When structuring a fundraising effort for a company, entrepreneurs have a lot of intricate details to consider. Structuring the size and price of the offering of equity, of course, is profoundly important, and often enough, a significant stack of documents must be prepared for the consideration of investors. Indeed, there is benefit for cutting corners during this process. And while entrepreneurs afford attention to these details, this consultancy must stress that entrepreneurs must give equal attention to the psychology of the investors.
It is important to remember that, all too often, the entrepreneur and the investor come to the table with different perspectives. For entrepreneur, the company may be the realization of a dream, and his attachment to its success may be driven more by emotional than anything else. Meanwhile, the investor, though committed to seeing the company success, has a greater obligation to the money that he has invested in it.
For his part, whether he is investing his own money or that of limited partners, the investor is basically putting his money to work, with the hope that the investment in this company will grow in value and net him more money in the future. And in a world where investors are bombarded with so many different investment opportunities – from new business ventures to real estate to cryptocurrencies – returns matter. Investors know that, if they want to make the most of their capital, they must put their capital into opportunities that seek and achieve alpha.
Consequently, for an investor, some key questions are very simple ones:
- How much money do you need?
- How will you be using this money?
- What will I get in return for investment in this venture?
- What are the projections for the growth of this venture?
- What is the exit strategy?
- How much money will I make from this investment?
To be sure, the lion’s share of the return on investment may not come before the investor exits the company. However, there are ways that the investor can realize some returns before that time. Here are just a few of those:
- Dividends – The company can routinely pay out to its shareholders any profits or surplus capital not likely to be reinvested in the company.
- Fees – The investor can negotiate a deal to be compensated for effort. For example, the investor can be paid to serve on the company’s board of directors, or he can be paid a management fee to provide services to the company.
- Incentives – Pursuant to the terms negotiated in the deal, the company may be obliged to pay the investor a predetermined percentage of profits (a “kicker”) or a multiple of the investment over a given time.
- Interest – In the event that the funds raised are categorized as a convertible note, rather than as an equity investment, the company shall be obligated to make interest payment to the investor. Contingent on the terms of the deal, the investor may have the option to convert the note into equity.
When structuring the deal, the entrepreneur must give serious attention to the role that the exit strategy might play. An investor might shy away from a venture that do not present a clear exit strategy. Therefore, the entrepreneur is well-advised to be adaptable. Don’t be too married to a venture, no matter how much time and effort has been put into it; don’t allow ego to block the bigger picture. To an investor, where there is no exit strategy, the entrepreneur might seem to be more interested in building a vehicle to support his own lifestyle than building a company that could be sold off to return a windfall to everyone involved.
The following are a few of the options for exit strategies that the entrepreneur might consider presenting during the fundraising effort:
- IPO – While an initial public offering might sound titillating, the odds of a business ever selling shares on a stock exchange are quite slim. In fact, only one percent of the 27 million companies in this country are publicly-traded company. Most others are small businesses that – although success, in their own right – do not have the capital or preparedness to meet the market and regulatory requirements.
- Acquisition – This is the most likely of options, as exit strategy goes, and there are multiple avenues to consider. For example, an entrepreneur and/or the company can put together a package to buy out an investor. Alternatively, funds from a subsequent and bigger round of investment can be used to buy out the investor. And what’s more, the entire company can be sold off to a financial or strategic buyer.
- Redemption – Prior to placing his investment, an investor might negotiate the right to demand the repayment of his investment (and additional proceeds, where applicable), should the company be found in breach of specified covenants, including, but not limited to, meeting performance expectations. Typically, a redemption is considered a clause of last resort, but it may afford an investor the comfort necessary to take part in an investment opportunity.
Unlike a bank, an investor brings a lot more to the table than just capital. He usually avails his know-how, network, and other strategic resources to the benefit of the company, because he has every reason to help the company grow. Understanding this, an entrepreneur can benefit greatly from aligning the right investor for his business venture, so long as he fully understands the motivations of that investor. After all, growing the company is one thing; helping the investor to realize his return on investment is another.