Wednesday, 22 August 2018 - About DavidElliott | Rss

Thinking outside the box

With funding from financial institutions continuing to be very difficult to obtain, have you thought about trying to obtain private funding for your company?

 

Suppose that you knew of someone with surplus cash (they do exist!) who is looking for an investment opportunity. They may simply be looking for a return greater than the paltry rate of interest that they are likely to be receiving at the moment from a bank or building society. In which case, could they deposit monies with your company for an agreed, finite period of time, during which you agree to pay them a rate of interest which is attractive to both parties? A possible option could be to offer the potential investor convertible loan stock. How does this work? Let’s take an example.

 

You want to borrow £25,000. You know someone with £25,000 going spare. Your company issues them with £25,000 of 6% convertible loan stock dated 2015. Between now and 2015 your company pays them £1,500 per annum (6% interest on the £25,000). In 2015 the investor has two options. Option one is for them to redeem the loan stock – in other words, they just ask your company to repay the £25,000 capital. For you and your company, this will have performed pretty much the same role as an interest-only mortgage, and you will need to have the £25,000 set aside to repay the investor (unless you make a fresh issue of loan stock in 2015). Option two is that, when 2015 arrives, the investor decides that instead of redemption, he or she prefers to convert the loan stock into shares. The number (or percentage) of shares the investor has the option over will have been determined in advance when you initially issued the loan stock. Let’s say that you had agreed that the £25,000 loan stock was convertible into 10% of the company’s share capital in 2015. Should the investor choose to convert, then instead of paying back the £25,000 your company would simply convert the debt into equity (share capital) and the investor would now own 10% of your company.

 

How likely is it that the investor would convert his loan stock into shares? That would depend on how strong your company was in 2015. If your company was worth £250,000 then the investor would have to choose between redemption (getting his £25,000 repaid) and conversion (into shares worth 10% x £250,000 = £25,000). In this scenario the investor might find the decision difficult, but you will have spotted that if the company is worth, say £500,000, then his 10% shareholding would be worth £50,000 and his decision, in theory, becomes much easier. He’s very likely to convert rather than redeem.

 

Something else that’s worth considering here is that, unlike the usual providers of finance who offer very little help in running your business, an investor with convertible loan stock has a vested interest in assisting you to increase the value of your company. In doing so, he’s helping himself as his shares will be worth more on conversion. So think about the sort of people who might have money to invest and who could also help your business to grow. Even existing customers and suppliers (depending on the relationship you have with them) could be worth approaching. If a customer had a financial interest in your company he would presumably be tempted to try and push more business your way. And a supplier might be prepared to give you a particularly good deal on your purchases!

 

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