When you pitch your business to investors, you want to get questions. If you don’t get questions, then your pitch fell flat and nobody is interested. So, plan on answering questions—and hope you have some to answer!Read More
When you pitch your business to investors, you want to get questions. If you don’t get questions, then your pitch fell flat and nobody is interested. So, plan on answering questions—and hope you have some to answer!Read More
One of the most pleasing outcomes of being a long-term investor is that history has demonstrated that the rewards of owning an excellent business in a tax-efficient manner can be life-changing. This sentiment was summed up by legendary investors Warren Buffett and Charlie Munger at the 1996 Berkshire Hathaway meeting when they commented, “If you find three wonderful businesses in your life, you’ll get very rich.” One year later, in 1997, Warren remarked, “The single biggest recurring mistake I’ve made has been my reluctance to pay up for outstanding businesses.”
As a new investor, you may hear this and wonder what actually makes a company an excellent business and how to spot one.
While that topic is expansive and difficult to condense, it’s not difficult to figure out what to look for in a private business or when acquiring shares of stock. Armed with this information, over time, you have a chance at being more successful in your quest to build a portfolio of wealth-generating assets that can provide financial independence and security for you and your family.
It is certainly possible to build a large net worth through value investing—that is, the disciplined purchase of securities and other assets that appear to be selling at a substantial discount to a reasonable expert opinion of intrinsic value (or the “real” value of the business). Think of it as if you knew a local car wash had gold buried underneath it. The proprietor might be asking $800,000 for the land and enterprise, but you know full well that you could pay substantially more, not only owning the business but also selling the gold you dug up on the open market.
Thus, you had reason to believe that it was being sold for far less than its intrinsic value.
The one major shortcoming of this approach is that an asset acquired on the cheap must be sold when it reaches its intrinsic value unless it is an excellent business. As Charlie Munger has pointed out, over long periods, the rate of return that an investor earns is likely to be very close to the total return on capital generated by a firm, adjusted for dilution in shares outstanding. Thus, you are likely to do better paying fair value for a business that can reinvest its capital at high rates of return—say, over 15 percent to 20 percent per annum—than buying a mediocre business trading at a small discount to its book value.
If you had unlimited funds, do you really believe that with your pick of any manager in the world, you could unseat Coca-Cola as the undisputed leader in the soft drink industry? How about Johnson & Johnson with its myriad of patents, trademarks, and brand name products? The reason these businesses are able to consistently succeed is that they have durable competitive advantages—they do things their competitors can’t reproduce.
Sometimes these advantages are easy to spot, as is the case of Coca-Cola, which is the second most recognized word on Earth after “OK.” However, it is possible for these durable competitive advantages to remain buried, out of sight and out of mind.
One of the secrets to the phenomenal success of Walmart is that Sam Walton built a distribution system with logistical capabilities that allowed him to lower the transportation costs of moving merchandise to his stores. These lower transportation costs resulted in far more profit on each item than his competitors could earn, even if those competitors sold at a higher price. He and his fellow shareholders won from the increased income while consumers won from the lower prices.
These forces worked in combination with one another, reinforcing and accelerating the results so much that the tiny five-and-dime grew into the largest retailer the world has ever seen and put scores competitors out of business. Eventually, anyone who wanted to remain in business on a large scale to compete against Walmart had to have a comparably efficient supply chain.
When you buy into a company through the purchase of its common stock, try to identify the durable competitive advantages it has that could stand up from attack by competitors and market forces such as outsourcing and increased globalization.
When businesses are highly successful and make their owners rich in a single generation, one of the key ingredients, more often than not, is scalability. Take American Eagle Outfitters, which has a strong long-term investment record over the past few decades. Why has it been successful? What about Walmart? McDonald’s? Coca-Cola? Microsoft? All are excellent businesses in part because they had products or services that they could very rapidly replicate in cookie-cutter fashion. Once they got the base formula right, it could be rolled out and stamped across the country, and in many cases, the world.
Think about it—the McDonald’s in Hong Kong is very much like the McDonald’s in Chicago or Southern California or Amsterdam. By having the menu, layout, fixtures, and technology packaged in a way that restaurants could be opened rapidly, it made it easier for the chain to steamroll across the United States and globe. Coupled with its relatively high returns on equity and the cash provided by the franchisees, who footed the bill to build a huge portion of the overall business, it’s not hard to see why shareholders revered Ray Kroc, founder of the McDonald’s franchise business.
Imagine you buy the best business in the world and it earns $100,000 in real inflation-adjusted purchasing power each year. No matter what the economy, no matter what the political environment, it produces that $100,000 in real profit for you year after year, decade after decade. If you pay $1,000,000 for that business, your return is going to be double what it would be if you paid $2,000,000 for it. If you paid $10,000,000 for it, you’re going to suffer inferior returns. It’s that simple. The moment you write a check, the die is cast.
Everything from that point forward depends on the net present value of the cash flows you get from your asset and the price you paid to acquire that asset.
By Joshua Kennon, Managing director of Kennon-Green & Co.
(1) High average returns
Angel investors have returned 2.5 times their original investment over a period of about four years.
(2) Potential for super returns
Peter Thiel, cofounder of Paypal, turned his $500K investment in Facebook into $1.6bn. Jeff Bezos turned $250k into $1.6bn on Google.
(3) Affect life changing solutions
Startups can change the world for many people. Think of the connections Facebook has fostered.
(4) Job creation
Supporting the next big thing has impacts far beyond financial returns and innovation, but into the wider employment side of the economy.
(5) Get involved
You will have the opportunity to influence and impact the future direction and prosperity of the startup.
(6) Tax incentives
Many countries offer juicy investor tax incentives for supporting startups.
Here are the things to look for:
Make sure that the business actually does something that someone will always want. For example, a business dedicated to bringing you the best housing, or a business that supplies people with books, is a solid foundation. A business that tells you to send them a dollar and pass the letter on is not. Any sort of business which doesn’t fill an actual need like multi level marketing (MLM) schemes are bound to fail. The more the need being filled matters, the more solid your business foundation. For example, people are fine without MLM books; people aren’t fine without food.
Does the CEO sound like he sits on his ass all day and drinks beer? Is management in it to make a quick buck for themselves, at YOUR expense? Find out about the people running the business. Make sure that they actually care about filling the need in part 1. Just remember, if the business isn’t filling the need, it’ll disappear.
The business should be hard to replicate. If it ends up making a lot of money and it’s easy to duplicate, pretty soon, there will be thousands of businesses just like it! People aren’t dumb – if they’re making their 8% in bonds and they see you’re making 200% with your business, they’re gonna come. This is where the branding of the company, and quality of the product becomes of paramount importance (see how much money is integrity worth?). If people trust the company, and the product is working just fine for them, it’ll be awfully hard to get them to switch. This is an interesting situation which I like to call the gap concept.
Let’s face it. We want to make money, so we’re looking for something cheap. Now, that doesn’t mean we’re ripping the other people off. It’s cheap for a reason. For example, if it’s a private business, the owner may need money to expand, or if it’s public, people may perceive the company to be very risky or unsuccessful for whatever reason. In that case, by putting your money in, you’re actually giving it your vote of confidence and making it slightly more expensive. Of course, the more promising you think the business is, the more you can pay for it. Just keep in mind though that there’s potential everywhere while good results are hard to come by.
While there are probably other things to look out for, these 4 are by far the most important. If you just follow these 4 tips, you should be well on your way to finding a good, safe business to invest in!
The goal for angel investors is to provide capital seed funding for early stage companies with the promise of receiving high net worth in the end. There are many misconceptions about the length of time that an angel investor should invest in a company. Some entrepreneurs believe that once the angel investors give them the money, these angels will simply wait around for years until their funds are returned with interest. Angel investors can be very patient and willing to make long-term investments; however, they need to envision a clear picture of the company’s overall rate of return on their investment.
According to Dr. Jeff Cornwall, the Director of Belmont University’s Center for Entrepreneurship, an angel investor should not be tied to any financial commitment with a company for more than three to seven years. Some contracts between entrepreneurs and angel investors may have a longer term commitment, but angels should never approach any financial agreement with that length of time in mind.
Both entrepreneurs and their investors must have the same ambitions for company growth and exit. This is why most angel investors request a time-frame set or viable exit strategy as part of their financial negotiations. Once entrepreneurs become successful at growing their business, angels make the returns on their investments and exit it through a sale or merger. It is crucial for the angel investor to meticulously study the industry to make sure that their exit plans are agreeable and realistic. The relationship and responsibilities of both the entrepreneur and angel investor can be complicated. That is why it is imperative to plan an early exit strategy and for all parties to mutually agree to all the terms.
In a recent study that analyzed 86 U.S. angel groups and 539 individual investors, it was discovered that an angel’s overall investment return was an impressive 2.6 times in 3.5 years. However, angels who invested in startups and provided more follow-up funding ended up losing more money on their investments 70% of the time. When angel investors are forced to reinvest in a company, many times, they have hope that the business will generate more revenue the second time around. What happens is they end up losing even more money, generate significantly lower returns, and the company eventually goes out of business. This is a common occurrence, since angel investors reinvest in 1/3 of all their deals. This is exactly why follow-on investments are risky.
Due diligence– This term refers to the investigation and analysis that angel investors perform in order to determine if the investment opportunity meets their criteria for funding. When investors exercised more comprehensive due diligence, they experienced better returns.
Industry expertise– Angels who have experience in a specific industry nearly doubled their investments when they invested in businesses that were in their related field of expertise.
Participation– Angels received more returns when they actively participated in a company’s financial venture, including mentoring, coaching, and financial monitoring.
*Angel investors who made follow-on investments generated significantly lower returns.*
The Exit Strategy: Every investor needs to know when and how they will leave their partnership and how they will make a return on their investment. In addition, business management teams need to carefully weigh the pros and cons of different exit strategies and be flexible regarding their specific needs.
There are a few basic exit strategies that investors usually encounter:
1. Buyout by a competitor. A practical known exit strategy is when larger competitors buyout their smaller counterparts. This is a common example of how large companies can grow even larger through acquisitions. An entrepreneur should reflect this in their detailed plans.
2. Going Public. Offering shares of your company to the public markets can be viewed by some as an appropriate exit strategy. If your management team agrees on going public, an entrepreneur must make certain that someone on the management team has some knowledge and experience of running a public company.
3. Investor Buyout. This occurs when a larger venture capital firm buys out angel investors or a smaller venture capital investor.
5 Tips on Negotiating an Investment Deal
Last night I listened to attorney Karen McKercher presenting tips for negotiating an investment deal to a group of angel investors (the Willamette Angel Conference members). I think her list of five points is good reading for both sides of the table, both startup founders and angel investors. Here’s a summary (points are Karen’s, and the explanations are my summary):
Balanced interest. If a deal isn’t good for both sides, it isn’t a good deal. An investment begins a deep mutual relationship. Both sides have to have shared goals, common objectives.
The deal lead should have specific industry experience. Deal lead in this context refers to the one angel investor who leads the negotiation for the group of angel investors.
Use an experienced lawyer. She means experience in the specifics of negotiating investment deals between investors and entrepreneurs.
Don’t over-negotiate. It happens a lot; people focus too hard on the negotiation process and end up spending too much time and money because of too much focus on relatively unimportant details.
Observe behavior. The negotiating is about creating a long-term business partnership between investors and entrepreneurs. There are things people can do that indicate the long term isn’t going to work out. Do you want to do business with these people? It’s a question both sides should be asking. Negotiations can reveal a lot about the way people approach business and, for that matter, life.
Entrepreneurs: keep this list in mind as you negotiate with investors. It will help you understand what they are thinking.
by Tim Berry, the founder of Palo Alto Software, a co-founder of Borland International, and a recognized expert in business planning.
Generally, angel investors do not invest in deals greater than $1 million whereas venture capital firms typically are not looking at deals under this amount. As an angel, you make your own decisions as opposed to a board or group of people representing investors that have pooled their money.
Entrepreneurs often expect that you may be more involved in the business and may provide assistance in ways that venture capital firms do not. You also do not typically own as large a stake in the company as a venture capital firm would. Another benefit of being an angel investor is tax exemption for capital gain.
12 Rules for Investing in Someone Else’s Business
1. Don’t be “sold” investments.
You select your investments. Don’t blindly accept a friend’s or family member’s pitch. If you haven’t established your own investment goals, do not invest in anything until you do so. Without your own goals or standards, you lack a basis for assessing the opportunity. You leave yourself vulnerable to the sales pitch that sounds good.
Only get into investments that meet your criteria. Check out the business plan yourself. If you do not have the ability to review the business plan, get help from someone who does.
2. Require a business plan.
Insist on seeing the business plan of anyone proposing that you invest in his or her business. Never even consider an investment without a business plan. The business plan should provide enough detail for you to determine whether the business is feasible and is likely to succeed. It should make clear how the business will make money and provide a return on investment to investors.
3. Calculate your downside risk.
Determine what the various outcomes might be. Under what circumstances will the business succeed? Under what circumstances will it fail? What is needed for the business to break even? If the business needs more money at some point, will that money be available or will the business fail for lack of additional cash? Will you be willing to refuse to provide additional funding and see the business collapse?
Do not accept any representation that “that can’t happen.” Determine for yourself what can happen. Can you afford to lose your entire investment? Will any assets be left for you if the business fails?
4. Consider tax consequences.
What are the tax consequences of this investment? Can this investment be structured to provide a tax benefit to you if it fails? Will the investment be a purchase of stock in a small corporation under IRC 1244, allowing you to get ordinary loss treatment on the sale of the stock or failure of the business?
If the investment is structured as a loan, remember that a loss on a loan to a business is treated by the IRS as a non-business loss. Unless this capital loss can be utilized to offset capital gains you have from other investments, the maximum capital loss which can be deducted from your ordinary income is $3,000 per year.
Is the entity an S corporation, LLC, or other pass-through entity? If so, remember that the tax consequences will be passed through to you. These tax consequences can be profits, losses, capital gains, etc. Make sure you can deal with these tax consequences.
You may find that you can’t take advantage of losses because they are passive losses, which can only be used to offset passive income which you may not have.
Another potential problem is being taxed on profits that are not distributed. In a pass-through entity you are taxed on your portion of the taxable income, whether or not any cash has been distributed to you.
Can you afford to be taxed on undistributed profits? If profits are reinvested in the business there may be no cash to distribute to the investors who must pay the taxes.
5. Use your influence.
Get what is best for you. Have the investment structured the way you want it, or don’t invest. Are you a key investor? Are you the only financial backer? If you are just one of several investors, what power will you have to influence the management of the business?
Don’t overestimate the value of the founder’s management contribution or underestimate the value of your financial contribution. Without your money, the founder may have nothing. Without the founder, you would still have your money and you would find another investment.
Have the investment structured to give you the control you need to protect your investment. If your investment is an equity investment, make sure you have the voting power you need, and protection from dilution of voting power.
Have the ability to elect the number of directors necessary to control the Board of Directors, or at least have veto power over certain actions by the Board. Don’t fall for the idea that the founder should have control of the business.
Do you prefer to provide a loan, instead of buying stock? A loan is intended to be paid back with interest whether the business does well or not. If the loan is to an entity, which might cease to exist, insist on a personal guarantee. Make sure the loan is secured by the most valuable assets of the business, and by assets of the guarantors.
6. Make sure the founders also have something to lose.
Don’t get into a business where the founders have nothing to lose. Make sure the founders will lose money or end up in debt if the business fails. The fear of failure should motivate them even when the possibility of success does not.
The business needs to have incentives and disincentives for management and the founders. Otherwise, they may be willing to operate a worthless business as long as your money provides income to them.
7. Do it right.
Make sure your paperwork is in order, even if you are investing in the business of a friend. Check to see if any of your rights as an investor must be covered in the articles of incorporation in order to be valid. If necessary, have the articles of incorporation amended.
Be sure to file your security interests in the right places. If any of the assets to be used as collateral are trademarks, patents, or copyrights, the security interests must be filed with the appropriate federal offices. While most security interests in assets are filed with the Secretary of State, you must check the filing requirements for the different types of assets you use as collateral.
If you are providing significant funding for a business, you should insist on other rights which go beyond collateral. You should have the right to receive financial reports on a regular basis, to inspect the books and the facility, and to audit the financial status of the company.
8. Get it in writing.
Cover all important aspects of your arrangement in the written documents. Don’t rely on oral promises or general trust.
9. Keep copies of all documents.
Don’t forget to keep copies of all paperwork for the entity. For a corporation, keep copies of minutes, bylaws, articles of incorporation, and shareholder agreements. For partnerships and limited liability companies, keep copies of the agreements which establish the entity. Keep copies of all filings with the Secretary of State and the IRS. Keep the original notes on your loans in a safe place.
10. Plan to get money out.
How will you get money out of the business? Will you be an employee? Will you spend enough time on the business to justify the income you want? Will you be paid consulting fees? Will you want dividends paid? Do you need to elect S corporation status as a basis for distribution of profits to you?
11. Don’t invest money that you can’t afford to lose.
Don’t invest money you need access to. Many investments in small businesses are completely illiquid. Even if the business survives and does well, your funds may be tied up until a major event frees up your money (and the major event may never happen). Don’t invest in a business where your only “out” is an initial public offering.
12. Invest responsibly.
Even if you can afford to lose the money, and even if the beneficiary of your investment is your child, don’t be reckless. Require even your child’s business to meet high standards of business planning. Irresponsible investing encourages irresponsible business management. A business out of control is a poor investment for you and a poor training ground for your child.
By Mary Hanson, www.angelscorner.com
This is very dependent on the situation, size of investment, size of company, industry trends, etc. However, it is estimated that many angel investment returns in Malaysia small businesses and start-ups have been in the range of 20-40% return on investment (ROI). Some prove to be less but they are sometimes much, much more.
Arguably, it could be easier to invest in or outright purchase a small business that is already up and running than establishing a new one from scratch. Although you need to know what type of business you want to invest in, you also need to present yourself as a serious investor otherwise the deal may pass you buy. This will require you undertake extensive research to illustrate you are prepared to begin the process.
Investing in a business without taking over ownership offers you the benefit of some profit without having to put in the initial work, but you won’t ever have the potential to make as much money as you would be capable of if you fully owned the business. You also have less control over the company, so if things take a bad turn you have a limited ability to change things. On the other hand, merely investing represents less of a risk for you overall.
It can be difficult deciding how deeply you want to get involved with a business someone else started up, so consider the following steps to ensure you go through the process properly in order to be fully prepared to decide.
Step 1: Choose a small business to invest in
Investigate businesses that combine the potential for profit and interest for you as the first step to finding a company to invest in. Once you’ve found a number of likely candidates, create a short list of those that are most likely to be a good fit based on your financing capabilities and goals.
Step 2: Approach the seller
Make a good first impression when you meet the business’ current owner. Not only do you want to come across as professional, but you also need to indicate you have the experience and knowledge to take part in the business, especially if you plan to purchase the company in its entirety. Once you have established yourself as someone to be taken seriously, you can move on to discussing the nature of your investment.
Step 3: Gather information
Don’t just look at the company’s financial information when considering its success, especially if you think you only need to focus on the income. You also need to consider the company’s assets — what is their value and will they need to be replaced soon? — and any outstanding debt you will inherit once you invest. Although you shouldn’t expect everyone to be deceitful, it is possible the buyer may keep important facts from you in order to put the best possible face on matters.
Step 4: Decide to invest, buy, or pass on by
Once you’ve obtained all the relevant information and looked it over (preferably with a professional, such as a buyer’s advocate), you need to decide if you are more comfortable with investing in the company in exchange for a profit share, buying the company and taking over ownership, or turning the deal down as something that is not currently in your best interests. You need to consider the risks involved versus the possible returns — how much are you willing to lay on the line?
It is also during this stage of the process that you should consider looking into government funding information if your current finances are insufficient to complete the deal.
Interested in investing? contact firstname.lastname@example.org