It may sound counter-intuitive but it’s important for businesses who are thinking about seeking an investor to understand how the relationship should play out. Before anything has happened, make sure you understand the exit route for the investor and yourself, and the associated plan.
Don’t approach investors too early. It’s better to have built up a good track record so that you can demonstrate the success of your business to date and its potential.
Understanding why your business needs an investor is key. Do you simply require the investment to fund product development or are you looking for an investor with specialist knowledge and contacts that will help propel your business forwards? Matching your needs with an investor’s is vital.
A level of financial capability is crucial to enable you to set out investment limits. Beware of the amount of ownership you give to investors. Technically, you may not be contractually obliged to repay an investor the money put into the business, but when you hand over equity, you are giving away a share in your future wealth. That could add up to a lot of money if the business grows. You have to balance the fact that the investor’s share will no longer be yours against the benefits that the investor brings to help you to grow larger or faster than would otherwise be the case.
Know the value of your company
Placing a sky high value on your business might seem appealing on paper but will lead to problems in practice, either because investors will be deterred or will swiftly become unhappy when the real value of the business unfolds. Undervaluing the business, on the other hand, will lead you to give a level of ownership to your investors that is higher than it should be.
It goes without saying that you should read the terms carefully when you receive an offer of investment, and be sure the amount of ownership you surrender doesn’t inhibit your ability to run the business.
Negotiating may be left to an agent or professional adviser, and there is a strong case for doing so in private companies where emotions and subjective behaviours can run high. When negotiating with an investor, establish expected outcomes and milestones. This will help to keep the relationship working professionally. Remember that investors can come in all shapes and sizes - involved, passive, financial, socially motivated, business angel or private equity house – and deciding which is right for your business depends very much on the type of business you have. Different kinds of investors have different priorities so the outcomes and milestones you set together should reflect those priorities. For example, angel investors often have high expectations, and may be looking for a rate of return of ten times their initial investment within the first five to seven years. Unless your business can deliver that kind of growth, you may be storing up trouble by going down the angel route.
Finally, prior to completing an investment negotiation both parties may have higher than reasonable expectations of its outcome. So, it may be worthwhile remembering the adage that, in such circumstances, if both parties feel slightly disappointed then it's probably a good result!
By Chris Wood, CEO of national training company DTL