Ask the investment banker: Should I bring in an investor?

Entrepreneurs often ask us to help them find capital. After all, who wouldn”™t want to have more cash on hand? However, despite television shows like “Shark Tank,” which have popularized investment, many companies never take a dime of outside money. In some cases, the size of their business and the industries they are in simply do not appeal to investors. In other cases, owners find that they are better off with other options, such as borrowing money or financing growth with internally generated cash.

This column assumes you are not a startup owner with a cash-burning plan to be the next Facebook, but instead are an entrepreneur who has been growing your business steadily for years.

Before you start looking for an investor, ask yourself four questions:

WHY DO I WANT AN INVESTOR?
Bringing on an investor adds a completely new level of complexity to your business and takes up a significant amount of time, both to find and maintain good relationships. Investors will typically require that you provide information regularly and consult with them on important decisions.

HAVE I CONSIDERED OTHER OPTIONS?
If you are cash-flow positive, have you considered loans or other types of financing to help you grow? Even though you have to pay interest on debt, in the long run, for growing companies, debt is cheaper than equity. If you aren”™t profitable, do you have a clear plan to become profitable based on your current trajectory? If neither is true and things aren”™t going well, outside investors will be reticent to back your company. Instead, fix things internally first. Outside money will not solve your problems.

WHY WOULD AN INVESTOR WANT TO
INVEST IN MY COMPANY?
While there are many different types of investors with different risk appetites, they are all looking for financial return on their capital. That means that your company must provide a financial return that compensates a potential investor for the risk and illiquidity of investing in you versus the public markets. For early-stage companies, because there is a high risk of failure, investors typically seek to realize at least a 30% annually compounded return. For later-stage companies, that number is reduced because your company is “derisked” as you”™ve proven it generates consistent revenue and profit. In all cases, an investor needs to believe that your people, processes and products can beat the competition and bring them outsized rewards. You and your investor must also be aligned on the time frame where they will see returns, either through dividends or when you sell the company so they realize their gain.

WHAT WILL YOU DO WITH THE MONEY AND WHAT WOULD
A POTENTIAL INVESTMENT LOOK LIKE?
You should have a specific plan to use the money raised. How much are you looking for, how will you use those funds, what will those funds enable you to achieve and what milestones will you accomplish that demonstrate your progress? Any smart investor will want to know this so you should prepare it in advance of making your pitch. You also need to decide how much of your company you are willing to sell and what you believe it is worth before the investment, also known as the “pre-money valuation.” The earlier your company is, the riskier it is and the lower its value. If your company is small and just getting off the ground, you”™ll need to sell a fairly big chunk of the equity to raise significant cash. If your company is more mature, has a track record of growth and continued strong prospects, you can justify a higher valuation and raise sufficient capital without having to sell too much of your equity.

Jon Rubin is the managing partner at Westbury Group in Westport, Connecticut. He can be reached at 203-745-0272 or jrubin@westburygroup.com. Ted Yang is the managing director at Westbury Group. He can be contacted at 203-803-4470 or ted@westburygroup.com.