Regardless of your industry, all small businesses share at least one common goal: substantial working capital. It’s almost impossible to grow an operation without the means for several major investments. When you hit the inevitable speed bump, your cash cushion will help you keep moving forward.
Access to business loans has improved dramatically as of late. But while it’s definitely easier for smaller businesses or entrepreneurs with bad credit to earn approval, younger businesses still struggle to obtain larger amounts. They haven’t been around long enough to fulfill the typical requirements for financial data. In order to approve larger loans, business lenders usually need proof that their new partner can generate stable revenue for one year or so. And even if they could get approved, you can’t blame younger businesses for not wanting to take on this much debt early on.
For these reasons, younger businesses often bypass debt financing and focus entirely on equity financing. This leaves them with two options for funding: venture capital firms and investors. Though the former can likely supply more funding, the latter option poses little (if any) threat to your authority as the business leader. Investors also don’t need to see as much data, partially because of the value they place in the business leader’s character.
There’s just one problem: Unlike venture capital firms, you can’t simply search for investors on the web and get their contact information. In this guide, we’ll explain how to find small business investors, and what kind of relationship most investors expect from new entrepreneurs.
Who are Small Business Investors?
Small business investors usually work with early-stage businesses and provide five-figure amounts (much less than venture capital firms). Most investors only work with certain types of businesses. In addition to industry, investors can specialize in specific business models (B2B, Ecommerce, etc.) or choose to work with entrepreneurs from specific backgrounds. For example, an increasing number of investors specifically pursue entrepreneurs who have the odds stacked against them due to uncontrollable circumstances like gender or race.
Equity financing does not guarantee returns, and investors understand that. They’re essentially betting on your company to succeed, which will likely take years. But when your business reaches the peak of its success, your investor might stand to make even more money by selling his or her shares.
Many small business investors are retired entrepreneurs who wish to bestow their knowledge and experience onto younger generations. But since investors don’t provide as much funding as venture capital firms, they typically expect little (if any) involvement in managerial decisions. Instead, they’ll show their true value by connecting you with other powerful partners when you need more resources later on.
Small Business Investors: Important Terms to Know
Before you start your search, you must first establish the type of investor you’re looking for, and not just in regards to specialty. The following terms are used to distinguish the various investment options available to small businesses:
Angel investors usually provide their entire investment at once, and that’s it. They help entrepreneurs turn their ideas into businesses, but then it’s up to the entrepreneur to maintain the upward momentum. Entrepreneurs in search of angel funding are usually looking for just one or two investors. This allows them to develop close relationships with these investors and avoid relinquishing too much equity.
Entrepreneurs in search of seed funding, on the other hand, are looking for a partnership similar to venture capital firms. They intend to take on multiple rounds of funding from multiple investors, giving up substantial portions of equity (and possibly managerial authority) in the process. The seed round is just another name for the first round. When you declare that you’re looking for seed funding instead of angel funding, it denotes that you will eventually require further rounds of funding from more investors to continue expanding your business. Hence, businesses that ask for seed funding are typically very confident in their potential for rapid growth.
According to the definition from the US Securities and Exchange Commission (SEC), an accredited investor must have earned at least $200,000 on their own or $300,000 through a partnership within the last two years. The investor must also be on track to earn a similar amount this year. However, you don’t have to full this income requirement if your net worth exceeds $1 million.
Accredited investors have access to investment opportunities that are very lucrative but also very risky. The SEC reserves these opportunities for accredited investors to protect lower-income investors from losing massive amounts of money on risky investments.
Hence, when talking to potential investors, make sure they have all achieved this status. You should never accept money from anyone without proof of accreditation.
Most investors provide funding in exchange for shares of equity, or ownership in your business. The amount of shares you sell usually corresponds to the amount of money provided by your investor. Selling shares decreases the business owner’s income from company profits. Every time you accept more funding, you lose more personal income.
Some investors and startups, however, prefer to use convertible notes, which is a form of debt financing. Basically, the investor gives you a loan with a due date (usually 1-2 years) and interest rate. But instead of paying the investor back like you would with a regular loan, you pay the
investor back with equity. When the due date arrives, the investor receives equity based on the principle (the amount of funding you initially received) plus interest. Your business lawyer will explain the details as to how the debt converts into shares.
Why would someone choose this over traditional equity financing?
When you approach investors for financing, the value of their shares depends on your business’s estimated valuation. Anyone who has watched Shark Tank knows that new entrepreneurs tend to dramatically overvalue their businesses. In order for the investor to accept the equity, he or she must agree with your valuation. Many pre-revenue startups have found that it’s very difficult to come to such an agreement. After all, it’s not as if you or the investor have lots of valuable data to base your estimation on. Convertible notes allow you to postpone this process until the loan’s due date, when you actually have data to support your valuation.
Earlier, we noted that small business investing puts tremendous risk on the investor. Well, that risk decreases significantly when the funding doesn’t come from just one person. Syndicates pool their money to invest as a group, most of which have lead investors who supply the bulk of the funding. You’ll probably correspond with one member of the group, since it would take too much time for every member to evaluate your business’s potential.
What Kinds of Small Businesses Should Look for Investors?
It’s entirely feasible for extremely young businesses to obtain equity financing from investors. But you need more than just a great idea or a hard-working team. Businesses that succeed in obtaining funding from investors usually have some sort of evidence that people will like their product or service. This could include proof of concept, data from focus groups, or market research that shows emerging trends or shifts in demand. Investors typically prefer to see as much data as possible because it gives you an idea of how to spend their money.
You should also consider seeking investors if taking on additional debt from business loans or credit cards would likely do more harm than good to your cash flow. And though your investor will probably have little involvement in your day-to-day routine, you should still welcome the advice of someone with real experience.
On the other hand, funding from investors might not be in your best interest if you have no form of evidence to support your potential success. This suggests that you don’t have specific purposes for the funds and no clear vision of your business’s future. It’s also perfectly understandable to not take on investors solely because you want to lead your business entirely on your own. Your personal goals may differ significantly from your potential investor’s goals, which may very well include making as much money as possible in the shortest amount of time.
Lastly, do not take on investors if you plan on using the funds primarily to offset major losses or pay off extensive debts. The same concept applies to small business loans.
5 Ways To Find Small Business Investors
Unfortunately, there’s no textbook method to finding small business investors. It’s not like venture capital firms, where you can just browse the National Venture Capital Association for firms that specialize in your industry and business model. But like any business endeavor, the right blend of strategy, patience and work ethic will bring you closer and closer to your goal.
Welcome to your first real test as an entrepreneur. You will most likely have to capitalize on all five of the following approaches in order to maximize your opportunities for that life-changing meeting:
All business owners know the power of referrals. Most people (including investors) trust recommendations from friends or business partners over any other form of marketing. So, do some personal inventory and think of everyone you know who could possibly introduce you to an investor. If you’re not sure about someone’s connections, it doesn’t hurt to ask. You could talk to other entrepreneurs, financial advisors, attorneys, or simply anyone connected to wealthy social circles.
Do you know any entrepreneurs from your industry who have obtained funding from investors? Your best chances for recommendations will likely come from successful entrepreneurs who can vouch for your expertise and determination. Investors trust the opinions of entrepreneurs they respect.
Networking can help you in at least two ways: tapping into your own networks or contacting groups of investors. You may already possess the requirements for joining certain networks in which entrepreneurs and investors co-mingle in social environments.
Many entrepreneurs start at the most logical place: their university’s alumni network. Though you might not find an investor who belongs to your alumni network, someone from this group could probably point you in the direction of one. You could also talk to former professors, social media contacts (especially LinkedIn), or even bloggers who write about small business financing.
With social media, you should undoubtedly let your LinkedIn contacts know that you’re looking for investors and ask if they can connect you with someone from the finance industry (not just investors). Remember: In addition to contacting investors directly, you must also connect with anyone who could possibly put you in contact with one.
3. Online Platforms
Many accredited investors use exclusive online platforms to choose their next venture. These platforms, like the Angel Investment Network or AngelList, showcase new businesses with above average potential to individual investors or syndicates. So, contact the platform with the structure you like best (individual or syndicate) and inquire about adding your business to their list of new opportunities.
4. Conferences and Summits
Every approach has the same goal: securing face-to-face meetings with investors who fit your criteria. Well, what if you found yourself in an environment with hundreds of potential investors with experience in your industry? Numerous industry conferences and summits take place every year, but entry doesn’t come cheap. So, before committing to one event, make sure it usually attracts the investors you have in mind, and see if you can reach out to any of them beforehand to secure your meeting.
Also, most investors won’t agree to deals after hearing one pitch. They might seem intrigued, but that doesn’t mean you have their word. It’s up to you to nurture the relationship after the event and ensure the investor won’t uncover any information that makes them reconsider. You may have perfected your elevator pitch, but it’s the post-event nurturing that ultimately seals the deal. It will likely take time to court your potential investor into an actual agreement, and there’s no guarantee that the investor won’t suddenly change their mind for reasons beyond your control.
As you can see, investing in industry conferences and summits might only make sense if you’ve got plenty of money and time to spare.
5. Cold Calling/Messaging
If cold outreach offers the lowest chances of success, then why do people keep doing it? Believe it or not, plenty of new businesses have secured funding through cold emails, phone calls, or direct messaging on social media. Unlike traditional cold outreach, however, these entrepreneurs likely researched potential investors before making contact so they could tailor their pitches to the investor’s preferences.
They also likely followed the number one rule of cold outreach: make it seem personal. Your tone and content must show the effort you’ve put in to crafting an original pitch. If you don’t do your research and use generic phrases, investors will immediately write you off as “spam” or “just another cold caller.”
Should You Also Consider Venture Capital Firms?
If your business has already gained traction and you wouldn’t mind taking someone else’s advice, you might want to consider pursuing venture capital firms instead of investors. Venture capital firms base their decisions almost entirely on data, rather than clever elevator pitches or personal connection. Your business plan should envision continuous growth and show that you will only spend their money on initiatives that coincide with this objective.
Here’s four more reasons to choose venture capital (VC) firms as your source of funding:
1. VC Firms Make Larger Investments
VC firms usually make minimum investments of $1 million. Larger investments, however, means more equity for the firm. You’ll receive multiple rounds of funding as your company grows. The more money you receive, the more equity (managerial authority and cut of company profits) you lose. VC firms make larger investments because want your company to grow quickly and exponentially.
2. VC Firms Expect More Authority
Most investors will allow you to manage your business on your own and limit their involvement to providing suggestions here and there. VC firms, on the other hand, have strict agendas that align with their goals. They will therefore expect you to manage the business according to their rules. Failing to follow their rules could jeopardize future rounds of funding. And thanks to the size of their investment, you’re not exactly in the position to say no.
3. VC Firms Want Explosive Growth
When we say that VC firms want to grow your business, we’re not just referring to making lots of money. For VC firms, success means turning startups into publically traded companies. Once you receive your final round of funding, your VC firm will likely set their sights on an IPO. If the firm made their investment very early on, an IPO could result in unbelievable earnings.
So, while investors might actually care about your personal goals, it’s all about the money for VC firms.
4. VC Firms Specialize in Thriving Industries
VC firms know what works and don’t like to take chances with unfamiliar industries. Unless your industry has massive growth potential, you should not pursue venture capital if you don’t work in the same industry as the firm’s previous businesses. Remember, VC firms base their decisions on hard data, logistics, and prior experience. They won’t invest in businesses with the odds stacked against them or partner up with entrepreneurs solely because they admire their courage or intelligence.
Are Small Business Investors Really Right for You?
Up until fairly recently, rapid growth was the most appealing path to success for startups. But if you look at virtually every online business article, they all offer the same advice: don’t grow too quickly. One of the biggest risks of taking on an investor is putting a tremendous budget in the hands of an inexperienced entrepreneur. Countless businesses have made the mistake of rushing the growth process (marketing, hiring, etc.) rather than spending their money steadily and wisely.
If you want to steer clear of this common misfortune, look into debt financing instead of equity financing. You can approach the growth process without haste and keep a close eye on your cash flow along the way. Paying off debt while covering growth-related expenses will also teach you how to make the best use of your budget. This skill will certainly come in handy when you have a lot more money at your disposal.