Top 4 Reasons Investors May Say No, What To Do and How to Deal With It.
Is your track record good enough to start raising capital? While the track record of the team and the firm’s advisors are very important, investors usually first focus on the Founder of the firm or the CEO.
In general, investors look for CEOs who:
Has “been there and done that”;
Has specific domain experience/expertise;
Is aware of his knowledge gaps and actively seeking resources to fill them;
Is capable of attracting, hiring, and managing top talents;
Demonstrates a powerful sense of ambition or determination;
Shows a tendency of under commit and over deliver;
Understands the distinction between being employed and being an employer;
Recognizes the need of generating revenue while keeping the burn rate to a minimum.
In particular, investors look for CEOs with the following characteristic:
A charismatic communicator capable of conveying the firm's value propositions and attracting top talents;
A superb dealmaker that able to close big deals;
Have a high personal energy level and a strong desire to achieve goals and motivate others to accomplish above and beyond.
How to prove yourself to investors if you don’t have a track record?
Investors are more inclined to invest in someone who has a track record of doing the most of what they are expected to do in the future. It is crucial that you assess yourself as a CEO against the criteria given above. However, even if you lack a track record, your actions and words can make up for that when meeting potential investors and making them believe in you.
Don’t be too concerned with the things you do not know; being a founder is still “faking it till you make it.” The investor just want to make sure they work with smart, ambitious, and hungry founders who can engage and inspire both investors and customers.
A frequent topic: “What is my burn rate?” Investors frequently talk about potential target companies in terms of their burn rate. When funding start- up companies, investors try to determine the potential target’s burn rate.
Burn rate is the rate at which a company will use its capital to finance operations before generating positive cash flow. It is usually expressed on a monthly or quarterly basis and is a measure of how fast a company will use up its cash.
For example, a company with a burn rate of $1 million per month will exhaust $12 million in capital in one year, obviously. Burn rate is synonymous with negative cash flow.
This is of importance to investors because it helps them to determine if a company will be sufficiently capitalized with their investment and how long their investment allows the company to operate before becoming cash flow positive. If an investor feels that their capital infusion is not enough to sustain operations for a long enough period, they will naturally assume that your company will require more financing in the future.
When burn rate is more than anticipated or sales are less than anticipated, companies usually respond by reducing burn rate, which generally means cutting expenses associated with overhead.
Accordingly, investors will look at your company from the standpoint of being able to reduce burn rate in the event that actual performance does not meet expectations. For early-stage companies’ cash is king.
Managing cash is one of the most important duties of an entrepreneur. Cash required for growing sales usually precede the receipts of cash from those sales. The lack of cash diverts management attention away from running the business and can disrupt operations as bills become more difficult to pay. Therefore, the sophisticated investor will take a very close look at a company’s burn rate, the underlying assumptions and the ability to reduce burn in the event of sluggish sales.
Valuation and Pricing
A question that I always ask an entrepreneur is, “What do you think your company is worth?” The answer usually comes back very vague or maybe just simply, “I don’t know.”
When seeking capital funding it’s very important to have a fact based, analytical sense of what your company is worth. After all, if you’re seeking equity financing you will be giving up a negotiated portion of your company in exchange for cash.
Admittedly, valuation is almost just as much art as science and everyone has their own way of doing it. Also, it’s very dependent on assumptions and how realistic you or an investor believes those assumptions to be.
It is also important to remember that an investor is going to be most interested in the value of your company at the time of exit via sale or public offering. You should conduct your analysis similarly.
There are several methods of valuing your company. Among them are price to earnings, discounted cash flow, price to sales. When determining the value of your company I recommend that you take all three methods and see if the results are convergent. If they are and the assumptions you made are reasonable and defendable, you’re probably on the right track. Let’s talk briefly about the methods we mentioned.
Price to earnings (P/E) is a ratio of the value of a company’s stock to its after-tax earnings. For instance, if a company’s stock sells for $20 per share and its earnings for the most recent year is $2 per share then the price to earnings ratio is 10. In order to value your company using this method you will need to gather market data about the price to earnings ratios of publicly traded companies in your industry and make some assumptions about stock market performance at the time of your planned exit.
Price to sales is very similar to price to earnings except that it expresses the value of a company’s stock relative to its sales revenue. Let’s say that our company whose stock price is $20 per share had sales in its most recent year of $20 per share. Its price to sales ratio is one. Like price to earnings, this method will require gathering market data about the price to sales ratios of publicly traded companies in your industry and make some assumptions about stock market performance at the time of your planned exit.
The discounted cash flow approach is different to price to earnings and price to sales in that it does not estimate company value by comparison with publicly traded companies. This method measures the cash flows at various points in the future and discounts them to the present and then sums them to arrive at a valuation.
Investor Considerations When Valuing Your Company
The question that is probably at the top of the list for every entrepreneur seeking funding is this: “How much of my company will I have to give up to get my desired level of funding?” The unfortunate answer is, “It depends.”
Investors consider many different factors and each investor knows what is important to them and what is not. That said there are some general questions that investors ask themselves when considering funding. Some examples are:
How attainable are the goals set forth in the company’s business plan? Sophisticated investors are sophisticated analysts. If they think there are items in your business plan that are unrealistic, they will normalize them to something they’re more comfortable with.
When will the company be able to go public or secure a buyer at an attractive price? The longer an investor has to wait for exit, the lower the value, or
What will the appetite be like for IPOs when the company is ready to go public? A bullish stock market will support IPOs at higher price to earnings ratios thereby raising the value of your company and reducing the amount of equity an investor will require in return for their funding.
Will the company need more money before exit?
How much does key management have invested in the company? If management has a significant amount of their own money in the company the investor will assume that management is committed to success.
How much of the initial investment will we get back if the company fails?
How will my investment be structured? If an investor puts all of their money into stock as opposed to a less risky instrument, then the price of investment will go up.
Once investors answer questions such as these, they will then begin to make adjustments to your business plan and consider their risk accordingly. It’s all about managing their risk and you need to be realistic in the actual value of your company to attract the real investors to fund your deal before they’ll get excited enough to move.
Return on Investment
Do you know what is most likely of chief concern for any investor when looking to fund a company? It’s their return on investment, also called ROI for short.
ROI is the return an investor receives on the money that they invest in a company. It is expressed as a compound annual rate in terms of a percentage. By knowing what ROI they require for a particular investment the investor can then take a company’s business plan and financials, make projections about a company’s growth and profitability and future valuation to determine how much stock they will need in a company in order to achieve their ROI objective.
Different investors have different requirements. But according to Clint Richardson, in his book entitled Growth Company Guide 4.0, that in times of an economy supporting prime interest rates of 10% or lower investors generally require greater than 35% ROI for seed or start-up investment, 20-50% for first or second stage and 15-30% for third stage and mezzanine investment. The amount of time an investor feels it will take to exit via sale or public offering will also factor into how much stock they will require in exchange for investment.
For example, an investor who gets three times their investment in three years will realize an ROI of approximately 44% while the same multiple in five years will reduce ROI to 25%. So, the investor in this case will require significantly less stock in exchange for capital if he or she feels an exit can be achieved in three years as opposed to five.