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What do investors look for?

  • As an entrepreneur, there may come a time where you would need to approach an investor for funding. There is a myriad of funding options available but the next question you should be asking is "what will make them invest in my business?".

    Different investors have different criteria and focus areas but we outline below what typical aspects they are likely to look at. We use the term 'investors' rather loosely here and it includes banks, alternative funders, venture capitals etc.

    When investors look at business they may look at two broad aspects- the jockey (i.e. the business owner) and the horse (the business). Let’s look at these a little closer.

    The jockey:

    Especially in a small business or a start-up, the business owner is critical to the survival of a business. Thus, investors would want to see whether you are qualified and/or experienced, knowledgeable about your sector as well as your business. Investors also look at how much 'skin in the game' you have i.e. how much have you put in? This usually comes in the form of hard cash or 'sweat capital'- how much time, effort and skill you have put into getting your business off the ground. As harsh as it might sound, some investors might not put much weight on sweat capital. Other investors might go as far as checking your (the owner’s’) legal and credit records to give some insight into how much they can trust you with large sums of money.

    The horse:

    Here investors want to see how well the business is operating and in some cases- how great the growth prospects look. In order to assess this, investors will look at a variety of financial ratios. We explore some basic concepts below:

    • How indebted is your business? The Debt Ratio (Debt ÷ Assets) will show how much of your business was funded by debt. A business that it overburdened by debt might struggle more so during tough times, thus debt financiers prefer a lower ratio.
    • Can your business afford to meet its short-term liabilities? Liquidity ratios such as (Short term assets like cash, inventory, debtors ÷ short term liabilities like trade creditors and debt repayments due within a year) gives insight into this. You want to this ratio to be more than 1- the higher the better.
    • How efficient are your operations? Investors will look at your working capital ratios such as your inventory turnover (how quickly are you able to sell your inventory), days receivable (how quickly are your debtors paying you back) and days payables (how quickly does you trade creditors expect to be paid). The quicker you can receive cash and the longer payment terms you can negotiate with your suppliers the better.
    • How profitable is your business? Investors will look at a host of profitability measures such as gross and net profit margins (Gross profit or net profit ÷ turnover) and return on equity (net profit after tax ÷ equity). The higher the profitability ratios, the better.   

    Depending on your industry, there could be other metrics that investors will investigate e.g. crop yields for agricultural companies. Investors would also look at how these ratios perform over a time to identify any trends. Moreover, they will benchmark these to other business in a similar industry.  

    They will also consider your business' track record- if you have in business for 5 years it is less likely that you will fail in the next year or so. They will assess your client and supplier base to see if it is well diversified and that there isn’t an over reliance on any one person or company.

    Investors may also look at your people, processes and systems depending on the size and complexity of your business as well as the industry you operate in. For example, if you are in fintech industry, investors would want to see that your IT security and firewalls are adequate whereas if you are in the manufacturing industry, they would want to see that you comply with all the applicable safety standards.

    Collateral- banks and other funders would typically require some sort of collateral, particularly for longer term loans. Collateral are hard assets that they can repossess and on sell should you default on the loan. The better collateral you can put forward, the better chance you stand on attracting a lower interest on your loan. There are ways and means of bypassing this should you not have collateral. For example, you could apply for working capital finance such as invoice discounting or merchant cash advance that typically do not require any collateral.

    It also depends on what type of investor you are approaching. If you are start-up and you approach a VC, they will look at how innovative and viable your idea is and whether there is a market it. If you are approaching a Development Financier or government institution, then they may look at the development angle e.g. how many jobs do you plan on creating or how many people do you intend on upskilling. It is important to do some research on the investor as well to understand what is important to them. As far as possible, elaborate on these aspects in your application.

    Typical admin requirements:

    Applying for funding can be quite onerous here are a few typical documentations: company founding documents (CIPC registrations, shareholders agreements), particulars of owners and directors (copy of IDs, personal bank details, personal balance sheets, personal sureties signed), annual financial statements (some may require that these be audited), management accounts, cashflow forecasts and company bank statements. Where applicable, further documentation may be required. For example, business plans (especially for start-ups) or copies of tender docs, invoices if applying for bridging finance or invoice discounting. It is your responsibility to enquire what documents are required and submit a complete and thorough application.

    Knowledge is power

    While this is by no means a comprehensive list, we think it is important that you are aware of these aspects. Hopefully this will assist you in identifying where your weaknesses and gaps are and then it’s up to you to improve or explain it before approaching funders.

    If you are in the fortunate position of being offered funding from more than one investors, be sure to understand all their terms and conditions and to compare all the costs (interest rates, admin fee etc, percentage ownership), administrative responsibilities (reporting on job creation) but most importantly, whether you can afford it.

    If you are unsuccessful, you could approach other types of funders or try other products. More importantly, ask for feedback and try to improve your business to get ready for finance in a few months’ time.