In my post, “Who will finance your ‘Great Idea’?” we identified where the required finance for your venture/idea could potentially come from.
The person or entity interested to finance your idea will require the answers to the following questions: (Wickham, P.A. (2004) Strategic Entrepreneurship. FT Prentice Hall)
1. Is the venture of the right type?
Most investors specialize in certain types of businesses, therefore they would mostly be interested to stick to the industry/sector in which they have experience and knowledge.
The investor will need to make sure that the venture is the right business for the investor.
2. How much investment is required?
This is crucial both for you and the investor. The investor will need to know the amount of money required. E.g. Retail banks will offer loans up to tens of thousands of dollars. Venture capitalists on the other hand will not be interested in investing anything less than about $500,000. A market flotation is usually concerned with raising at least $10,000,000.
The key question here is, is the investor really the right source given the level of investment needed?
3. What return is likely?
The ROI (Return on Investment) is the likely financial outcome of making a specific investment. The calculation of the ROI is something that the investor will want to know along with how reasonable the ROI is given the potential for the venture and its management team. Their decision to invest will be based on the assessment of the returns in relation to the risk and how this opportunity compares to others available.
Note: Venture capitalists take more risks than retail banks.
4. What is the growth stage of the venture?
This relates to what the investment is required for. Is it to start a new business? Or is it to fund the growth of an existing business? Usually, investing in a new business will be more risky than investing in an established/existing business.
It is very important to be clear as to why you want the investment and what exactly do you intend to do once you get it.
5. What projects will the capital be used for?
This relates to how the investment will be used within the business. Is it to cover the cash-flow shortfalls that result from strong growth or is it to be used for a more specific project like development of a new product or funding a marketing campaign?
Again, the key question is, how does this impact the risk and return from the investor’s point of view.
6. What is the potential for the venture?
The investor will want to know what the business can achieve in the future. This will depend on two things -
i. Its Market Potential i.e. how innovative is the product/service being offered to the customer, how much value is it giving to the customer as compared to existing alternatives, and the possibilities and problems the business faces in delivering this innovation to the customer.
ii. Quality of the Entrepreneur & Team i.e. the skills and experience of the venture’s key people and their ability to deliver the potential that the venture has.
The key question is, will the investor find the venture’s potential attractive and if not, why not?
7. What are the risks for the venture?
The risk of any venture to the investor is the possibility that it will not deliver the return anticipated. It is very important for the investor to understand the assumptions that have been made in estimating the likely return. Critical assumptions are about customer demand, costs, distribution and reaction of competitors.
The investor will also judge risk based on their ability to exit the business by selling their stake. The easier it is for the investor to successfully and profitably exit, the more likely he/she is to invest in the company.
8. How does the investor get in?
The investor will want to know exactly how the investment is to be made. Is it to be a lump sum upfront or will it take a form of a regular series of cash transactions.
You must ask how the investor usually operates.
9. How does the investor get out?
The investor will want to know how they will see their returns. Will it take the form of cash? If so, will it be a single cash payment at some point in the future, or will it be a series of payments over time? Alternatively, will it take the form of holding of stock in the firm? If so, how can such a holding be liquidated/sold?
Loans are usually paid back in cash form whereas equity holdings will mature as a holding in the firm. Venture capitalists with equity holdings will insist on a clear exit strategy, which will enable them to convert their equity to cash by selling it.
10. What post-investment monitoring procedures will be in place?
An investor will want to know how they can keep track of their investment. A business plan is usually required before an investment is made. The business plan is an excellent way of communicating and of managing the investors’ expectations. Regular financial reports will provide key information on the performance of the business and its liquidity.
In order to eliminate any doubts in process, a clear discussion regarding the monitoring procedures must take place between the investor and you.
11. What control mechanisms will be available?
Monitoring is of little use to the investor, if he/she can’t use the information gained to influence the behaviour of the venture’s management. The investor who owns shares can signal their approval or disapproval by buying and selling their stock in the market. This buying and selling changes the value of the company. Large investors will usually take a more direct route to control. This may be by influencing the venture’s management or by having a representative permanently on the board of the firm.
The key question here is, how will the control mechanism on offer influence the investor’s decision?
You must be prepared to answer the above questions if you wish to successfully receive investment for your idea/venture. These questions are meant to guide you only. They do not represent an exhaustive list of questions that an investor can demand to know. Also, there may be a situation where you are the investor and will be asking the same questions to the person who is seeking the investment from you. You should know everything worth knowing about your venture. Remember to do your homework before talking to any investor.
“Before everything else, getting ready is the secret to success” - Henry Ford
Are you ready?
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