Capital providers for a business project

Without a doubt, a critical element with the start-up of an entrepreneurship or general business project has to do with the search for financing, in short, with the capital provider management.

When talking about capital providers we have to do it in a double way: in a debt and/or equity. In the first case, in Europe and predominantly the debt providers are the Bank entities. In the case of capital provision in equity format (own resources), we would be talking about business angels or venture capital in its “higher caliber” version.

Let's see what critical elements appear in the relationship with these two types of capital providers for a business project.

When a company requests a financing operation (credit) from a financial entity, the entity uses its “rating” system to decide whether or not to grant it and at what price.

Rating systems

All relevant financial entities have a internal credit risk analysis system with clients which is called “rating”. Each entity has prepared its own, although its methodological analysis has been approved by the Bank of Spain. On the other hand, the final result of the concession or credit could not differ between the different rating systems of the various entities.

A rating system evaluates the probability of default by the company. It is made up of several modules that incorporate different variables of each of them that are computed according to certain weights or proportions in a final algorithm whose result is said rating associated with the aforementioned probability of default. Each entity gives different “weight” to each of the variables of each module that are incorporated into the algorithm.

The modules of a rating system are:

• Economic-financial information: This module draws on different variables from the company's Balance Sheet and Income Statement with their different weights in the final algorithm. This information is entered into the rating system through the audited financial information (Balance Sheet and Income Statement) provided by the company.

• Qualitative information about the company and its managers: This is information that the business manager of the entity that owns that company enters into the computer system. This is qualitative information not included in the previous official financial statements such as: quality and possible replacement capacity of the management team, suitability and condition of its production facilities, adequate level of amortization and investments in capex depending on the sector, degree of concentration of sales, etc.

• Relationship and previous experience with the financial institution: automatically introduces into the rating algorithm those variables related to past experience with the client (for example, if they had previous credit positions and these evolved and were canceled satisfactorily) as well as the rest of the business positions (balances, etc. ) of the company with the entity.

• Alerts with the external system: Those events (alerts) that the company has with the external environment, such as notifications of embargoes from Social Security, Treasury, etc., are also automatically entered into the rating system. These events become penalizing variables for the company's final rating.

How are the results obtained from a company's rating defined?

The rating of the company that the system grants, and which, as we have mentioned, is associated with the probability of non-payment by it, also serves to establish the price of credit to the company. The spread or differential of the credit over the reference (let's assume the Euribor) must serve to compensate: the operating costs of the transaction, the “cost of risk” due to the possible non-payment of the credit and the adequate remuneration of the capital (the solvency regulations of Basel of financial entities requires them to have minimum own resources that logically have a cost of equity).

Logically, the worse the company's rating, the worse the risk profile and therefore the spread and final price of the credit will be higher. It is interesting to contact the financial institution of which you are a client so that they can inform us of the rating they have assigned to us and thus try to improve it. Logically, when it comes to a company that begins to operate with a financial institution, the connection and experience previous with the financial institution will not exist.

In the module economic-financial information which is part of the rating algorithm, many financial ratios are taken. As we have said, what they are and their weight in the algorithm are part of the confidential information of the entity's rating system. In any case, we can already sense the importance of some of them, such as: liquidity, solvency, indebtedness, economic profitability and financial profitability ratios.

When we talk about an entrepreneurial project, the initial phase of the company in which you cannot yet go to a conventional commercial banking financial institution, your capital supply can come through private investors (business angels). This will also occur in later phases of growth in which the company may need capital for its growth and expansion through venture capital operators.

Requirements of a private investor to provide funds

Let's initially focus on the critical aspects of capital provision through private investors (business angels) for companies in early stages or startups. It seems reasonable that a private investor (business angel) will provide funds to the startup under a series of premises:

1. That the startup already has a value proposition validated in the market. It is not enough to present an idea, no matter how innovative it may seem a priori, much less a power-point. We believe that realistically there are no relevant capital providers in Spain today if there is no validated value proposition.
2. That he main management team is constituted and “full time” dedicated to the startup. On the other hand, if the company is a startup with a strong technological focus, it would be necessary for the CTO to be “internalized” (not an outsourced function) from the beginning and within the shareholder and management team.
3. That the startup has a clear and defined business model. The best proof of this is to show that the startup already has income (revenues) and that these are recurring and growing. In short, from the theoretical “pain factor” and business model to having income (the first line of the income statement is called “sales”, not “visits”, nor login, etc).
4. That the startup can have a growth scale model. This is an aspect that a priori is not entirely “visible”. To give an example on the opposite side, we would say that, for example, an entrepreneurial project in the “professional services” sector would be “not very investable.”
5. Equity valuation for the investor as consideration for their capital contribution. It is a critically important issue to which we will devote specific future attention.
6. Efficient use of capital. This is an aspect that should be of special concern to the equity provider (business angle), they are taking a special risk as a shareholder, not as the bank does as a creditor and therefore with a better priority than those who finance the project. from own resources.

 In short, they are aspects of critical importance in relation to the various providers of capital for the business project.

Do you want to know more about the author of this post? Visit their LinkedIn profile, Fernando Moroy, president of the Madrid Chapter of the Business Angels Keiretsu Network of San Francisco.