Why would someone invest in your business? Or why wouldn’t they?

February 24, 2011Post by Laura Humphreys

I’m currently looking at my investment portfolio and deciding how much of my wealth I want tied up in businesses… my own and others.  Investing in business is a high risk strategy as so much depends on the people running the business and their understanding of what business really is.  I’m always on my soap box about small business owner operators needing to grasp the basics of what makes their business valuable.  I know what I think, but I wanted to see if other business experts think the same.  So I googled.. “why would you invest in a business?” and found a similar thread running throughout.  Venture capitalists, ‘angel’ investors… it seems the critieria for a good business are much the same.  But here’s the criteria for NOT investing in a business from Michael Blakeyof  private equity firm Avonmore Development… it hammers home some very clear fundamentals for business owners, and of course ends with my favourite soap box topic… having an exit strategy.  Enjoy….

When not to invest in a business…

1. Failing to describe what your business does

It may come as a surprise, but many entrepreneurs struggle succinctly to describe what their business has been set up to do and why it differs from the competition. The old idea of the elevator pitch really holds true for most angels and you need to get to the point in a minute or less. Experienced angels can assess an opportunity quite accurately in the opening minutes of a presentation – we see so many ideas, so it’s essential to focus on the key points. So work hard on that opening presentation, it’s absolutely vital.

2. Entrepreneurs who over-value their businesses

Early-stage entrepreneurs are frequently unrealistic about what their businesses are worth when they first talk to us, and what they will be worth over the period of the investment. They see the headlines about massive valuations for the likes of Google, Facebook and Twitter but fail to appreciate that these are the exceptions rather than the rule. They also often apply the “hockey stick” approach to sales forecasting, where their expectations of massive growth determine their overall valuation – often without real justification.

Valuation issues aren’t reserved for “naive companies”; 90 per cent of the businesses which excite us still fail to receive investment due to valuation issues. It’s important to be brutally honest and realistic about valuation – aggressive and ambitious numbers are great news, but only if you have the evidence to support them. As a rule of thumb we are looking to achieve at least a ten times return on our investments.

3. Entrepreneurs who don’t research what investors need

It is not unusual for businesses to seek investment without doing any research about the potential partners they are pitching to. There is little point in pitching a business idea to an angel who has no interest in the entrepreneur’s market segment. Similarly, most VCs are not going to be interested in an investment of a few hundred thousand pounds and most angels are not going to look at multi-million pound funding rounds (although of course there are sometimes exceptions to this rule).

4. Large founder salaries, large debts

Angels worry if the business owners looking for investment plan on paying themselves a large salary. What’s the objective? Is it just a lifestyle business or is everyone involved going to earn a real return? Equally, a business looking for investment when it already has large debts may be looking to survive rather than excel.

5. Bad funding models

Growing businesses needs their management team working on what makes them a success, not constantly raising finance. So, a business which plans to raise one tranche of money and then more again in six months can quite easily be held back by the sheer effort this process required. As investors, we want to see the company raise sufficient capital to ensure that they have a realistic chance to reach critical value milestone – at least 12 months cash on prudent financial forecasts is a good figures to go for.

6. No clear exit strategy

It can be difficult to imagine exiting from a business when you’re still on the road to success. Entrepreneurs will often at best have only a rough idea but it’s a vital consideration for us – who are the likely buyers? When will our investment mature? What strategy will get us all to the point when we can meet the objective of the exercise, which is to make a profitable investment?

Business owners who can effectively address all these issues early in their relationship with any potential angel investor have a much greater chance of success – not just in securing financial backing, but in realising the ambition which has brought them to us in the first place.