8 Questions to Ask Potential Investors
Many business owners are excited about fundraising opportunities that involve capital from outside investors — and with good reason. The right type of financing can help a business scale and achieve major growth.
Yet there are also good reasons to be cautious about investment partners. Saying yes to a capital investment without digging deeply into the investor’s expectations can end up harming a business more than helping it.
To find the right investment partners, a business owner should ask potential investors some key questions about the terms before signing on. Known as “due diligence,” this process is a must for business owners seeking any type of funding, whether it’s a cash infusion, a business loan, or business line of credit.
With that in mind, here are eight questions to ask potential investors:
What do you seek to gain from this investment?
An investor’s goals may seem obvious: an ownership stake in a growing business and a lucrative return on the investor’s capital.
But business owners seeking capital need to know more. Is the investor trying to break into a new industry? Are they looking for a short-term payout or a long-term investment?
Investors may also want other things, such as intel about a business’ products and services, seats on their board of directors, or a say in running the company.
Asking investors what they seek to gain should help evaluate whether their expectations are a good fit for a business or if the business owner would prefer to seek funding elsewhere.
How much are you looking to invest?
It’s important to try to ensure the business’ needs and the investor’s capacity align.
If a deal is too small for a business owner’s needs, they may have to try to close the gap with other financing. If it’s too large, they may need to grow too big, too fast — resulting in severe growing pains.
Either way, if the level of investment is mismatched, that could make it difficult for a business to meet the investor’s expectations and secure the next round of funding to finance further growth.
What is your investment timeline?
Some investors have funds on hand that they’re ready to invest as soon as the ink dries on their next deal. Others may be building a list of companies they would like to fund as soon as they raise additional capital for their own investment pipeline.
If a business needs capital immediately, but the investor’s funds won’t be available for several months, the business owner may have to look at other investors or financing options.
A related question to ask is whether the investor envisions a one-time capital infusion or multiple funding rounds. If future rounds may be on the table, here are some questions to consider:
- What’s the likely timeline for those later stages?
- What metrics will be used to evaluate progress before those additional funds are offered?
- How confident is the investor that additional capital will be available when the business anticipates needing it?
Who has the final say over your investment decision?
When meeting with potential investors, the people who participate on the investor’s side may not be the final decision-makers who will determine whether a company will receive a funding offer. Finding out who can green light the deal could help small business owners get to yes faster.
Investors tend to use one of three frameworks to make investment decisions:
- Sole decision-makers: Most individual investors and some investment firm partners have the authority to make investment decisions without seeking approval from other people.
- Formal voting or scoring: Some investment firms use a more formal process for investment decisions. This process may involve voting or scoring various investment opportunities. Investments that receive the most votes or highest scores are more likely to receive funds first.
- Consensus decision-making: Other investment firms rely on internal discussions about various investment opportunities to arrive at a consensus for the deals they want to fund.
Investors may also use a combination of these processes to evaluate different types or sizes of investment opportunities.
Asking potential investors about the process they use to make investment decisions may give important insights into key decision-makers and their priorities.
How would you define your investment structure?
There are several main types of investors. Some are more focused on financial return. Others want to develop strategic partners or acquisition candidates. Some prefer to invest in startups, while others may look for a specific time horizon for their investment.
Understanding which type of investor has taken an interest in their business may help business owners evaluate whether the investor is a good fit.
Here are four common types:
Financial investors may be individuals or investment firms. They’re primarily interested in the financial aspects of their investment, including the return they expect to receive and the timeline for them to exit from the investment.
Financial investors may get involved at any stage of a company’s growth and invest thousands to millions of dollars. Businesses can expect to gain a wide variety of opportunities from financial investors; however, the return on investment is their main focus.
Strategic investors tend to be larger corporations that may be interested in a variety of objectives in addition to their financial returns. These objectives may include hands-on involvement in the company’s operations or decisions about its strategic direction. This investor may intend to acquire all or part of the company when it reaches a certain size or achieves specific milestones.
Angel investors are individuals who invest their own funds, typically in small or startup businesses. Angel investors may be more flexible in their investment choices since they typically don’t have to convince anyone else that an investment they are interested in is worth funding. Some angel investors focus on a specific sector, such as medical devices or technology innovations.
Venture capitalists (VCs) are individual investors or investment firms that provide capital to businesses at various stages of growth. Many VC firms — there are about 2,000 of them in the U.S. — have access to capital from pension plans or private foundations as well as wealthy individuals. VCs may be able to offer access to a network of potential venture partners as well as venture capital.
What is your risk tolerance?
Businesses tend to become less risky for investors as they grow: from seed-money stage, to startup, to early stages of operations, to finally the later stages when there’s an expectation of profit.
Some investors specialize in startups, which may result in a total loss of their funds, while others prefer to get involved at a later stage, when the risk of failure or a sizable financial loss is expected to be lower.
A mismatch between the investor’s risk tolerance and the company’s risk profile can lead to stress for both the business owner and the investor. For this reason, evaluating a potential investor’s risk tolerance should be part of a business owner’s due diligence.
What will the next round of funding look like?
Many investors focus on funding a specific phase of a business’ growth, and may specialize in startup, middle, or late fundraising rounds. Asking upfront whether future rounds might be an option and what those future rounds might look like can help evaluate the potential for a longer-term relationship with an investor.
Some investors may be open to additional funding rounds based on key metrics. Those metrics should be defined before deciding whether the investor is a fit for a company.
Do you have any references for other potential investors?
Regardless of whether a business is a startup or at a later phase of growth, every potential investor could help a business owner find leads for other investors. Don’t be shy about asking for names and contact information, references, and even introductions.
Keep in mind that an introduction or referral from an investor that is well suited to a business doesn’t necessarily mean the second investor will prove a fit for that company. Business owners should perform the same level of due diligence for every new contact as they did for the original investor.
Asking well-researched questions for inventors
The questions a business owner asks potential investors may be just as important as the questions an investor asks a business owner. Asking about an investors’ objectives, time frame, decision-making process, and risk tolerance should be a routine part of the due diligence process. A business owner’s goal should be to understand the investors’ expectations before negotiating an investment or ownership stake in the company.
Seeking investment capital may seem like a necessary next step for every small business, but it’s not without risk. Other options, such as a bank loan or business line of credit, are also well worth exploring when assessing how to grow a small business.