What Investors Look for Before Investing in a Small Business
Before approaching investors, it's important to find out what investors look for. Here's how to attract the right investor to your business.
Let’s face it, starting a business can be expensive. Few entrepreneurs have the cash on hand to get the ball rolling without some outside help. If you’re starting a small business or looking to grow your business, you may seek financing through a traditional loan, a microloan, or cash from your friends and family. You can also seek funding from investors which is why it’s important to understand what investors look for before investing.
Remember that investors are fundamentally different from lenders, and you’ll need to consider that when you decide what kind of funding you want. Lenders give you money and you repay it with interest. Investors give you money in exchange for ownership of part of your business. Their investments may come with restrictions–that you have to get approval for transactions over a certain dollar amount, for example, or that you have to set up an independent Board of Directors. And investors have certain rights, too, which you should discuss with your lawyer before jumping in.
Investors can be a great thing for your business. First, an investor isn’t demanding repayment every month because it’s not a loan. An investor can also be a reliable source for business advice and may have a strong business network that you can draw on. But this isn’t free money – your investors will have certain expectations.
If you do decide that you want to seek funding from investors, how do you draw them in? What is it that makes them decide to put money into a business?
The Most Important Thing
More than anything, investors want to see a return on their investment. Investors are in the business of putting money into growing businesses so they can make money. If you can demonstrate that your business will make them money, then you’re 90% there.
While each investor will want to make money, the hard part becomes knowing how to woo each prospective investor in a way that piques their interest. Remember, at the end of the day, investors are just people — each investor will have different pain points and different intangible sets of criteria for how they arrive at investment decisions. Some investors will be strictly number-based, whereas other investors will base their decisions on a “gut” feeling.
Here’s how to hit all the points for potential investors so that you’ve covered all bases as best you can. We break down the top ten criteria many investors will use so that you can develop your best plan and your best possible pitch to earn capital for your small business funding needs.
1. Hard Data: Crunch the Numbers
Let’s start with hard data. As we just covered, investors want to make money. It’s your job to show them that your company will make that goal happen for them.
If your company has been up and running for a while, then you need to show that you’ve had an excellent financial performance so far. If your company hasn’t yet started up, then you need to show what you can expect to bring in, when you’ll hit your goal numbers, and when your investor can expect to start earning their money back. In other words, you need a really strong (and well backed-up) business plan.
2. A Rock-Solid Solid Business Plan
A solid business plan demonstrates to investors that you’re serious about your business and that you’ve given thought to your plans to make money. While your business plan alone won’t be enough to convince investors to back you, no investor will put money in without one.
Among other things, your business plan should include:
- Your intended market, with data to show why that market is your target
- Data-based, hard number financial projections
- Sales channels, with data to show why those channels will be effective
- Marketing plans and goals, with data to show why those plans will be effective
- Analysis of the competition for your product or service
- Projected timeline for when you’ll start making money
- Potential obstacles and your plans for dealing with them
3. A Unique Idea
Both investors and the general public get excited about the words “new and innovative.” The bottom line is that if the market is saturated with hundreds of identical products, then your company isn’t likely to be a huge hit.
Convey to investors what it is about your product or services that make it stand out. Is there market potential for your unique product? Does it solve a unique problem? Is it a brand-new innovation or invention?
You don’t have to have come up with a brand new invention, but you do need to show why your product or service is different from or better than what your competitors offer. In business terms, this is your “competitive advantage.” It’s what will make you successful over your competitors. You may also show that your business is going to fulfill an unmet need – like a bakery in an area that doesn’t already have one.
4. A Strong Narrative
Investors hear a lot of pitches packed with hard data – given two companies with similar projected returns, what makes an investor choose one over the other? The story! Your investors are people, not robots, and they can be swayed by a great narrative about why this business matters to you, where the idea came from, and where you’re planning to take it. What need is your business going to meet? How will it change the world? What makes it special? In fact, opening your pitch with your story is a great way to set the tone and draw your potential investors in.
5. Business Readiness
Many people have prospective business ideas, but not many people have the drive and wherewithal to take those ideas and shape them into a working, financially viable business. Show your investors that not only can you talk the talk, but that you’re ready to walk the walk.
Is your company ready to take off and hit the ground running? If you can show that you’ve got all the key components in place, you’ll pique investors’ interest because they’ll know that they’ll get a return on their investment sooner rather than later.
To show business readiness, you have to do your homework – your market research and your business plan, for example. You need to show that you have a clear plan in place (for example, that you’ve already staked out a new location or supplier).
6. What You Need, Where It Will Go, And When They’ll Get It Back
Your investors aren’t just going to hand you the cash you want and walk away. Again, they’re in this for the return. So they’re going to want to know exactly why you need the cash and exactly what you plan to do with it. They’ll also want to know when they can expect a return – that should be a part of your business plan.
Investors will also be looking for an exit strategy, and you need to think about that in advance. When they want to sell, will you buy them out? Can they sell to another party? If they don’t know that they can get their money out, they’re not going to want to put it in in the first place.
7. A Clear Investment Structure
Buying ownership in a company has legal ramifications and investors will want to know that you’ve already considered those issues. You’ll need to have a business structure in place that allows for other parties to buy in. You’ll also need to have a clear plan for how the investment will work. If the investors are partners or shareholders, will they have the right to vote on business decisions?
Part of this involves having a clear valuation for your business – a way to back up your request for a certain amount of money in exchange for a certain amount of ownership. If you want $100,000 for a 10% share, for example, you need to be able to show that your business is actually worth $1 million.
Part of it involves putting together a stockholder’s agreement (and maybe also a corporate constitution) that clearly sets out the rights of all owners. That should include owners’ rights and obligations, what happens if an owner wants to sell, what happens if there’s a change in leadership, what happens if the business closes, and other issues. Will investors get dividends or just the increase in the value of their shares over time? If you’re planning on distributing dividends, you need to have a plan for how much, how often, and what will happen if you can’t make a distribution.
Note that this particular area is likely to involve some negotiation. Your investors may want a larger share for a lower price and they may want adjustments or additions to the stockholder’s agreement. The trick is to come in prepared, knowing that these issues are important and that you’ve already thought of them. This is one of those times when you should really consult your lawyer – you don’t want to grow into a successful business only to find that you’ve lost control to your investors.
The Bottom Line
Investors are in it to make money. Your task is to show them that you’ll do just that – and that you’ll do it better than their other investment opportunities. To make a successful pitch, the most important thing you can do is to be prepared. That business plan should be as watertight as you can make it. Your story should be compelling and well-thought-out. You should know exactly what you’re going to do with the money and exactly how the investment is going to be structured. Show your potential investors that you’re thinking about the future – because that’s their number one concern.