Business Solutions

Each day we are asked by Entrepreneurs about investors that might be interested in their business projects, that are poor candidates for lender or bank funding for reasons from collateral issues, to equity injection issues, to new market issues, all of which can greatly increase the amount of risk exposure to the point where banks are not in the fundamental position to approve even limited funding, if any at all, and many Entrepreneurs have a limited understanding and knowledge of just what investors are all about.

An investor is someone who places money into a business usually receiving an ownership or partnership stake in the business, and they are looking for high growth industries and markets and experienced management teams, and investors also undertake a great deal of risk since most of the money they provide is unsecured, therefore in many cases they seek very aggressive rates of return on their money.

It must be remembered and considered by Entrepreneurs that an investor is undertaking a lot of risk, therefore they may want a substantial share of ownership in your company, but just as important, investors typically don’t want in forever, usually after three, five, or seven years they want to exit the business, and if you have a problem with giving up ownership in your business then you’re going to have a very big problem in securing outside investment.

It’s important to understand the kind of money investors provide your business, which is typically not a loan and therefore not debt-based capital. In other words, since they are not providing your business with a loan, equity-based capital is placed in your business, and equity is money provided to your business in exchange for an ownership stake in the project.

Clearly, some advantages of equity are that equity capital can be much more flexible than debt, since there are no collateral requirements for equity capital, and repayment terms and conditions can be tailored to the needs of the business. Usually, payments to investors can be put off until the business exceeds break-even or reaches a certain level of profitability, so needless to say, this can really help the cash flow of an emerging business, and also equity capital can be a great way of raising large amounts of money for your business.

Advantages of having investors, are investors contribute to the credibility of a startup or growing business through their scrutiny, certification, and investment, and investors can also draw upon their own reputations and contacts to help the startup secure customers, employees, suppliers, and so on. Indeed, most Entrepreneurs that are recipients of venture capital indicate that the advice and mentoring they received from their investors was worth more than the money itself.

It is just as important for Entrepreneurs to know the disadvantages of equity which can come at a very steep price, while a debt-based bank loan might run you say 6% to 10%, an investor or venture capitalist seeks much higher rates of return around 20% to 40%. Also, as stated earlier, equity investors generally want to share the business so you’ll have to give up some ownership (difficult for many Entrepreneurs to come to terms with), and while these investors don’t want be involved in running the day to day operations of your business, they usually want a seat on the board of directors where they can influence the decisions of the management team.

When determining when equity-based capital should be used, it is important know equity capital is well suited for startup and later stage growth businesses that require large amounts of working capital, or involve a new product launch, and banks are most assuredly not fond of lending working capital to a business, especially if they are in the startup phase. The reasoning is simple, that when a dollar is spent on payroll or advertising, it is gone forever and cannot be liquidated by the bank should the borrower default on the loan, so instead, this is the domain of the equity investor, and the investor is willing to take on more risk, for more reward of course.

When defining the types of investors in general, outside investors fall into three broad groups, Seed Capital from friends and family, Angel Investors, and Venture Capitalists, and these three groups differ with respect to the type of deal they are looking for, the size of the deal they want to do, and their specific motivations behind the investment, and Entrepreneurs need to understand and become familiar with each group, the deals they look for, and motivations specific to each investment.