Winning a big investment is the dream for many start-up founders. But is your business ready to take on the commitment? We asked Margaret Coughtrie, a member of the Investing Women syndicate and ex-hedge fund manager, about how startups can decide if they’re ready to take the funding plunge.
Investment is usually welcome for start-up entrepreneurs, as it means additional resources can be added to the normally usual scant supply. Usually financial investment, i.e. money, is the first type of investment that comes to mind; there are however other types of investment, namely other forms of economic investment as well as social, symbolic and human, and each of them are just as important in developing and growing a business.
What does investment mean for you?
Investment, whatever type it is, generally means there is some benefit given in return by the company, often equity, so the investor can enjoy the benefits of the growth of the company in return for the time, access or money they put in.
Taking investment as an entrepreneur is an important decision, as most likely you will give up some of your ownership of the company. To be a fruitful decision, that trade-off needs to bring a value which creates greater value for your company in the future than what is given up today. The golden rule is to give away as little as possible, but you do need to be realistic as to the company valuation, which of course determines what you give away, as that values the amount of investment you bring on…
Sometimes this is where the company forgoes well-needed resources, as a valuation cannot be agreed with potential investors as you (or the founder/CEO) values the company much more generously than the potential investors.
Considering company structure – and your people
The most important consideration before any investment comes is the company’s structure and accountability systems. Start-up entrepreneurs are often very creative people and sometimes often their interest in the operational aspects of the company are less developed. That means they can easily go off on tangents, deploying these new-found resources in ’off –piste’ activities or with less productivity demands than are required for small developing businesses. A Board’s job is to govern the company’s activities, and part of that is to ensure the CEO is using the resources for the benefit of all the stakeholders. Establishing a Board with regular monthly meetings, which are minuted and which review the past month’s activities in terms of the deployment of resources and use of cash, as well as the future development of such activities, is key. It is also important to choose Board members who bring skills that will help the business but who are not afraid to challenge the CEO’s strategy and actions… and if you want to grow your company you need to be ready for that!
A key consideration on the receipt of any investment is the people who are behind the investment - especially if they will end up working in the business or on the Board. Are they really bringing skills that are needed? Do they have a personality that will fit in ( and I don’t mean a ‘yes-man’). Growing a business is very challenging and stressful and often brings out the worst in people. Many relationships end during a start-up experience, so make sure you chose your people wisely and make sure they add real value.
Another consideration on the receipt of investment is the estimated value this investment will bring – it’s important to consider the effect it will have on the future valuation of the company or/and social impact, depending on what the goals of the company are. An idea might be that you accept a human investment by taking Sarah on board as a Digital Marketing Director for a 20% equity share, and you think her contribution over the next two years will generate an additional £800,000 sales p.a. and £2,000 monthly recurring revenue. This may add an extra £0.5m to the value of your company.
The next question to consider, however, is could you accomplish that increase in company valuation or social impact in another way? It’s clear you can’t afford to pay Sarah her required £50k a year salary, but could that 20% equity, which was paid out, have been deployed in a better way to create a greater value? Having said that, valuing start-up businesses or estimating their social impact is notoriously difficult, as businesses are often valued on the basis of their profitability or impact and many start-up businesses are not yet generating profit or impact. Often too, the future development of start-up businesses is uncertain and so a few major changes in strategy or pivots along the way may possibly be necessary to get the business on the right course. This too makes any attempt at valuing the company or estimating its impact challenging.
With start-up businesses investors are buying a vision and there will be points when that vision will have a greater valuation, and hence you give up a lower percentage of equity, than others. When people are investing in a vision they are investing in an outcome which may or may not happen. There are a whole array of other possible outcomes around this, which will also have different values. To all of this the investor attaches a risk premium which discounts these outcomes, as indeed they may never happen.
Ultimately, investment can be a great opportunity for startups to expand, and a chance to bring expertise and guidance into your business – but it’s important to think long-term, to consider your company goals and objectives, and to not let yourself be bowled over by pound signs.
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