What does a good investor look like?
On occasion, business owners find themselves in need of additional capital for growth or they may even be seeking to sell their business. Regardless of whether the goal is to raise money or sell a company, too often business owners focus only on the “money” aspects of a transaction and neglect to properly qualify the investor/buyer for their specific purposes.
Even in the context of a sale, most buyers today insist on some sort of management transition period and may include consideration in the form of an “earn-out” or retained equity which will require continued participation of the current owner and management, sometimes for as long as three to five years.
As a result, while a business owner might successfully close a financing or sale, they end up being miserable in the long run because their new “partner” is not the right fit. Worse yet, the poor fit causes their equity value in the business to deteriorate. Money is just one part of a transaction – picking your new partner is much like a marriage or hiring a critical employee – you must pay attention to getting it right the first time.
So, how do you determine if an investor or buyer is “good”? There are two types of questions you need to ask: the first type of question revolves around fundamental principles of due diligence, and the second type is tailored to your unique needs with respect to a new partner. Briefly, basic due diligence questions focus on an investor’s basic qualifications, their financing capacity, reference checks in connection with prior investments they have made, and other questions relating to their background and history.
You should ask a lot of questions around how they have handled adversity in the past: Were they true partners with management, or did they become adversarial? Were they collaborative with management or were they demanding and intransigent? Ask about specific examples – these stories will tell you a lot about them as your future partner. Just as in marriage, when things are going poorly is when the strength of the relationship is most accurately measured.
These fundamental questions can help answer the question of whether your investors are capable of financing the deal, what type of people they are, and what you might expect from them following a transaction, but these questions don’t answer the second question of whether they are the right “fit” for you and your company specifically. To answer this question, you need to delve a bit deeper with your analysis and questions.
The first question about fit you need to ask is, “What am I really seeking in my new investor?” Ultimately, you should be seeking to maximize the return you get from their additional capital plus your continued investment of time, money and energy. Be mindful that all money is not created equal, particularly when you have to work with your new investor to continue to drive future growth and create value.
Some owners mistakenly believe all they need is additional capital, when in fact they might also need relevant experience taking a business to the next level. Having an investor who has “been there, done that” or who has a deep understanding of your industry can help you avoid making common mistakes, and can give you a leg up on competition who may not have this experience.
Many investors are really only financial architects – they make money by using financial leverage and driving cost out of a business only to flip the business a few years later (you can usually identify these investors as the ones who have no real operating experience). While this can be lucrative to an investor and in some limited instances (particularly turnarounds) it might be exactly what the business needs, it often does not result in any true value-add for a business’s customers.
As a result, it can be more risky and generate poorer returns than in the case where the investor truly understands how to drive additional value to customers and in the process create more value for the business and its shareholders.
In order to assess an investor’s ability to help you add value to your customers (and in the process create more equity value for you), ask several questions about how the investor or buyer will enhance your value proposition to customers. Some investors will be absolutely flummoxed by these questions – these are the ones to avoid in most cases.
Others will have insightful ideas that cause you to step back and listen. Because you know your business and its customers, you will know whether these investors are onto something, and would therefore be a good fit for what you are trying to accomplish.
Once you have qualified a potential investor or buyer on a fundamental level, spend time asking penetrating questions to see if they will be able to help you create more value for your customers. The good investors will answer your questions with a combination of experience, judgment and creativity – these are the ones that will help you drive more value, and in the process, create more equity value for you.
Chris Younger is Managing Director of CapitalValue Advisors, LLC (www.capitalvalue.net). Chris has over 20 years of experience in managing deals and business management, sales and operations. He was the co-founder and president of a 4,200-employee telecommunications company, has purchased and sold over 30 business as a principal and investor, and has been an advisor to hundreds of companies. Additionally, he is the co-author with David Tolson of the book Harvest: The Definitive Guide To Selling Your Company, available on Amazon. He can be contacted at firstname.lastname@example.org.