As an entrepreneur, you might find the whole idea of finding financing for your business as a necessary evil. Finding an investor isn’t an easy thing to do in the first place and ensuring your investor is a good one might sound like a step too far.

But it is important to take your time and make sure you don’t just find an investor, but the right investor for your business.

174 - Analytical Framework for Choosing the Right Investor

This guide will help you choose the right investor by focusing on the key points of selecting investors. You’ll learn to find the right financing option, define your financing needs and discuss your business values and goals with the potential investor.

FIND THE RIGHT FINANCING OPTION

The most important thing to understand first are the different financing options. Many entrepreneurs make the mistake of taking whatever money they are offered, without thinking whether the financing option is good for the specific business.

Depending on your business model and the industry you work in, certain financing options can be more beneficial than others. As well as ensuring your company is attractive to investors, you also need to make sure you are looking for the right type of financing.

The most common financing options

First, let’s look at the most common external financing options.

  • Private equity – Private equity covers most investment types, which are made by private individuals or privately owned institutions. Private equity is often considered the best financing option for established companies, although you could attract this type of financing even as a start-up.
    Private equity financing is often provided for buying a company, funding a specific project or simply for making a private investment.
  • Venture capitalVenture capital on the other hand is mainly designed to finance start-ups. Venture capital is a good financing option for new businesses, which have high-growth potential. VCs don’t only provide financing, but can also provide the business assistance in running the business.
  • Angel investingAngel investors are people with high net worth and who are looking to finance companies as private investment opportunity. The investors are often focused on helping out start-ups and can provide crucial mentoring opportunities for entrepreneurs.
    Angel investing is often different to venture capital in terms of ticket size. Angels tend to invest smaller sums as they are making the investment as individuals.

The above three financing options can sometimes be divided into seed funding and venture capital. Seed funding refers to smaller investments individuals or investment entities make and are often a big part of the early funding for start-ups. As the company matures and develops, it is generally more able to attract venture capitalists and eventually even private equity.

You can learn more about those financing options from the US Small Business Administration guide.

Other financing options

Depending on your business, you might also want to consider other financing alternatives:

  • Friends and family – Friends and family are typically an option for financing at the earliest stage of setting up a business. This ‘investor group’ is not particularly interested in your business development and might not have any industry expertise. The funding tends to be relatively small and terms might be more than beneficial to you. You should remember that using your friends and family’s money for financing your business is not always straightforward. It could potentially be problematic, if things don’t turn out good. So, be sure the option is right for you and your business.
  • Loans – you could also gain financing by loaning money from different entities. The most common options include:
    • Government agencies
    • Commercial banks

All of the above options have their pros and cons. Before you start looking for the investor, it is a good idea to make sure you understand all of these options. You can then ensure you narrow your research to investors who can provide the most benefit for your business and who are most likely interested in investing in your business.

DEFINE WHAT YOU NEED FROM THE INVESTOR

Once you are aware of the different funding options to be offered, you can start analyzing what you are looking for from the investor. While this also deals with the actual amount of capital you are looking for, it also deals with more in-depth requirements.

First, let’s look at the things you should consider when you are outlining your financing needs. Afterwards, you can read about the signs of a good investor.

Things to consider

Start outlining your investor needs by figuring out the most important aspect: how much money you need. You are much more likely to accept the right type of investor when you know what you’d like them to invest.

It is essential to have a figure in mind because you don’t want to accept an investment offer that simply doesn’t meet your demands. You also need to be wary of accepting more than you need – the money rarely comes without a bigger stake in your business.

There are further things you must consider as well. A good approach to figuring out your requirements is by asking the following questions:

  • How involved do you want the investor to be? If you are experienced and your business has been operating for a while, you might not be looking for anything other than the capital.
    On the other hand, if you are a start-up, further business mentoring and assistance might be more than welcomed. Certain angel investors, for example, can provide limited help from dealing with business finances to gaining further financing.
    If you feel you require a lot of help from your investor, not just in terms of funding, be clear and upfront about it. You also don’t want to select an investor who is going to dedicate much of his time for you, if you aren’t interested in this advice.
  • Are you looking for a specialist? You also need to consider whether you are looking for simple financing or an investment specialist. For example, you might find seed funding a better alternative if you are looking for capital to boost your growth. On the other hand, if you are a new start-up, you might benefit more from having a start-up specialist invest in your company. Essentially, this comes down to whether you are looking for involvement or simple cold, hard cash.
  • Should the investor have a background in your business? For a new entrepreneur, setting up a business in a relatively unknown field, a seasoned professional can be a better alternative to an all-round investor. If you want expert insights, then picking an investor who has background in your industry is a good option.
  • What are the problems you want to solve? You also need to think about why you are looking for financing in the first place. Start-ups shouldn’t seek for investments just for the sake of it. Therefore, you must clearly define the problems you like the investor to help you solve.

The signs of a good investor

While your specific needs will be key to defining what a good investor is for your business, there are certain qualities you want to keep in mind. These can help you better understand your options and ensure you focus your attention on the points that matter most to you and your business.

Reputation. First, you want to focus on the reputation of the investor. It might seem vain, but it does make a big difference. An investor with a good reputation can provide your business future contacts and a certain standing in the industry, as well as financing.

A reputable investor or investment company can help make future financing a lot easier to obtain. In addition, the investor has most likely not gained the reputation by being bad at what he or she does. Therefore, you can know what you are getting with a reputable investor.

Track record. Even if you are looking for a less established investor, you still want to look at their track record. You want to see whether the investor has done similar deals in the past and analyze how successful these have been. Keep in mind the investor is not the sole reason a business might have failed, but if their portfolio only has companies, which have failed, you should start asking questions.

Furthermore, don’t just look at success, but focus on finding investors with a track record in companies such as your own. Even though an investor might have had successes building up pharmaceutical companies, your clothing business might not benefit much from their expertise.

Resources. Talking about money can be the hardest things for many new entrepreneurs, but you need to learn to do so, if you want to save your time. Don’t spend an eternity talking to an investor before you’ve gotten the big question out of the way: the resources.

You must be clear about your investment needs – how much capital are you looking to raise, for instance. In addition, you should have a discussion regarding future funding. You want to know whether the investor is able to back you with additional funding as your business grows.

Industry expertise. As mentioned before, the investor’s industry expertise can be crucial. The expertise isn’t just about mentoring you and ensuring your business strategies are aligned with the current industry climate. An expert in your industry can also provide you with more contacts, which can boost your business success.

Attracting an industry expert can also provide more credibility to your business. Even if you are dealing with a less established investor, the expertise and knowledge they have about your industry can be worth more than attracting a more reputable investor.

Personal relationship with you. Finally, a good investor will need to be able to have a great working relationship with you. The importance naturally depends on how much involvement you require from the investor; if you don’t want them too involved, your personal relationship doesn’t need to be as close, as with someone with a more hands-on approach.

The most important thing is that you can trust your investor and your investor trusts you. The early stages of starting a business can be quite daunting and you need to have an investor who you can rely on. This also means that you need someone who will tell you the truth, even if you don’t want to hear it.

DISCUSS CORE VALUES AND STRATEGIES WITH THE INVESTOR

At the final stage of selecting the right investor, you need to go through the values and strategies your business has. It is important these values and strategies align with the investor’s own approach to your company. This ensures you are both on the same page, in terms of where the business is heading and the way it wants to achieve these goals.

Below are some of the key questions you need to discuss with the investor in order to determine your values and align strategies.

What is the timeline for the investment?

Different investors have very different investment strategies. Many venture capitalists, for example, invest in the company in a relatively short-term focus and look to exit from the business as soon as it reaches its growth potential. On the other hand, some angel and private equity investors might be looking to invest in the long-term.

Make sure your expectations of the investment timeline meet with the investor’s plans. The timeline does not have to deal with a single date. Instead of deciding the investment is over after two years, the timeline could be determined by a goal, such as increasing sales by 200%.

Be aware that many investors face a lot of pressure to cash out of investments as soon as possible, especially when the investor or entity isn’t a private venture. Is your business able to meet the pressure? You don’t want to end up in a situation where the investor is looking towards business strategies only to pave way for their own exit.

What happens when the investment ends?

Your term sheet will have a certain end-date for the investment. But you want to discuss the future beyond this to ensure the end doesn’t come as a shock. Are you, for example, looking to raise more money after a certain period? Would the investor be willing to invest again or perhaps continue their involvement after you’ve paid them back?

You both need to have a strategy for ending the investment and what happens after it. Discussing this through before the investment can help build trust and ensure you aren’t met with ugly surprises at any point.

What do you consider a success?

Earlier we discussed the importance of defining the problems you want the investment to solve. In addition to this, you also need to define what a successful investment would look like and see whether your definition aligns with the investor’s expectation.

If you share a common goal, you are able to measure how well the investment is going, as well as align the business strategy to better meet these demands.

What is the vision for the business?

Your business should have a clear vision of what it wants to achieve. While you want to ensure your investor feels able to provide his or her input and expertise towards this vision, you don’t want to go with an investor who completely disagrees with you. Discussing details is good, but you should be on the same page when it comes to the broad vision for your company.

If you have certain lines you aren’t willing to cross, then you want to discuss these before you get into an investment deal. A good investor won’t be afraid to tell you, if they disagree with you, but they will also be able to see your vision. Although you might not always agree on the path you take to get to your goals, the end goal should be commonly shared between your business and the investor.

FINAL THOUGHTS

When it comes to raising funds for your business, it can seem tempting to accept the first investor that offers you money. But finding investment isn’t just about securing capital; it is also about finding the right investor to boost your business’ prospects.

The above has shown it is essential to clearly define your investment needs before you start looking for an investor. Knowing what your business is looking in an investor will help you select the right financing option and focus your search on investors that can offer you all that you require – not just money. Make sure to listen to your guts when choosing your investor – you want an investor who is as passionate about your business as you are.

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