The Story
Very seldom do companies start out life with a view to lose any investors money. Defaults and delays do happen, but we have seen that there is a very similar story we see in companies that have run into trouble.
Stage 1 – The Failed Set Up
The business is funded and doing well. They need to raise some additional money for growth but do not have the in-house experience in the capital markets space. They get referred to an advisor who understands investment structuring. The advisor doesn’t truly understand the business, or the loan note market, but regardless, charges huge up-front fees, with no downside risk. They promise the world but ultimately the investment goes to market and struggles to raise meaningful levels of investment.
Stage 2 – Successful!
The company bring in an expert in the loan note market. They re-structure the investment to suit the market. It’s quite expensive, there’s additional marketing and structuring fees, but the expert only takes fees at the point any clients invest. The business then starts to attract meaningful levels of capital and they can raise the money to complete their project.
Stage 3 – Hidden Fees and Capital Allocation
For every investment there are up-front distribution fees, marketing fees and introducer fees. These can be up to 30% (!) in some cases. The business quickly realises, if they need £4m for their project, they need a total raise of more than £5m to ensure they can pay for the marketing fees and still get the amount required. Typically, in other types of investments, the client may pay these fees, however not in the loan note market. 100% of a client’s capital investment is interest bearing, but not 100% of the clients capital investment is allocated to the project or company.
Taking the previous examples further…
| Amount Required | £4,000,000 |
| Fees (20%) | £1,200,000 |
| Raise Amount | £5,200,000 |
| Interest (12% per annum) | £1,872,000 |
| Term | 3 Years |
| Required Return | £12,272,000 |
| Required Return Per Annum % | 102% |
Stage 4 – “Tail Wagging the Dog”
They successfully close their first investment, paying investors back and make a healthy profit. Perfect! The initial investors and introducers, buoyed by the company’s initial success, then start to make suggestions for the next investment. The company then realise that they could attract more investment if they make tweaks to the: term of the investment, investor returns, interest payment frequency, fee and commission payments, etc etc etc. The company run the numbers, it was hard enough work making 100% per annum return on the capital to break even, but they still feel they can operate in this way.
Stage 5 – The Focus on Liabilities
The management team are getting dragged more and more into the day-to-day capital raising operations. Meeting investors, marketing materials, roadshows, podcasts and due diligence meetings. The focus slips from the underlying projects and assets. The company does not deploy any capital into projects for over 6 months since the investment structure was launched. This plus the investment term being reduced (due to investor demand) leaves them with only 18 months to make a 300% return on capital.
Stage 6 – “Ponzi”
The drive to attract investors and brokers can very quickly overshadow the businesses initial principals and corporate strategy. Given the large capital repayments owed out to previous investors, and the lack of profit from the previous project, new investor funds begin repaying old investors’ funds.
Stage 7 – Default
The company has a poor month in raising capital, they can’t easily repay previous investors capital or interest payments. They begin delaying commissions, then interest payments and then capital repayments. The bad press means they have a few poor months consecutively. The business has no option but to propose an extension to investors. This does not go down well, and the investors are requesting all of their capital to be repaid.
Stage 8 – Liquidation
The company officially defaults and then the game begins to see whether the investors have any security at all on their investments and how liquid these assets are. Will investors be repaid anything?
Summary
The issue that many companies fall into when raising capital from the offshore markets is that up-front fees and commissions can kill the business. If you are a company looking to raise capital and you’re speaking with an “advisor” who is telling you that you need pay large commissions to compete, they are just looking for an easy pay day.
If you are looking to raise capital or seeking an investment option, we’d be more than happy to have a conversation about how we may be able to help. Our Advisory division works with SME from across Europe and the Middle East supporting them with their funding and capital markets requirements.
To speak with us, please contact us at hello@kingsburyandpartners.ae
