Three tests to see whether your start-up is investment ready

Start-ups looking for cash might consider equity as an option to fund their early stage and ongoing funding requirements.

When talking equity, the most commonly known option is venture capital. However, venture capital funding in Australia is tightening with fewer deals completed in the 2012 financial year compared to previous years.

Also given the general downturn in the economy and the lack of returns from the venture capital sector, venture capital funds are now finding it difficult to secure funds from their traditional investor base of funds, as indicated in the AVCAL Deal Metrics Report 2012.

As a result, start-ups should consider the other equity options available to them.

A significant investor segment to consider is high-net worth individuals. According to the Capgemini and RBC Wealth Management Annual World Wealth Report, Australia is ranked as the 9^th largest high-net worth investor population by country, with 180,000 high-net worth investors in 2011.

Another alternative is angel investors, who typically invest as a group of individuals to provide cash and in-kind support to seed and early stage start-ups.

The Australian Association of Angel Investors estimated angel investors invested $1 billion in 5,000 early stage businesses just in 2010.

Given the volume and number of potential investments that these two segments provide in Australia, there’s compelling motivation to investigate whether your start-up presents a good investment opportunity and is investment ready.

Here are my top three tips to evaluate whether your start-up is investment ready:

1. Assess whether you are the right type of business for equity investment

Investors take on a high degree of risk when they invest in a private business, so they want to know your business is scalable or saleable and will return a reasonable profit on their investment to compensate them for that risk. Scalable businesses are set up to handle massive growth often within a rapid time frame.

Saleable businesses are just that, businesses set up with a vision to be sold in the short term and provide the founder and their investors with a return on their investment as a result of that sale.

All investors expect to see a clear path to getting their cash back, plus some, either through a sale or some other form of liquidation event such as an IPO, or the introduction of other investors that buy out the initial investor group.

Venture capital funds have specific and stringent requirements around when and how that return will be delivered as funds are set up with a specified life and need to cash out and provide a return to their investors before the fund is wound up.

If your motivation is to establish a business that remains small and provides for your personal financial and lifestyle objectives with limited growth plans beyond that, you might not be a suitable candidate for equity investment and should consider your other funding options such as debt or grants.

2. Have an investment ready plan

Among other things your plan should address:

• What type of support you need – cash or in-kind support.

• How much cash do you need and when?

• What are you willing to give away in return?

Investors bring money, but can also provide a wealth of contacts, industry or management expertise and knowledge. Different investors may be experienced and focused on different stages of the business cycle, some looking for seed and early stage investment, others looking for investment in later growth stages.

Match the type of investor you target to your business plans and goals and you’re more likely to be successful in engaging them.

The stage of investment also brings other considerations as well. The greener your start-up the higher the risk, the greater the return investors will expect. So if you’re still at the stage where you’re testing and proving your business idea and developing your initial customers, expect investors to ask for more.

Conversely, when your business model has been proven and you’ve started to build more value in your business, your risk will start to reduce and investors will seek a return but generally not as high as for early stage investments.

Story continues on page 2. Please click below.