Know What You Want To Ask Investors
If an investor decides to help your business, theyll be a big part of your business. Youll want to have a good idea of what they expect out of the investment. Consider these questions:
- How often do you like to meet with the businesses you invest in?
- What other companies have you invested in? How did they do?
- What does your investment portfolio look like?
Justify Use Of Proceeds
Investors want to know precisely how your company plans to use its proceeds. Will you allocate their money to capital expenses? Research and development? Legal and accounting fees? What about recruiting costs and salaries? Establishing capital efficiency early in the process can help your company develop insightful leadership and ultimately make you more attractive to investors. Be prepared to explain to investors what milestones youre aiming to achieve and the anticipated results.
Familiarize Yourself With Debt Vs Equity Financing
Theres a significant difference between debt vs. equity financing. With debt financing, such as a loan, the money is expected to be paid back, and the lender makes their profit from interest charged on the loan amount over time. With equity financing, however, the money isnt usually paid back. The value received to the funder comes through owning a portion of the company. When the company grows as a result of their investments, their value in the company grows, too.
The pros of equity financing are that the investor has a significant interest in seeing you do well with your idea. In addition to giving you money, they can advise and counsel the founders, give you access to their talent network, or help you with marketing and promotion. The downside is that they would own part of your company. If, at any time, you didnt like working with them, its difficult to unentangle.
The pros of debt financing are that you are free of the relationship once that last loan payment is paid off. While youre making payments, theres little the lender can tell you to do with regard to your business. The downside to debt is that, if you fail to make your payments on time, you could lose your business or significant assets. You are also only getting cash. Theres no additional advice that most banks give. The exception is some of the SBA loan programs, which can provide technical support or mentoring as part of the loan program.
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How To Attract Investors And Get Funding For Your Startup Business
You poured your heart and soul into your business, and now its time to determine how to attract investors and secure funding to continue growing. But how would you fare if investors like VCs, angel investors, and bankers were to evaluate your company? What components will drive their decision to invest or not? When you know what to expect, pitching your idea to investors may feel less intimidating and more like, Lets see if were the right fit.The process of getting startup funding for your business may put you on edge just a bit not because you dont know your company inside and out, but because youre uncertain what will be asked of you when you meet with potential investors.
Weve worked with all kinds of entrepreneurs from many industries, and came up with 11 steps that will help you attract investors and get funding for your startup business.
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Factors To Consider In Making A Contribution To Your Business
In a 2011 Tax Court case, the Court listed several factors it reviewed in considering whether an owner’s contribution was a debt or equity. These factors include:
- The labels on the documents: That is, is the document stated as a loan or an investment?
- A maturity date: The presence of a maturity date strongly suggests a loan.
- The source of payment. Is the payment being made in the form of a dividend or a payment on a loan?
- The right of the lender to enforce payment: What happens if the loan isn’t repaid? Will there be penalties? Can the loan be foreclosed? This should be stated in the loan documents. This language would not be present in a share of stock.
- The lender’s right to participate in management applies in both cases. A lender shouldn’t be on a business board of directors . And usually, stockholders do not participate in management as a qualification for buying shares.
- The lender shouldn’t have a greater right to collect compared to other creditors. This language would be present in the documents and has to do with both collection policies and bankruptcy of the company.
- The parties’ intent: The presence of a document helps with this part.
- The adequacy of the borrower’s/the company’s) capitalization: In other words, is this a reasonable amount? In a partnership, for example, partners should contribute similar amounts letting someone into a partnership without enough investment could be an issue.
- The borrower’s ability to obtain loans from outside lenders.
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Land On The Right Figure
Here’s a not-so-shocking statement: investors want to know where their money is going. If you ask for too much capital or too little to make any difference this could be seen as a red flag.
If you’re stumped on the right figure to ask, you may need input from a third party, such as a financial advisor or consultant. Or, if you’re a scrappy new startup, you may want to consider establishing an advisory board.
What Steps Should A Small Business Take Before Looking For Investors
Equity funding may be the favored option of debt-resistant small businesses, but it carries the major downside of the relinquishment of control. On the other hand, few small businesses possess the credit score or sufficient collateral to secure a bank loan.
Luckily, cash-strapped small businesses can benefit from a growing number of new forms of lending.
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Debt Investments In Small Businesses
When you make a debt investment in a small business, you loan it money in exchange for the promise of interest income and eventual repayment of the principal.
Debt capital is most often provided either in the form of direct loans with regular amortization or the purchase of bonds issued by the business, which provide semi-annual interest payments mailed to the bondholder.
The biggest advantage of debt is that it has a privileged place in the capitalization structure. That means if the company goes bust, the debt has priority over the stockholders . Generally speaking, the highest level of debt is a first mortgage secured bond that has a lien on a specific piece of valuable property or an asset, such as a plant or factory.
A first mortgage secured bond requires property, such as real estate, as collateral.
For example, if you loan money to an ice cream shop and are given a lien on the real estate and building, you can foreclose upon it in the event the company implodes. It may take time, effort, and money, but you should be able to recover whatever net proceeds you can get from the sale of the underlying property that you confiscate.
The lowest level of debt is known as a debenture, which is a debt not secured by any specific asset but, rather, by the company’s good name and credit. This is generally a bond, issued as a loan without collateral with fixed payments and interest.
Icipating In Incubator Events
Accelerator programs are geared to providing startups with the tools they need to be successful. Startup accelerators can be run by non-profits, business schools, civic groups, the government, and others. They will host incubator events to help entrepreneurs problem solve and succeed.
You can apply to develop your work as part of their incubator events. Often, you get funding to continue work on your business as well as access to business advice and mentoring. Youll also meet other entrepreneurs looking to jumpstart their business success too.
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Show The Users Benefit
Its easy even for experts to overlook this basic notion. At an MIT Enterprise Forum session an entrepreneur spent the bulk of his 20-minute presentation period extolling the virtues of his companys productan instrument to control certain aspects of the production process in the textile industry. He concluded with some financial projections looking five years down the road.
The first panelist to react to the business plana partner in a venture capital firmwas completely negative about the companys prospects for obtaining investment funds because, he stated, its market was in a depressed industry.
Another panelist asked, How long does it take your product to pay for itself in decreased production costs? The presenter immediately responded, Six months. The second panelist replied, Thats the most important thing youve said tonight.
The venture capitalist quickly reversed his original opinion. He said he would back a company in almost any industry if it could prove such an important user benefitand emphasize it in its sales approach. After all, if it paid back the customers cost in six months, the product would after that time essentially print money.
The venture capitalist knew that instruments, machinery, and services that pay for themselves in less than one year are mandatory purchases for many potential customers. If this payback period is less than two years, it is a probable purchase beyond three years, they do not back the product.
Doctor And Dental Offices
If you want to invest in companies that are all but guaranteed to generate reliably strong short- and long-term profits, consider investing in doctor or dental offices and clinics. As the population ages, demand for doctors and other health professionals will increase in the coming years.
While the labor expenses of the medical industry are high, they can be offset by the cost of medical services.
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How Do You Attract Investors
Founders with a path for success can create attention for their business in a number of ways, including networking with proven startup investors, asking for advice, partnering up with a well-known co-founder, and promoting your early success to the right crowds including on social media. Consistent performance matters. Whatever you do, appear to be the best of the opportunities that the right investor would be wise to take on.
Sufficient Returns At Acceptable Risk
Investors in venture capital funds are typically very large institutions such as pension funds, financial firms, insurance companies, and university endowmentsall of which put a small percentage of their total funds into high-risk investments. They expect a return of between 25% and 35% per year over the lifetime of the investment. Because these investments represent such a tiny part of the institutional investors portfolios, venture capitalists have a lot of latitude. What leads these institutions to invest in a fund is not the specific investments but the firms overall track record, the funds story, and their confidence in the partners themselves.
How do venture capitalists meet their investors expectations at acceptable risk levels? The answer lies in their investment profile and in how they structure each deal.
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Master The Elevator Pitch
To master the elevator pitch, you need to describe what problem your business solves, how, and why all in a sentence or two. If you’re unable to do this, or you’re not exactly sure what problem your business solves, investors won’t know either.
A solid elevator pitch will pique someone’s interest nothing more, nothing less. Once you grab someone’s attention, you can dive into more detail about your company, the market, and how funding will bring it to the next level.
Investing Vs Lending Money To Your Business
As a new business owner, you will probably need to put money into your business from your personal savings. If you don’t need a bank loan, you’ll need what is called an “infusion of capital” or a capital contribution to get the business started.
Even if you can get money from friends or family, or from a lender, you will need to put some of your own money into the business. If you are joining a partnership, a capital contribution is usually required. A lender will want to see that you have some of your own collateral as a stake in the business.
But should that money be a loan to your business or an investment? There are tax and ownership implications for each situation.
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Do Small Business Investors Get A Percentage Forever
Getting your business off the ground or taking it to the next level usually means securing funds from a small business investor. This provides an attractive way to get working capital in exchange for a stake in the business. Before you make a presentation to an investor, be clear about the amount of money you need and how much of your company youre willing to give in exchange.
While it may be possible to buy back some of the shares that you have issued to an angel investor, in general terms, once the shares are gone, they are gone. The investor is with you until you sell your business.
Dont Diversify Too Early
Many budding entrepreneurs make the mistake of diversifying their investments too early in the process. 401k plans are great, but you could be using those dollars to grow your business. Stocks and bonds are important, but so is building your empire. To invest your first profits, start with what you know. No one knows your business like you do, so it seems like the natural place to start.
Diversification and 401ks can come later. For now, enjoy your first profits by putting them back into the fruits of your labor. Take care of your employees and customers, and your profits have a better chance of growing organically. With time and proper investment, youll soon be poised to open another location or expand to a new market. Reinvestment will always be a smart business move.
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How Do Small Businesses Find Private Investors
The first piece of advice for small businesses seeking investors is to be realistic about their options. Venture capital firms tend to operate in the $2 million-plus range, whereas seed investors usually offer up $100,000 to $500,000, Cairns said.
When courting private equity firms, it’s up to the startup to first make sure they fit the requirements.
“The entrepreneur has to make sure that his or her deal fits within our ‘box,'” said Lyneir Richardson, investor and director of Rutgers University Business School’s Center for Urban Entrepreneurship and Economic Development. Next, Richardson reviews the startup’s track record and current capacity.
Only then does Richardson look into the deal itself and decide whether or not it’s investable “in other words, if the sources and uses of capital are reasonable, if the pro forma believable, and if it’s feasible that I will get the projected return on my investment,” he said.
For this reason, financial projections such as future capital requirements, revenue and profit, and an ROI timeline must be crystal clear. Many startups avoid guesswork by paying for a third-party valuation.
Companies should avoid going overboard on the metrics, however precision, not volume, is key. Richardson said one of the most common mistakes he sees during pitches is a PowerPoint overloaded with text. “I want the entrepreneur to clearly communicate a concise story that I can understand, believe and get excited about,” he said.
The Logic Of The Deal
There are many variants of the basic deal structure, but whatever the specifics, the logic of the deal is always the same: to give investors in the venture capital fund both ample downside protection and a favorable position for additional investment if the company proves to be a winner.
In a typical start-up deal, for example, the venture capital fund will invest $3 million in exchange for a 40% preferred-equity ownership position, although recent valuations have been much higher. The preferred provisions offer downside protection. For instance, the venture capitalists receive a liquidation preference. A liquidation feature simulates debt by giving 100% preference over common shares held by management until the VCs $3 million is returned. In other words, should the venture fail, they are given first claim to all the companys assets and technology. In addition, the deal often includes blocking rights or disproportional voting rights over key decisions, including the sale of the company or the timing of an IPO.
Alternatively, if a company is doing well, investors enjoy upside provisions, sometimes giving them the right to put additional money into the venture at a predetermined price. That means venture investors can increase their stakes in successful ventures at below market prices.
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When It Comes To Personal Investing Business Owners Should Resist Conventional Wisdom
You’ve heard the advice before: Diversify, make time work for you, and embrace stocks. For most folks, those are the core pillars of any investment strategy. For business owners, that’s true only up to a point. You are different and need to invest accordingly.
That assumes, ahem, that you’re investing at all–and haven’t fallen for the old misconception that your company is the only investment you will ever need. Says Jeffrey Levine of Alkon & Levine, a Newton, Massachusetts, accounting firm specializing in small business: “I want entrepreneurs to know that the odds that their company will become a huge success–enough to meet all their financial needs through retirement–are against them.
So it’s important to put something aside on a regular basis.” In other words: Build your company as if it will last forever, but invest your personal wealth as if everything will collapse tomorrow. We talked with experts such as Levine and Allan Roth, of Wealth Logic, an investment-advisory firm in Colorado Springs, Colorado, about the other mistakes business owners make.
Here are some ways not to be your own financial enemy.
In fact, treating your business as your sole investment is the ultimate “antidiversification” strategy. Says Levine: “To me, it always makes sense to save for a rainy day…build your business and your portfolio.”
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