Funding Sources (part 2)By Fabian Aguilar | Fri, 11/19/2021 - 10:47
If you’ve decided that your best option is to seek capital from an investment fund or angel investor, here’s how the process works and what you need to apply.
Each investment fund or angel investor has a different way of reviewing investment opportunities. The companies in which they invest are innovative, i.e., they are not replicas of proven businesses (such as a dry cleaner or a distributor) and, therefore, they are looking for the best way to bring their product or service to the customer. An example might be a company that has developed a novel cancer diagnosis system that uses artificial intelligence or a virtual reality platform for videoconferencing.
In a nutshell, when the investor encounters these types of companies, the investment process typically seeks to validate and answer the following questions:
- What is the company’s history to date, what are the sources of value generation and how does that value translate into money?
- Why is the product it sells necessary for the customer and for the market? Who is out there offering similar things and why is this business model better?
- Who is the entrepreneur? Why is he/she the right one to take this company to new heights and what tools/processes does he/she need to get there?
- Why does he/she need the money and how far does he/she want to go with it, once it is fully used?
- How do I benefit financially from this transaction (remember they are investors, so they look for a return on the capital they put in)?
Investors understand perfectly well that there are no right answers (if they were all right, you wouldn’t be raising capital), so don’t panic if you don’t have the answers to these questions. The important factors are that the story you tell them is exciting enough to get their attention, that they fall in love with it in the same way you are in love with your project and that you convince them it will be a win-win relationship as you both generate wealth (in your respective shapes and forms).
To apply to the process, you need at least two essential documents:
First, a presentation or pitch that is no longer than 20 slides and that you can explain in a maximum of 20-25 minutes, addressing all the questions mentioned above. We suggest the following table of contents so that you can explain your story coherently:
4. Business model: How the value you deliver is transformed into money and the process behind it
5. Competition and competitive advantages
6. Market strategy: How do you expect to execute your vision in the marketplace? How will you grow your customer base?
7. The current state of your company: What have you achieved? How? Why is it important?8. Financial analysis: Basically, explain the above points with numbers, which can be through financial projections and historical information.
8. The offer: Explain what you need, amounts, what investors receive, how you expect to structure the investment, etc.
Second, a financial model that details how the money you will receive will be reflected in higher sales (i.e., projecting the company's growth). It is very important that you focus on cash flow, as investment funds and angel investors are most interested in how money flows into your company and how it affects your operating activities.
Unfortunately, each fund has its own list of requirements, so some will ask for more than others. Some additional documents may include an executive summary, term sheet, a customized application form to fill out, official IDs, company by-laws, etc.
The time it takes for an investment fund to analyze your investment can vary from three to 10 months (angel investors might only take weeks) and depends on the level of scrutiny of the fund, the history of your company (the younger the company, the fewer data to validate and therefore, the faster the analysis), its approval process (some funds have several “filters” where you interview with advisers, executive members of the fund, other investors, etc.), and its negotiation process (some funds perform this step before auditing the company, others do it at the end of their negotiation process. Funds follow at least four basic stages:
- Analysis and profiling: Funds analyze several variables, such as revenue generation, how well the company fits their “investment thesis” (which is nothing more than the set of rules they use to look for opportunities that interest them), the amounts required and the amounts they can invest.
- Due diligence. Once the fund has a firm interest in investing, it proceeds to “audit” the company. In this process, the fund will ask the entrepreneur for a large amount of information about the company (financial, operational, tax, human resources, market, historical and future information, etc.) to understand where the company stands and where it is going. The aim is mainly to detect “risks,” understand them, and analyze if the investor will face these risks with you (for example, not having a financial director is not life or death, but should be taken care of) or if it is better to end the process and not continue with the investment (if the investor finds, for example, labor lawsuits, or a large amount of money invested that has not been translated into consistent sales).
- Approval. Funds are institutions; therefore, they have a corporate governance that dictates the rules to invest in a project. One of these rules is the approval of the investment through a corporate body, such as an investment committee or shareholders’ meeting. It is likely that the entrepreneur will have to present the project to the committee (although there are funds that keep their committees private, and it is the firm’s directors who present the opportunity). Therefore, the entrepreneur must not only convince the investment team but also the fund’s supervisory body.
- Negotiation. During the process, the investment team will sit down with you and begin negotiating the terms of the transaction. The evaluation of the company, the rights the investor receives, the legal vehicle to be used, among other legal issues, are set out in a term sheet that, after several meetings, will serve as the master document for the lawyers to write the documentation to execute the transaction.
With angel investors, the process is simpler. Because they usually invest in very early stages (even, on occasion, when the entrepreneur only has an idea), their decision-making is faster, and it can result from a couple of meetings or a detailed process similar to an investment fund (and you usually find them when you apply through angel investor networks)