It is surprising how many businesses are seeking investment without actually being investable.

 

I am astonished when I see an investment proposal, where the business promoter has invested no or very little of their own money, however have the expectation that a third-party investor would be happy to do so with theirs. Big investment often equates to big risk, leaving the investor with the majority of the risk of bringing the promotor’s idea to market. This error is compounded by assuming that the investor will be happy with a small share in the company, leaving the majority of the business and its profits to the promoter to reap. Also see ‘How Venture Capitalist Make Decisions’

There seems to be a consequential misunderstanding of the role of the business promoter and what they must deliver before a third-party investor will come on board. Investors enable the scaling process, thereby creating a business which can be sold for a significant multiple over the business’ turnover or net profit.

 

Do you have a saleable product?

The business promoter by their very nature has a new product, service or platform which they have developed. The key question is what is the status of the that product, service or platform? is it ready to be sold to customers? This is a key question it because the answer to this question places the business in either the pre-revenue space or post-revenue quadrant. 

Pre-revenue businesses are very hard to fund with third party money. They largely must be funded by the founders, their friends and family. This can be a bit of a catch 22 position. For the new business owner this provides a Darwinian winnowing factor. Those businesses who can get to the post-revenue quadrant can then be funded with third-party money. Whereas those who fail simply die due to lack of money. 

This is not to say that the business idea is any worse for the businesses that failed to get to post revenue. it is simply that the business promoter and his team along with their friends and family have to get over this first hurdle getting to post revenue status.

 

Have you properly researched the market?

Understanding that there is a market for the product that is being developed, knowing who your most profitable customers are makes a huge difference to getting a new business off the ground. It is important in get clarity on sources of revenue since it would enable you to identify your most profitable customers. Which will identify those most in need of the new product or service.  This makes it more likely that they will buy from the new business  taking a risk of doing business with a new company with no track record.

Customers who have a desperate need for the new product may even support the product development phase of the business since they have a much deeper understanding of the product itself and an interest it is success. So, to some extent they become part of management of the business and associated with the management team.

The first management buyout that I was involved with was largely a fundraising success since we were able to identify the worldwide market for our product. We could name all the potential customers and demonstrate that they would need our product.

Often the view of the market is less clear and this can have an impact on the ability of third party investors obtaining confidence that there is sufficient business to justify the risks associated with this new business. Therefore a well-developed sales forecast improves the investability of the new business venture.

 

What is your sales pricing structure?

The sales price for your new product or service it is an important consideration.  It needs to be considered in the light of the nature of the market in which you are selling your product. If you are selling into a low-price high-volume market then you will need to price accordingly assuming that your product is the same or similar to those already on the market. If you are in a market with volume discounts et cetera and different prices depend on the size of a company or its complexity, then you need to consider how you want to address of your product’s pricing.

Businesses often fall into the trap of trying to sell their product too cheaply because thay believe that a business will buy it because it is cheap. This may be case if market you are operating is a price based. However, if you are trying to be a premium priced product then starting at a cheaper price may undermine your long-term marketing strategy. Therefore, your pricing strategy will reveal much about your understanding of the market in which operating as well as whether you are selling high or low volumes.

What is your gross profit per unit sold?

It is important to have clarity around the costs per unit. This may vary depending on the volumes produced and you may need to consider this question in the light of lower initial volumes with higher subsequent volumes. 

This should mean that you are planning to price your initial product at a higher price it may be priced in the longer term. This obviously has to be integrated with previous section on sales pricing structure.

What is your breakeven turnover?

The gross profit per unit sold is a critical factor in assessing the level of break-even turnover. The importance of this statistic can’t be understated. Any investor will want clarity around break even turn over because this not only incorporates with the gross profit aspect of the business but also the overheads which you have assessed as necessary for the running the business on a day to day basis over the initial period of the business.

 

How long to get too breakeven?

The interaction between sales forecast and the gross profit per unit sold well contribute to the projections of the company’s ability to generates money. For too many businesses this date too far into the future. 

In practise income tends to come in later than planned and costs tend to come in earlier than planned. If the break-even point is too far away you risk running out of money before you get there. This may not be terminal if your investors are prepared to reinvest. However, it can have a significant impact on your personal wealth. 

Since investors will require a higher level of shareholding % in subsequent rounds of investment necessitated due to failure of the business promotor to meet the business plan performance agreed with the investors at the outset. It will therefore result in a reduction in the business promotors shareholding and consequently return exit. In an earlier business I was involved with the business promoter started with over 50% of the shareholding in the company but this was reduced under 25% after the third-party shareholder introduce further funds after 18 months of trading. Delivering late can seriously undermine you wealth.

 

What is in it for the investor?

This question is unfortunately too often ignored by business promoters. This blind spot is unfortunate since it is important to understand the role of the third-party investor. 

The third-party investor has surplus cash and is just looking to make a return on his investment in your business. He is expecting his investment in the new venture to make him between three to five times return on his money. He is not investing for your benefit but for his benefit.  Investing in the business should be for mutual benefit.

However, do not expect the investor to simply accept that you have failed to deliver the projected revenues and profit which you offered when they invested. Failure to keep your word well be punished since no investor wants to lose his shirt on your business.

How will you scale up the business?

Having a clear business proposal, is important to include how the business will grow to a level at which it can be sold to a third party, a trade sale or an IPO. An investor will want to have a clear route to exit so that everyone can’t work towards the same goal. 

There will need to be a acceptable turnover target which will need to be underpinned by realistic sales and marketing plans as well as production plans and staffing plans. Don’t underestimate the hardship around this planning process and the importance of getting it right.

 

Exit plans

As previously said there are three routes to exit a sale to a third party such as a private equity firm,  a sale too and another company in the industry or an IPO. It is important to understand what is being sold. Currently several technology businesses are being sold based on a multiple of turnover. 

However, this is not the case for other businesses which are sold based on net profit.

It is important have a clear run too exit whereby the appropriate metric on which the business is being sold can be maximised. This is in the best interests of both the business founder and the third-party investors.

Conclusion

It is very important that the business is in a post-revenue position at which third party investors are contacted. If you go to market too early you can undermine your long term investability. 

You can become known as someone who is a little flaky and this can undermine a sound long term investment because you have tried to raise funds before the business is ready.

 

In conclusion it is imperative to be in the post revenue quadrant before third party funds are sought even though getting there may seem insurmountable. 

Achieving the impossible is considered normal for a start-up business to be investable. This gives third party investors’ confidence in the capability off the business owner and his management team and reassurance that their money will be put to good use generating surplus cash and profit.