Wed 31 Mar 2021

Equity Investment - Working Together

This is the first in a series of blogs about equity investment. In this introductory blog I will discuss the purpose and motivation for investment for both Company and Investor, as well as discussing the importance of their ongoing relationship

Why do Investors invest?

Investors will typically identify businesses with potential for growth and invest with a view to seeing a return on their investment. A return on investment might mean a payment of dividend income once the Company starts generating sufficient profits. Alternatively (and perhaps more commonly) Investors will seek capital appreciation in the value of their shares, where the investor might look to 'exit' after a period of time. An 'exit' could take various forms, such as a share sale to a third party purchaser, a listing on a share exchange or even a share buyback, where the Company buys out the Investor at an agreed price.

Why do Companies seek investment?

Companies seeking investment do so principally to enable growth. The investment funds may be used to hire new staff, to acquire assets or technology, to increase research and development activity, to expand into overseas territories, among many other reasons. Typically Investors will invest based on a business plan prepared by the Company which sets out where the investment funds are to be spent and contains financial projections of where the Company sees itself in the years ahead. 

What will the Investor want to know about the Company?

Investors will typically carry out 'due diligence' on any Company they are looking to invest in to ensure the Company is a viable option. Investors might reasonably want to see the most recent and historic financial records and accounts to determine the financial position of the Company before they invest. In addition, if a big part of the Company's business relies on intellectual property (such as patents, trade marks, copyrights, rights in software etc.) the Investor will want to know that the Company has proper ownership of those assets. The Investor might also want to have an overview of the Company's commercial contracts, employees and competitors. Due diligence could be considered to be a 'health check' on the Company enabling the Investor to highlight risks and opportunities. 

Investors will also want to know who the board of directors and major shareholders are of the Company. The relevant experience of the directors and their track record will be considered. In carrying out that assessment, the Investor might identify gaps in the board structure that need to be addressed as part of their investment. Key individuals with relevant skill sets, be that in sales, operational or technical roles, may be recruited, often subject to input from the Investor. Investors will also want to understand the existing shareholding structure before they invest, particularly if the Company has taken on equity investment before. There may be instances where shareholder consent is required in which case the Investor will want to know who they have to deal with to obtain such consent. 

What will the Company want to know about the Investor?

The Company will also want to carry out its own due diligence on the prospective Investor. This might involve understanding how aggressive or passive the Investor is with its investments. This could perhaps be achieved by speaking with other companies in the Investor's portfolio to understand how that Investor works in practice. It would also be prudent for the Company to understand what sort of return or exit the Investor is looking for. Does the investor have to see an exit within a certain period of time, or will the Company be given more free rein to establish and grow the business?

The Investor-Company Relationship

Most investments will form the basis of an ongoing relationship between Investor and Company, which could last for several years. Once the investment takes place, the interests of both Investor and Company will largely be aligned where the mutual goal is the success of the Company's business. The market shows that many companies require further funding for their continued growth and expansion. It stands to reason that the Investor will have a vested interest in ensuring the Company succeeds so is likely to be the first port-of-call when new funding is needed. Accordingly, it will be important for both sides to seek to maintain a good relationship as they may be together for the long-haul.

Morton Fraser has an experienced team of corporate and private equity lawyers in Edinburgh and Glasgow who advise both Investors and Companies on a wide range of equity investments and corporate transactions. Please do get in touch should you wish to discuss any of these issues.

Stephen Clark, Senior Associate - or call 0131 247 1344


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