How to Evaluate Investors

For entrepreneurs who are beginning discussions with investors, here are the key questions you need to ask yourself to evaluate which investor make sense for your business.

Does the investor pass an initial sniff test?

Google the firm before you agree to a call or meeting.  Nearly all reputable investors have an online presence.

While information on firms’ websites is limited, you can determine high-level investment profile and criteria.  If your business and transaction interests don’t align, then you will likely waste your time talking to the investor.  If you get past initial conversations, it’s essential to do a background check on the investor by talking to their existing and past portfolio companies.

Does the investor deploy the type of capital and invest in the kind of transaction you want?

Even if you’ve researched the company thoroughly, sometimes websites aren’t in line with the types of transactions investors actually do.  Make sure you understand if your desired transaction is in-line with the investor’s typical investment profile.

Does the investor’s typical investment size line up with your business?

As a general rule of thumb, investors invest about 10% of their total fund in each portfolio company.  If an investor has a $100M fund, it is a safe assumption they are looking to put $10M to work in each deal they do.

Can the investor help you meet future goals with follow-on capital?

Companies need additional capital for all sorts of reasons. Sometimes it’s because the company is struggling, other times it’s to fund growth initiatives such as acquisitions. Make sure you understand whether or not an investor has the ability to fund additional cash.  FYI – If an investor is nearing the end of its fund and hasn’t started raising an additional fund, they may be out of cash.

Are you comfortable with where the investor’s capital comes from?

Traditional investment firms raise a dedicated fund from high net worth individuals and institutional investors.  This is committed capital the investor draws down on for each deal.

However, some firms never raise a committed fund and are instead set up as “fundless sponsors”  Fundless sponsors are either 1) pledge funds, who sign up a deal then raise capital, 2) investment clubs, which have a group of individuals who participate in deals on a deal by deal basis, or 3) family offices.

Whether it’s a traditional investor or a fundless sponsor, inquire as to who the underlying investors are and make sure you’re comfortable with it.

Do you understand the investor’s management style?

Some firms are very involved in the day to day operations while others are passive investors who leave running the company up to the management team.

Are you comfortable with the investor’s oversight requirements?

There are two types of oversight requirements: Board seats and Reporting.

Investors will require management to share information on an annual, quarterly or even monthly basis.  Ask for an example of existing portfolio reporting.  This will help you understand the time commitment and resources needed to comply with oversight requirements.

Most investors will require at least one board seat.

Does the investor provide something other than capital?

Investors will differentiate themselves by offering value-added capabilities. This is anything from a network of relationships, bulk purchasing power, operational resources, etc.

Are you and the investor on the same page for the strategic plan for the business?

If you are still running the business, get a clear understanding of the investor’s goals.  Are you on the same page with the growth strategy?  Do you understand if the investor is going to push for cost reductions?

What is the firm’s track record?

Do the firm and the partners involved have a track record of success? Have they profitably invested in and helped build businesses?  Probe on the key partner’s experience.

Can you work with these people for the next few years?

This is probably the most important of all questions.  Do you want to partner with this firm and the people who represent it? Reflect carefully on each of your interactions with the firm.  Ask for references from existing portfolio company executive teams to hear about their experiences.

Additional Questions to Ask During Initial Meetings:

  • What is your background?
  • What industries/sectors are you focused on?
  • Do you lead rounds?
  • Do you co-invest with other investors?
  • Who have you co-invested with?
  • What does your typical investment process look like?
  • How long does your typical process take?
  • What does your diligence process look like?
  • What does the decision-making process look like?
  • Who is involved in the diligence process?
  • Do you require a board seat?
  • Who would be the board members?
  • Can I speak with a few of your existing and past portfolio company CEOs?
  • How often have you had to replace the executive team?
  • Is my business a fit with your investment strategy?
  • What do you find interesting about my sector/space?
  • How do you support your portfolio executive teams?
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