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Posted by on Mar 19, 2013 in Business Plan, Finance | 0 comments

The Three Things Investors Look For and Questions They Ask You

The Three Things Investors Look For and Questions They Ask You

If pitching to investors is a frightening thought for you, you’re not alone. Many entrepreneurs are intimidated by investors, especially if they never pitched to any before. How can an entrepreneur prepare for the million possible questions the investors will ask?

All the questions investors will ask you will be to get to three things. Here are these three categories and some questions they use to get to them:

1- THE IDEA

This is where most of the questions will focus. Investors want to ensure your idea solves a problem in the world, can sell and make a profit, and can grow significantly (i.e. scale up ). Here is what they want to know and questions they might ask to get it:

  • The product sells (i.e. solves a problem & people are willing to pay for it)
    • How much have you sold? This will probably be their first question
    • How much have your sales grown?
    • How many customers repurchased?
    • Do you have a prototype? (if you don’t have sales yet)
  • You make enough profit to sustain the business
    • How much are you selling it and how much doest it cost you? or how much profit do you make per product?
    • What’s your break-even point (i.e. how much do you need to sell to get to zero profits)?
    • How much does it cost to acquire customers? (to make sure you are making enough to keep a profit)
    • How/where are you making the product? (to see how efficient your operations are and if there is room for improvement)
  • You can scale up the company in the future
    • How will you grow the business?
    • How much are you expecting the business to make in the coming year?
    • What stage is your company in (idea, early-stage startup, late-stage startup, growth, expansion). They will generally shy away from the idea and early startup stages because the companies still don’t have a chance to show if their products are viable.
  • You can compete effectively against new entrants, especially large players.
    • Do you have a patent?
    • What stops others from replicating this? do you have anything unique that will prevent competitors from stealing your customers and crushing you. This is especially important if your business is one that allows large players to muscle in on you and steal your business away (e.g. undercutting your prices)
  • Your industry is attractive.
    • What’s the size of your industry?
    • How fast is your industry/segment growing?
    • Who are the big players in your industry?
  • You have a good business model. This is a tricky one because investors might believe in a very different business model. They might believe licensing is a better way to go than making the product yourself or vica versa.
    • Have you tried to license this product to a large player in the industry?
    • Have you looked into outsourcing manufacturing to Asia to reduce your costs?
    • Did you try to sell your product to distributors instead of retail?

Note: Investors might give you great advice here to adjust your business model to run better. However, take advice carefully. Take into account how much experience the investor has in your field and what vested interest s/he has in the advice (will s/he benefit if you take the advice). They might open your eyes to a better way or you might choose to stick to your path.

2- THE PEOPLE

This is where investors will put the most weight, but ask the least questions. The investors will be assessing you as you interact with them. Here is what they want to know:

  • You are capable of running the company
    • What is your background? your past experience
    • Did you successfully run a company before? How much do you know about the industry? What’s your educational background?
  • You are fully committed to make the company succeed
    • How much of your time and energy are you dedicating to the business?
    • How much money have you invested into the business? They want to see that you have your own money invested into it (“have your own skin in the game”)
    • How much of your time are you putting into this business? Do you have another job or business?
    • Why are you doing this? (are you passionate about the company, product and the future. Will you persevere when things get tough?)
  • You have the right team working with you. Are you covering the important functions (marketing, finance, sales, operations, IT, etc) and that you are managing your growth well (controlling your cost effectively)
  • You have personality that fits: Investors will be assessing how well they will be able to work with you. They might not ask you specific questions or say anything about this explicitly, but they will be assessing you as a person for sure. There is no “right” or “wrong” personality. It’s like dating to see if you will get along. But generally, they will scare away from you if you are argumentative, too hard-headed, greedy, flaky, etc. It’s a subjective assessment, so one investor might love you while the other might not. Don’t take it personally.

 

3- THE INVESTOR FIT (Input / Output)

Investors will assess how well the opportunity fits with their needs. They will assess how well they can contribute and benefit from the deal.

Investors will put in some of their resources to push your business to the next level. They include:

  • Money: Obviously, the investor will inject money into your business to fuel its goals.
    • How much money do you need?
    • How much equity are you offering for that investment?
    • What will you use the money for?
    • Will you need follow on financing later as the company grows?
    • Note: Make sure you value the company fairly. As a rule of thumb, the investor will value your company at around three to five times revenues. So if you sold $100k the last year, then the discussion should be around $500k valuation. So if you are looking for $200k investment, expect the investor to take around 40% in your company.  A lot of things can change these numbers (e.g. how desparate you are, whether you have other investors interested, if the investor has to put other input, etc)
  • Contacts: access to key partners like retailers, distributors, suppliers, customers, etc
  • Resources: manufacturing facilities, office space, one of their businesses might be a key customer, etc
  • Time: In the form of guidance, making key sales, coordinating with suppliers. The less experienced and capable the entrepreneur is, the more time the investor needs to put in to compensate and ensure the business succeeds. Time is the most precious resource for successful people and is worth more for them than money. The less time they will need to put in, the more attractive you will be for them.

The investors will be expecting returns for their input. Make sure you think of them while formulating your offer. They will be looking for:

  • Money: They simply want to get more money out than they put in (i.e. Return on Investment)
  • Assets: Your company might have other assets they are interested in to leverage for their other businesses. These might be patents, people, key customers, you, etc
  • Personal satisfaction: this is not talked about much, but many investors have soft spots. They might seem like cold hearted scavengers (some are), but they are human after all. Some are actually nice people (e.g. Robert Herjavec). An investor might see her/himself in you, or believe in your cause, and choose to invest despite gaps that might stop them otherwise.

HOW TO PREPARE:

Here are some quick tips to help you get the most out of your pitch to investors:

  • Have a Business Plan: Prepare it yourself and write it down so you know all the details. The plan will force you to cover all the issues to help your company succeed, which is what your investors will want to know.
  • Know your numbers: Make sure you know your sales, profits, costs (past, present, and future projections). Not knowing your numbers one of the best ways to turn investors off.
  • Prepare your presentation: Make sure it’s concise and covers the most important points.
  • Rehearse, rehearse, rehearse! Present to someone and have them drill you with questions. It’s great if you find someone who has successfully raised funding before to guide you. Watching shows like Shark Tank and Dragon’s Den might help too.
  • Be yourself: Investors will be deciding if they like you and so should you. Be yourself. It’s better to identify personality clashes early on rather than later when you have a partner you don’t get along with. Be respectful, don’t get defensive, but stand your ground on what you want and don’t want.
  • Know the investor: do your homework on the investors to know their backgrounds (industries, prior investments, reputation, preferences, etc.  
  • Set your boundaries: Decide what you are willing and not willing to give up before you meet investors. What is the minimum valuation you are willing to accept for your company, the maximum equity you are willing to give, are you willing to give royalties, any operational decisions (e.g. whether you are willing to change your business model), etc. The more you are prepared the better you can handle questions and the offer/negotiation stage.

Don’t be discouraged if you don’t get the first investors on board. Learn from the experience, make necessary adjustments and approach others. Good luck.

 

Update: I came across a well written and informative post by Tomasz Tunguz, who is a venture capitalist at Redpoint. Straight from the horses’ mouth as they say: 

Breaking Down a Typical VC/Startup Diligence Process

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