Every business needs funding to launch and grow. Often, that funding comes directly from the founder or a business loan. For some businesses, though, getting to that next level requires the help of a business investor. That avenue can be rewarding but carries unique challenges, such as finding the right investors and successfully courting them. Whether you court venture capitalists, angel investors or crowdfund your investments, you must recognize a good deal from a bad one to avoid getting burned.
What makes a good investment deal?
If you create a detailed investor persona and a compelling pitch, your hard work will eventually pay off, and you will be rewarded with an investment deal. However, not all investment deals are created equal. How can you tell the good from the bad? Don’t just jump at the money. Stop to think about where the deal in question can get you down the line and how it might influence the overall growth of your business in the long term.
A balance of equity and control
Perhaps an investment deal will support the creation of full-time jobs you need to drive your business forward. But if it comes at the cost of giving up a majority stake in your own business, is it worth it?
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Money is vital in business, but, ultimately, what matters is equity, or your stake of ownership in the company. When an investor chooses to fund your business, they’re buying equity of their own. This gives them influence over how things are done. For many small business owners, retaining control is a top priority.
“A good offer from an investor leaves plenty of equity in the hands of the founders — preferably with little or no vesting,” Nicole Toomey Davis, a serial entrepreneur and business coach, told us.
FYI
Angel investors typically take between 20 percent and 25 percent ownership, whereas venture capitalists may take 40 percent.
Fair and reasonable terms
In addition to maintaining the right balance of equity and control, small business owners should pay attention to their investment terms and ensure they are fair and reasonable. Consider how an investment deal takes employees into account. Any clauses about how profits are distributed in the event the company is sold should also be closely scrutinized.
“[A good investment offer] includes a pool of options for current and future employees, and it doesn’t include ratchets or extreme preferences that take all the profits when the company is sold,” Toomey Davis said. “As an experienced entrepreneur and entrepreneur coach, I recommend entrepreneurs make sure they are getting a reasonable salary as part of the deal and that they invest alongside their investors to get the same preferences that investors are getting.”
Honesty, transparency and legal soundness
Securing an investment deal isn’t just about the money. An investor in your business is a partner, so you should always start with a relationship based on trust. Look for honesty and transparency when courting investors, and trust your instincts.
“Good and fair investors want to reduce risk and earn a healthy return by being sure both sides of the deal are legally and fiscally sound up front,” said Baron Christopher Hanson, an advisor with John Burpree & Associates. “Good and fair investors want you and your team to operationally and sustainably run an excellent business that makes customers happier than your competitors. Good and fair investors want to be paid out fairly and via healthy dividends, profits or interest, and, yes, a little more if things are late, behind schedule or not exactly to plan.”
“However, good and fair investors will never try to slit your throat, make huge fees upfront by brokering your deal to others or charge such a high cost of capital that your business chokes a slow and painful death whilst they bask on a yacht,” Hanson added.
How to avoid a bad investment deal
Perhaps more important than spotting a good investment deal is avoiding a bad one. Look for red flags when discussing any potential terms with a business investor and take the following steps.
Have your team review the terms of the deal.
Your team of professionals and advisors should always review any deal before you sign. They are your team for a reason, and their input could raise questions that would otherwise go unaddressed. Any investors who try to prevent you from collaborating with your team should not be trusted.
“Any investor who coerces you or bullies your business plan into working with their advisors and legal team only, usually under the guise of saving money and time, should be shown the door,” Hanson said.
Avoid unreasonable ROI demands.
Investors expect a return on their investment; it’s why, after all, they are investing in businesses in the first place. However, small business owners need to understand what reasonable expectations are and what are just greedy money grabs designed to pull the rug out from under founders.
“It is not unreasonable for an investor to get back their invested capital and a reasonable return upon a sale before the common shareholders get paid, but terms that insist investors get multiples of their investment back (i.e., two or three times their investment) just about guarantee nothing for founders,” Toomey Davis said.
Avoid excessive fees or commissions.
If you are looking for investors, be sure you are talking to someone ready to write the check themselves. Plenty of middlemen and brokers will attempt to insert themselves into the process to siphon off funds in the form of excessive fees and commissions.
“Any seemingly high fees or commissions or ‘points’ just to raise or broker initial and subsequent funds upfront — especially from ‘other investors in their exclusive network’ — is typically suspect and nothing more than a dangerous broker situation,” Hanson said.
Beware of “vulture investors.”
Not all investors operate in good faith. A true business investor wants you to succeed and will work with you to craft a mutually beneficial deal that supports your business’s long-term growth. Another class of investors, called vulture investors, are more interested in creating untenable situations that result in their takeover of your company.
“Be very wary of vulture investors who prey upon entrepreneurs by drafting dangerously strict repayment terms, deadlines or sums, usually in exchange for seemingly low interest rates. Their goal is for you to default so that the business or property or creative recipe becomes theirs by your default or inability to meet their doomsday deadlines,” Hanson said.
Watch out for swindlers.
Not everyone who poses as a business investor is interested in investing. Some people are just out to secure sensitive information about your business so they can use it against you in the marketplace. Carefully vet anyone you are considering pitching. Make sure they are who they say they are and that they aren’t involved with any of your competitors.
“Not every investor is what they seem. Watch out for people posing as investors, who are actually swindlers, working for your competitors,” said Marsha Kelly, president at Best 4 Businesses. “They are trying to get inside information about your marketing strategies, suppliers and financials, which they plan to exploit. Research all investors thoroughly before you share proprietary information about your business operation.”
Finding the right business investor to fund your business can be a challenge, but it is well worth it when a fair deal is reached. Partnering with a business investor in good faith can get you the much-needed funding to launch and grow your company in a way that will ensure success for years to come.
Tip
You should not have one pitch for all investors. Know which type of business investor you are pitching, and adjust your presentation accordingly.
What is a business investor?
A business investor is someone who provides you with capital and expects financial returns. An investor can be a person, firm or mutual fund. Some common types of startup investors can include personal investors, angel investors, venture capitalists and peer-to-peer lenders.
The different types of business investors
There are several kinds of small business investors, each of which is best suited to fund businesses in different circ*mstances. Depending on your preferences and needs, you might find that venture capital is best for your business. Or perhaps crowdfunding platforms offer you the deal you need. You can determine this when designing your investor persona.
Here’s a closer look at some of the most common types of small business investors:
- Venture capitalists: Venture capital is generally geared toward small companies in the early stages of growth. Oftentimes, venture capital is focused on businesses with high-growth potential. Generally, venture capitalists offer funding in exchange for equity in a company.
- Angel investors: “Angel investor” is another term for a private investor or seed investor. This type of business investor provides funding generally to startups or entrepreneurs in exchange for equity in the company. Angel investors tend to be high-net-worth individuals who use their own money to fund businesses, unlike venture capitalists who tend to be larger institution investment firms. [Read related article: Meet the Angels: Silicon Valley’s Most Well-Known Investors]
- Crowdfunding platforms: Crowdfunding platforms, as the name suggests, bring together a large number of people who provide small-dollar investments to fund businesses. While each crowdfunding investor might only pledge a fraction of the money your business needs, collectively, the crowd can provide enough capital to get your business off the ground. It is a form of financing similar to peer-to-peer lending, however, instead of debt financing, crowdfunding platforms are investment-based.
Whether you partner with investment firms, private investors or a large group of crowdfunding microinvestors, pursuing investment opportunities offers an alternative to securing funding from financial institutions or taking on debt.
FYI
If you're on the fence about what type of business investor you need, check out our related article about the differences between angel investors and venture capitalists. It outlines when and how to pitch each investor.
How to find business investors
Unless you already have a business investor or group in your network, it can be difficult to know where to begin. There are a few steps you can follow to find the perfect investor for your business.
1. Define what “the perfect investor” looks like to you.
Before you start searching for angel investor groups or venture capitalist funds to contact, it benefits you to sketch out what type of business investor you are looking for. Remember, an investor is as much a partner as they are a source of funding. You need to choose the right one, and that requires planning.
“If you are an entrepreneur who is interested in raising capital, the first thing you must do is to design the perfect investor,” said Toomey Davis.
“Once you can clearly design the perfect investor for you and for your business, then you can identify and pitch to only those who are already interested in your type of business, your location and the amount you are trying to raise.”
That might only be a few dozen individuals, she added. Narrowing your focus in this way ensures relevancy and makes getting in front of these targeted business investors much easier. Further, it is easier to keep them engaged with your pitch since they are already your target demographic.
2. Start networking to find potential investors.
To identify investors that fit your persona, you have to network. This could involve joining trade organizations or business associations, as well as exhibiting at trade shows. It can also involve cold calls or sending an executive summary of your business to investor groups you’ve identified as suitable for your business.
3. Stay diligent until you find the right fit.
Stay diligent, even if you don’t get any bites at first; networking is often a numbers game. Once you get your foot in the door with business investors that match your persona, you have an opportunity to secure their funding and partnership.
How to secure an investment
Once you create an ideal business investor persona and identify investors who fit the profile, you’re ready to move on to the next phase, which is securing the investment.
1. Create a clear, yet descriptive, pitch.
The first step to securing an investment is to come up with a compelling pitch. However, there are many elements to creating an effective pitch. For example, an investment pitch and associated pitch deck should be a short, punchy presentation that conveys both the premise of your idea and the value, with numbers to back it up. Investors hear from a lot of entrepreneurs, so you need to make your idea stand out with a brief but effective pitch.
2. Provide potential investors with concrete, numerical projections.
Generally, pitching your idea isn’t enough; you need to offer concrete, numerical projections that are grounded in reality to really captivate people who are considering investing in your business. After all, why would someone purchase private equity without a clear road map as to how and when they would receive a return on their investment?
3. Be persistent and learn from each pitch.
You might have to pitch many investors before you are offered a deal. Keep at it, and try your best to analyze what worked well and what didn’t after each pitch. Use that knowledge to improve your pitch and continue reaching out to potential investors until you finally secure the right investment.
Additional reporting by Skye Schooley. Source interviews were conducted for a previous version of this article.
