Is There Such A Thing As A Bad Investor? With Elliot Smith and Pete EvisonWednesday 27 July 2022
This week on Extraordinary Entrepreneurs Together, we expanded on an issue that came up in our last podcast: is there such a thing as a bad investor? If there is, how do you spot one?
On the most recent episode of our podcast, Extraordinary Entrepreneurs Together, we were joined by accountant and EHE Director Elliot Smith as well as EHE Chief Financial Officer Ross Faith to discuss their contributions to our upcoming book, which focuses on everything to do with funding – how to make your business investor ready, what to look for in an investor, and how to decide what kind of funding is right for you.
Getting investor ready
For all entrepreneurs, securing funding is an essential step in establishing the foundation for long-term success. This can be broken down into three simple stages:
- Investor Engagement
- Deal Execution
Bear in mind that this can be a drawn-out process, especially for new startups or entrepreneurs seeking funding for the first time, taking anything from three to twelve months. At EHE, one of our main focuses is to steer entrepreneurs through their funding journey, ensuring that they have the right tools to give them the maximum chance of success.
As is so often the case in our line of work, preparation is the key to a good outcome. By investing time and resources in the planning phase, you will set yourself up to complete phases two and three as smoothly and quickly as possible. Part of this means knowing what a savvy investor will be looking for in your business.
Elliot: “Management teams have got to demonstrate to potential investors that they’ve got a sustainable, well-run business with a growth plan that they believe they can execute; that they’ve got a good-value proposition; they’ve got a qualified team; they’ve got a good business model; they’ve got financial projections; that they’ve thought about the deal structure.”
Being investor ready means not only having a business that embodies all of these qualities, but also having the right materials to help you pitch it. This means having a truly tantalising investment teaser, a great pitch deck, a detailed business plan, solid financial models – essentially, all the things you need to tell a compelling story to investors. All of this needs to be in place well before you move on to the Investor Engagement stage of your funding journey.
Do your due diligence
Investors will leave no stone unturned when it comes to assessing the growth potential of your business. The best way to be prepared for this examination is to apply this same level of rigour to yourself. What will investors want to know about your business, and what evidence will convince them to believe in your story? How can you provide it to them in the most appealing format?
It's vital that you start asking yourself these questions as soon as possible, ensuring that you have the right processes and documentation in place from the get-go.
Elliot: “It’s never too early to start putting due diligence in place for a company with high-growth aspirations… It’s a great process for getting management teams actually thinking about what they want to achieve. A lot of people think due diligence is an onerous process, but it can be viewed as a kind of opportunity. Even if people aren’t successful in raising finance they’re still going to get something from the process that will put them in good stead for the future.”
For early-stage businesses, it might be necessary to get a bit creative when it comes to evidencing your business case, as Ross explained.
Ross: “An entrepreneur might come up with a fantastic idea that has never been proven in the marketplace, so the investor is thinking, ‘How do I stress test this? How innovative is it going to be?’”
When you’re trying to make a case for an untested value proposition, you need to think about what other information you can provide to show proof of concept – academic research, case studies, public demos, evidence of success in past ventures. When you partner with EHE, we’ll do whatever we can to help you discover how best to demonstrate your credibility as an entrepreneur.
Debt-Based Vs. Equity-Based Funding
Another important part of being investor ready is knowing what kind of funding you’re looking for. In the broadest sense, there are two main types of funding:
Debt-Based: A loan which has to be paid back with interest over an agreed term.
Equity-Based: An agreement to sell a shareholding in your business in return for investment.
Depending on your circumstances, one or the other of these, or even a combination of the two, might be your best option. At EHE Capital, one of our specialisms is helping entrepreneurs find a funding solution tailored to the needs of their business.
These two models each have their own pros and cons. With Debt-Based funding, the loan has to be paid back out of your revenues, which can slow your growth in the medium term. Lenders will also probably require some form of security or collateral from you and your partners. On the other hand, they will generally not be looking for high multiples on their investment, just the capital plus interest.
With Equity-Based funding, investors will be looking for a high rate of return, and may demand some degree of oversight or input into decision-making in the business. Alternatively, they will probably be more open to risk, won’t require security or repayments that eat into your profit margin.
Equity-Based funding can also provide more space for flexibility. For example, EHE Capital recently concluded a deal in which the entrepreneur can claim equity back from the investor when the business hits certain milestones, providing security to the investor while giving the entrepreneur a powerful motivation to meet their targets. It’s solutions like this that put EHE Capital ahead of the game when it comes to helping entrepreneurs find the right funding balance.
What makes a great investor?
EHE Capital specialises in matching the right investor with the right entrepreneur. In practice, this will vary from business to business, but there are a few principles that guide us in all cases.
Elliot: “It’s got to be about investors bringing more than cash to the table, because most businesses with high-growth aspirations need lots of support during the process. Generally they have a foundation they need to build on, and they need people throughout the process who can help them build upon that foundation.”
Some of the most important qualities to look for in a good investor include:
- Trusting your management team to get on with their jobs.
- Sharing your vision for the business.
- Having a wide network of contacts and is prepared to make introductions.
- Having industry experience and a record of past success.
- Being prepared to give time to your business, and perhaps to join as a non-exec or investor-director.
Whilst some of the traits you’ll want to avoid are:
- Meddling with day-to-day business operations.
- Lacking a deep understanding of your sector.
- Not adding value to your growth plan.
- Not aligned with your vision
- Simply looking for the highest returns with the shortest turnaround
This is just a taste of what you’ll find in Elliot and Ross’ sections of our upcoming book Fast Growth Through Funding, so if you’d like to hear more please sign up to our community so that you’ll be the first to hear news of its upcoming release.
If you’re an entrepreneur looking to find out more about funding, due diligence or being investor ready, then submit your details through our website today. We have resources to help with pitch decks, business plans, and lots more info on funding models. If you’re an investor looking to be matched with entrepreneurs, then please get in touch through the “Looking to Invest?” tab on the EHE Capital homepage.
When investments go wrong
When an entrepreneur is presented with a deal that could cover their operating costs for the next twelve or twenty-four months, it can be tempting to shake on it straight away. However, there are all sorts of things that can go wrong if you rush into an investment relationship without doing your due diligence.
This might sound crazy, but it’s not unknown for investors to lack the funds required to follow through on an investment. If you’re not up to speed with their track record, how can you be sure that they’ll come through for your business when required?
Then there are investors who are obsessed with trying to micro-manage your day-to-day operations, slowing down your decision-making processes and putting undue pressure on you and your staff. Sure, they might have contributed hundreds of thousands to your balance sheet, but how much value are they costing you with their constant interference?
Ultimately, unsuitable investors gradually turn into bad investors over a period of time. What starts out as a misunderstanding or a slight misalignment in values or expectations gets magnified into a serious disagreement and then an acrimonious dispute. This can result in the withdrawal of funds, or even legal disputes that end up costing you money and drawing your focus away from your work. In the worst case, your company could break up altogether.
Vetting your investor
The best way to avoid the issues outlined above is to make sure you thoroughly vet all potential investors. You can be sure that any investor worth their salt will be running the ruler over every aspect of your business – so why shouldn’t you do the same in return! As Pete explained, you should treat this just as you would any other professional relationship. Don’t rush in without doing your homework!
Pete: “If you were looking for someone to do an extension on your home, you wouldn’t just hire the first builder that came in off the street. You’d do your homework and speak to customers of theirs. The same applies with investment. Speak to their portfolio, find out what their journey was like, what the support was like.”
Your investor may provide you with a few references to reach out to, but don’t be afraid of doing a bit of detective work here. There’s nothing wrong with making a few unsolicited calls if they help you build a better picture of your investor’s track record.
Social media is also a useful tool. Check out your investor’s profile, see who’s in their network, who they’ve worked with and what events they attend. You may not be able to ask for proof of funds in the early stage of an investment relationship, but you can get a pretty good idea whether someone’s the real deal by looking at the kind of people they associate with.
Remember – all investors will have high hopes for success at the get-go, but at some point along your journey, you’ll inevitably face challenges that test you and your team to the limit. At times like these, can you count on your investor to support you, not just with their wallet, but with their experience and their expertise?
Don’t be afraid to walk away
Sometimes, entrepreneurs get themselves trapped into a relationship with a single investor. They put so much effort into getting this one person onside that they ultimately feel like they have to do a deal with them, even if the terms or the cultural fit aren’t quite right. As Pete explained, getting locked into a single relationship like this can have serious consequences down the line.
Pete: “Entrepreneurs who put all their effort into one investor often feel forced to take the first deal that’s offered them. They might give away too much equity, and then the next funding round becomes impossible because there’s not enough equity left to give away.”
No matter how much effort you feel like you’ve put into courting a particular investor, you should never be afraid to walk away if the deal doesn’t feel 100% right for you.
Elliot: “If you’ve gone through the due diligence process with an investor to the point where you’ve got a term sheet on the table, you’ve probably ticked a lot of the boxes that other investors will look at. So I would say don’t rush into things with the first offer on the table; carry on reaching out to other contacts and networking. Hopefully, you’ll get a better cultural fit.”
Choice is everything
At EHE Capital, two of the most important things we offer to our community members are transparency and choice. It’s our job to understand investors – their preferences, their goals, what type of investment they go for, what their terms or fees are – and to share that knowledge with entrepreneurs so that they can go into the relationship with their eyes open.
All the investors on our platform are fully vetted so that you can have full confidence that they have the wherewithal to follow through on their commitment. We never advise entrepreneurs to sign a deal where they give up a controlling stake, and we always ensure that they have a range of different offers to choose from.
What’s more, we’ll help you find investors who add value beyond a cash injection, whether through their experience, their mentoring skills or their contacts. We can also help you explore different funding models, so you can find the balance of cash and equity that works best for your business.
If you’re seeking investment but you’re not quite sure what to look for, or are trying to decide if a particular opportunity is right for you, send us your details today! Whether or not you believe in “bad investors”, one thing’s for certain: once you’ve joined the EHE community, you’ll never have to worry about them again.
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