This brings me to the last difference I want to discuss in this article. Investors have standards which define an ‘investment grade’ opportunity. There are generally some very specific conditions which are essential before they will even consider committing funds. Here are just a few to consider:
The first of these is the demonstration that the team can successfully monetize the value proposition. To investors, that means delivering a product or service that clients have proved willing to pay for. Further, it means that the pricing structure leaves sufficient room to provide for overhead and a profit margin. Without this demonstration, most investors will not show much interest. They will gravitate towards those situations where the team has generated revenues and show that they understand the need to prove market acceptance.
Secondly, investors look to the composition of the team. They will be more favorable to a well-balanced, experienced team that has already demonstrated the ability to work together. Each team member will be scrutinized. Weak links will be taken as a sign that the CEO had poor judgment and weak team-building skills.
Thirdly, investors will look for assets that can serve as collateral in the event that the company is not successful. This may include founders’ guarantees, personal assets, intellectual property and assignment of ownership rights. This protection is their insurance policy against catastrophic loss.
Finally, investors will look to the structure of the investment agreements and the performance metrics that guide the allocation of ownership. Their objective is to protect themselves offer a wide range of possible outcomes. If the company is very successful, they will be happy to own a relatively smaller percentage of the equity. If it barely manages to stay afloat, they will want to own most of it. In situations that require follow-on funding, they will most often require close to 100% ownership.
Oil and Water
Mixing investors and entrepreneurs is truly akin to mixing oil and water. But, the challenge is greater for the entrepreneur who wants the funding than for the investor who already had the funds. If you are going to successfully arrange the financial resources that your company needs, you have to understand how investors think and what they are looking for in an investment.
© Dr. Earl R. Smith II
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Related Articles:
- The Money Chase: Should You
- The Money Chase: One Way to Avoid Being ‘Avoided’
- The Money Chase: Who They Do Not Invest In
- Funding Strategies for New Businesses
- Angel Investors to Avoid
- Angel Investors – The Good, Bad and Very Ugly
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Tomi Price wrote:
I think that the process for seeking funds is so complex that anyone of the people seeking funds can fall into any of these challenges, especially if it is their first time seeking funds. I would suggest that the entrepreneur who reads this, be able to identify which challenge is most recognizable to their actions, and improve from there.
I watch the show, “Shark Tank”, and they show a few examples of some of the challenges you have referenced.
Ali Zartash-Lloyd wrote:
Dear Earl
Hope you had a great Christmas and thank you for an excellent article. As always, it is concise and covers many points that we should all know but it is amazing how often we ignore the basic rules of business at our cost and peril.
Without the doubt the points you have made are valid and are worth remembering when looking for investors for growth or survival. What I would like to add is the need for entrepreneurs to take a critical look at their business and in essence become their own toughest critic. Have a look at my recent article on Business Grooming ( http://www.cognisantassociates.co.uk/articles/Business_Grooming_1.html ) to see how critical this issue is when dealing with investors or just running your business on day-to-day basis. Principal of sound business management is universal across industries and no matter which country we are operating within.
I hope you and your readers find my article a useful resource.
Happy New Year.
Randy Long wrote:
Dr. Smith,
As a newbie to Angel and VC financing I found your article to be very beneficial.
I am a retired banker and work for a national business lender that among other things is involved in Bulk Portfolio Real Estate Foreclosure and Non-Performing Note Brokerage. We locate banks, federal lending agencies, credit unions, credit companies, RMBS and CMBS investors, etc. who need to sell portfolios and match them up with Private Equity Groups, REITs, and Hedge Funds that want to buy. We try to set-up a minimum 25% ROI.
So far we’ve used our capital plus wealthy private investor’s capital for
operating expenses, portfolio deposits, and initial portfolio acquisitions. The
minimum portfolio size is ~ $5MM and the maximum tends to be $150MM.
Our small capital base limits our acquisitions to the smaller portfolios which require higher prices (less ROI) and/or we can only bid on a small percentage of a large portfolio which impairs our ability to obtain larger price discounts which would produce a higher ROI. Typically, we hold most properties &
notes from 60 days to 6 months before we retail them or sell them to one
of the end users mentioned above.
Thus, we need more leverage and investment capital primarily from Private Money Sources. I have located a couple of warehouse lines-of-credit lenders that will extend a $10MM line-of-credit for 13% + 2PTS. which will help us to leverage our acquisitions. Next, we need additional Private Equity Capital of $50MM-$150MM so that we can bid on the larger portfolios and increase the ROI to 30%-40%.
Questions:
1) What suggestions can you make in regard to our business model?
2) What minimum ROI is acceptable for the Private Equity Groups?
3) How do you locate the experienced and equitable Private Equity
Groups? Are there any that you can recommend?
4) What other suggestions can you make?
Please advise.
Randy Long, National Accounts
HomeCoast Capital LLC.
Direct: 770.635.7800
Email: rlong@homecoastcapital.com
Vic Williams wrote:
Cooking a turkey mixes the oil and water into a delicious dinner. The sustained interactive engagement through cooking is a recipe for success. As in the Hudson’s Bay Company – since 1670. The most hazardous thing for a smaller North American company using a bank-investor is that the bank will change its mind and take its money elsewhere.
More interesting might be China. A Western company outsources manufacturing, shipping, and a call center to China. Those all combine investing and entrepreneurial activity in the same injection into China, and all too many companies depend on a contract as a way to manage/regulate the operations.
Jhank Regmi wrote:
Good article.. I would like to appreciate and many thanks to the writer.
Ray, Thanks for the kind words. I am glad that you found the article useful. Dr. Smith
Ray Zoeller wrote:
A great article, with points made succinctly. Excellent advice for those contemplating a possible search for funding. — Ray Zoeller
James Troscinski wrote:
Dr. Smith,
As being involved in three start ups from a management team aspect, I found your article on target.
I must agree that “oil and water” is a great analogy, since many entrepreneurs are very passionate and emotional. They have great difficulty grasping the need for a metered approach.
I also agree that a great management team makes or breaks the relationship. They can usually adapt to investor concerns while maintaining the integrity of the company’s vision.
Vithal Donakonda wrote:
Dear Dr. Earl,
very nice article which concisely addresses the shadows in thought process of investors & entrepreneurs.
Appreciate your sharing it with the group.
Regards
Vithal