Equity Capital?

Investor Financing, some times referred to as Equity Capital or an Equity Investment, is generally obtained from one of the following three sources.  Investor financing is unique in that it generally is not secured with any collateral (like a traditional bank loan) and the investor is not subject to losses greater than the amount that they invest (unlike a general partner).  Although, there is nothing saying that these terms cannot be negotiated in the investment agreement, also known as a term sheet. 

Often times, an equity investment has a conversion feature written into the agreement.  This states that if the investment is not paid back at the end of the stated term, the equity investment will convert into an unsecured loan or preferred stock with a stated return or dividend.

The Players:

o         Venture Capitalists – VCs usually are looking for the home run.  Typically a VC group will invest in 10 ventures knowing that 7 will fail, 2 will pay back the money they invested and 1 will have a return 100 times the amount invested.  They are not interested in solid slow growth companies in mature industries.  VC firms are looking for companies on the edge of an exploding industry trend with national or multinational market potential. 

Management is key when investing in these types of high-risk/high-return companies.  VC firms will spend months completing the due diligence or background check of the owners, management and key employees. 

Also, VC firms want a relatively short term exit strategy meaning 2-5 years.  They are not in it for the long haul and before they invest an exit strategy will be laid out.  An exit strategy is a plan of how the VC firm will be paid back and at what return...usually stated as X times the amount invested in X years.  If they invest $100,000 dollars and require 3 times in 5 years repayment you would owe them $300,000 in five years.  Sure it is a high interest rate but 100% of their money is at risk if this business fails and again there is usually not collateral to secure the investment. 

VC funds do not usually get involved in micromanaging businesses unless the venture becomes so grossly mismanaged that they have to step in to try salvage their investment. 

o         Angel Investors  - Angels are like venture capitalists in that they are also looking for high risk high return businesses but...and this is a big but...they usually also have a vested or personal interest in seeing a project succeed. 

A typical Angel Investor is a high net worth individual (liquid $1MM+) and earns more than $200,000 a year in order to be accredited.  They may have made their fortune in a similar industry as yours and therefore want to see others succeed as they did.  In addition, they may have valuable expertise about the industry making them a value added investor by being involved in upper level management decisions. 

Returns to Angel Investors are usually lower than that to a typical Venture Capital Fund but higher than Commercial Lenders.

o         Silent Partners – Equity Investors that are not day to day investors but want to help the entrepreneur in financing a business.  Silent Partners are generally not accredited and in most cases the investment does not transfer any ownership to the investor.  Usually the investor has a personal relationship with the owner and the capital is often referred to as “Love Money” because it comes from friends and family (and fools). 

It is always a good idea to have a written agreement with anybody you take an investment from to avoid the potential for different expectations.  When the investor and entrepreneur are on the same page, both understand what is at risk, what control the investor has (if any) in the business, what the expected return will be and who decides how the money will be used.  While a written agreement is recommended many times “Love Money” from close friends and family members does not involve a written agreement and while repayment is expected, is not guaranteed.

Preparing to “Pitch”

Many metropolitan areas have local equity funds.  Often times these equity funds will hold local information sessions to get to know local entrepreneurs and give them the opportunity to pitch their ideas and funding needs.  Be prepared to discuss the highlights of your project.  It is helpful to know and practice an “elevator pitch”. 

An elevator pitch is a clear concise speech that highlights the business opportunity, funding needs and potential return in about the time it takes to ride an elevator between floors.  This (short) statement should be designed to get the potential investor excited enough to want to view the “white paper” or prospectus for the project.

If your local equity fund doesn’t hold information sessions it will be your responsibility to schedule an appointment to present your opportunity to them directly.  BE PREPARED!  The first meeting may be the only chance you get, but understand that your presentation will have to be brief.  There will be no time for product demonstrations, lengthy technical descriptions, or information gathering.  Most presentations only last about 15-30 minutes plus a Q&A session following the presentation.

The following is a list of key characteristics that VC/Angel investors look for in a project:

·          Management – Your management team’s skills and abilities is number one.  Investors like to see experience, education and a history of excellence in decision making.

·          Return on Investment (ROI) – Funding the next big thing is a high risk proposition and therefore the potential for an exponential return is a must.

·          Market Potential – A solid target market with nationwide or worldwide potential backed up with data.

·          Solid Business Model – Management will have to demonstrate that it can handle, and profit from, rapid growth.  Growing too fast is one of the top reasons companies suffer cash flow crunches.  Understanding the cash to cash cycle is a key element in proper cash flow management.

·          Timing – Seasoned investors have learned when it is too early to invest in a potential project.  Ventures with little or no history have years worth of dues to pay, and typically, a savvy investor will not allow those dues to be paid on their dime.  Once the company is on the cusp of exploding growth, venture capitalists will be chomping at the bit to get in on the action and fund the project.   

Regardless of what type of equity investment you are looking for success in raising equity is almost solely dependant on your ability to network to find potential investors.  The more leads you put out the more responses you will get back.  Remember, for every one person you talk to that says "not interested" there usually five to ten other investors in their network who may say yes.  A quick and easy way to put out a massive number of leads is through the web on the GO Big Network where you can post your funding request to be viewed by thousands of potential investors.

No matter who invests in your business it is important that you check with your states Securities Department or a securities attorney to determine if you need to file a Registration for Public Offering.  Most states have exemptions for investments that involve small numbers of people, small dollar amounts, and start-ups but in most cases you must execute a notice of filing at the appropriate time according to state and/or federal law.