Three tests to see whether your start-up is investment ready
Start-ups looking for cash might consider equity as an option to fund their early stage and ongoing funding requirements.
When talking equity, the most commonly known option is venture capital. However, venture capital funding in Australia is tightening with fewer deals completed in the 2012 financial year compared to previous years.
Also given the general downturn in the economy and the lack of returns from the venture capital sector, venture capital funds are now finding it difficult to secure funds from their traditional investor base of funds, as indicated in the AVCAL Deal Metrics Report 2012.
As a result, start-ups should consider the other equity options available to them.
A significant investor segment to consider is high-net worth individuals. According to the Capgemini and RBC Wealth Management Annual World Wealth Report, Australia is ranked as the 9th largest high-net worth investor population by country, with 180,000 high-net worth investors in 2011.
Another alternative is angel investors, who typically invest as a group of individuals to provide cash and in-kind support to seed and early stage start-ups.
The Australian Association of Angel Investors estimated angel investors invested $1 billion in 5,000 early stage businesses just in 2010.
Given the volume and number of potential investments that these two segments provide in Australia, there’s compelling motivation to investigate whether your start-up presents a good investment opportunity and is investment ready.
Here are my top three tips to evaluate whether your start-up is investment ready:
1. Assess whether you are the right type of business for equity investment
Investors take on a high degree of risk when they invest in a private business, so they want to know your business is scalable or saleable and will return a reasonable profit on their investment to compensate them for that risk. Scalable businesses are set up to handle massive growth often within a rapid time frame.
Saleable businesses are just that, businesses set up with a vision to be sold in the short term and provide the founder and their investors with a return on their investment as a result of that sale.
All investors expect to see a clear path to getting their cash back, plus some, either through a sale or some other form of liquidation event such as an IPO, or the introduction of other investors that buy out the initial investor group.
Venture capital funds have specific and stringent requirements around when and how that return will be delivered as funds are set up with a specified life and need to cash out and provide a return to their investors before the fund is wound up.
If your motivation is to establish a business that remains small and provides for your personal financial and lifestyle objectives with limited growth plans beyond that, you might not be a suitable candidate for equity investment and should consider your other funding options such as debt or grants.
2. Have an investment ready plan
Among other things your plan should address:
- What type of support you need – cash or in-kind support.
- How much cash do you need and when?
- What are you willing to give away in return?
Investors bring money, but can also provide a wealth of contacts, industry or management expertise and knowledge. Different investors may be experienced and focused on different stages of the business cycle, some looking for seed and early stage investment, others looking for investment in later growth stages.
Match the type of investor you target to your business plans and goals and you’re more likely to be successful in engaging them.
The stage of investment also brings other considerations as well. The greener your start-up the higher the risk, the greater the return investors will expect. So if you’re still at the stage where you’re testing and proving your business idea and developing your initial customers, expect investors to ask for more.
Conversely, when your business model has been proven and you’ve started to build more value in your business, your risk will start to reduce and investors will seek a return but generally not as high as for early stage investments.
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What you’re giving away in return for their investment is typically shares in the business. Sometimes convertible notes are used for short term funding arrangements or where it’s difficult to determine the value of the business. Convertible notes earn interest on your investment until the notes expiry date when an investor may ask the money be returned or converted to shares in the business.
In many instances you may also be asked to provide a level of information or control of the business, in the form of a position on the board, management team or say in the decision making process within the business. Many investors also require regular information and reporting about the performance of the business.
Whatever option you choose, you should be planning your investment strategy to match your business strategy at the outset.
As investors often invest in a particular stage of the business cycle, you’ll often find many investors will invest in one but not necessarily subsequent rounds to match your requirement, making it important to plan early.
What professional investors often can do though is introduce you to their networks of other investors and opportunities you can tap into. You should also consider your own networks and personal contacts, formal angel investor groups, associations like the Australian Association of Angel Investors, AVCAL or online referral sites such as Angel List.
3. Have a compelling pitch
Once you know you’re the right type of business and have a plan to pursue investors, you’ll soon have to pitch your business. A solid pitch should succinctly incorporate the following:
- The problem your company solves.
- The unique attributes of your solution.
- How pressing solving that problem is for your potential customers and the size of the opportunity to do so.
- How you intend to reach your customers and how much money you will make.
- Your progress so far, what you’ve tested and accomplished, any you’ve revenue generated and how you can leverage that to support your claims in the areas above.
- Who your founding team are, what their past experience is and what they’ve accomplished, to give investors the assurance you’ve chosen the right team to deliver results.
- What you’re asking investors for, what their return will be and when. As previously mentioned they want a clear path to a liquidity event that will provide them with their cash return.
- Finally, be clear and confident about your numbers. Not all entrepreneurs are confident when it comes to managing and talking financials.
However, given financials are what matters most to investors you need to be able to comfortably address how you’ll make cash, when you’ll break even, your knowledge of market statistics, growth projections, business value growth expectations, cash and resources you’ll need to achieve your goals.
Start-ups can outsource the expertise of financial management and forecasting to their accountants, who should help you to understand and discuss the detail with potential investors.
Marc Peskett is a Director of MPR Group, a Melbourne based business that specialises in providing business advisory, tax, outsourced accounting and grants and funding services, to fast growing technology and innovation businesses.
You can follow Marc on Twitter @mpeskett