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Column by Michael Lechter
The Definition of Success
Convincing risk-averse investors that you have a plan for success, and profits, will help secure financing for your business.
In order to attract Other People's Money (OPM), and to minimize the cost of using OPM, you typically need to be able to demonstrate that your business is likely to succeed. However, success means different things to different sources of OPM.
Some sources of OPM have greater expectations for profits than others. For example:
- Family and friends may invest in your business simply on the basis of their relationship with you, and without any particular expectations.
- Other types of investors (Venture Capitalists or Angels) are looking for certain minimum returns on their investment (often referred to as their "hurdle rate"). They will not invest in your business unless you can demonstrate that it will be successful enough to provide at least the hurdle rate of return. In those cases, you will have to demonstrate not only a likelihood of success, but that you play in "a big enough game" (your market is large enough) to generate the threshold returns on investment.
- A traditional lender such as a commercial bank is often satisfied if you can show your ability to repay the loan.
- A (non-principal) co-venturer is likely to be concerned with the viability of your business and its ability to perform its obligations (e.g., ongoing participation, or provide support and improvements) but the profitability of your business is often much less important to them than to other sources of OPM.
Some sources of OPM are also less "risk averse" than others. For example, institutional lenders are notoriously risk averse. They will typically not provide funding unless there is a virtual certainty that they will be repaid. (Some people would say that they are not willing to lend you money unless you can show them that you don't really need it). On the other hand, other sources of OPM are typically willing to assume some risk (some more than others) as long as the potential return on their investment warrants taking the risk.
In any case, the more risk that a source of OPM perceives, the higher the return on investment they will demand before they will make the investment. There are entities that will invest in businesses that cannot show a likelihood of success. The question there, however, is whether you would want to have them involved with your business. While you can occasionally find an investor of that type that is altruistic or community minded, that type of investor typically has an ulterior motive, e.g., takeover or to acquire the assets of your business. You need to be very careful. It is extremely important that your arrangement with that type of investor is understood and very carefully documented.
How do you demonstrate a likelihood of success to potential investors? The standard vehicles for telling your story to potential investors include:
- An "elevator speech": This is an effective three-minute pitch giving the essence of the opportunity and why it will be successful.
- A Website and effective online presence: A good Website and effective online presence can be a very persuasive introduction to your business. However, you must be careful that the website does not solicit investment. As a general proposition, unless you have registered with the Securities Exchange Commission (SEC) or qualify for certain exemptions, you are not allowed to make "general solicitations" for investments.
- A business plan and financials: This should be a succinct but persuasive story showing not only where your business is going and why and how you and your team will succeed in getting there, but also why your venture presents an opportunity to the investor -- essentially, what's in it for him or her.
- An executive summary: This is a two to three page summary of your business plan.
Ignoring for the moment friends and family that are investing in you as opposed to the business, in order to attract OPM you typically need to demonstrate that your team (management and advisers) has all the skills and expertise needed not only to actively manage the company, but also to seize opportunities and solve any problems that arise. You should present a viable plan to bring your product or service to market, and show that you have, or will have, the right type of resources, and that all of the components, materials and other resources that you will need will be available.
You must also be able to explain how and when the investor will receive an expected level of return on the investment, and how and when the investor will be able to "exit" (extract the investment from the venture).
In a nutshell, you need to convince investors that your business actually has a carefully thought-out plan for growth that will meet their expectations for a return on investment.
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