From venture capitalists to angel investors, here’s what your business plan needs to include to catch the eye of startup investors.
September 12, 2005
By Tim Berry
Although you definitely need a business plan to find investors, your plan alone–no matter how good it is–isn’t enough to attract investors. The investment decision depends on a lot of other factors: the business team and its track record, the product you’ll be selling, the competitive advantage you have and what your market is, among others. By itself, your plan is like an automobile engine–the car won’t go anywhere without it. But the engine alone isn’t enough to make the car go, and you need to recognize this from the beginning.
Another important point to understand is that investors are not all the same. At the high end, there are a few thousand venture capitalists working for a few hundred venture capital firms. At the low end, you have friends and family. And in the middle, there are tens of thousands of private investors called “angels.”
The venture capitalists are the most demanding. They fund only a few thousand plans per year, and they have to reduce their risks because they’re investing other people’s money. They probably won’t consider your venture unless you’re introduced to them first because they have no other way to screen and process all the proposals they get. They aren’t sharks or bad people–they’re just professional managers doing their job. They won’t steal your idea: The last thing they want is another business idea without a team to implement it. Therefore, when they search for investment vehicles, they look for the following:
- A management team with a proven track record. Yes, that often means they won’t fund your plan because you don’t have experience, but you don’t have experience because they won’t fund your plan. Deal with it. If this is the case, look for angel investors or friends and family (and keep reading).
- A defensible product with a competitive advantage. It’s easier to predict the success of a tangible product than it is a service, which is why service businesses are rarely interesting to venture capitalists. Of course, there is the occasional exception, such as Netflix, the popular home delivery service for DVD movie rentals, for example.
- Reasonable valuation. Divide the amount you plan to take as investment by the percent of ownership you’re offering to give in exchange. For example, offering 50 percent of a company for $5 million means you’re valuing your company at $10 million. An outrageous valuation shows investors you may still have your head in the clouds.
- A clear statement of the investment offering Check with your attorneys about the legality of your offering, including how much equity for how much money you’re planning to offer this time through, and the planned future dilution for later rounds of investment.
Other things that interest venture capitalists include:
- A shot at increasing the value of the company from whatever they think it is now to about 100 times that in three to five years.
- A plan that requires at least a $3 million investment–in fact, the more the better. Your plan has to show that the money is carefully planned and really needed.
- A plan that has several other similar investors ready to invest at the same time. Venture capitalists find safety in numbers so they don’t want to be the only investor in a deal.
- A clearly stated exit strategy. Investors like to see that you’ve thought ahead to how they’re going to get their money back on the deal.
Angel investors are harder to predict. They’re usually wealthy individuals or small groups who invest in different ways. Most of them look at almost the same factors as venture capitalists. Some of them, however, will consider lesser investment amounts and will even invest alone. They often specialize in a specific type of business, such as retail or technology, perhaps because they know that sector well.
When it comes to friends and family, I can’t tell you what they’ll look for because they’re your friends and family. I can tell you to be very careful about seeking friends and family to invest in your new venture because businesses frequently fail and you don’t want to lose your friends and family when you lose your business. And don’t make the deal based on a handshake–you should treat your deals with friends and family just as you would with a professional investor.
I can also tell you that you absolutely must check with an attorney before taking any type of investment for your startup. There are laws that control private investment; most of them were enacted to prevent stock fraud. And selling stock takes significant legal work. Whether you’re one of the very few startups that land venture capital investment or you’re taking investment from angel investors, friends or family, work closely with an attorney to be sure that any deal you do is structured properly.
Tim Berry is the “Business Plans” coach at Entrepreneur.com and is the president of Palo Alto Software Inc., which produces the industry’s leading business planning software, Business Plan Pro, as well as other popular planning applications for businesses.
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