Why You Aren’t Ready for an Investment in Your Business

I am pitched for funding by business owners and real estate entrepreneurs daily. Almost all face a similar challenge: they need capital to start, grow or save their venture. All that’s required is a simple [insert $_____] investment.

Unfortunately, I have to reject 99% of the deals that I’m presented with. Sometimes it’s because the opportunity is a money graveyard. But more often than not, I pass on them because the entrepreneur has not considered the financier’s perspective.

Investors fund entities, not ventures

There’s usually a broad disconnect between a small business owner and an investor. The gap widens when the entrepreneur looks beyond her friends and family members for capital. When they approach people and companies whose livelihoods depend on making good investments, it’s often too hard to bridge the divide.

For example, I am not a skilled real estate developer. I couldn’t intelligently discuss installing new floors or cabinets that might increase a property’s value. I don’t have connections with skilled contractors or joiners. I’m not an expert.

Conversely, a “small” real estate entrepreneur – the type I usually work with – is generally not a corporate finance professional. They may not know the difference between a general security agreement, promissory note or convertible debenture. They can develop lucrative properties, but their finance knowledge often doesn’t extend beyond what’s asked by unsophisticated investors. They can answer questions from mom and pop, but they likely couldn’t survive a meeting with a hedge fund manager.

At the end of the day, an investment is a contract. It’s a legal agreement that documents various terms and conditions that the parties agree upon. A bad contract can turn a fantastic asset into a horrible investment. And therein lies the rub.

I’m often given pitches like this: “Alexis, if you invest $50,000 into this house, we’ll split the profits equally.” It will be accompanied by a thin package of pictures, numbers and basic market statistics.

What the entrepreneur typically doesn’t understand, however, is that the investment will actually be into a legal entity, like a corporation or partnership, which will then acquire the property. It’s a prerequisite for any informed investor. Shares will be purchased in, or loans will be made to, some form of legal body. Not the underlying asset. In most cases, the entrepreneur isn’t aware of that.

As such, the pitch should sound more like this:

“Alexis, if you invest $50,000 into this house, we’ll split the profits equally. We’ll form a corporation in which you’ll own 50% of the common stock. I’ll own the other half in exchange for the work I intend to do on the property. The corporation will then be used to buy the house. After the fees of maintaining the corporation are paid, it will distribute 100% of the real estate’s earnings to the shareholders.”

The average entrepreneur’s proposal will usually ask an investor to fund an idea. But investors don’t write cheques to concepts or imaginations. They write them to entities. That’s where negotiations begin to falter.

Why deal structure matters

Unwitting investors are often burned because a deal’s structure is disadvantageous to their interests. The asset that is purchased by the entity may perform well, but certain terms in the contract can preclude the investor from participating in all of the profits. Sometimes that’s because of innocent mistakes like poor tax planning. Perhaps the entity used to acquire the asset is inefficient for tax purposes.

Other times it’s due to the fact that not enough of the profits are directed to the investor. For example, the entrepreneur may charge a high management fee to the entity, which must be paid before cash is distributed to others. Or the entrepreneur might issue a separate share structure for investors that entitles them to less. Unsophisticated buyers will often blindly sign contracts without understanding that the fine print will ultimately determine their investment’s performance.

Knowing that, any investor worth her salt knows that structure, fine print and rights are king. They recognize that while the business idea has to be great, the contract must also be. Entrepreneurs will usually fall short in the latter part of that sentence. It just isn’t their expertise.

Does the entrepreneur need to be a finance expert?

When looking for funding from my firm, Assadi Capital Partners, the answer is: they’ve got to at least try. I can’t entertain detail-light business plans because I don’t have the time (or the interest). They’ve got to attempt to separate themselves from other contenders.

To be perfectly honest, it’s almost insulting to be asked for $100,000 without being provided with real due diligence material. When that happens, I think to myself, “Are you seriously expecting me to give you that much money with such little information? Do I look like a fool?” Entrepreneurs must know that we want information about the asset, the structure and how funds will flow from the asset to the structure and back into our pockets. And that’s just a starting point.

To make it easier, I have a page on this website with a set of questions that must be answered before I’ll consider a deal. Note that I ask for material about taxes, securities regulation and forums for dispute resolution. It extends far beyond business plans. I don’t need an offering memorandum or an academic understanding of corporate finance. But a real effort must be made.

Other financiers aren’t as helpful. They’ll immediately dismiss unprepared pitchers as amateurs. I have even heard of people being laughed out of a room. Remember, investors often have clients of their own. They’ve got a fiduciary duty to protect their interests. They won’t look at anything that’s less than perfect.

Conclusion

I’ve tried to mitigate the tone of this article so that I don’t appear conceited. But I think business owners would do well to hear the truth: no good investor will require less information than what I’ve put on the Funding page of this site.

To expand beyond friends and family members for capital, the entrepreneur has to take their pitch to a different level. There’s an endless source of good deals, but money is limited. The easiest way to weed through opportunities is by judging the sophistication and preparedness of the entrepreneur.

Many business owners are amazing at what they do. They are true experts in their craft. But approaching investors requires a new skill set: the ability to raise capital from professionals.

Finally, if you’re planning to go down this route, you should consider the following. Once you’ve got an investor, you’ve also got a master. You’ll likely have legal obligations to your client. You’ll have to take their phone calls, answer questions and even consult with them before making decisions. It can impact your personal life (sorry honey, no vacation this winter because the investment property needs to be renovated. If I don’t do it now, I might get sued.). Perhaps most importantly, you may have to deal with the burden of losing someone’s money if the deal fails.

About The Author

Alexis Assadi

Alexis Assadi is an investor, entrepreneur and writer, who advocates for making high-performing income investments and the lifelong pursuit of financial intelligence. He is a shareholder and director in three companies that provide funding to small businesses, entrepreneurs and real estate projects. His most recent venture is a firm called Pacific Income LP.

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1 Comment

  • Why Greenidge

    Reply Reply December 6, 2016

    “Alexis, if you invest $50,000 into this house, we’ll split the profits equally. We’ll form a corporation in which you’ll own 50% of the common stock. I’ll own the other half in exchange for the work I intend to do on the property. The corporation will then be used to buy the house. After the fees of maintaining the corporation are paid, it will distribute 100% of the real estate’s earnings to the shareholders.”

    that is what I needed thanks

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