For many specialized startups, the only way to obtain funding is to work with a private investor or related group. Most banks and financial institutions will not extend credit to a startup unless the founder has substantial collateral for the loan or line of credit. To this end, many of these entrepreneurs seek to acquire equity funding in exchange for a negotiable percentage of a business. Most importantly, when you are talking with investors it is important to note that you should have a CPA and an attorney work with you in order to ensure that a proper negotiation is taken place. Your CPA can help you greatly as it relates to issues pertaining to valuation. This is especially important if you have developed proprietary technology (including patented technology).
The vast majority of private investors want to see both a pitch deck and a business plan. Usually, they will review the pitch deck first in order to get an overview of what you are looking to achieve. Most pitch decks range in length from 10 to 15 slides. It should not be any longer than this as it is designed to pique an investor’s interest. The business plan is where most of the information regarding how your company will operate can be found. The business plan should feature three to five year financials (profit and loss statement, cash flow analysis, balance sheet, burn rate, and breakeven analysis). It should also include full industry research specifically geared towards what you are looking to achieve. The business plan should also have sections that discuss what will occur if things do not go according to plan. This is important as it will indicate to the investors that you understand that there are going to be numerous hurdles that must be mounted before your company becomes profitable. Exit scenarios for both the investor and the company as a whole should also be clearly defined in this document. We have a number of documents on this website that showcase potential exit strategies for a variety of different types of businesses.
Once you begin your negotiations with an investor, this is the time where your attorney should be actively involved with the process. They will ensure that all of the necessary investment terms are clearly spelled out within the contract as well as all matters pertaining to contingencies. A properly produced investment contract will mitigate any potential legal matters that may occur down the road. Your attorney may also draft out your operating agreement.
One of the other factors that you will need to consider with your attorney will be corporate structure. This is something that only a qualified attorney can assist you in determining as each entity has its benefits and drawbacks. The limited liability company (LLC) is the most commonly used structure, but this may not fit in with what you are looking to achieve. A simple discussion with a qualified business attorney will ensure that the business is properly formed to receive capital from a private investor.
On a side note, the vast majority of private investors are going to want to acquire an equity interest in the business. Often, many entrepreneurs feel that they can acquire a private loan from these entities but it is rarely the case. They are going to want to obtain the capital appreciation and potential dividends that come from a successful business over a long period of time. As such, you should plan ahead for this very likely scenario when you are developing your business plan. As such, it may be in your best interest to have a formal valuation completed so that you can properly negotiate with a private funding source in regards to what equity percentage will be provided to a private investor. However, this can be expensive. Many proforma valuations can have a cost of $2,000 to $10,000 depending on the scope and scale of the study. Another document that is usually accompanied by a proforma valuation is a feasibility study. This overview focuses on whether or not the business can achieve profitability based on a number of different factors (including market size, number of competitors, etc.). Much like a proforma valuation, a feasibility study can range from $5,000 to $10,000 depending on the scope and scale of the project. It is important that you find someone that has extensive experience in your field as a consultant in order to have these issues addressed appropriately.
Another consideration when working with an investor will be to determine what would occur in the event of a business liquidation. Most importantly, some investors want to ensure that nearly all of their capital will be returned in the event of a business failure. The terms of your investment contract may include providing the investor with all tangible assets in the event that things to do not go as planned. These are further issues that your CPA and attorney can guide you with as you progress through this process.
After the contract is signed, the funds are usually deposited into the corporate account (all at once or in steps) within a few business days. From there, your business has officially launched. Good luck with your new venture!