The Investor Crisis Mindset
Do you want to know how to stay investable? A lot of people have asked me “What is going to happen with the funding process when things return back to normal?”, “Should I raise funds now or wait?”, “What can I do to increase my chances of success when I do want to approach investors?” These are not easy questions to answer and without a crystal ball it’s difficult to say with certainty what will happen. However, what you can do is try to understand the mind set of investors during this time so that you can walk a mile in their shoes and better prepare for the road ahead.
This current pandemic has brought with it some unprecedented challenges and changes both in the way that we live and work. Whilst it’s hard to work out exactly what will happen once things return to “normal”, and it is indeed possible that things may shift dramatically and we will have to find a new normal, the one thing that is certain, is that show must go on, and businesses will still have to find funding to survive and grow.
In this uncertain environment, it’s important for entrepreneurs to understand investors’ perspectives, how they have reacted to this crisis and what they are likely to do next. Understanding these things and their likely consequences will no doubt help entrepreneurs looking for funding, in their conversations with investors.
Now the first thing that you must understand is that investors are human beings too. I know that you may think of them as glorified cash dispenser, but aside from having cash, they also have businesses, families, and existing investments that have all been impacted by this crisis. Many venture capital firms and angel investors are spending the vast majority of their time at the moment in triage, nursing their own businesses where staff may have been furloughed and their revenues have shrunk. They are probably also nursing losses from their investments in the stock market, where prices across the world have dropped significantly and volatility remains high. Not to add that for those investors that manage funds or collectively invest, they have their underlying investors to manage. They need to let them know how their underlying investments are performing through this crisis, and what are the risks that these investments will blow up in the near future.
Needless to say investors in general are currently very busy trying to maintain their existing investment portfolios. Following on from all of that it is probably unsurprising to hear that at the moment there are few investors that are looking for new investment opportunities right now.
As with every crisis, there are those savvy investors that are around and still looking to do deals. As time passes more and more investors will come back to the table looking to invest in promising businesses. But, when investors do come back to the table, what should we expect? Will they be looking for the same things as they always were? Or have things changed? Well, in short the answer is that yes, things have changed!
Think of it this way. If you have ever seen a still pond or lake and then dropped a pebble into the water, you see the ripples expand out in concentric circles. Well, if you imagine a bolder hitting the same water, the ripples are going to be bigger and extend out further. Now that you can picture that, those ripples are a way of describing volatility, which is more commonly expressed as risk! The size of the risk is the biggest thing that has changed for investors and that’s the thing that will have the biggest impact on how investors will behave going forward.
So, let’s just touch on a few of the basics of investing to help you understand what the consequences might look like. Everyone knows that investors want to see a return on their investment, they want that little acorn of cash they provide to turn into a boatload of cash. Now what many people often forget, is that investors also strongly consider the other side of the coin, the risks involved in each investment.
These risks are generally to do with the team involved in the business and their ability to deliver revenue and growth; the strategy that a business has to expand; the market environment and competition. With the world being in such an unprecedented situation, and so many unknown variables it is unsurprising that investors are unsure about what the future will bring. Without that clarity, it is difficult for them to make calls with any conviction on which businesses are going come out of this situation as winners.
In short, until the dust settles and the water becomes calmer, investors in general are going to be more averse to taking risk; and when they do take risk, they’ll need to be compensated more for doing so. Hopefully, this gives you a bit of a better understanding of how investors are thinking right now. But the big question is, “What can I do to make my business more attractive to investors?”. Well, the first thing to do is to try and minimise the risk of your business to an investor as much as possible. Easy to say, not so easy to do.
For startups, then the best thing that you can do is to start making money. Companies that are pre-revenue are going to find it harder than ever to raise funding as there is a much bigger risk for investors with companies that have yet to prove that their business can generate revenue and has a business model that works. So the focus has to be on revenue first rather than putting all the bells and whistles on your business. Get the core concept right and get it rolling as quickly as possible. That significantly reduces the risk for investors.
For scaleups, it’s all about streamlining costs and showing you can be adaptable. Many companies have been looking to cut costs of operation, but for investors, now is the time to show that your business has the leadership to be able to create a lean mean money making machine. Showing that you have the resilience to survive these challenging times means that they will have more faith in your ability to keep the business alive and therefore reduces their risk.
People often quote Darwin and say it’s “survival of the fittest”, but that’s not actually true. What he meant was more like “survival of the most adaptable”. It’s the same with businesses, if you can show that your business can evolve and quickly adapt and take advantage of changing circumstances this will be a significant advantage for you with investors.
Pivoting your focus and adapting your strategy to the new normal will show investors that you are ahead of the game and this also reduces their risk. Investors think of businesses like sharks, if they don’t keep moving forward, they drown! Take full advantage of all the government assistance that is currently available. Consider the government loan schemes such as the UK’s Coronavirus Business Interruption Loan Scheme, or the Coronavirus Bounce Back Loan, or equity schemes such as the UK Future Fund, or regional co-investment funds.
Think about tax incentives such as R&D tax credits or grants from organisations such as Innovate UK. Showing that you are resourceful and can raise funding from other sources will also reduce the risk for investors.
Now, to talk about the elephant in the room - valuation. Even at the best of times, valuation is a touchy subject, but now more than ever it’s something that needs to be handled with care. When an investor values a business, they always (whether this is done explicitly or implicitly) take account of the risk.
Given that we are in a much more risky market environment, it is therefore no surprise that the increased risk is likely to mean that business valuations will have to reduce to be attractive for investors. It’s important to remember that for investors the price that they pay for an investment today, has a significant impact on the return they will make tomorrow. Higher risk, demands a higher return, which in turn leads to lower valuations. So, be conservative with your valuation. If I had a penny for every time I’ve said that to an entrepreneur and they have ignored me, I’d have been able to buy a new Ferrari. Now is the time to take this seriously, having an expensive valuation now could seriously hobble your chances of getting funding.
We all know that these are challenging times, for entrepreneurs and investors too. The aim of this article was mainly to help entrepreneurs to understand the investor perspective. By understanding each other’s position better in these extraordinary times, the hope is that you will be able to communicate better, reach agreement with each other and hopefully close more deals.