The relationship between small business investor and entrepreneur is a two-way street. Just as an investor puts a lot of time, energy and resources into researching investment opportunities, owners should take the time to thoroughly evaluate potential investors when seeking capital for their growing business.
More than likely, this partnership will be one that evolves over many years, so it’s important to make sure that an investor is the right fit, has a framework for business growth and can add value to your business. Asking potential investors the right questions – before they invest in your company – will pay off in the long run.
1. Does the Investor Understand Your Business?
In most cases, entrepreneurs will have far more success with an investor who understands their business model and has experience in their particular industry. When communicating with potential investors, pay close attention to how much information they need in order to understand your business. In addition, take a look at an investor’s area of focus and current portfolio, as this will help you to assess the level of expertise.
Without solid experience, an investor will likely not have the appropriate networks to help grow your business or the context necessary for providing informed counsel during tough decisions. Potential investors should be able to turn lessons learned from their other portfolio companies into useful advice and benchmarks for your small business.
2. How Committed is the Investor to Your Type of Business?
Just as it may be necessary for potential investors to understand your business, it’s equally as important that an investor has a strong track record of success with businesses of your size or at a similar stage.
Find out what types of projects your potential investors are working on. This will help you determine if your type of business is a major focus area. For instance, do they have other portfolio companies in the same space? Are they planning to invest in more businesses like yours? An investor who is a strong advocate for similar companies will have the passion, knowledge and resources to help build value for your business.
3. Is the Investor Well Connected?
From a business perspective, well-connected investors are invaluable. An investor with extensive networks can pull the right strings to get you access to valuable resources and expertise, bring other investors on board and accelerate the growth of your business.
In fact, a study from the Sloan School of Management found that the number of contacts a person has, as well as the closeness of those contacts, is a key factor that results in an increase in revenue and completed projects for a business.
4. At What Stage is the Investor in His or Her Career?
It’s important to consider where your potential investors are currently at in their own careers, as this can have a significant impact on the success of your business. For instance, do you want an investor who knows what it takes to build a successful business from scratch? Should he or she understand the nuts and bolts of venture fundraising over multiple rounds? Does the investor need to have strong operational experience in a particular area, such as marketing, sales or product development?
An investor who is in the first few years of his or her career may not have established strong networks, a thorough understanding of your business model or experience building a company from the ground up. On the flipside, an investor who is at the tail end of his or her career may be starting to scale back and might not put as much time and energy into helping your business to succeed.
5. How Much Capital Will the Investor Allocate to Your Business?
The amount of capital that potential investors are willing to invest will vary, so it’s important to do your homework on each investor’s typical bite size. Some may invest in the $25k-$100k range, while others might not write checks smaller than $250k.
Find out what the investor’s typical funding schedule is, where the fund is in its lifecycle, and when the investor will want an exit and return on capital. This will help you determine which stage of your business the investor is willing to fund.
In addition, don’t forget to think ahead to the next round of capital. Has the investor earmarked dollars for follow-on investment? Some investors don’t reserve any funds, while others may have a hard reserve or soft-allocated future funds. Be sure you understand the process and decision making for raising more capital in the future.