When we think about investment, we often think of public equity markets and the many, many faceless investors buying and selling shares in public companies. As a result, we think of entrepreneurial financing as obtaining a cheque from a passive investor. Nothing could be further from the truth.
And that’s a great thing if you have the right mindset. Early stage investment is a relationship with your investor and is multifaceted. Your investor is someone that you will communicate with, meet with and, if you are very strategic, someone who will help your venture succeed.
Seasoned entrepreneurs look for investment with benefits. Do you need to scale your venture? Your investor should have experience scaling, or a deep knowledge of the industry and relationships, so that they can help you in that task. Do you need to grow your team? Your investor should have experience in organizational structure, hiring and retention through high-growth scenarios.
When Do You Need Your First External Investor?
Ideally, entrepreneurs look for their first external investment when:
- The risk to the venture has been lowered to the point where it makes sense to take someone else’s money; and,
- The investor is likely to get a return that is reasonable, based on risk.
Investors have options. A risk-averse investor can choose fixed-income, low-risk opportunities and will earn relatively low rewards, in the two to five per cent range.
An investor willing to take on more risk can build an equity portfolio of stable, blue-chip stocks and earn higher returns over the long term. Investing in early-stage ventures is riskier, and investors are looking for returns in the 15 to 20 per cent per year range.
The work of an entrepreneur through these early stages is to de-risk the venture by securing ongoing revenue and finding a business model that works and generates consistent or growing cash flow, all while managing costs and investing for the future. In these early stages, entrepreneurs have several options that should be considered before taking external funds, including:
- Business plan and pitch competitions
- Self-financing through reinvestment of profits
- Crowdfunding via rewards and presales
- Love money, a.k.a. money from family and friends, a form of external funding
- Early stage grant and loan programs such as community microloans, Futurpreneur, Export Development Canada, Pacific Economic Development Canada, National Research Council — Industrial Research Assistance Program, and Scientific Research and Experimental Development tax credits
- Traditional loan programs, including a line of credit, likely personally guaranteed, or asset loans
In each case, entrepreneurs need to think hard about skill development and the resources of their company. When you need external financing, the work to research, assess, deliberate, propose or pitch, and manage any of the options, takes time and resources away from the operations of the company.
Company culture and desired skill development play a role. Some seasoned entrepreneurs avoid grant and loan programs; it may be antithetical to your company to develop skills to write grant proposals and to focus attention on government funding, rather than generating sales and cash.
Why We Need External Investment
Once the early stage options have been effectively used to de-risk the venture, and it is time to seek external funds, you have three options:
- Love money
- Angel investment
- Investment by a group of angels
And it is time to think about the benefits you need from these important relationships.
Some love money is considered the best first step because some angel investors see love money as confirmation that the people who know you best believe in you. Not all angel investors require you to have raised love money, but, it is important to some angel investors and it can be a wise first step.
Angel investment research shows that angels are more likely to write a cheque when there are co-investors; when the entrepreneur is connected to the angel via group screening, a group presentation or a referral from a friend or professional, such as an accountant or a lawyer.
This is where local groups like VIATEC, Coast Capital Innovation Centre at UVic, Cindicates and the Women’s Equity Lab are important elements of our business community. Presenting to a group of investors is the best way to create connections, gather feedback and, ultimately, obtain financing. You can also meet these people by participating in incubator programs, which gives you access to venture coaching.
Who are these angels? The research tells us that they are often serial entrepreneurs. Investing in your company is a combination of expecting a return, helping another entrepreneur succeed as they were helped by someone in the past and enjoying the thrill of the early stages without the stress of being responsible for the day to day. Who knows? Someday you might have the opportunity to invest in an entrepreneur in our community. ′
3 Early Stage External Investor Options
- Love money
Money or capital given by family, friends or other personal connections for a business startup.
- Angel investment
An individual who provides capital for a business or startup, often in return for equity, just when it’s needed most.
- Group of angels
High net-worth individuals who are often serial entrepreneurs and provide financial backing for startups.
Mia Maki is an associate dean, faculty outreach, at the Gustavson School of Business at UVic; a professor of finance, accounting and entrepreneurship; and a principal at Quimper Consulting. Maki has helped raise over $50 million for international initiatives, including acquisitions, strategic partnerships and joint subsidiary creation projects.