(By William R. Patterson)
“Whenever you want someone to help you, no matter what kind of help it happens to be, it is important that you answer the question, “What’s in it for them?” Many entrepreneurs and business owners seek financing from investors without first having a clear strategy for how investors will get their money back. You can increase your chances of receiving funding if you have a clear plan for how investors will recoup and profit from their investment in your business“.
Entrepreneurs often want to know how they can tap into the billions of dollars in private investment capital available and increase their odds of getting funded.
Avoiding these five big mistakes can help you increase your odds of success, while reducing the amount of equity that you have to give up in your negotiations:
- Not having a scalable business. The most attractive businesses for investors are those that have significant growth potential and scalable business models. Investors want to know that if they put additional financing behind your concept, you have the ability, or at least a sound plan, to scale the business into a large, profitable enterprise. For example, investors want to know that if they invest in your business, you have the ability to go from serving 10,000 customers to 1,000,000 customers. If you want to make your business more attractive to investors, make sure your business is scalable in terms of manufacturing, distribution, customer service, and management capability. The more pieces you have in place the better your valuation will be and the less equity you will have to give up.
- Choosing the wrong type of financing. There are a lot of financing options available for your business including private investment, business loans, trade lines of credit, grants, sponsorships, and strategic partnerships. Many entrepreneurs and business owners make the mistake of going after the wrong type of financing. It’s important to choose the right type of financing at the right time based on your needs and growth strategy. You generally want to look for the financing options with the lowest cost of capital that would allow you to retain the greatest amount of equity. The exception to this rule would be if you need the relationships and management advice that a particular investor or company can offer.
- Not properly valuing your business (asking for too much). Far too often, entrepreneurs have not properly valued their businesses. As such, they make the mistake of asking for too much money based on the amount of equity that they are willing to give up. Too many times I’ve heard entrepreneurs say something like, “I want a million dollars for 10 percent of my company.”
To which I would reply, “So you’re valuing your business at 10 million dollars? How much is the business generating in profit, and what are the assets of the business?”
The entrepreneur then replies, “Well, we are not profitable right now, and we don’t really have any assets; that valuation is based on future earnings.”
My reply, “Well, your business is not worth 10 million dollars.”
If you want to be taken seriously and have the greatest chance of funding success, know how much your business is worth and have reasonable expectations about equity before approaching investors.
- Asking too soon. Many people also make the mistake of asking for money too soon, which forces them to give up more equity than necessary to their investors. Most investors will value your company primarily based on the profits the business is currently generating. Additionally, investors will factor in any pending order commitments, signed agreements, and distribution deals that you have in place that can give them a sense of your company’s future earnings potential. By implementing your business model on a small scale and showing a profit before you seek significant funding, you can prove to investors that your concept is viable. This proof of concept will give you greater leverage in your negotiations to obtain a better valuation and allow you to keep more equity.
- Not creating an exit strategy for investors. Whenever you want someone to help you, no matter what kind of help it happens to be, it is important that you answer the question, “What’s in it for them?” Many entrepreneurs and business owners seek financing from investors without first having a clear strategy for how investors will get their money back. You can increase your chances of receiving funding if you have a clear plan for how investors will recoup and profit from their investment in your business. This plan and exit strategy can include royalties on sales, dividends or distributions based on profits, arranging new financing options that would allow you or another investor to buy them out once the business reaches a certain stage, or selling stock through an initial or direct public offering.
Avoid these five big money mistakes, and you’ll find your business in a much better position to gain access to the capital it needs to grow. Remember, choosing the right kind of financing for your business at the right time can be challenging. However, these are not decisions that you have to make alone. You can leverage a business coach, consultant, or financial advisor to help you work through these critical decisions and help you gain access to the capital you need while retaining the greatest amount of equity.
William R. Patterson is an international, award-winning entrepreneurship trainer, business coach, and speaker. He is the CEO of the Baron Solution Group, which creates strategies to help business leaders increase capacity and accelerate growth.