By Thoko Mkavea, Chief Executive Officer/Managing Director, CDH Investment Bank
Attracting investors to finance a company can be challenging. In the many years we have advised companies in raising either debt or equity capital and also advised investors in selecting investments, we have obtained a fair understanding of the needs of investors. Investors, whether seeking to buy shares in a company or debt securities do look for some selected information before deciding to invest. In this article, we share some of the information which investors look for and some of the common challenges encountered by companies seeking to raise capital either privately or on stock exchanges.
What investors look for
Equity investors look for sustainable returns. To determine this, investors analyse a company’s historical performance, projected earnings and strength of a balance sheet to gauge the potential return on their investment. Further, investors search for qualitative information about a company’s strategy for serving its market, growing market share and generating profitable outcomes. Debt investors on the other hand prioritize the security and stability of their investments, often placing greater emphasis on cash flow analysis and the company’s ability to meet debt obligations.
In assessing what future returns can be achieved, an investor will delve into a company’s financial health as a fundamental aspect of their assessment. A stable balance sheet, manageable debt levels, and consistent profitability are key indicators of financial robustness. Investors seek assurances that a company’s financial structure can weather economic fluctuations, ensuring a steady return on their equity investment over the long term.
Investors mind about security of their investment. In our experience, this has remained one of the profound influences on investor’s decision-making. Investors place a premium on safeguarding their capital, requiring companies seeking funding to not only promise returns but to ensure that these returns surpass inflation. Maintaining the real value of investors’ funds becomes important, requiring companies to present compelling strategies that not only generate profits but also outpace inflationary trends. For debt financing, security can also take on a more tangible form, often as assets or additional guarantees that investors can lay a claim on in the unfortunate event of a company default. Overall, for both debt and equity there is need for companies to proactively address concerns on security to provide confidence and attract prudent investors.
Another important consideration for investors evaluating equity and debt opportunities is liquidity. Investors favour investments which would be easily converted to cash when they need to. Though licenced market players, investment bankers and advisors in the market help placing debt or equity securities privately, through over the counter platforms, listing debt or equity securities on a stock exchange like the Malawi Stock Exchange is a sure way of enhancing liquidity of securities. While equity and debt investors share common factors of interest, debt investors often place a greater focus on cash flows. A robust analysis of a company’s ability to generate consistent and reliable cash flows is paramount in attracting debt financing.
A compelling narrative outlining the quality of board and management, record of compliance with laws and regulations, insights into the industry in which the company is operating, risks and documented ways of mitigating industry inherent and emerging risks and a well-defined strategy for expansion and adaptation to market trends will ease decision making by investors. Companies that can effectively communicate their plans for scaling operations, entering new markets, and seizing growth opportunities stand out in the eyes of investors seeking long-term sustainable value.
Some key financial indicators
When assessing a company’s financial health, equity investors have tended to look at several financial ratios. We highlight the three ratios namely; dividend yield, Price-to-Book (P/Bv) ratio, and Price-to-Earnings (P/E) ratio which we have noted investors taking a close eye on in our market.
The dividend yield is defined as a measure of a company’s dividend distribution relative to its stock price. Expressed as a percentage, it is calculated by dividing the annual dividend per share by the current stock price. While a higher dividend yield may seem attractive, it’s important to note that this doesn’t always indicate favorable investment opportunities, particularly in cases of declining stock prices.
A pertinent example was the Airtel Plc Initial Public Offering (IPO) which raised K28 billion in 2020. The IPO was oversubscribed by 34%. Airtel projected a dividend yield of 10.2%, surpassing a benchmark yield of 3.39% at the time and the comparing favorably to the average Treasury Bill yield of 11.16%. Even though the price to book value was outside acceptable levels, the stock was oversubscribed as we noted above.
The second ratio, the P/bv ratio compares a company’s market value to its book value, in a way offering insights into a stock valuation. A lower P/bv ratio suggests that the stock price is fairly valued and is trading closer to its book value, while a high ratio indicates that a stock is being offered at a premium. Investors also compare the P/bv ratio with other listed companies in the same industry. If the stock is within the range of other well-known companies, investors are more likely to prefer the stock and where a stock’s P/bv ratio is above peer range, investors will look at other compensating factors before drawing a decision. An example could be the FDH Bank Plc IPO in 2020, which was oversubscribed by 2.4%. The estimated P/bv ratio for the stock was 3.04x which compared well with other listed banks at the time. Investor were willing to pay a premium above the book value for the stock, driven by
prospects of a positive future for the company. Similarly, ICON Properties Plc IPO in 2019, with a P/bv ratio of 1.60x compared well to its closest peer company which had a P/bv of 1.08x and therefore successfully attracted investors.
The P/E ratio, also known as the price multiple, compares a company’s price per share to its earnings per share (EPS). It is the number of times an investor is willing to pay for a single unit of earnings in a company and demonstrates confidence in the future earnings potential of a company. The ratio serves as a measure of relative value of a share and can be assessed on a trailing or forward basis. For investors investing in debt instruments a common ratio is the Debt-to-Income (DTI). DTI ratio assesses a company’s ability to manage debt obligations relative to its income. A low ratio indicates sufficient income for debt servicing, rendering the issuer more attractive to investors. Typically, a ratio below 40% is seen as acceptable to investors.
MyBucks Banking Corporation Limited (“MyBucks”) in 2019 successfully placed a K14 billion note program with investors on the back of an acceptable DTI ratio and good security. In addition, investors liked the liquidity of the security because it was listed on the Malawi Stock Exchange. Furthermore, the attractive yield potential presented by the investment bolstered its appeal, promising returns that aligned with investor expectations.
Beyond returns
While financial returns are important, investors also consider other qualitative factors when deciding on investments. A more nuanced evaluation involves a comprehensive assessment of various elements that contribute to the long-term sustainability and success of a company. Above an issuer’s reputation and good standing in the market, strong board, solid management, investment in a growing industry, good environmental , social, and governance (ESG) responsibility marks become integral to investment decisions, with investors increasingly seeking companies that prioritize sustainability, social responsibility, and ethical business practices. Integration of ESG principles into operations not only contributes to a better world but also aligns with the values of socially conscious investors, enhancing a company’s reputation and resilience across a broader spectrum of potential stakeholders.
In the context of ESG factors, the significance of governance structures and a commitment to transparency cannot be overstated. Emphasizing a well-defined governance framework is crucial, ensuring effective decision-making, robust risk management, and ethical business practices. Transparent reporting mechanisms offer investors a clear view of the company’s operations, fostering trust and confidence. A dedication to accountability and integrity further positions the company as a reliable and responsible investment, reinforcing its appeal to discerning investors.
In tandem with governance and transparency considerations, adherence to regulatory requirements becomes a non-negotiable aspect for attracting both equity and debt investments. Prioritizing compliance not only demonstrates a commitment to ethical business practices and risk mitigation but also resonates with investors who favour businesses operating within legal and tax frameworks. Investors also pay close attention to a company’s management team, as the leadership team plays a pivotal role in shaping a company’s trajectory. Investors seek companies led by experienced, visionary, and adaptable executives. A capable management team not only navigates challenges effectively but also capitalizes on opportunities for growth. Investors are more likely to commit capital when they have confidence in the team’s ability to execute strategic plans, adapt to market changes, and drive the company towards success.
Lastly, in a rapidly evolving business landscape, investors value companies that understand and adapt to industry trends. Companies that demonstrate awareness of market dynamics and proactively adjust their strategies to align with industry shifts are viewed favourably. A forward-thinking approach to technology, consumer behaviour, and market trends enhances a company’s resilience and ability to thrive in changing environments.
Common challenges in raising capital
The capital market in Malawi is growing at a reasonably fast rate. For example, fund available for investments in pensions have grown from K716 billion in 2018 to 2.3 trillion in 2023 and estimated to grow further by K3.6 trillion within the next 10 years. However, raising capital for many companies remains challenging calling for critical strategic foresight and adept navigation. While the potential rewards can be substantial, companies often encounter common hurdles that require careful consideration and proactive solutions.
One of the most common challenges is a lack of a clear business plan. A robust and comprehensive business plan serves as the cornerstone of successful capital raising. However, one of the most common challenges is the presence of a poorly articulated or insufficient business plan. Investors seek clarity on a company’s mission, objectives, market positioning, and financial projections. A lack of a coherent and compelling business plan can significantly undermine a company’s chances of attracting investment, as it fails to provide investors with a clear roadmap for success.
Secondly, a weak board, investors place considerable importance on the composition and effectiveness of the board, as it reflects the company’s commitment to sound corporate governance practices. A weak board may struggle to make informed decisions, effectively manage risks, or provide strategic guidance, ultimately undermining the company’s ability to attract capital.
Thirdly, lack of strong leadership and weak workforce. A not so impressive skill base, whether in the management team or broader workforce would be a difficult sale to many investors. Investors assess the capabilities and expertise of the team driving the company forward. Companies must focus on talent acquisition, skill development, and creating a team that inspires confidence in its ability to execute strategies and navigate challenges.
Unclear business strategy can also pose significant obstacles to capital raising efforts. Investors seek companies with a well-defined and coherent strategy for achieving their goals and capturing market opportunities. A lack of clarity or consistency in the business strategy can signal uncertainty and increase perceived risk for investors. Companies with a well-defined strategy can more effectively allocate resources, prioritize initiatives, and capitalize on market opportunities, enhancing their attractiveness to investors.
Additionally, the lack of track record is a major hurdle faced by many entrepreneurs looking for funding. Investors naturally gravitate towards companies with proven track records of success. The absence of track records, particularly for newer ventures, pose significant challenges. Building credibility requires showcasing past achievements, milestones, and successful outcomes. Companies facing this challenge must focus on highlighting their strengths, industry expertise, and any notable achievements that demonstrate their capability to deliver on promises and generate returns for investors.
Innovation is a key driver of success in today’s dynamic business environment. Companies that fail to innovate, risk becoming stagnant and less attractive to investors. The lack of a culture of innovation can be a significant challenge, as investors seek ventures that demonstrate adaptability and a commitment to staying ahead of industry trends. Overcoming this challenge involves fostering a culture that encourages creativity, embraces change and consistently seeks opportunities for improvement.
Conclusion
In conclusion, the journey to secure capital does have challenges; however, a strategic approach to addressing these common hurdles can substantially elevate a company’s outlook. Despite the seemingly daunting nature of raising capital, companies don’t need to navigate the hurdles alone. The market has with experienced advisors, like CDH Investment Bank, ready to assist companies meet the needs of investors and raise the required capital.
