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 might 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 in a potential business partnership.
Investors vs. lenders: What’s the difference?
Remember that investors are fundamentally different from lenders, and you’ll need to consider that when you decide what kind of funding you want. While lenders give you money under the assumption that you’ll repay it with interest, investors give you money in exchange for partial ownership of your business.
As such, their investments may come with restrictions. Some may require their approval for transactions over a certain limit, for example, or ask you to set up an independent Board of Directors. And investors have certain rights, too, which you should discuss with your lawyer before jumping in.
Why should investors invest in your business? A 10-point checklist to prove your readiness
Investors can be a great thing for your business. First, an investor won’t demand repayment every month because their involvement is not a loan. An investor can also be a reliable source of business advice and may have a strong business network that you can draw on. Still, you should understand that investment isn’t free money — your investors will have certain expectations.
If you do decide to seek funding from investors, your next step is to figure out how to draw them in. What is it that makes an investor decide to put money into one business over another? Here’s what you’ll need to convince them to choose yours.
1. Past performance data
More than anything, early-stage business investors want to see a return on their investment (ROI). If you can demonstrate that your business will make them money, then you’re 90% of the way there.
If your company has been up and running for a while, then you need to show excellent financial performance so far. (If your company has yet to start up, then you’ll need to rely less on exact numbers and more on projections in your business plan.) Here are some specific metrics investors will want to see:
- Gross margin: Sometimes called “gross profit margin,” gross margin is calculated by taking your total business sales revenue and subtracting the cost of goods sold. This number lets investors know the amount of profit a business makes before sales and administrative costs. That provides a good indication of a firm’s financial health.
- Revenue growth: This is sometimes called “the top line number” and shows trends in business income — that is, how your business is doing today compared to the same time last month or last year, for instance. Revenue growth is generally calculated as a percentage, and can be calculated for any given period of a business’s history. The formula is:
Revenue growth = (Current period revenue – Previous period revenue) / Previous period revenue - Monthly Recurring Revenue (MRR): A company’s monthly recurring revenue is how much the business earns every month. By looking at this number over many months, investors are able to determine whether or not your revenue is consistent. Sometimes spikes in sales, and therefore income, are caused by ad-hoc events such as marketing campaigns or product launches. As much as possible, you want to show investors that your cash flow is steady month to month.
- Net income: Net income is also referred to as the “bottom line” or “burn rate.” Basically, this is the amount that’s left in the business after all expenses, including payroll, interest, and taxes, are subtracted from your total annual revenue. While a healthy business should, in theory, have positive net income, this isn’t always true for early-stage businesses that are still growing.
- Churn rate: Sometimes known as the attrition rate, churn is the rate at which customers drop off a company’s books over a period of time. This term is particularly relevant for subscription businesses. The higher the churn rate, the more customers you’re losing, which can reflect negatively on your product quality, your marketing practices, and your retention strategies. For that reason, investors generally look for low churn rates.
- Customer acquisition: How much does it cost you to acquire a customer? That’s your customer acquisition number. It’s cheaper to retain existing customers than it is to attract new ones, which is another reason investors value low churn rates. It can sometimes take a lot of investment to bring new customers through the door. While spending money is necessary to build a business, investors will still look at these numbers to determine whether your revenue growth can handle the ongoing expense.
- Revenue per employee: This metric is useful for measuring how efficient a business is when it comes to utilizing its employees. A high revenue-per-employee metric shows investors that your team is working efficiently. The reverse, however, can be an indication of poor management, overstaffing, and other inefficiencies.
- Liquidity: This is the amount of available cash a company has on hand, i.e., the immediate spending power of the business. This number allows investors to see whether or not the company can cover its expenses over the coming year. Good liquidity can demonstrate that your business has reserves for unforeseen circ*mstances and that it’s not overextended. Once again, it’s not uncommon for startups to have insufficient liquidity, but combined with other metrics, liquidity can be a valuable number for gauging the financial health of the business.
2. A rock-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 offer you funding without one. If past performance data shows that you’ve historically succeeded, a business and financial plan will show that you will continue succeeding in the future.
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 service that makes 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,” also known as your unique selling proposition (USP). 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 market for your product or service
Your job is to convince investors that not only is there a big enough market for your product, but that your place in that market is a sure thing. You also need to make sure your requested investment capital makes sense. If you’re asking for $100,000 in investment for a 10% share in the business, for instance, you need to show that there’s sufficient market size for you to become a million-dollar company.
To do this, first lay out data proving that there’s a large market opportunity and customer base. Then, explain in detail how you have an unprecedented advantage, how your business model makes you unique, and what problem you’re solving that your competitors aren’t. If you’re an early-stage founder seeking venture capital and lack past performance metrics, it’s even more crucial to get this right.
5. A strong narrative
Investors hear a lot of pitches packed with hard data. So, given two companies with similar projected returns, what makes an investor choose one over the other? Your story. 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? Opening you pitch with your story is a great way to set the tone and draw your potential investors in.
6. Background and experience
Your business idea is only a small piece of what will push a company to succeed. The other piece, of course, is you. Investors know that a startup’s founding team is crucial to the success or failure of the business. They don’t want to lose money because the founders or management team lacked experience in the marketplace or weren’t the right fit for a partnership. This is why — in addition to your idea and your financial projections — investors want to know about you before they make an investment decision.
What experience do you have with this business and industry, or with business in general? Have you founded a company before? What is the nature of the relationship between the co-founders? Is this a team that knows their market, their brand, and their business — or are they still trying to figure it all out? You’ll need to build a compelling case for you and your team as part of your pitch.
7. A passion for solving customer problems
The difference between a numbers-only business robot and someone with a passion is that the passionate entrepreneur won’t give up — even when everything seems to be going wrong. Where others call it quits, a passionate team keeps fighting, launching new products, trying new marketing strategies, and coming up with new ideas. That’s the kind of commitment and determination investors are looking for.
All things being equal, a passionate entrepreneur is more likely to stick it out through the inevitable difficulties that come with starting a business and eventually push it to success. For that reason, investors want to know that your business isn’t just your job — it’s something you feel you were born to do.
8. Business readiness
Many people have great business ideas, but not many people have the drive and wherewithal to shape those ideas 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 the right investors’ interest because they know that they’ll get a return on investment sooner rather than later.
To show business readiness, you have to do your homework, including your market research and your business plan. You also need to show that you have a clear plan in place (for example, that you’ve already staked out a new location and the right suppliers).
9. A good reason for the investment
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 if things start to go south, they’re not going to want to put it in in the first place.
10. A clear investment structure
Buying ownership of a company has legal ramifications, and investors will want to know that you’ve already considered them. You’ll need to have a business structure in place that allows 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. This brings us back to that previous example: If you want $100,000 for a 10% share, you need to be able to show that your business is actually worth $1 million.
This involves putting together a stockholder’s agreement (and maybe also a corporate constitution) that clearly sets out the rights of all owners. Your stockholder’s agreement 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, among 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 request adjustments or additions to the stockholder’s agreement. The trick is to come into the negotiation 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: Imagine yourself in the investor’s shoes
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. What would you want to know if you were the investor?
Your 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 partnership is going to be structured. Show your potential investors that you’re thinking about the future — because that’s their number-one concern.
Explore funding opportunities with Accion Opportunity Fund
If you’ve exhausted all your investment options but still need funding for your business growth, consider a small business loan instead of, or in addition to, investors. Accion Opportunity Fund works with the dual goals of supporting small businesses and advancing justice, ensuring that no business owner goes without the funding they need. Our loan programs are flexible and customized to meet each individual business owner’s needs. To find the right program for you, visit our small business loans page today.
