3 factors which will guarantee the failure of your investment round!May 31, 2023
I’m usually an advocate for positive reinforcement, favouring the carrot over the stick for motivating success. There are however some people who respond better when they’re directly confronted with an ‘or else’ scenario. So if you’re someone who is exhilarated by the prospect of failure but secretly would prefer to avoid getting dressed up in your best failure costume, then do read on. And for everyone else, you should be able to reposition these three Critical Failure Factors to help push your investment round in the right direction.
CFF 1 - Excessively Ambitious Valuation
Let’s cut to the chase here; if you’ve got your house on the market for twice the price anyone is prepared to pay, it’s not going to sell. You might have the nicest home in the neighbourhood, a heated swimming pool, a jacuzzi and a pro-level gym. But if prospective buyers don’t agree that your price is reasonable, you’re left with only two options, give up or drop your price.
Exactly the same principle applies when raising equity investment; if the price is too high, the investor won’t buy.
It’s important to remember that just as the housing market rises and falls according to economic conditions, so does the equity investment market. What might be a fair and reasonable business valuation in a strong economic climate could be totally unrealistic in weaker economic circumstances.
If you want to learn more about valuing your business when raising equity investment, take a look at our article here 9 One-Liners about valuation
CFF 2 - No Strategy For Investor Return
I regularly encounter situations where the leader of a business raising equity investment hasn’t considered the question “How will the investor enjoy a return on their investment”.
If your polished investment deck outlining your brilliant business proposition is silent on your plans for investor return, at the very best you’re being rude and arrogant. A prospective investor should not have to ask you this question; you should be upfront with the answer.
What’s especially interesting about this topic is that it’s almost impossible to envisage a scenario where you can be absolutely held to account for your ROI predictions, with the possible exception of out-and-out fraud.
Nor is there usually a lot of detail expected; most investors just want to understand the mechanism by which they might enjoy a return along with some indication of the timing.
So this could be as simple as “We anticipate exit by trade sale within the next 4-7 years”. Even better if you can suggest who might buy your business and at what level of return. That might look like “We anticipate exit by trade sale within the next 4-7 years. The prospective acquirer is likely to be a Global Search Engine service seeking to take advantage of the rapid development in AI. Our ambition is to achieve a valuation multiple of between 9X - 15X.”
While it might not be true for absolutely each and every investor, there is a well-known expression not to be lost sight of, which is:
“When an angel investor walks into the room, the first thing they look for is the exit.”
Caveat: I’m not saying an exit is the only option for investor return. There are any number of others including IPO, share buy-back, and even dividends. My point is you at least need to have an answer to the what’s in it for me question.
CFF 3 - Unproven Business Proposition
As for the previous two factors, proof of business concept is totally a topic in its own right.
What’s interesting here is that just like valuation, it is a factor susceptible to economic conditions. Cast your mind back to the 1990’s of the .com bubble. To say those times were turbulent is something of an understatement. New business propositions that were barely more than an idea sought and secured investment often at what we’d now consider outrageous valuations.
In these post-pandemic/post-Brexit times, investors are looking for more surety. They want to know that the business they’re considering investing in is actually a business. They want to see proof. Absolutely no question that the best proof is recurring and increasing revenue. Nothing validates a business more than it having customers buying what the business sells, for a profit. Oh, if you’re one of those people who hasn’t got around to launching a business website, you’re nowhere near being ready to have sensible conversations with prospective investors, with the possible exception of your mum.
So what does that mean for earlier stage, especially pre-revenue businesses? Is it impossible for them? The answer is no, it’s not impossible but yes it is a damn sight harder. Absolutely no doubt the earlier your stage of business, the more work you’ll have to do in order to find investors willing to take a chance on you. Pre-revenue businesses have to be much much more pragmatic about the size of their initial rounds. For most, I’d make a sweeping statement that raising £250k is probably doable - but still not easy - whereas £2M is for most going to be no more than fantasy. And don’t forget the Valuation CFF; a five-year-old business successfully trading and growing will command a much higher valuation vs a pre-revenue business which has to be way more modest in its expectations.
What does this all mean for a business wanting to raise equity investment via the public crowdfunding platforms? They will without doubt ask you the same questions. If you don’t have the right answers, it will probably be a very short conversation.
The good news is, we can help you with all this and more. Here’s a quick and easy tool to check if your business is suitable for crowdfunding investment: Readiness Quiz
If that suggests the time is right, you’ll be invited to book a call with us to discuss how we might be able to help you achieve your business ambitions.
Author: Richard Mojel - Commercial Director, ISQ Crowdfunding