Running a startup is exciting, but it’s not without its challenges and a lack of funds is often a major one.
Banks aren’t always too keen on lending money to high-risk startups. So, how do you raise capital? Thankfully, there are private investors who are willing to back startups.
In this guide, we’ll highlight the different types of investors, tell you how to find investors and explain what they want to know about your business.
But first, you need to decide if your business is ready for investment.
Is your business ready for outside investment?
Before taking on investors, it’s essential to consider whether you actually need outside investment and understand what it'd mean for your business.
For example, you might consider taking on outside investment if you need extra capital to cover your startup costs or if you want to scale your business quickly.
Other factors to weigh up include:
Structure
Make sure you have the correct business structure. If you’re a sole trader, for instance, your company isn't suitable for investors.
Shareholders
Next, you need to consider how many investors you want. Each investor will want a share of your company. So the more investors you have, the more diluted your owner’s equity becomes. It might also prevent larger investors from investing in the future if there are too many shareholders. So, consider how many shareholders you want.
Valuation
Next, you’ll need a professional business valuation to know precisely what your company shares are worth.
Advice
Finally, make sure you seek professional advice from your accountant and lawyer before taking any outside investment.
Types of business investors
As banks have become less willing to lend money to small businesses and startups, more types of private investors have emerged to create a larger investment community.
Here are 5 different potential types of investors for your business:
1. Angel investors
Angel investors (aka “angels”) are wealthy individuals who invest their own money into a business in exchange for convertible debt or ownership equity. They typically invest in startups where they have experience and contacts.
Angels can provide a substantial lump-sum investment to develop and grow your business, and they generally want to be involved in critical business decisions. They may want to cash out after a few years, so it’s essential to set realistic expectations from the outset so that both parties know where they stand.
2. Venture capitalists (VCs)
Venture capitalists (VCs) belong to a venture capital firm that sources investment funds from various clients, including financial institutions. They typically invest larger sums of money than individual investors in later-stage startups that have significant growth potential.
3. Accelerators and incubators
Accelerators and incubators are specific development organisations, platforms or programs designed to develop or grow small businesses. Some focus on a particular industry, such as tech companies, and many also provide funding.
It’s more common for accelerators than incubators to have seed money to invest. Accelerators are focused on scaling a business they believe has potential rather than on innovation and providing the initial seed funding to start a business.
4. Equity crowdfunding
Equity crowdfunding platforms enable you to finance the launch of a product or business by raising funds from the public. In essence, you get many small investments from a crowd of people in exchange for equity in the business. However, some platforms, such as Kickstarter, offer perks along with purchases instead of shares in the business.
Crowdfunding is generally better suited for B2C products or services than B2B offerings.
5. Friends and family
Many entrepreneurs turn to friends and family to invest in their small business ventures. It’s one of the fastest ways to raise capital since you already have the necessary connections. Plus, you won’t have to go through the same rigorous process as you would with angel investors or venture capitalists.
However, the drawback of this type of investment is that it’s not regulated. So, it’s advisable to formalise the agreement to set expectations around whether the finance is a loan that'll you'll need to repay, or an investment in exchange for equity.
Where to find investors
Wondering how to find angel investors, or where to look for startup investors? These are the six best ways to connect with investors:
1. Business incubators
Non-profit organisations, government agencies and business schools may run business incubators.
For example, the Australian Institute of Music's iHUB in Sydney is a business incubator for music-related startups with a community of industry partners, mentors, investors and artists.
You can apply for funding to continue working on your business and seek business advice and mentoring. Also, you’ll meet other entrepreneurs looking to get their businesses started.
2. Banks
You might be able to get in touch with equity funders or venture capital firms through your bank.
3. Accountants
Your accountant may have clients looking to become angel investors or clients who’ve successfully obtained equity funding.
4. Crowdfunding platforms
Crowdfunding platforms let you share your business ideas with the wider public. You can either accept donations or offer shares in your business.
Here are 5 crowdfunding websites in Australia:
MyCause
GoFundraise
Pozible
Equitise
VentureCrowd
5. Networking events
Networking events allow you to connect with local investors. They may be hosted by:
Meetup groups in your city
Co-working spaces
Toastmaster clubs
Specialised groups, like Women in Business Networking and Professional Groups
You can search online directories, forums and social networks like LinkedIn for relevant networking events. Even if you don’t find an investor, these events let you connect with like-minded people.
6. Pitch nights
Taking part in pitch nights allows you to showcase your business idea and gain visibility.
Different investment groups host pitch nights. For example, Startup Victoria recently hosted a Wellbeing Pitch Night for startups in the wellbeing space to connect with investors, partners, prospective employees, customers and the broader Startup Vic community.
Some industry conferences also include a pitch night in their schedules.
How do you choose the right investor?
Not every potential investor is suitable for your startup. The right investor can bring more than cash to your company - they can share their industry knowledge and experience and introduce you to relevant people to help grow your business.
So, before you accept the first offer that comes along, here are some qualities you should look for.
Your ideal investor will be:
Local — so you can reach them and they won't forget you
Knowledgeable — so you can benefit from their industry experience and contacts
Connected — so they can put you in touch with the right people
Committed — so they’ll stick with you for the long term
What do investors want to know about your business?
From an investor’s point of view, the most important point is to know they’ll make a return on their investment. So, they’ll want to find out more about you and your business before they invest.
Here’s a list of the nine most important things that investors want to know about your business:
1. Business plan
Investors won’t proceed without a business plan. Although your business plan alone may not convince investors to back you, it demonstrates that you're serious about your venture.
Your business plan should present the company strategy and include:
A compelling and engaging executive summary
A company overview
Market analysis
Detail on company products and services
A team structure and bios of the management team
A financial section, including projections
An appendix
2. Business model
You'll need to present your current business model and show how it generates profit for your company. Your business model should include:
Your target customers
Your target market
Your organisation's strengths and challenges
Your product or service
Your sales plan
You’ll need to demonstrate how the business model makes money and highlight ways to improve it.
3. Company differentiators
Investors want to be sure that your product or service is unique and that your market potential is significant enough to warrant investing. You'll need to think about what makes you different from your competitors? What’s your unique selling point?
Investors look for proprietary features that set you apart from your competitors and give you some advantage, such as a patent, intellectual property protection, exclusive licenses or exclusive marketing agreements.
4. Team members
Investors will be investing in your whole team, so they’ll want to know that competent leadership is in place for each of the key roles, such as CEO, sales manager and CMO.
They’ll want to know they’re investing in an experienced, knowledgeable, and driven team with a passion for making the business a success. Sometimes, investors will ask for changes to the management team as a condition of their investment.
5. Financial records
Investors will spend time examining your financial records. They’ll want to comb through cashflow statements and balance sheets to determine income, expenses, burn rate, assets and liabilities. They’ll also want to see your forecast for turnover and profit, so make sure you have everything available for close inspection.
6. Growth prospects
Potential investors will want to know there's potential for growth and expansion — after all, this is how they'll make a return on their investment.
So, you’ll need to demonstrate that there’s room for growth in the market for your product or service and share plans for how you can use their investment to grow the business. For example, do you need to hire more people or invest in new equipment for the next growth stage?
7. Method of return
Investors want a positive return on their investment. Typically that either comes via a dividend or as an increase in the value of the business so that they can sell their shares at a profit.
You need to demonstrate that you can deliver one of those options. Also, you should be aware that if they want to sell the company, you may need to sell your shares too.
8. Investment structure
Investors will expect you to have a clear investment structure in place, starting with a professional valuation. For example, if you’re asking for $100,000 for a 20% share, you need to prove your business is worth $500,000.
You’ll also need your lawyer to draw up a stockholder’s agreement detailing:
Owners’ rights and obligations
What happens if an owner wants to sell
What happens if there’s a change in leadership
What happens if the business closes
Dividend distribution
Investors may want to negotiate on these terms, but you should at least have them prepared as a starting point.
9. Exit plan
Investors need to have an exit plan to make their money, so it’s important their goals align with your long-term strategy.
Do you want to build the business quickly and sell it?
Do you plan to continue growing, dominating the space?
Do you only want them for a few years before you get more prominent investors on board?
Do you plan to take the business public through an IPO?
Is your business ready for investors?
When you’re ready to take on outside investment, make sure you have a sound business structure, decide what type of investor you want and then search for your investor.
Additionally, you should prepare the business information that potential investors will want to see, including your business plan, financial records, growth prospects, investment structure and exit plan.
You can keep track of your financials with an online accounting system. MYOB’s accounting software makes it easy to keep track of and present accurate financials to potential investors, helping to set you up for success.
Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.