Looking for investors for your new invention can be an arduous process - by understanding what potential investors are looking for in a lender, you'll be better equip when pitching your idea. Obviously they expect the details of the business, such as organization, location, marketing strategy and implementation strategy, but investors also have specific key areas they focus on. They want to see that you know the ins and outs of the industry, how your product or service is unique, if you have researched your competition thoroughly, if they can expect a return on their investment, and how soon.
Debt capital is money raised by taking out loans, which must be repaid with interest, and equity capital is cash raised for a business in exchange for an ownership stake in the business (sometimes called capital risk). Sources of debt capital are more numerous than sources of equity capital, but you must be certain the business can generate enough cash flow to repay the loan.
A bank loan is a type of debt capital. You must repay the principal, plus interest, after a specific time frame. Banks were once a primary source of operating capital (money used to support short term operations) for businesses, but today their lending practices are much more conservative.
Commercial lenders, like banks, rely on the five C's to determine whether a business loan applicant is acceptable: Character, Capacity, Capital, Collateral and Conditions.
- Character - A borrower's reputation for fair and ethical practices, including business experience, dealings with other businesses, and reputation in the community. A bank must believe in the character of the entrepreneur before making a loan.
- Capacity - Banks consider the capacity of a business to pay its debts. Capacity is the ability of a business to pay a loan, taking into consideration its income and obligations.
- Capital - This is the net worth of your business, or the amount by which your assets exceed liabilities. Banks place a strong emphasis on whether a business has a financially stable capital structure.
- Collateral - Security in the form of assets that a company pledges to a lender. Banks are more likely to lend to businesses with valuable collateral.
- Conditions - The circumstances at the time of the loan request, including potential for growth, amount of competition, location, form of ownership, and insurance. Banks consider all the conditions in which your business operates.
Venture Capital Firms
Venture capital firms obtain financing for your company in exchange for a certain amount of ownership (equity). In the long run, when using venture capital to finance your company, you lose the ability to control the decision making process, and after a few years you may not even own the company.
Venture capital is a source of equity financing saved for small businesses with exceptional growth potential and experienced senior management. Aside from the ability to raise a large amount of capital, venture capitalists often provide managerial and technical expertise for your business. Venture capitalists rarely invest in start-up companies, but when they do, they expect:
- 30-70% return on investment
- 50% or more return for an early stage venture
- A business with good management
- That you can provide the vision necessary for success
If a VC firm is interested in funding your business and decides you have a sound business plan, it will begin due diligence. Due Diligence is the investigation and analysis a prudent investor does before making business decisions.
A private investor is a private, non-professional investor such as a friend, relative, or business associate who funds start-up companies. They are also referred to as angel investors, because they can provide help when it seems like no one else will. An angel often invests because of his or her belief in a business concept and the founding team. Private investors generally expect:
- A business concept they understand and believe in
- To invest with like-minded investors
- Ten times their investment at the end of five years
- A strong management team
Private investors can present a great opportunity for your business. Not only can they provide the capital you need, but they don't expect to take control of your business, and you don't have to risk collateral such as your home.
Initial Public Offering
An initial public offering (IPO) is the sale of stock in a company on a public stock exchange such as Nasdaq, or the New York Stock Exchange. An IPO is a popular way to raise a lot of money for growth since all proceeds go to the company. There are five steps to become a public company with stock for sale on a public exchange:
- Choose an underwriter or investment banker
- Draw up a letter of intent
File a registration statement with the SEC
- Announce the offering in the financial press
Do a road show
The CEO of a company that has made an IPO is responsible to the people who own company stock. Stock is a type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings.
Different types of financiers look for specific attributes in an entrepreneur and a business plan when making a decision. Make a good first impression and portray a sense of confidence in yourself. If you don't seem confident in yourself, why would anyone lend you their money? Most investors will tell you that they are investing in the entrepreneur more than the business itself. It doesn't matter if you have the best plan in the world, if you can't show that you have vision and confidence, no one is going to listen.
When looking for investors for your business venture, make sure to investigate all of the methods available to you. Don't limit yourself to one type of financing, try to tap into multiple financial sources.
Try to see your business pitch from the perspective of your investor. What would you look for if you were going to invest thousands of dollars into some one else's business?