If you ask business owners, managers and entrepreneurs the topmost challenge they face with their businesses, you are most likely going to be told it is with funding. Today, this need has been heightened with businesses requiring financial support to navigate the impact of the COVID-19 pandemic. An even more important question that needs to be answered is this: Is it really the case of lack or unavailability of funding to businesses in the country or the case that the businesses do not meet what is required by the funding institutions or both? Admittedly, funds are not in abundance, yet one can still raise reasonable funding for his/her business venture if businesses are prepared well enough to access these funds. The two sides of the coin would be explored in Parts III and IV of the Business Outlook Series. Part III of this series seeks to provide insight into what funding institutions or investors look for in businesses to serve as a guide to businesses in developing their investor readiness. Part IV would discuss investor requirements for businesses that wish to access funding as well as what businesses could do to be prepared to attract and access funding.
First of all, it should be clear that investors and funding institutions take risks when putting their hard-earned money into a business and so are careful to select which business to invest in. In other words, business owners and managers must understand that, there are alternative investment opportunities available to those who have the funds and so are comparing many opportunities by evaluating the risk – return of each business before making a decision. Here are some factors that investors and funding institutions, irrespective of the type of funding (equity, debt or hybrid) consider:
- Legal Structure of the Business: The legal structure of a business communicates different levels of risk. For example, a limited liability company that has multiple ownership may be deemed less risky than a sole proprietorship in terms of shared risk. A limited liability company however suggests owners are less personally liable for corporate failure as compared with partnerships and sole proprietorship. The legal structure also influences the legal obligations such as governance requirements, financial statements preparation, tax obligations among others. Investors process legal structures differently and are largely more comfortable with a limited liability structures that has well-diverse ownership.
- Business Model: Investors mostly define their sectors of focus and the nature of businesses in which they wish to invest. The business model provides information on the business’ sector/industry of operation and nature of business. More importantly, the business model provides the rationale of how the business creates, delivers and captures value. It is the basis for innovation, serves as a basis for revenue generation, and serves as a common objective that is shared by those involved in the business. Investors will evaluate the business model to satisfy themselves that the communicated value would meet clients’ needs and that the business suits their investment focus.
- Profile of Owners, Board and Management Team: Investors are primarily concerned with the risk exposures of the owners of the business. A key area of concern is Politically Exposed Persons (PEPs). PEPs are deemed to carry a high level of reputational and political risk and investors are gravely concerned. Investors also want to be sure the business has competent board and management team members that have relevant and diverse skills set to lead the business. The profiles of owners, board and management gives investors insight into the credibility and degree of trust they can place on them to protect their investment.
- Market Availability: The viability of the business depends significantly on the quality of the markets it serves. A growing market gives confidence of ready demand for the goods and services. Investors look forward to the business’ in-depth understanding of the markets the business serves. Investors pay attention to market trends over the period. Investors are comfortable when there are off-taker agreements and other pre-production contracts with major customers especially where the funding is intended for expansion.
- Competition: A business’ ability to take advantage of available markets also depends on the degree of competition in the market. The investor would be keenly interested in the level of competition in the market and most importantly, the business’ competitive advantage, market share and competition strategies.
- Supply Chain: Investors and funding institutions are also interested in knowing the reliability and adequacy of all major sources of supply of key inputs to the business. The number and power of suppliers to influence the activities of the business is of much concern to investors. They will therefore evaluate service level agreements signed with major suppliers and the extent to which they are enforceable.
- Current Level of Investment: The current level of investments the owners have made in the business to some extent, determine the owners’ commitment to the business idea and is important to potential investors and funding institutions. Investors would like to share the business risk with the investee, so it is important when the owners have committed adequate resources to the business.
- Financial Health: Generally, it is believed that the success or failure of the business’ operations is expressed in the financial performance and position of the business. Investors are therefore interested in the financial performance, financial position and the cashflows of the business. Investors pay attention to the gearing levels of the business to assess the risk of insolvency. It is important to state that the reliability of these financial information is of major consideration and that is why the audited financial statements is preferred. Investors would also like to evaluate the trends in the profitability, liquidity and capital structure of the business. The evaluation of the financial performance and extent of reliability of the financial information are usually checked through financial due diligence exercise.
- Business Strategies: Investors may be impressed with the business’ historical performance. They however view the safety of their investment as one that depends on the future viability of the business. Investors are therefore interested in what strategies management have to ensure the business remains competitive and profitable in the medium to long term. They look forward to well-thought-through objectives with well-defined road maps for achieving these objectives.
- Compliance: Investors, especially where they are foreign, place emphasis on the business’ compliance with legal and regulatory requirements. They pay attention to issues such as compliance with licensing requirements; obtaining and adhering to certification rules; keeping the environment safe; treating employees and other stakeholders fairly; meeting tax obligation among others. This is because legal sanctions have a high potential to damage the reputation and continuity of the business. No investor would want to risk his funds nor reputation with a non-compliant business.
- Business Culture: Investors are mostly external to the business and would therefore rely on existing business structures and practices as the first step to safeguarding their investment. They pay attention to practices such as adherence to business policies and procedures; attitude towards work; corporate core values and adherence to same; relationship between superiors-subordinates; human resource management style among others.This is used to assess the sustainability of the business’ internal environment and its impact on the general health of the business.
In conclusion, it should be noted that investors and funding institutions have their own expectations that businesses seeking funding must meet and this puts some significant responsibility on business owners and managers to be ready before seeking funding. Remember that, your business is but one of the many investment options available to the investor. Consider the fact that ultimately, the investor selects the business whose risks translates into the potential returns. The look forward to minimized risks and maximized returns.
WATCH OUT FOR THE NEXT EDITION: What should business do to meet investors’ expectations.
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