Is My Company Ready for an Outside Investor?
Is your business ready to raise money from outside investors? As for most business decisions, the answer depends on the stage of your company’s growth, the type of business, and what you intend to do with the capital. A business owner must be able to answer some questions: What is my business story? What will I do with the funding? And importantly, why am I raising money from outside investors instead of investing or borrowing it on my own? You should be able to answer these questions easily and convincingly before proceeding down this path.
Some businesses are more attractive to investors, such as technology companies, which often have high valuations because of their potential for growth and being acquired. Other more traditional businesses, such as manufacturing or retail, tend to be valued lower and accordingly rely on banks and lenders for funding, rather than investors.
It is also important to consider the downside of bringing in outside funding. There is the cost associated with raising money generally, including legal and accounting expenses and investment banking fees, not to mention your team’s time and energy. Additionally, funding may require you to reduce your ownership in the company, and likely some level of control. You will also need to allocate time to managing outside investors such as providing regular reports and financial statements. In addition to the normal stresses of operating a company, you will now have another constituency to worry about and answer to. These negatives will need to be balanced with the funding and other benefits, including knowledge, connections, and skills that investors will bring.
It is important to recognize what stage your company is in before looking for investors. These stages are often categorized as seed stage (very early, just an idea and a business plan), early stage (business has started but success is far from guaranteed), expansion stage (your company is operating but needs funds to get to the next level) and late stage (a mature company that needs funds for specific types of growth such as acquisitions). It is important to identify the type of investor you are looking for and whether the investor is right for the stage that your business is in. Friends and family and some angel investors are usually ideal in the seed stage, angel investors and venture capital funds are more common in the early stage and expansion stages, and late stage companies are almost always funded by venture capitalists. People in the friends and family category may or may not be looking for a return on investment. Angel investors are usually wealthy investors, often retired entrepreneurs, looking for opportunities for their capital or focused on helping startups. Venture capitalists are professional funders. Their business is to raise money and then invest it in companies for an eventual profit. Venture capitalists are definitely looking for a market return on their investment, while angels and friends and family may just want to help you out.
You will need the following in place before
beginning to fundraise:
1. A Business Plan – This is a summary of your business or idea and how it will make money. The business plan needs to be compelling enough to attract investors but also be factually accurate. This is typically what investors will use to make their investment decision, especially angels and venture capitalists.
2. Identification of Customers and your Market – Investors will want to see that you understand your market, including specific research on both the potential customer base and competitors.
3. Financial Statements and Projections – You will need to show how the company will operate financially, including a clear understanding of revenues and capital and operating expenditures. Additionally, most investors want to see a 3 to 5 year plan on how the company is projected to grow using the revenues and funds raised.
4. Use of Funds – This is critical information to potential investors. Investors want to see funds being used for the company’s growth, not to maintain status quo.
5. Payout and Goals – Investors will need to know what a successful exit or payout looks like for them. Having a clear vision of how they will achieve that is a key to an investor’s decision.
In deciding whether to raise money from outside investors, a business owner should consider many factors including whether the business is the right type, at the right stage, and able to attract the right kind of money.
Business Insights is hosted by the Law Firm of KPPB LAW (www.kppblaw.com).
Sonjui L. Kumar is a founding partner of KPPB LAW, practicing in the area of corporate law and governance.
Disclaimer: This article is for general information purposes only, and does not constitute legal, tax, or other professional advice.
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