Making Investors and Lenders Happy: How to Predict Your Company’s ROIPosted by Jessica Oman
In a recent guest post, I offered tips on how to estimate the amount of capital you’ll need to open your small business. Once you know that number, it’s time to decide whether equity investment or a loan (or some combination) makes the most sense for your type of business. Much of this decision rests on how your investors or lenders will benefit from funding your company, and what you can afford to pay them.
Considering all the implications of loan or investment financing can be overwhelming. Even if your investor or lender is your mom, the most important consideration you need to make is when that person will get their money back and how they’ll benefit (usually, profit) from taking the risk of financing your business.
You Won’t Get a Loan Today
First, know that you probably won’t get your loan tomorrow if you go to the bank today. Banks usually require a sound business plan, and the whole process of obtaining loan financing can take a couple of months. If you’re going for loan financing, I recommend planning at least a quarter (3 months) ahead.
Your repayment period will be 3-5 years. Your financial projections should show your approximate monthly payments and separate interest from principal, so lenders can easily see that you’ve budgeted for the interest that the bank will earn. Think about the risks you’re taking in your business and what you will do to mitigate them so you can keep making your loan payments. The bank will make some of these same assessments, but you can show that you’ve done your homework, and thereby boost your entrepreneurial credibility, by doing the legwork yourself and showing it in your business plan.
How Investors Make Money
Investors rarely fund businesses just because they love a product or want to help an entrepreneur in dire straits. They almost always want to profit in some way; a bit of equity (a percentage of the business) isn’t enough. Investors can profit in many ways, and these are just a few:
- They can be paid a royalty on each product sold
- They can be paid a percentage of net profit
- They can get back many times their investment when the company is sold or acquired
Before you approach any investor, take a look at her track record and figure out how she likes to invest. What industries does she seem to prefer? How much does she usually invest, and on what terms?
Show investors how and when they’ll make money from investing in you. Equity isn’t enough; investors will want to know your exit strategy (such as a sale of the business) so they know when they can convert their equity into more cash than they paid for it.
Don’t Overvalue Your Company
You can make lots of creative arrangements with investors, but at the beginning, the smartest thing you can do is avoid overvaluing your company. If you have no sales, your business isn’t worth $1 million. Consult a professional if you’re not sure how to value your company. It’s worth the work up front.
What type of financing do you think is best for your business?