How to reduce the risk factor for the Investor

By Reuben Buchanan, Director of Integral Capital Group

Anyone who has raised or tried to raise venture capital for their business will tell you it is no easy road. There are lots of obstacles but if I had to narrow it down, I'd have to say that risk is the biggest one.


Investors have a hard time believing that the entrepreneur is going to make anything of their idea. A lot of investors are tending to lean towards established companies or listed companies because the returns are great (at the moment) and risk is much lower.


So the key is to lower the risk for the investor. This will greatly increase the chance of getting funding.

How to lower the risk factor for the Investor...
In a typical situation, the entrepreneur or promoter has had little prior experience building a successful company. If they had, they probably would not need an outside investor. It's sort of a catch 22 situation, therefore the most successful approach for start-ups is to:-



1.


Take their idea/concept as far as they can with their own funds (if possible get some sales or at least pre-commitments fo sales from worthy buyers)
2.
Raise small amounts of money from people who are close to them at a reasonable valuation (most promoters value their idea too high which is a turn off to investors). Say $10k to $20k each from a number of friends/family who are close to them and believe in the promoters vision.

3.
Use those funds to get the product into the market and get one years trading/sales behind them.

A year's trading gives them a couple of things. Firstly it proves up the business idea and demonstrates that there is a ready market for it. Secondly it proves that the promoter can start/run a business to some degree, and thirdly it gives some figures by which a basic valuation can be done from (for the next capital raising).


All of this lowers the risk for the investor, who may be asked to put up $250k or even $1m if the opportunity/technology is great.


The next round of funding may come from a wealthy individual, professional angel investor, or even early stage VC fund (the latter is the hardest to get funds from). The next investor may also take out the first couple of investors giving the first group an exit.


There are many other factors which can affect the promotor's ability to raise funds such as:-


General capital market conditions (at the moment, they are pretty good - most investors have a bit of spare money to play with.

Appetite for their particular idea (ie. anything in the green or clean energy sector is pretty hot at the moment)

The promotors ability to 'sell' their idea or concept.

The promotors track record

The investors personal situation (they may like the idea but have funds committed elsewhere or may be about to go on holiday)

Luck (promotor may by chance stumble across the right investor at the right time)

Typical criticisms of the Investor versus the Promoter/Entrepreneur...

Investor Criticisms:-


Poor investor presentation (sometimes no presentation at all)

Too early stage - still an idea on a piece of paper

Poor business planning or lack of

Business model is wrong

Promoter does not have the skills required to make it work

Idea is not scaleable - limited market opportunity

The sector is not favorable

Idea/technology is easily copied (no trade marks/patents in place)

Projections are too high

Entrepreneur Criticisms:-


Investor does not understand their idea

Investor does not get back to them with an answer

Investor wants too much of the company for their investment

Investor want control of the company (more than 15%)

Investor terms are too tough (ie. money comes with many stiff terms and conditions)

The best advice is for entrepreneurs to get as much knowledge on raising capital as possible. There are many books including many by Professor Tom McKaskill (www.tommckaskill.com). Also, get a mentor involved in your business who has a track record of raising capital and building businesses. They may not invest into your business, but knowledge is far better than capital. This is because knowledge will attract capital.


© Reuben Buchanan, Integral Capital Group
www.integralcapital.com.au