Before you sign on the dotted line
There are five things start ups should ask potential investors before signing the dotted line, writes Alan Manly
Entrepreneurs start new businesses to solve a customer need or often improve the way a customer need is delivered. Undoubtedly, this business that has more potential than immediate funding can support and you’ll need the assistance of investors to help with growth. Finding the right financial partner can be challenging, and there are key things you should ask to ensure you’re working with the right one:
#1 Have you done this before?
This question sorts out the newbies from the veteran investor. Put another way, family, friends and fools, the famous three F’s, fall into the newbies category. You would be very brave to accept an investment made by any of the three f’s. Such investment comes with many emotional strings attached and can be a major distraction to you and your business far out weighing any advantage. Professional investors are slower to sign up but will have a professional relationship with you as an investor and nothing more.
#2 Your investment, short, medium or long term?
All investments are really loans waiting to be repaid with interest. The waiting part is called the term which must be discussed and agreed upon. Both parties could have wildly different views of when the investor is likely to get their money back. The answer should be clearly expressed in the business plan with time frames showing the link between the investment and the actual scaling up of the business. With the scaling up of the business there must be a consequent increase in returns or profit that allow the investment to be returned to the investor.
#3 Shares Wanted
Nothing is for nothing. What percentage of the business are you prepared to relinquish in return for an investment to grow the business. This will be a big challenge for a passionate start up entrepreneur that in this case is you. Ownership gives you freedom in decision making. However, when you want an investor the serious bits start. How big do you want this business to grow? Better that you own sixty percent of a business than one hundred percent of a start up that, due to a lack of investment, died.
#4 Plan B
Having agreed on the percentage of shares that the investor will have in return for their investment, the next question is what if the business does not perform as planned and the investor can’t get their money out as committed in the business plan? Emotions may run high. Plan B will now be implemented. Best that you understand what the investors Plan B is before you take the investment. The investor may take legal action to recover the investment claiming that your business plan was misleading. All start up expenses may be reviewed and challenged for any personal usage that is common in a start up. Accusations will fly as most start ups have messy paper work. A legal cat fight is now on the cards. Moving to the end of this scenario we see two obvious outcomes. If the business has not performed as hoped then it may need more investment. The investor may be the only person interested in further investment so as to recover sunk costs. This would usually be in exchange for a controlling interest in your company. This may be a blessing for all parties or a sad ending to your promising start up. Often emotions have run so high, and the lawyers have been paid so much, that the parties go their own separate ways. Proving again that there is never a lack of risk when you venture to set up a start up.
#5 How much is needed?
Most start ups need twice as much investment, take twice as long as the
Alan Manly is an entrepreneur with extensive experience owning and managing SMEs. He is also the author of When There Are Too Many Lawyers … There Is No Justice ($24.95), visit www.alanmanly.com.au