A shift in focus for SME capital raising

  • Publications and reports

    08 February 2024

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In the past few years, with low interest rates and expansionary monetary policy settings, high growth SMEs have found it relatively easy to attract equity capital to fund their growth plans. However, the recent surge in interest rates and operating costs, and the corresponding decrease in valuations have changed this picture.

In past M&A Forecasts, we discussed how angel, venture capital and private equity investors are increasingly focusing on supporting their existing portfolio companies with necessary follow-on funding. This trend makes it challenging for new companies entering the market to attract investment.

Follow-on investment and capital raising

Established companies seeking follow-on investment or additional capital raising rounds are also facing hurdles. Given current economic conditions, extracting more funds from shareholders can be a tough task. We are witnessing an increasing number of situations where shareholders are not willing or able to provide follow on investments and are seeking to sell their shares to deal with their own financial challenges. These shareholders often compete with the company for funds, which can impede capital raising efforts, especially when pricing expectations are not perfectly aligned.

Rising interest rates and lower valuations

With the rise in interest rates and lower valuations, investors are shifting their focus towards companies that can demonstrate sustainable cash flow and profit, and not just high revenue growth. Alternatively, they are looking for businesses that can at least present a clear short to medium-term pathway to profitability. As a result, investors have more leverage and are demanding more investor-friendly investment terms – with liquidation preferences and anti-dilute protections becoming more prevalent.

These factors can sometimes mean that putting the company on the market for outright sale to a trade or financial buyer is a better option than trying to raise additional capital.

Capital still looking for a home

It’s not all doom and gloom for SMEs though. There is still plenty of capital looking for a home, albeit slightly harder to attract and at lower valuations. So before approaching the market, companies need to ensure they have “run the ruler” over the business and have taken the necessary steps to ensure they can demonstrate a path to profitability.

It can be done – for instance, Clare Capital (Tech Insights #312) recently highlighted a trend back towards profitability among listed tech stocks – showing how quickly tech companies can go from generating significant losses in the pursuit of high revenue growth, to significant profits; often driven by higher gross margins than bricks and mortar businesses.

The year ahead

Looking ahead to this year, the challenging environment looks set to continue. So, companies must be prepared for lower valuations and a more challenging process and investment terms.

Of course, with the recent change in government, companies also will need to keep a close eye on government policy changes and be agile enough to adapt their capital raising strategies accordingly.

While the landscape for SME capital raising in 2024 may seem daunting, with the right approach and adaptability, SMEs can navigate these challenges and secure the necessary capital for growth.

Read the M&A Forecast 2024