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Funding product development

BGF News 05.14.2013

What is it that fast-growing businesses have that enables them to leap forward when so many companies are simply coasting? The answer, very often, is an unerring commitment to product development – both of the existing range and of new goods or services.

Take AFG Media, the company behind the Morphsuit phenomenon. After its three founders racked up £1m of sales in their first year, having launched the business in their spare time with just £3,000 of their own money, one might have expected the company to catch its breath. Not a bit of it – instead, AFG’s focus has been on developing its core product, the spandex all-in-one suits that have brightened up so many Halloween parties and stag-dos, while launching two new product lines.

“Once we were able to give up our day jobs, we became much more ambitious,” recalls Fraser Smeaton, one of the trio of founding directors at AFG. “We started to think about going after licensing deals with the Morphsuit product, as well as launching into the children’s market,” he says. “And we launched two new ventures – Foul Fashion, selling outlandish party shirts, and Royal & Awesome, which sells golfing trousers.”

Still, despite its stellar organic growth since that 2010 launch year – AFG’s sales hit £11m in 2012 – the business could never have pursued such an aggressive product development strategy without support from investors. “As we scaled up, we really started to think about equity finance,” says Smeaton. “Our cashflow was incredibly tight and while we were able to get limited trade loans, we were paying through the nose for them because the banks want to see that you have a backer with deep pockets and we didn’t have that.”

For AFG, the answer was growth capital, in the form of a £4.2m investment in the company from BGF, which completed in June 2012. BGF took a minority stake in the business, rather than buying its founders out, as other private equity firms might have wanted. And the company no longer had to beg for funding from the banks.

Duncan Macrae, an investment director in BGF’s Edinburgh office, who joined AFG’s board following the deal, says the company impressed from day one. “AFG had great management even though they were young – they had followed their convictions and committed themselves fully to maximising the potential of their idea,” he says. “But they really needed capital to pursue those licensing opportunities, which are huge but can require a financial commitment that might take two years to pay off, especially as they were also developing other product lines.”

Growth capital is ideal for growing companies concentrating on product development argues Macrae, because it gives them the time to bring the right offer to market. “If AFG had gone to the bank and asked for millions of pounds with no security to sit on the balance sheet so that they had the confidence to go after licenses, for example, we think that most debt providers would have laughed them out of the building,” he says.

However, says Smeaton, it wasn’t just money that attracted AFG to equity investment and BGF in particular. The company’s founders were acutely aware that while they had developed one smash-hit product, they had no experience of developing a business capable of repeating the trick. “We were three young guys who had previously worked in middle management and we had no idea about how to build a multi-national company,” he concedes.

To that end, BGF introduced AFG to Ralph Kugler, who joined the business as chairman. Kugler, whose career has included stints on the board at consumer giants Unilever and InterContinental Hotels, has provided AFG’s founders with the experience they so sorely lacked. “He is someone who the company would just never have met, let alone persuaded to join, without our introduction,” says Macrae.

The tie-up between AFG and BGF has already begun to pay off, Smeaton says. “We were already profitable but this money has given us a platform that has really set us on our next stage of growth.”

The company’s new brands are beginning to take off, it has appointed a developer to work on a new offering for the thousands of fancy dress shops that already stock its products and, in October, AFG announced its first licensing deal – within days, Power Rangers Morphsuits hit the streets (literally, since Facebookorganised flashmobs are one of the company’s most successful marketing tricks).

AFG’s product development and diversification strategy is one that is familiar to Graeme Malcolm, the chief executive of M Squared Lasers , another of BGF’s portfolio businesses. For Malcolm, who co-founded the high-tech business in Glasgow in 2005, has been on a similar growth trajectory.

By 2011, M Squared was already producing strong growth, with an impressive roster of science-focused blue-chip clients for its precision laser technology. “However, we were at an inflexion point,” says Malcolm “We knew our existing technology had a wide variety of different applications that could push it into new industry sectors, and we had also developed a new product using our lasers for remote sensing that would take us into a whole new market.”

However, the company needed capital to exploit those opportunities – partly to develop the infrastructure to support sales and marketing, particularly in export markets, but also to commercialise all its potential technology applications as quickly as possible. “It’s possible we could have chosen to go for further organic growth, but it would have been significantly slower,” says Malcolm. “In an emerging technology, you need to be one of the first movers in the market and we would have missed that opportunity.”

Duncan Macrae, who was also involved in BGF’s decision to invest in M Squared – the fund injected £3.85m of growth capital into the business in April 2012 – says the deal was recognised as the right way for the company to pursue its ambitions. “Would M Squared have got debt funding for their core product? Maybe, but cashflow lending is very limited and if you need to build a product to sell, rather than having the order upfront, you won’t get it,” he says.

“The business certainly wouldn’t have got funding for its products in development – you couldn’t finance that in any other way than with equity – so their growth potential would have been really limited.”

Malcolm shared that analysis, but he was also wary of investors that would have wanted to buy the company outright or take full control. Together with his co-founder at M Squared, Gareth Maker, he had launched a similar business in the mid-nineties which the pair eventually sold to a US technology company that subsequently reaped all the benefits of its growth. This time around, the BGF deal has worked out much better, Malcolm says. “The money has already had a substantial impact on our business,” he explains. “We’ve been able to scale up in order to really confront those technical and marketing challenges and we’ve already made inroads into those new sectors – we’re really excited about where we go from here.”