Let’s say that you have an idea for a business, or you have a business that you have started and it is starting to show traction. You typically would like to raise money in order to either:
- Carry your business through a development and growth process so that you reach the break-even point, become profitable and from there move on to your exit.
- Accelerate the growth of your business so that you can reach an exit much faster than you could through organic growth.
If you are unfamiliar with the idea of “an exit“, it is an important concept to understand if you are seeking money from angels and/or VCs. Investors invest money in order to make money. The way angel and VC investors make money is for the company that they invest in to reach a liquidity event. The two most common liquidity events are an acquisition or a public stock offering, with acquisition being the far more common exit.
The essence of the investment transaction looks something like this.
- You start a company and grow it to the point where an investor gives you, for example, $100,000 on a company worth $500,000. That is, the investor tells you that he/she believes your company is worth $500,000 (before the investment, or pre-money) and is willing to give you $125,000 in return for 20% of the company’s stock.
- Five years later, your company has grown significantly, and a large company buys your company for $20 million.
- Assuming no other investment in the company has taken place, the investor’s 20% in the company gets cashed out for $4 million when the deal closes. The investor is happy, having made a 32x return on investment in 5 years.
This is a successful exit – the kind of exit that every entrepreneur and investor hopes for. But note that there must me an exit like this, or the investor has no way to get his/her money back out of your business. Generally speaking, investors invest in companies that have an exit in mind and a path to an exit laid out.
This “path to an exit” is just one of the criteria than an investor will look for when determining whether or not to invest in a company. We will discuss many of the other criteria as we walk through the steps.
[What if you do not want your company to be acquired or go public? This is OK, but in this case you probably will not want to raise money from angels or venture capital firms. You will be growing your company organically (funding growth from the company’s own profits) or financing it in some other way.]
So let’s imagine that you are an entrepreneur who would like to raise money. You have created a business plan and you are ready to think about approaching investors. Your first step is to prepare yourself for these conversations. So let’s cover a little terminology>>>