3 Questions every Business Angel must ask – and every Entrepreneur needs to Answer

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There are three questions that every business angel (or Venture Capitalist, for that matter) will ask, and hence, these are the three questions that every entrepreneur and investment proposal needs to answer.

That is, assuming the entreprenuer wants to get funding.

Question 1. What will you spend my money on?

Business Angels want to know why you need the money in the first place.

And, they expect a specific and clear answer such as

to further product development

and / or

to commercialise the product or service/ take the product to market

Be warned, spending on anything is a waste of money and shows that the entrepreneur and his or her team may be developing bad or expensive habits.

A rule of thumb is that no more than 10% of the money invested should be spent outside of these two key areas.

Peter Drucker said that ‘money should be spent on marketing (and sales) and R&D (or product development/ innovation), everything else is a waste’.

Hence, Business Angels should expect a clear answer to this question.

Question 2. Are you a pay packet in search of funding?

If the entrepreneur / shareholder is using the new funding to pay himself or herself a big salary then as an angel investor you should reject the project.

For a business angel or VC firm to have confidence in the project, they want to know that the interests of the shareholders are all aligned.

Therefore, the scenario in which some shareholders earn large salaries (or siphon off the cash before it gets to dividends or before it can be reinvested) and others do not, will lead to disputes and disagreements.

Hence, it is fair and reasonable to expect that the entreprenuer’ pay-off will be in the sale of the business – a capital gain – not a big salary along the way.

Of course, entrepreneurs and their team need to eat during the business build and it is fair to pay some salary, but the rate needs to be set below market rate – by anything between 20 and 80%.

In general, a proposal that is still raising cash to develop the product might offer an entreprenur 20% of his or her market rate salary, whereas a developed product which is looking to commercialise and take the service to new markets (having already been proven) would look to pay upto 80% of fair market rate.

This discount to market rate salary should also apply to any commissions earned by the shareholder entreprenuers.

Question 3. When (and how) will I get my money back?

This is, of course, the most important question because investors want their money back.

Most entrepreneurs don’t realise that this is really important for the Business Angels and VCs and hence, don’t give sufficient thought to how or when this might occur.

Equally, as a Business Angel, you are wise to recognise that entrepreneurs are emotionally attached to their idea – as you’d expect and hence, they may be reluctant to sell the business or create lower quality but higher profit products and services.

A key part of your Business Angel due diligence will focus on whether or not you believe this team of entrepreneurs will be able to do the deal and sell the business when the opportunity arises.

As an investor, it is worth spelling out to entreprenurs and potential investees at the outset that you are just as emotionally attached to your money as they are to their idea or product/ service.

If the entrepreneur / investor relationship is going to work, then you both need to spell out this point early on and reach an agreement.

All 3 Questions Answered?

Okay, let’s say that this proposal and this team answer these three critical questions satisfactorarily.

Only then will the investor ask – do I have a reasonable chance to make a x3 (for low risk, highly developed business) or a x10 (for early stage or seed investment) return on my money within 3 years?

This question may become a reflective question as many entrepreneurs’ teams will lack the experience to accurately forecast the exit timing and method?

In which case, this will be the opportunity for the Business Angel to add value to the business proposal.

Without a credible exit plan, it may be difficult for the entrepreneurs to raise further funds. If you, the business angel, through experience and credibillity can help provide that clear plan, then you can negotiate a lower share price for the benefit of your experience and build an exit plan that you can believe in.

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Want to know if your business plan is suitable for funding? Easy, click here to take our free investment readiness survey and see if you can answer these key Business Angel questions….http://goo.gl/2VJLX