Bringing Investors to the Party
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Have you ever heard the expression “all cash is green”? This expression is apt when the cash is coming in a one shot deal with no continuing relationship. Of course, that is not the case when a private company is seeking investment. Often, companies will look at a proposed investment and be satisfied with the economic terms of the deal, only to realize after the fact that the investor’s vision for the company and the business does not align with that of management or the Company’s existing ownership. Companies looking for investment should consider more than the pure economics of a proposed investment when selecting investors. Choosing the right investors will pay significant dividends going forward as the company needs to manage its business as well as its investors.
In seeking professional investors, a company needs to do some diligence on the investors to make sure that the investors’ interests align with those of the company. A few things that companies should consider:
- Recognize different circumstances and different motivations. For example, is the investor a super wealthy individual? A private equity fund? Is this a seasoned investor who understands the risk of investment in private companies?
- If the investor is a private equity fund (regardless of how it characterizes itself, be it venture capital, growth capital, hedge fund, etc.), how long has the current fund been in operation and how long does the fund expect to wait for its return on investment?
- If the investor is an angel investor, the same question should be asked about the investor’s expected time before he sees a return on investment. With angel investors, the question of experience and sophistication is generally more pertinent than with private equity funds.
- The company should understand the investment strategy of all of its investors. Some investors are more fiscally conservative than others. Using baseball terminology, do the investors hit for average or power?
- Does the investor have the ability to invest more and does the investor typically participate in subsequent rounds of financing with its other investments?
- Does the investor easily have the ability to absorb a complete loss of its investment? Said in another way, would the investment account for an overly large percentage of the investor’s assets?
- What is the investor really intending to invest in? Is it the company’s current product(s)/services? Is it the company’s proprietary technology? Is it the company’s management team? Is it the company’s business plan? Or is it something else?
- How well does the investor understand the company’s business and industry and how well connected is the investor in that industry? Can the investor open doors for the company with those connections?
Doing due diligence on prospective investors is key to a company’s success. However, that diligence is not done in a vacuum. The company needs to be honest with itself about its business plan. For example, if an investor typically seeks an exit from its investments in 2 years, but the company believes that it needs 5 years to be ready to exit, the company must stick to its beliefs and not set itself up for failure by unrealistically re-setting its goals.