What Small Business Investors Want - Five Key Items

What do Investors want? What do angel investors, venture capitalists, private equity investors and others seek when considering investing in a business?

1. A strong return on investment. Ranges from 8% (friendly, debt) to 40%

-Different types of investors investing at various stages of the company's growth and development will have different expectations. (Notice the emphasis on and repeated use of the word different!) An angel investor who is taking on the most risk by investing when the company is still in its nascent (i.e., very early) stage and has yet to generate much revenue, if any, has no contracts, and has negative cash flow, will want the highest return of 40% or close to it. If the company is successful, due to the early entry stage, one would expect the company to generate at least that. Often, though, the angel investor will sell out during one of the subsequent financing periods. Rarely does an angel investor stay on board until the company reaches maturity.

-Venture capitalists come in later but still before the company is cash flow positive. Therefore, they typically want returns of 30-35%.

-Mezzanine financiers provide a mixture of debt and equity to more stable and established businesses so they expect blended returns of 16-20%.

2. A clear pay-off date (exit strategy) - typically 3 - 7 years

-Very few investors wish to wait indefinitely for their money. They are investing not to make you feel good but because they believe in you and your business and the ability of the business under your management (and sometimes with their additional efforts) to generate enough revenue and cash flow and/or grow large enough in value to return them their investment and their expected return within a specific time frame.

-This varies based on the investor. Angel investors prefer a shorter period of time (3 years). Private equity funds typically expect 4-5 years. Strategic investors derive a number of benefits so their investment timeframe tends to be the longest, with a trend of ~7 years.

3. A strong management team

-There are many great ideas out there. It's not so much the idea that counts (look at all the inventors who never get anywhere) but the ability of the management team to capitalize on that idea and provide the leadership, strategy, sales, marketing, and operational skills and acumen to bring that idea to market. Or to apply those same skills to a purchase of an existing business and continue to generate similar growth if acquiring a high growth business or turn around the enterprise and grow it, if acquiring an underperforming company.

-The management team is the most important component. A great management team can make a good idea or a so-so company into a great company. But a great idea may never make it off the ground with poor management and a great company can go rapidly downhill with mediocre management.

4. A base valuation of the company

-You don't want to approach investors with no idea of what your company is worth. How do you know if the investor is proposing a good price for the portion of their investment? Angel investors sometimes are not highly financial savvy and can't do their own valuations. So you need to do one or have one done for your company and be able to explain it to the interested investor. You need to show them in these pro-forma financials how their investment will help move your business to the next level. And they need to see in this valuation how the requested investment amount was determined. Venture capital firms will do their own valuation but you should have your own in order to understand the financial impact of your company's strengths. This will facilitate your negotiations with these firms.

-Since they usually deal with existing stable businesses, mezzanine firms and private equity funds expect you to tell them what your firm is valued at, how you arrived at the numbers, and what amount you expect from them to invest. They will run their own valuation but want something to compare it to. Also, if your firm has $10 - 20 million or more in revenue (typical for companies that attract this type of equity investment), your management team should have someone with financial acumen -a CFO - or have access to someone (a consultant,...) who can do this. Otherwise, your ability to financially manage the company could be called into question.

5. A business plan to accomplish goals

- You need an abbreviated business plan. If you have a full strategic business plan, that's even better. If you also have an operational business plan, that's all the more impressive. But you need something that provides an overview of the market, background on the business, industry and competitor assessment, management overview, sales and marketing plan, risks, financial snapshot, goals, and the strategy to accomplish these goals. Most investors only want to see an Executive Summary - 3-5 pages - to determine if they're interested. Then, once they've expressed full interest, they'd like to see the complete business plan.

-Remember, the business plan is an ongoing work in progress. The purpose is not to clearly map out exactly what you'll do but to chart a course for what you'll do that enables you to respond to market changes and new information that may differ from the assumptions you made. If you're not fully aware of your ideas of the market, competitor, and customer behavior, then you don't know what to do when things don't go as expected. A business plan gets you to think creatively.

-Review your business plan on a quarterly basis and make changes semi-annually as needed. Remember, the business plan shows an investor that you treat your business seriously and have thought about what it takes to get to where you need their money to help you go. The business plan says to the investor, "Here's what I'm going to do with your money to make sure you get it back with the return you seek".