INTRODUCTION
“Money is the oxygen of life” – and rightly so for business enterprises too. An entrepreneur’s long, painstaking yet exciting quest to convert an idea into a product or service and a thriving business requires money. Money in the form of equity or debt has proven to be an important resource for building and maintaining businesses. And due to its significance, “fundraising” has become a priority activity for entrepreneurs to ensure there is sufficient money to support their operations.
Indeed, a major concern for entrepreneurs is ensuring there is sufficient inflow of money, especially at the early stage of their business where there is low sales revenue. Investors in this regard have become the go-to persons for the funding needs of entrepreneurs. However, investors do not just invest. They do so based on a tall list of considerations that guide their investment appraisals and inform their decisions on whether to open the tap for money to flow into businesses.
To increase an entrepreneur’s prospect of securing funding from investors, there is the need to understand who investors are, what is important to them, and what they consider in making an investment decision. The purpose of this article is to help entrepreneurs appreciate these issues and be investment ready so that the investor’s dilemma of “to invest or not to invest” can be resolved in their favor.
INVESTORS – THE PERSONALITIES, OPPORTUNITIES AND RISKS
Apart from “bootstrapping” involving the use of an entrepreneur’s own resources, individuals or entities that provide funding in the form of equity or debt, or both for a business may be considered investors.
On the individual level, investors could be friends and family, angel investors, or a network of individuals with resources and interest in financing business opportunities. Entities such as venture capitals, private equity firms, fund managers, incubators and accelerators, hubs, etc. represent the institutional opportunities for fundraising for entrepreneurs. Either as individuals or institutions, investors invest with the primary expectation of financial returns. This expectation drives investors to adopt measures that minimize risks and maximize returns.
Monies from investors sometimes represent the best chance of patience capital that help in getting a business idea off the ground. However, due to the high rates of failures of funded businesses and startups, investors are compelled not only to invest money but also to make available their professional expertise, network, and time to support building the funded businesses into sustainable ones.
But all investors are not the same. The appetite for risks, capital/fund size, investment amount and structure, investment industry, or business activity type among others may vary from one investor to another. For instance, some investors may prefer very low-risk investments that will lead to conservative gains while others may be more inclined to take on higher risks for greater benefits.
Invariably, despite the differences, investors have similar or the same considerations either investing large or small amounts of monies into big or small businesses.
In the ensuing investment relationship, investors are not the only ones faced with risks. Equally, the funded businesses may be exposed to some risk(s) by accepting investments from investors. While investments have advantages, they are risky too. The disparity or changes in investor interest, unmet sales forecast, profits and other financial returns, personal attitude, and commitments among others may result in “undue” pressure on funded entrepreneurs to perform or risk losing investment. Likewise, any change in the funding sources of the investor may significantly cut inflows for the funded business.
THE INVESTOR’S INVESTMENT CHECKLIST
This checklist is representative of the various investor types and is not discussed in any order of priority. It includes considerations that are general and legally expected of businesses - whether seeking investments or not.
It is a list that must guide businesses in their investment preparedness efforts and ensure they tick the relevant boxes (what investors are looking for) before approaching investors. The adoption of this checklist and compliance with same will enhance the chance of securing investments from investors – thereby highly recommended.
- A COMPLIANT BUSINESS
The legal existence of any business is deeply rooted in the compliance with law – as a business is the permission of law. Hence, for a business to exist, it must comply with the demands of law. Adherence to regulatory compliance is therefore non-negotiable for businesses – whether looking for funding or not.
There are general and specific (based on the operational activities of a business) regulatory demands that every business must religiously comply with – in order to facilitate its existence and permission to operate. These demands invariably test the legality of an entrepreneur’s ideas, products, or services – as compliance offers a seal of approval by regulators.
While some investors may be willing to invest in a non-compliant business and support same to regularize compliance, others view non-compliance differently despite the potential of an idea, product, or service. Investors see the history of strict adherence to regulatory and business demands as a form of security and insurance for their investments and are more likely to invest in compliant businesses. Complying with regulatory requirements gives start-ups a positive outlook of a well-managed business and influences favorably pre-investment legal due diligence normally carried out by potential investors. It showcases a high level of operational competence – mitigating against risks of sanctions, penalties, fines, etc. for non-compliance.
A history of consistent regulatory compliance regarding business registrations, permits, or licenses is essential in the determination of the investment readiness of a business and investors do not discount its relevance.
- OWNERSHIP/ORIGINAL CREATION OF THE BUSINESS IDEA
At an early stage, the entrepreneur’s only resource usually is the “business idea” which may have been converted into a minimum viable product (MVP) or some other form. Underlying the ownership of a business idea will be intellectual property assets that give the entrepreneur rights to exclusive use, license, sales, etc. of the idea.
Subject to the nature, incidence, regulatory demands, and the accruing benefits of the various intellectual property rights such as copyright, patent, trademarks, and trade secrets among others, an entrepreneur must always demonstrate the ownership/original creation of a business idea or the acquisition of the necessary permits or license from its original owner for use in the proposed business manner.
No investor will invest without satisfying him or herself of the ownership or original creation of the business idea. Investors will need to know who owns the intellectual property (IP), whether it has been registered and, in whose name, the real or potential breaches of existing IPs, the real or potential disputes over creation or ownership (especially in co-founders' situations), etc.
This is a paramount consideration for investors because the product or service idea is the engine for any anticipated growth of the business and expected financial returns. And where its ownership or original creation cannot be easily ascertained, no investor will be willing to invest. The guarantees of a great business idea can be a security for investment as despite business operational failures, such ideas could be sold for a return – hence its ownership is extremely important to investors.
Therefore, before an entrepreneur commences fundraising activities, he or she must be certain of the ownership or original creation of the business idea, recognize its forms, and know that it’s the biggest trade-off for any investment from investors. And as a caution, begin those investment conversations with the signing of Non-Disclosure Agreements to protect confidentiality and restrict the use and disclosure of shared business ideas and information.
- A BUSINESS IDEA THAT ADDRESSES A NEED OR PAIN POINT
It is great to own a business idea or originally create or design a product or service. But it is not enough to get investors to invest. Your idea, product, or service must necessarily seek to address an identified need or pain point.
A clear demonstration of the problem and one’s proposed solution always wins over investors. This must include the demonstration of the point of difference between the proposed solution and existing ones, the business model, how an entrepreneur intends to remain competitive, the uniqueness of the proposed solution, and how that can be leveraged among others.
Business ideas – products or services that address a need or pain point have the highest chance of commercial success on deployment. This is a point of attraction for investors who expect funded businesses to remain viable and commercially successful returning profit year-on-year – don’t forget investors want to know how they will get their money back before they invest.
So be sure your business idea is addressing a need or pain point and you have clarity on its usefulness before approaching investors – because not all business ideas attract investments.
- DEMONSTRATION OF TRACTION
Some entrepreneurs bootstrap their idea into an MVP or some other form before approaching investors. At this stage, the product or service is expected to have attained some “product-fit” where the target consumers/customers may already be buying, using, and/or having some engagements including referrals with the products in numbers adequate to sustain growth and steady profitability. This demonstrates how the product or service satisfies strong market demands.
Additionally, there must be some evidence of “traction” showing the continuous evolution with impact on product fine-tuning or improved service offering, sales, cost especially production cost, profit, and other operational issues such as customer acquisition, number of employees, etc.
Hardly do investors invest in “ideas” without any evidence of traction. They want proof of how the idea and its related product or service are being accepted by its target consumers/customers and have the potential to scale up and expand based on the historical operational and financial performance of the company.
In this respect, investors will request samples of the developed product or the demonstration of the proposed service, sales record for a period, cost of producing a unit, selling price, and who the entrepreneur is selling to among others.
The more “product-fit” and “traction” a business has, the more the likelihood of attracting funding from investors. Therefore, entrepreneurs must make sure they have demonstrable product-fit and traction before approaching investors.
- JUSTIFICATION FOR THE USE OF FUNDS
As stated earlier, investors are not benevolent personalities and do not go about handing free money and will never do.
Before an investor decides to part with money, he or she will need to know precisely how the entrepreneur plans to use the proceeds. Is the money covering planned capital expenditures or recurrent ones? Is it for research and development? Is it for service provider payments such as legal and accounting fees? Is it covering recruiting costs and salaries? etc.
An entrepreneur must be ready to convince investors of the appropriateness of the spending plan and how that will impact issues of product or service improvements, reach more consumers/customers, recruit and retain qualified employees, and make profits. Thus, the intended use of funds must be clearly itemized and outlined in a manner that demonstrates the real business need for funding – no investor will fund superfluous and frivolous expenditures.
In appraising investments, investors will scrutinize the intended use of funds and will want some assurances of their functionality in aiding business growth and expansion. It is therefore important to demonstrate to investors how you intend to scale your business quickly using the requested investment amount.
- DEMONSTRATION OF AN ENTREPRENEURIAL SPIRIT
Also on the checklist of investors is the character of the person behind the business idea. The interest is not only in character manifested in the understanding of the problem and clarity of the proposed solution. Investors are also interested in the demonstration of passion for what an entrepreneur is engaged in, his or her ability to commit to a full-time pursuit of the business idea, grit, focus, and some relevant professional expertise or training.
An entrepreneur serious about securing funding from investors must demonstrate he or she is an entrepreneur and embodies the entrepreneurial spirit – clear and simple. The enterprise cannot be the backup plan – it must be the only plan and the entrepreneur must be fully committed to it.
While there may be multiple measures of this expectation, investors may tick this box through the observation of how you speak and your work ethic – so be prepared and remember it’s your audition as well.
- A PROPOSED INVESTMENT STRUCTURE
Although it is up to investors to decide how they want their investments structured, an entrepreneur seeking an investment must have a structure in mind and in hand. An entrepreneur must have worked out the share of the business he or she is prepared to trade for funding and other plausible options which will still get a deal done.
Investment deals could be strictly equity or debt, or both. In equity deals, the entrepreneur trades off part of ownership and usually, investors may be seeking majority ownership for its related advantages of control, the share of profit, and decision-making. While debt financing does not result in parting with ownership, debt arrangements will require repayments with interest or in default converting into ownership.
A deal structure may also involve other arrangements that provide soft support apart from money for the enterprise. While there are no time frames for closing an investment deal, an entrepreneur with a structure in mind and its variation is able to negotiate quickly and secure a deal. So, never walk into an investment discussion without a deal structure in mind – you may walk out without one because investors will make offers and counteroffers with varied impacts on your business.
CONCLUSION
Investors assume risk whenever they invest. As a result, they are very cautious and doubtful when considering pitches for investments. However, entrepreneurs can always increase their chances of securing the needed investment by checking off the aforementioned boxes and becoming investment ready before approaching investors.
With these in mind and in hand, entrepreneurs can be confident of resolving the investors’ investment dilemma in their favor – by securing a deal.
ABOUT THE AUTHORS
RICHARD NUNEKPEKU is the Managing Partner of SUSTINERI ATTORNEYS PRUC (www.sustineriattorneys.com) a client-centric law firm specializing in transactions, corporate legal services, dispute resolutions, and tax. He also heads the firm’s Start-ups, Fintech, and Innovations Practice division. He welcomes views on this article at richard@sustineriattorneys.com
HAROLD KWABENA FEARON is a Trainee Associate at SUSTINERI ATTORNEYS PRUC with its Corporate, Governance, and Transactions Practice Group, specializing in legal service provision for Startups/SMEs, Fintechs, and Innovations. He welcomes views on this article via harold@sustineriattorneys.com