Newspapers are filled with stories about unwary investors misled by duplicitous CEOs and corporate founders. But what is far less covered is the unreasonable or bad faith investor who peppers all levels of the organization with demands for information, who panics over every change in the marketplace or the business plan, who doesn’t trust management, who poisons fellow investors against the company, who tries to mount an internal takeover, or who threatens legal action to secure preferential treatment.
Understanding whom you’re inviting into your business is important–if not critical. Here are five steps to consider when evaluating investors and devising best practices and procedures for longer term investor management:
Step 1. Profile Whom You’re Willing to Consider As An Investor.
Before you begin adding investors to your business, it is helpful to know what sort of investor you want at the deal table. Consider these factors before tapping on potential capital sources:
- What does the business need from an investor? Is it more than just money?
- Are you looking for just one type of investor? Or would your business benefit from a range of differing investors who can provide things like access, experience and expertise?
- What are you willing to exchange in return for an investor’s time and capital? Is it more than just shares?
- Is there anyone you think inappropriate as an investor; for example, someone who has interests in a competitor?
Money is important. But other things matter too. Thinking through whom you’re inviting into your company and the terms of investment can be important to avoiding subsequent disputes.
Step 2. Treat Due Diligence as a Mutual Exercise.
Due diligence isn’t only about the investor evaluating the benefits and risks of investing in your business. It’s also your opportunity to learn about the benefits and risks of allowing the investor into your business. In doing your own due diligence, think about:
- what the investor says they can do for your business.
- the investor’s sophistication generally, and in regard to your industry.
- how well the investor understands your information and the opportunity as presented.
- the investor’s finances and ability to bear a loss.
- the investor’s legal history, including as a plaintiff and defendant.
Step 3. Know Thy Investor.
Performing due diligence on a potential investor may feel much like conducting a job interview. And in some ways it is. As much as you’re selling the investor on why you’re a good opportunity, it’s not unreasonable to expect that the investor ought to try and sell you on who they are and what they can do for your business. Here’s some things to consider:
- Ask for references.
- Collect concrete information, like tax returns and personal financial statements.
- Don’t discount your feelings and what they’re telling you.
- Ensure the investor’s values align with those of your organization.
- The best predictor of future behavior is past behavior, including the investor’s conduct during due diligence and in negotiations.
Step 4. Know What You’re Willing to Do – and Not.
There’s always a sunk cost when engaging with a prospective investor. But an investor may ask for more than you initially planned to give, whether in transaction value, time, or both. In deciding whether to make the extra effort, pay attention to the following red flags:
- Does the investor treat due diligence cavalierly?
- Is the investor’s due diligence disrupting your business?
- Is the investor always the “smartest guy” in the room?
- Is the investor a little too creative, stalling decisions and eating time with schemes that depart from the concrete and practical?
- Is the investor dishonest or inconstant?
- Does the investor employ weaponized or strategic incompetence?
You may be willing to absorb the risks that come with these red flags depending on the business need and what the investor brings to the table. But at a minimum, they should inform (1) your strategic response during due diligence, (2) the terms, acknowledgments, representations, and warranties incorporated into the final investment agreement, and (3) post-investment investor management protocols and procedures.
Step 5. Don’t Cheapen Your Value.
Good manners cost little. And they can help foster valuable connections even if the parties don’t proceed with an investment on this round. But in dealing with potential investors, don’t lose sight of the fact that:
- Your business is valuable.
- Your time is valuable.
- Your sanity is valuable.
- The continuing smooth operation of your business is valuable.
- Your team members and what they do are valuable.
Even good investors may require periodic reminders that your hard work and years of dedication matter, even if they’re the ones holding the cash. Don’t sell yourself short. And be prepared at various points to say “no.”
The attorneys at Baker Jenner LLLP have helped clients ranging from startups to middle market movers and shakers and Fortune 500 companies in a wide variety of corporate governance and investor situations. Whether your business needs assistance in planning an investment approach, engaging in a merger or acquisition, or advice and representation in litigation, contact Baker Jenner to schedule a consultation today.
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