12/04/11

By Simon Clark, Managing Partner, Fidelity Growth Partners Europe

A common, and all too justified, complaint of entrepreneurs is that no one was prepared to fund them when the business was young and struggling, but once it becomes successful their phone starts ringing constantly with offers of investment. Why on earth should they even consider taking money when they don’t really need it, or as one particularly successful founder said to me a while ago — “ I like you, but why should I cut you in?”

This isn’t an easy question to answer as individual circumstances vary, but it’s worth noticing that some of the most successful companies have taken growth capital, and have used it wisely to accelerate their growth, and that a whole growth capital industry has grown up around this concept, so there must be something going on here.

Let’s consider a situation in which taking growth capital might make sense. I am going to assume that we are dealing with a high growth technology business that has proven its products in the market, has meaningful revenues and is either profitable or close to being so.

The first question the founders then face is: what is the size of the opportunity that they have uncovered and how to exploit it? We know that the market leader in a technology market generally obtains the bulk of the value and that winning that position creates disproportionate wealth if the market is big enough, and growing fast enough to be interesting.

So if the answer to the first question is that the company is operating in a big enough, and high growth market, and has the chance for leadership, then it’s worth moving to the next question: so what do we do about it?

If the team believe they have all the resources they need to win on their own, then taking growth capital might still make sense, but only as insurance against unexpected setbacks. However, in many cases, the team may identify some weaknesses, either in the company’s positioning, funding base, strategy or indeed in the team itself, which might hold them back from winning. In that case, growth capital becomes a potentially very useful tool.

A growth capital investment brings a number of benefits for teams with a strong business and aspiration for greatness. Enough capital on the balance sheet, and sometimes the ability to take a bit of money home as well, can catalyse growth and demonstrate that the company is here to stay. It can also fund expansion either into new geographies or into new product lines. Growth capital firms are experienced in helping companies grow by building partnerships, helping to recruit new senior team members, supporting companies as they go global and thinking through the eventual exit paths. Because the company has already demonstrated its viability, it should be able to negotiate sensible terms and limit the dilution to the founders, while obtaining enough fresh capital to change the game.

As always, this move needs careful thought. Taking growth funding doesn’t make sense if the opportunity isn’t really that big, or the company isn’t well positioned to take advantage of it. In those circumstances, other moves might create more value for the founders. Also, not all growth investors are created equal, and entrepreneurs should take careful references on any investors who turn up and promise the earth — there’s nothing like a view from other companies they have backed to get behind the claims and the pretty brochures. But, used wisely, growth capital is a tool which can help entrepreneurs make their business more valuable and fulfil the company’s true potential.