This self-paced training exercise provides an introduction to finding and attracting investors.Topics include determining the need for outside financing, defining what an investor is and where to find them, explaining the investment process and understanding investor expectations.
Duration of the course: 00:30:00
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1.3 Course Topics
This course will cover five topics. These topics will illustrate how locating and attracting investors can improve your business’ success:
• When is outside financing necessary?
• What is an investor?
• Where can you find investors?
• What is the investment process?
• What are investor expectations?
Numerous additional resources are identified to assist you. Visit the resource icon in the course player or locate additional tools, templates, and mentors on SBA.gov once you finish the course.
Let’s get started!
1.4 The Challenge
Finding and securing investors can be challenging. Let’s explore the issues facing a small business when deciding to expand the use of investors.
The focus of this course is to help the small business owner decide if bringing in partners or outside investors is the best option for their business; to give the small business owner methods to incorporate partners or outside investors; and to list some of the potential complications that can occur when taking on partners or outside investors.
1.5 Outside Financing
When is outside financing necessary? If you want to expand your business, you will have to decide if you can do so with your operations cash flow or if you will need outside financing of some kind. When starting a business, you will have to decide if you need outside financing as start-up capital.
Reflect for a moment and consider whether you need outside financing. (Pause)
There are traditional sources of financing, including banks and commercial loan companies that are debt-oriented.
There are other financing options involving investors -- these include factoring, venture capital firms, individuals, and business acquaintances.
In addition, there are non-traditional sources like crowd-funding.
1.6 Equity or Debt
If you choose to pursue outside financing, you will need to decide whether you want to acquire it through equity or debt. You can take out a traditional loan from a bank to fund your expansion
or start-up costs. This allows you to maintain full ownership of your company, but the additional capital is listed as a liability on your balance sheet.
You can also sell equity in your company. Selling equity can be difficult, but there are significant advantages to equity financing. You will not have a repayment burden on your cash flow from operations. On your balance sheet, capital is listed under stockholders’ equity rather than liabilities. Also, professional investors, such as venture capital firms, can bring substantial expertise to help your business succeed.
Of course, there are some significant disadvantages, depending upon your point of view. Advice from investors can be seen as interference. Once you or your company accepts money from investors, you must run the business for the good of all stockholders. Professional investors will require audited financial statements and independent accountants. Finally, professional investors will require a voice on the board of directors.
Reflect for a moment. Would you prefer to take on debt to expand or start your business or would you prefer to sell equity in your company? Carefully consider the pros and cons of each before deciding.
1.7 Equity and Debt Equity Hybrids
Equity comes in several forms. You can sell common stock which gives an ownership interest and right to vote to your investor. You can also sell preferred stock, which gives the investor an interest in assets and revenues.
However, there are hybrid options as well. You can sell convertible preferred stock or get convertible debt, which can convert to common stock in the future. These terms are defined below:
• Convertible Preferred Stock: Convertible preferred stock allows the holder to convert the preferred shares into common shares. This would be especially valuable to investors should you anticipate rapid growth and increase in value of your common stock.
• Convertible Debt: A convertible debt is essentially a loan that may require repayment at some level of interest. However, should your company experience incredible growth and you decide to raise a round of venture capital, the convertible debt can become equity, giving the investor an ownership stake in your company.
1.8 What is an Investor?
Now that you have decided you need equity, let’s discuss who investors are and what they expect from you. An investor is someone who places money into a business, usually receiving an ownership or partner stake in the business. Since the investors undertake a great risk, they may require a substantial share of ownership in the business in return. It’s important to remember
that investors do not place debt capital in your business; investment is not a loan. Investors can also contribute to the credibility of a start-up or growing business through their scrutiny, certification, and investment.
There are several different types of investors and methods of investment, such as equity financing. Equity financing is based on the company selling part of its ownership to other investors, either private investors or to the public. In its simplest form, the owner of a company decides to raise some additional capital by selling shares of stock to family members, business acquaintances, or key employees.
Another option is a formal private placement of securities to angel investors. Angel investors are generally wealthy individuals who invest in early-stage companies or mature companies wishing to expand, with the hope of earning a substantial return on their investment.
• Equity Financing: Equity financing is accomplished through selling common or preferred stock to individuals or institutional investors. After purchasing the stock, the investors own some portion of your company.
• Formal Private Placement of Securities: Formal private placement of securities is the private sale of stock in your company. This method of raising capital allows a business owner to avoid a public offering.
A third option is venture capital firms. A venture capital firm is one that provides funds to early- stage, high-risk/high-potential startup companies. Venture capital firms recoup their investments by owning equity in the company in which they invest. Venture capitalists have more requirements and usually involve funding at a much higher level than most angel investors. Almost all venture capitalists will require a seat on your board in return for their investment.
A final option is casual or non-professional investors, such as friends and family who are interested in helping your business succeed.
Now reflect for a moment: which kind of financing appeals to you? Which kind of investor within that kind of financing appeals to you?
1.10 Sell, Sell, Sell
You found a potential investor! Now how do you convince them to invest in your business? The main strategy is to sell, sell, and sell.
• You have to give the potential investor a reason to invest in your business. You can fine- tune your pitch based on what the potential investor’s needs are.
• Sell Your Business Plan. After you convince your potential investors to hear you out, you must prove that your business plan is strong and convincing. Make sure you have a detailed and well-written business plan to show you have done your homework. Include financials and market research.
• Show Them the Money. Detail how your business will generate profit and how that profit ends up in their pockets. Ultimately, all investors want a solid return on their investment.
Reflect for a moment. Are you really prepared to approach an investor?
1.11 Investment Process
Due diligence and preparation are equally important for all investors. You should go through the same preparation process for a venture capitalist or a family member. To evaluate an investment in your company, investors want:
• A business plan
• Five-year financial projections
• Current audited financials (if available)
• A reason to invest in you – What is the return on investment?
Once an investor is satisfied that the investment works from a financial point of view, the investor takes a very close look at the management team.
A company must expect that any deal with angel investors or venture capitalists will be heavily negotiated. The company's leverage depends on its need for the investment and the tolerance of the owner for oversight by the investors. Investment from family and friends typically does not require the same level of negotiation.
1.12 Crowd-Funding for Equity
A recently emerging source of investment is crowd-funding or crowd-sourcing. You can sell up to $1 million of securities a year without doing a public offering
How does it work? A crowd of people, each of whom takes a small stake in a business idea, contributes toward an online funding target.
• Raising your own capital
• Creating a strong network of support for your business
• Providing a newsworthy backstory
• Full rules and regulations regarding crowd-funding are not complete
• You must use a pre-existing crowd-funding portal or gain approval from the Securities & Exchange Commission, or SEC, to set up your own
• You may need legal counsel to assist with the legal forms
Would crowd-sourcing be a good approach for you?
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