A survey amongst venture capital investors revealed the top three criteria that are used in assessing the attractiveness of a proposition. Business angel investors are probably no different. The top three criteria arising from the survey were:
- Management team;
- Exit opportunity; and
- Revenue potential.
Tip: make sure that every contact with a potential investor addresses the top three investment criteria in some form.
From the above, it is worth noting that venture capital investors are not overly focused on what the company does (the product or service is not in the top three criteria). They are interested in how they will make money from their investment. Whilst business angel investors tend to focus more on what the company does and aim to add their relevant domain experience to the opportunity, the ‘sell’ is not a ‘product sell’ but a ‘commercial opportunity sell’. Entrepreneurs often miss this point as they are passionate about their product.
1. MANAGEMENT TEAM
This is the number one, most important criterion for investors. People (investors) invest in people. Question: how well would you need to know someone before you gave them €100,000 of your own money? Investors spend a great deal of time becoming comfortable with the management team and the business. They will assess your knowledge of the market, the opportunity and your ability to execute the business plan. The management team’s track record will be assessed. Using advisors and/or non- executive directors will add further credibility to your proposition.
A management team consists of more than one person – investors do not usually back one-man bands. They usually also avoid family businesses with family members (husbands, wives, brothers, sisters, etc.) being actively involved in the management of the business. Investors do not want to add the potential for family relationship breakdown to their list of risks. Investors like to see at least the core of a developed management team. Early stage businesses in particular often do not have a full time team. Therefore your business plan needs to address how you plan to fill the gaps in the management team as the business grows and develops.
2. EXIT POTENTIAL
This is another critical criterion. It is important to recognise that investors want to make as much money as possible from their investment. That is the business that they are in. Typically an investor will seek to invest at €1 per share and sell at €7 or more per share. Whilst that is the usual aim, outcomes can be lower than this. Most investors invest for a capital gain at the end of the investment. They do not want to be locked into a company ‘forever’. Venture capital funds have a typical life of ten years so that they must make and realise their investments in that time frame. Business angels do not have the same constraints but they still wish to realise their investment, typically in a five year time frame. Consequently investors seek capital plays rather than income plays (e.g. annual dividends).
There are three main investor exits. They are a share buyback, an Initial Public Offering (‘IPO’) and a trade sale.
- A share buyback is where the company or the other shareholders buy the investor’s shares. It is the most unattractive option as it will lead to the investor and the other shareholders being in serious conflict at exit: the investor wants the company to be valued as high as possible whilst the other shareholders will want the company valuation to be as low as possible. Share buybacks do happen but are not preferred at the outset by investors;
- An IPO is listing the company’s shares on a recognised stock exchange and, in theory, the investor is free to sell its shares on the open market. However, selling a significant amount of shares in a relatively young thinly-traded public company is likely to have a hugely negative impact on its share price (it will bomb!) and is, therefore, usually not a preferred exit for investors; and
- Usually the best exit option to maximise investment sale proceeds is a trade sale for cash, where all shareholders exit at the same time as the entire company is sold to a third party (usually another corporate). This alignment of interest means everyone wins and is in stark contrast to the share buyback mentioned earlier. The business plan should mention any mergers and acquisitions (M&A) activity in your industry that would give some substance to the trade sale aspiration.
Other exits exist (such as secondary buy-outs, management buy-outs (MBOs) and liquidation (both solvent and insolvent)) but the one that maximises value for all is the trade sale.
3. REVENUE POTENTIAL
This is the third most important criterion. The revenue potential needs to demonstrate that the business is scalable; scalable enough to yield a significant return for an investor. Anything that you identify that demonstrates this is important:
- The scale of existing orders and sales funnel;
- The size of the market – it needs to be big enough (usually involving international sales) to build a significant business; and
- Evidence of any other business in the industry showing similar growth to the growth that is being planned.
Tip: the revenue potential of the company must demonstrate a scalable business that is capable of producing significant returns for an investor.