitment only until a better deal comes their way or things get a little hard and the deal is looking tough to close. They see commitment from you and feel an onus to deliver. You get what you pay for. Success only transactions – if they don’t work quickly and easily – will not work. Retainers for raises of £5-10m can vary from £5k to £20k for a top-tier broker. £5-10k is acceptable however make sure you set clear deliverables for this retainer. I personally prefer a broker who charges for time spent on preparation in a transparent manner (X for a model, X for a presentation) as opposed to a flat monthly fee.
  • Terms – A tail fee is typical – try and negotiate it to be as short as possible (by tail-fee I mean that when a broker is let go – they still get success fees on any deal which is done by a party they introduced for a period thereafter – I’ve seen some push for two years – or take a another fee should parties they introduced subsequently invest again in subsequent rounds). Be firm on this  9 -12 months can work.
  • Fees – 5% seems typical in the market – anything above is extortionate and will make the deal seem in jeopardy from the start i.e the broker thinks it is so hard to do they are charging a huge fee.

There can be more economical alternatives – which we ourselves White Lake offer whereby a fundraise can be run in-house, project managed and use the contacts of the board and thus have less fees overall – success and retainer. This model works if you have the right people executing.

So the above are some simple tips. Always remember – the best brokers/bankers will be in demand and have the best VC relationships and they could essentially will be picking you. The best brokers will not take on high-risk raises projects where they have not high confidence in completing.

Anyway if possible – Start-ups should invest in their core product, not in broker fees.



Authors: John Rowland, Managing Partner, Sierra Choi, Marketing Manager, White lake Group



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The Start-Up Fundraising Advisor: The how-to guide

KPI setting for an early stage business – the path to sales – but how do we measure progress? “Not measuring is not an option”

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Recently I was working at an early stage business which was not turning over regular revenue each month. The management team were at a loss as to what KPIs they could measure, which would be useful for reviewing in Board Meetings, for prospective investors and team management. Typical example KPIs for most established companies are metrics around revenue, margin – gross & net, client satisfaction, market growth, faulty goods returned, complaints etc. Using a Balanced Scorecard approach this would be extended to employee and other stakeholder satisfaction metrics (The Balanced Scorecard approach works on measuring progress on metrics in Finance, Internal Business Processes, Learning and Growth and the Customer). However what if you are not (or barely) revenue generating? What do you measure?

For many web based or social media businesses this is easy – impressions(hits) on the website, app downloads  – growth per month, click-through rates, results of traffic increase from SEO spend, PPC spend effect on traffic, Then you move from conversion of traffic to trials of products or increase in time spent on your website. If your business is looking to build up a user base as opposed to monetise just yet – these are all useful metrics. However what if you are selling an actual product now – be that SAAS or a piece of kit?

The key maxim as always is “KPIs drive behaviour” or in more basic form “What gets measured gets done”.  Certain activities executed well by the team will move the company along the path to making initials sales then to increasing sales. Of course there is the age old predicament of ‘Doing the right things’ and then ‘Doing the right things well’. As in – effectiveness versus efficiency is another thing which much be considered – i.e doing the wrong thing in a hyper efficient manner will not help you. An example being – you pick the wrong segment of the market to sell to initially – perhaps you are selling where your value proposition is not strongest and buyers are most risk averse. In that case calling all the people in that sector as quickly and professionally as possible will not lead to sales (although the speed element will assist you in learning you error more quickly it must be said). Hence the moral of the story is  – you need to measure “Outcomes” along with “Process Activities” – Effectiveness and Efficiency.

Example process based around Sales Growth (the lifeblood of a business):

Step 1 – Have a focused strategy for growth with key milestones and stages.

Do not broadbrush and try attack many market segments. Pick one sizeable niche and focus all of your company’s efforts here. (We will examine using the “Crossing the Chasm” approach in another blog on how to pick the right niche and how to attack it)

Step 2 – Take each stage and decide what activities/behaviours will drive progress through that stage. Decide what metrics define success and completion of that stage.

Step 3 – The KPIs you need to measure both in activity and outcomes will come from Stage 2. Form targets around these for key individuals or teams.

Step 4 – Execute, measure and review periodically – activity can be measured weekly – outcomes often better to be measured monthly.

Recently we worked on just this project with a client – we cannot divulge names as it’s currently in motion.

We picked a target market which was a sizeable niche based on where we knew the value proposition to be strongest. First off we listed all the potential clients in that sector in a certain geography. Based on what we knew about each potential client (size, company culture, contacts there) – we segmented them into likely Early Adopters(Visionaries) or Early Majority or Pragmatists.

We then simply built us excel sheet to monitor stage one which was getting reference projects and sales with the Early Adopters and assigned Managers with targets to push through an on-boarding process within a specified time period.  Once we had five early adopters – the stage was deemed complete and we pushed ahead with the plan for the Early Majority stage which would require feedback and proof points from the Early Adopters.

Monitoring tool:



This is a simple example of how KPIs can be built up – even when you have not the comfort metrics of revenue and margin to measure monthly – you can measure progress scientifically to push you towards your goals.

Author: John Rowland, Managing Partner, White Lake Group

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KPI setting for an early stage business – the path to sales – but how do we measure progress? “Not measuring is not an option”

The Exit: Waterfalls explained & some innovative incentive structuring for growth Companies

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This article looks at how a typical waterfall for a sale of a VC backed company works.

So you are finally executing an exit or more importantly you are about to enter an exit process for your company and as CEO/CFO know that your common equity options are at the bottom of a long stack of debt, convertibles, preferred equity and additional warrant coverage. They are worth something for sure – but how much? Are the VCs motivated by a different target exit price than required by the management team to make a decent return? As CFO you need to understand these issues intimately to be able to work with all the shareholders and buyer in order to get a successful transaction approved.

The purpose of this article (where the accompanying excel is available should you email me) is to go through a simple example of how a waterfall works on an exit – in this case a trade sale. An IPO comes with different complications, structures and lock-ups. If you need to work with waterfalls then it is worth your while working through the figures and getting the excel attachment – if not – just read the descriptions and skip to section Alternative Ways to Incentivise…

The scenario – Company Dotcom Boom:

You have a company which is 6 years old.

The capital structure developed like this: You had initial angel funding (common equity) followed by a Series A (again in common equity), two preference rounds (Series B and C) – one of which occurred when you were under financial duress (running out of cash thus a down round and a liquidation preference was attached to this capital). In this Series C round the Series B prefs were forced to give up their liquidation preference in the negotiation so outside of some veto rights are essentially now common equity.

Also you have recently taken on some convertible debt with a rolled-up PIK interest to boost the company with some final growth in a new market before exit. This convertible debt also had 5% warrant coverage. You financed some asset purchases using senior debt which has a bullet payment trigger on a Change of Control. We will leave out any factoring instruments for now assumed to be covered by the working capital wind-up.

Employee options of some original senior management were underwater (ie strike prices way out of the money due to a recent down round) that Management have managed to negotiate a carve-out after debt with the VC of 1% of the sales price to ensure these vital senior managers are motivated through the sale process.

So at the last round (the Series C pref round) the company details were as such:


Figure 1 – Company Details (Series C)

The capital structure (debt & equity) from most senior to junior looks like this: – ignore the column on the far right for now – this is linked to the exit which I will now describe.


Figure 2 – Overall Capital Structure

After running a sale process with an Investment Bank a purchaser has signed an LOI to purchase the business for £140m Enterprise Value (EV – Debt + Equity less cash) with an agreed level of cash left plus working capital (cash and working capital equalisation on transfer we will ignore for now for simplicities sake).

The first thing we need to do is find what portion of the agreed purchase price is left for common equity to then come up with a share price. To do this – we need to know if the Convertible Debt will convert or not to come up with a fully diluted share number. This then affects the share price (equity value/number of shares)…which affects the decision on whether the debt will convert or not…which…(we have just entered a circular reference where we can be for a while……). In the excel file to calculate this we use a simple macro to bottom out on this circular reference and come up with a share price which automatically includes the conversion of the debt or not. The convertible debt has a convertible price of £3.50 (as agreed at a valuation in the original deal) – hence if any sale share price is above this figure the debt will take advantage of the conversion option and take the upside.

In our debt conversion example presented here – the end share price is £4.29 so yes the debt will convert. We then use this info to calculate the selling share price.


Figure 3 – Conversion Calculation

The Waterfall:
So with the debt converting – how does the waterfall work?

The first items to come off the total selling price will be:

  1. Banking fees (these may be a % on the EV or the Equity value)
  2. Senior debt
  3. Convertible debt – if it does not convert would come out now
  4. Next we have the negotiated Management carve out of 1% – given as a bonus as opposed toworked in shares (it can also be worked as a share claw back or issue).
  5. The preference shares are both participating or “double dipping” which means thepreference gets paid and then they participate “as if” converted to common equity again.
  6. At this point we have the capital available for distribution to ordinary shareholders – which will not include the participating preference shareholders, the converted debt, employeesand original common shareholders.


Figure 4 – Exit Valuation EV

So there you have it. Look back up to the Capital Structure before Exit chart to see the returns for each investor. Note how Series B’s potential returns were decimated by losing their liquidation preference in the last round negotiation and how the series C participation boosted theirs. Last capital in – especially in a struggling company controls the cap table.

The thing for management to think about in the sales negotiation is – “Due to the preferences, are the VCs incentivised to take a lower sales price than other shareholders or management and who controls the vote on the approval deal at Board or shareholder level?”

Fun and games indeed.

Alternative ways to incentivise management in an exit:

Over the years I have seen funds that are a lot smarter than others on the way they structure the cap table to incentivise management. One of my favourites I first saw executed by the Aloe Fund – whom I consider expert in incentivising management.

Their basic philosophy is thus: We are structuring our deals for a certain minimum return and once we have achieved this return we are prepared to share disproportionately with management from that valuation onwards to incentivise them to push for as high an exit as possible. Management are protected on the downside however on the upside will be prepared to work harder to achieve a certain minimum figure.

An example may be:

Management have 20% of the business. After a preferred return to the VC, they share 20% of common equity. However once the VC has made say 3X (or could be stated as an IRR) management share may rise to 40%. So say the VC has invested £40m at 1X Liq pref and the target return is 3X.

From the exit: The first £40m goes to the VC thereafter management share 20%. However once the VC has made £120m – thereafter management take 40% of excess returns.

Some thoughts on this approach:

While devising management incentivisation formulas based on upside, I think it is very important to remember that:

a. The upside is not so excessively large that it tempts the management to take on projects which are far too risky which they would not take in normal course.

b. Hence a business plan prepared by the management should be a first step which should clearly state how much additional funding they expect. Based on this – an exit valuation should be worked out and then accordingly management pay-out structured.

c. Additional % of the upside after a certain return is made by the shareholders can be a good motivator, however, if the management feels that they may just fall just short of the return made by investors then they will not get anything. This can have a demotivating effect at a certain point.

d. Hence instead of going for a 100% pay-out after 4x or 3x returns are made by investor, it is better to adopt a scale i.e.

  1. Management can be issued ordinary shares in the company and the investors preferred share with say 8% dividend.
  2. Management has to at least return the money to investors plus 8% return before they start sharing the returns.
  3. After this there can be a catch-up payment of say 20% – 40% to the management with usually a cap
  4. 100% share of upside for management at any point is normally unheard of
  5. In this structure, you can also keep the management motivated if things are not going as well as expected i.e. they see some returns to them. You do not want them to leave whenthings are turning bad as they do not see they can make 3x or 4x returns to the investors.

The way to structure this can be to have two classes of shares prefs and common with the return maths written into the Articles or Shareholder Agreements with example waterfalls also. This is less complicated than it seems. I have seen other ways of doing this by issuing special share classes to management on certain return criteria to investors.

Conclusion: Waterfalls and returns sharing can be as simple or complicated as you like. Some of the most complicated modelling I’ve ever seen has been on convoluted cap tables on an exit. The trick is to keep as simple and clear as possible whilst making sure your management team are incentivised through a sought after range of returns. However if you have multiple bridging rounds or downrounds – it will inevitably get complicated.

Author: John Rowland, Managing Partner, White Lake Group




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The Exit: Waterfalls explained & some innovative incentive structuring for growth Companies

Factoring -What is it ? And the Implications for your business

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Factoring: Selling your invoices to a third party financial party at a discount as a form in finance has in one form or another, has been around for about a 1000 years and can be an invaluable source of financing for start-up companies.

We will take a brief look at the two main types of invoice factoring in the UK and then highlight some advantages, disadvantages and potential pitfalls.

There are two main types of invoice financing and while closely related they differ:

Debt Factoring

‘Debt Factoring’ usually involves an invoice financier managing your sales ledger and collecting money owed by your customers themselves. This means your customers will know you’re using invoice finance.

  1. When you raise an invoice, the invoice financier will buy the debt owed to you by your customer.
  2. They make a percentage of the cost available to you upfront. This can range from 50%-90% of the invoice amount.
  3. They then collect the full amount directly from your customer.
  4. Once they’ve received the money from your customer, they make the remaining balance available to you.
  5. You’ll have to pay them a discount charge (interest) and fees

There is a further distinction in debt factoring – If the factoring transfers the receivable “without recourse”, the entire financial liability is transferred to your finance partner and they must bear the loss is your customer does not pay. If you transfer the receivable “with recourse”, you remain on the hook in the event your customer does not pay.

Invoice discounting

With ‘invoice discounting’, the invoice financier won’t manage your sales ledger or collect debts on your behalf. Instead, they lend you money against your unpaid invoices – this is usually an agreed percentage of their total value [Sometimes up to 90%]. You’ll have to pay them a fee. As they are not managing your sales ledger, this is will be less than the cost of full outsourcing to a debt factored.

As your customers pay their invoices, the money goes to the invoice financier. This reduces the amount you owe, which means you can then borrow more money on invoices from new sales up to the percentage you originally agreed.

You’ll still be responsible for collecting debts if you use invoice discounting, but it can be arranged confidentially so your customers won’t find out.


Both kinds of invoice financing can provide a large and quick boost to your cash flow.

Advantages of debt factoring include:

  • The invoice financier will look after your sales ledger, freeing up your time to manage your business.
  • They credit check potential customers meaning you are likely to trade with customers that pay on time.
  • They can help you to negotiate better terms with your suppliers as your suppliers will have much greater confidence that your cashflow is secure and not solely dependent upon your customer base paying on time.

Advantages of invoice discounting include:

  • It can be arranged confidentially, so your customers won’t know that you’re borrowing against their invoices
  • It lets you maintain closer relationships with your customers, because you’re still managing their accounts


Some disadvantages of invoice financing are that:

  • The cost reduces your profit margins on each transaction
  • It may affect your ability to get other funding, as you won’t have ‘book debts’ available as security

If you use factoring:

  • Your customers may prefer to deal with you directly
  • It may affect what your customers think of you if the invoice financier deals with them badly

If you are considering either using invoice discounting or factoring for your business, what are some of the issues that you may face:

Set-Up Costs: Set-up costs can be very high.  You are likely to have to pay a one-off fee to set up the facility, it may be a lump-sum or a percentage of the facility (typically 1% of the facility size). One has to think beyond just the initial fee that a factor may charge because extensive legal work may be required to set up an initial facility and this can add to your costs substantially.  You may also enter seemingly innocuous terms at the beginning, (for example pledging not to sell a certain machine)  but then may need to modify them which will require costly lawyers.

Concentration Limits: A factoring firm will typically impose concentration limits, so one has to consider if this is right for your business.

A concentration limit indicates how much debt an invoice finance funder will allow with a single debtor. By way of an example if your concentration limit is 30% and your total ledger is £100,000 then the lender will only consider £30,000 of funding with any single debtor. Supposing you had £50,000 of debt with your largest debtor then only £30,000 would be considered as eligible debt. This would reduce the total eligible debt to £80,000 so if your prepayment was 85% the funding generated would be £68,000.

It is important to understand the impact of a concentration limit on your funding. In the example above although you as a business have an 85% prepayment level the impact of the concentration limit has reduced the actual prepayment level to just 68%.

Concentration limits will not be an issue for many businesses who have a good spread of customers. However, if you feel that one customer could account for 20% of the money owed to you at any one time it is important to consider the concentration limit. Some lenders impose a rigid 20% concentration limit while others will offer a concentration limit as high as 100% meaning they will finance a single debtor. Be honest with yourself and try to envisage what may happen in the future.

Credit Limits: Closely related to the concentration limit is that you must consider the credit limits that a firm may apply to your debtors.  If your customer base is not well known or well established the finance company may be reluctant to grant them credit (Remember the factoring firm is essentially making a call on your customer’s credit worthiness).  If your customer based is widely spread geographically, you may also spread, your factoring firm may only grant credit to customers in certain countries.

Facility Limits:  Based upon your individual business, your factoring firm will likely impose an overall facility limit.  You want to ensure that this is large enough for the level of receivables that you intend to factor but you also should remember that you may also be paying an annual facility fee which can range from 0.25% -1.5% of your limit, so having an unnecessarily high facility limit that you will not be using can be very costly.

Business Knowledge: There are literally thousands of different types of firms offering invoice discounting and factoring services.  It is important to align yourself with a firm that understands your industry, your business and most importantly your customers.  Otherwise you face the prospect of being with a factoring firm that, due to lack of knowledge, perceives your customers as “riskier” and thus not extending the levels of credit that you had hoped.  With one technology firm that I have worked with their invoice discounted provider classified many of their clients as “construction” (which they were not at all –but again this was due to a lack of understanding of the business) and thus would only extend 60% versus the expectation of 90%

Fees: One has to be vigilant on fees as they are numerous.  Typical debt factoring charges are 0.75%-3% of the total value of the turnover that you put through the facility, while in invoice discounting the normal range is 0.5%-1.5%.   So if your clients tend to pay very promptly or even early anyway, this can be very expensive for very little gain.  You may also be charged a one-off fee per new customer and then depending upon your arrangements you may be charged separate fees for each invoice added to the facility.  In general, if you have a large number of customers that you send small invoice too, this form of finance is unlikely to be economical.   Other possible fees, which can all add up to be aware of include termination fees if you decide to end the arrangement with your factor, a refactoring fees (which is an additional fee if debts reach a certain age) and BACS charges.  Remember, these are all in addition to the interest you are paying on the amount in the facility which currently ranges from 7%-12% (on an annualized basis).

Holdbacks: If you are going down the full debt factoring route, you should be aware that any merchandise returns that may diminish the invoice amount that is collectable from your customer and the factor will typically have a holdback, until the return period for merchandise expires.

Covenants:  Depending upon the type of facility you enter into, you need to be careful with the covenants both positive and negative that you provide to the financing companies.  In certain instances you will be providing a charge against all your fixed property, which can then impact your ability to raise other types of finance in the longer term.  In other instances, you may have such EBITDDA covenants or will restrict our ability to alter the capital structure of the company (i.e. a capital raise).  If you are a start-up business, you may also be required to give personal guarantees as well

Relationships: Your bank may not be willing or able to provide factoring services.  If you do choose another bank as your invoice discounter, they may require you to move your entire banking relationship to them.  This may be problematic if you have a solid relationship with your existing bank that provides other services to your firm. It could also be costly, especially if your new bank, though providing you with factoring services is charging you more for other banking services such as overdrafts or foreign exchange.

Sales Cycle: Many factoring facilities impose minimum balances (or minimum effective interest to the factor). If your sales cycle is lumpy, you may end up in the situation where you are paying fee/interest despite having no outstanding accounts payable.

Total Costs – While it would appear obvious, you have to consider the total costs of your factoring relationship.  Set-up costs, handling fees, interest rate, relationship costs all have to be considered as a whole.   If you have a strong customer base, with tight credit terms that pays on time, you have to give consideration to whether a simple overdraft would be a better option.

In closing, the use of factoring to obtain the cash needed to accommodate a firm’s immediate cash needs will allow the firm to maintain a smaller ongoing cash balance. By reducing the size of its cash balances, more money is made available for your firm’s growth. It is also very useful if you have a lot of accounts receivable with different credit terms to manage.  However, you have to take a good look at the nature of your business and the total costs that a factoring relationship can incur to determine if it is right for your business.

Author: Ashok Parekh, Director

Thanks for input from John Rowland, Managing Partner

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Factoring -What is it ? And the Implications for your business

Convertible Loan Notes for early stage companies – to do or not to do……

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This article looks at the increased use of Convertible Loan Notes lately, from the point of view of the investor and the borrower – from a team that gets involved on both sides of the fence:

Convertible Loan Note: Debt piece with typical expected protections, however fully convertible into equity (common or other) under certain specified circumstances.


The attraction of Convertible Loan Notes to borrowers….less dilution

Lately a couple of CEOs I’ve worked with in early stage (i.e. pre-revenue start-ups) have asked me about the virtues of raising capital via Convertible Loan Notes (hereafter CLNs) as opposed to straight or even preferred equity. Their premise and desire to do so is quite simple – avoid dilution now at the current valuation and have the conversion occur at a time when they feel a higher valuation will be warranted.

Obviously these CEOs have a lot of confidence in their company’s prospects – they have to or they would not have started in the first place. However I urged them to tread carefully for reasons we will go into. Having a debt instrument on the balance sheet with a termination date (however long-dated) in a company with no cash flow can be a dangerous game to play and I have seen this first hand seriously backlash against original equity holders when things don’t go according to plan. As for the investors in CLNs – It’s always nice to have your cake and eat it – as long as you are not spoiling the cake for the next investors…


Or maybe there is no other option but a CLN….

Another company took on CLNs for the exact opposite reason. The company was running out of cash in a few weeks and current investors were losing confidence in the business plan or cash flow projection and their own ability to price the company at that time (alternative approach being to do a total whitewash/recap of the business). Hence without taking this nuclear option, investors wanted the most protection they could achieve with an investment instrument however with the full upside maintained. Again this solution may also not have been optimal as we found out in the medium term to our detriment as a company and CLN investors. A total renegotiation of the original CLN terms ensued, as required by an incoming investor who felt they were too harsh on the original shareholders.

To analyse the above scenarios – let’s first look at where a CLN can sit in the capital structure. Due to the “Convertible” element of this debt form it can essentially sit anywhere in the below charted spectrum of returns and essentially switch places at will to suit the investor generally. It can be an extremely powerful instrument with protective negative covenants/vetoes and controls associated with it. Next we will look at what those key terms could be.


The spectrum of capital instruments in a company – CLN can essentially sit ANYWHERE below:

*Preferred equity sits above common mainly due to the preferred return or liquidation pref which may be part of it – a convertible preferred of course can “double dip” –take a preferred return (typically 1-2X) and then convert to common and share equally in the remaining proceeds.


What is it exactly? It’s whatever you want it to be….or don’t want it to be….

At its most basic a CLN is piece of debt which may convert into equity if certain events (normally to the upside for the company i.e. sale, IPO, up-round) come to pass. However, and here is the important bit – the terms around when it may convert can be many and varied i.e. on a qualifying up-round size and price; on a liquidity event – sale or IPO; conversion compulsory or at the note holder’s option; conversion into which equity instrument… etc. Alongside that is the real negotiation point – the conversion price, typically at a discount to the next round (which can be damaging which we shall see later) or a specified uplift price above the deemed current valuation.


Typical terms and what is important to consider:



So after all that – when are they used and the purpose?

Coming from the opening paragraph – In my experience CLNs are generally used in three situations:

  1. Disaster Situations/Bridge Rounds: Company is running out of capital and current investors want to put in a bridge/emergency capital to get to a larger round. Most likely the company is at turnaround status at this point i.e the company is struggling badly to execute on it original plan.

What to look for:

Investors: Obviously need to protect your last capital in, however watch that your terms are not so harsh that the next incoming investor has no choice but to renegotiate these before doing a deal. An example may be: a CLN comes in with a term dictating that when it converts it is more senior to the next incoming instrument – not nice for new money. Effectively by not having a cram-down round at this point in-time you have left current investors who do not follow in the CLN alive to fight another day (depending on how you adjust their voting rights). You can then be faced with a potential new investor insisting you change terms or they won’t invest, leaving you with the choice of liquidation or cave in on your original terms.

Company: Try to resist terms that are too punitive or complicated as it could put off new money. A cram down round can often be better to clean up the cap table for a restart with supportive shareholders. Also the amount: better to get enough to give a decent runway – at least 9 months and an amount which won’t skew the behaviour of the team to pure cost-cutting instead of growth – only growth will get your out of this hole.

  1. Avoiding dilution for early stage companies – Founders decide to take on a CLN to avoid dilution as they feel valuation inflection points are imminent. Be wary of putting an instrument in your business simply because you do not like the valuation at that point in time. Face the reality and price the company if you can. What you feel may be a valuation inflection point in the very near future may not be shared by professional investors unless it is a hard metric such as sales/EBITDA. Also again it skews the rewards of the next investors versus the investors before the CLN. Please see here this brilliant article from Early Stage Partners which can explain it a lot better than I can – the maths in this article deserve study.

What to look for:

Investors: As seen from the article referenced above (to summarise the article – 1.by putting in an instrument at a discount to the next round, then in a wind-up situation you are penalising the new investors and in an upside case the same; 2. warrants are often a better solution than using a discount – as warrants penalise the existing shareholders in an upside situation and are powerless in a liquidation/wind-up)

Company: Be very clear on the default terms and what happens on maturity for the CLN you are taking on. As a loan at some point it will need to be repaid (if not converted) and as an early stage company with no cash flow – this is not a situation you need to be facing even if the instrument is long-dated. Wirth reference to my statement in the opening paragraph – I have seen a company confident in its growth prospects take on such a CLN instrument then struggle to achieve their own targets and for a relatively small amount of funding had the CLN tail wagging the dog for five years. Careful how you make your bed….

  1. Later stage companies that cannot get senior debt but don’t want equity dilution – With the lack of bank capital on offer at the moment for growing businesses who are doing well but will struggle with harsh covenants of a senior debt piece – there are funds now setting up issuing CLNs with equity kickers to boost the debt like returns for investors. For the company they are a senior instrument but without the strict covenants and default provision of typical senior debt – i.e. ratio analysis monthly etc. allowing them to grow the pie without immediate dilution or default risks.

What to look for:

Investors: If a company accepts an instrument that is effectively preferred equity but with protective provisions – set to convert at the current valuation of the company – well then they are either extremely confident in their growth plans or really need funds and can’t get any other offers. A company that pushes back on the equity kicker/conversion price is most likely a better prospect on the risk/return graph.

Company: Be certain that you can handle the covenants on any pay current element of the loan – ideally this would be based on a solid recurring revenue stream. A simple cure can be a rollover to a PIK (Payment in Kind) type instrument if the cash element becomes too much to bear. Again the conversion price – where this is set is determined by your negotiating position in terms of a. the growth opportunity this capital will unlock – how big the pie can get, and b. access to cheaper capital.


Conclusion – the terms, the terms, the terms

Depending on the terms associated with it – this instrument can be the most powerful on your balance sheet or the kindest. So when should you use a CLN?

In my opinion only in two situations 1. if you are in an extreme position and running out of cash and do not have much negotiating power or 2. if you cannot get bank debt on covenants you are happy with but need capital to finance growth you are confident in – then CLNs can work for you or may be your best option. Taking a CLN which converts at the current valuation sometime in the future at the request of the holder – is just equity with extreme downside protections – so call it how it is. Taking a CLN into an early stage business at a discount to the next round just because you are trying to avoid dilution right now is, in my opinion, just passing the buck on valuation in my opinion at the expense of having a debt instrument which could have to be repaid on your balance sheet. It also transfers negotiating power to the CLN holders vis a vis new equity. It could come back to bite down the line.

To get some templates of typical CLN term sheets to suit your needs feel free to email me Jrowland@whitelake-group.com

Author: John Rowland, Managing Partner

Thanks for input from Ashok Parekh.

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