Dan MacDonald on how to approach investors

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Dan MacDonald is president and CEO of Halifax-based InNOVAcorp, which operates as a venture capitalist through management of the Nova Scotia First Fund. Its seed and early stage investments target emerging technology companies that have high growth potential. Mr. MacDonald, who has 23 years of experience building businesses, talks about the investor-entrepreneur relationship.

What's your advice on how entrepreneurs can attract investors? What are investors looking for?

Dan MacDonald: Entrepreneurs need to be aware that individual investors – be they angel investors or institutions – tend to invest in certain types of industry sectors, business models, stages of growth, business size, locations, etc. While investors can obviously expand their scope from time to time, it is important to understand, as much as possible, the investor's tendencies in order to determine compatibility.

Investors who are open to considering investments in entrepreneurs are looking for opportunities that have the right combination of five elements: people, market, “barrier,” fundability and potential return. (And, of course, a product or service that is compelling and articulated clearly in a couple of minutes.)

People: This one is key. Investors might make their mind up in the first 60 seconds based on the approach and style of the entrepreneur. Beyond first impressions, investors want to understand the entrepreneur's relevant expertise, commitment to success, the level of their own skin in the game (money and time), ability to recruit and lead additional talent, to manage finances and to clearly communicate and execute the path forward.

Market: The addressable market for the product or service needs to be large enough for the potential revenues and profits to be interesting.

Barrier: The barrier to entry for a potential competitor must be high. The recipe of expertise, trade secrets, industry contacts, intellectual property, partners – or put another way, the “unfair advantage” of the opportunity – must be such that it will not be relegated to one of many.

Fundability: When the investor considers the amount of funds and time that will be needed to obtain a return on investment, the investor needs to believe that the business can attract the required funds and execute the plan.

Return: At the most basic level, investors are looking for a return on their investment. The potential risk and return from investing in an entrepreneur competes with the other types of investments. Entrepreneurs must appreciate the fact that the opportunity they are presenting to an investor may be one of many the investor has been presented with that month, that week, even that day.

What are common pitfalls of negotiating with an investor from the perspective of the entrepreneur?

Dan MacDonald: Entrepreneurs commonly approach investors before they are ready to clearly articulate the opportunity and answer or defend the questions on people, market, barrier, fundability and potential return. Many investors do not give second chances.

It's also not ideal to negotiate with your back against the wall. Obviously an entrepreneur who is virtually out of money is not going to be able to negotiate as good a deal as one who has time to consider other options.

Also, entrepreneurs need to consider the investment under negotiation in the context of what will likely happen, in at least the medium term. For example, how will the company valuation (that is, enterprise value based on the percentage of company purchased for the amount of investment) set by this investment look to future investors? Ideally, the valuation of the company will rise over time.

Another common pitfall is providing too much information too early. To get to a point where you are actually negotiating with an investor who seems compatible and trustworthy is an accomplishment in itself. Until this point, the entrepreneur needs to be careful to be truthful, of course, but also be aware of the timing and depth of certain information provided to the investor.
Proprietary information relating to the technology, detailed plans, financial information, etc., should be held until the investor has put an offer, pending due diligence, on the table. While the investor can back out of the deal at any time, the entrepreneur needs to understand the types of terms and conditions the investor expects for the given amount of investment. Better to know early on than find out after you have bared all.

Geneviève Gagnon, owner of La fourmi bionique granola company, got to know her investor. But she had her business mentor do the actual negotiating, so as to limit tension. She says this worked very well for her. What are your thoughts on this?

Dan MacDonald: Having a representative negotiate on your behalf has its pros and cons. Potential pros include avoiding potential damage to the working relationship, and time to consider and discuss terms and conditions without the pressure of a face-to-face encounter.

But there are cons, too. If you delegate negotiation responsibility, then you may end up with a deal you do not like. If you can't negotiate your own deal with a potential investor, it may be perceived as a weakness. You could also miss getting to really know the character of the investor. Many investors would not accept negotiating through a delegate.

Ideally, you, the entrepreneur, would seek advice prior to and during the negotiation. If you are uncomfortable with a term or condition, ask for it in writing so that you can seek advice. Have a sense of urgency but do not let yourself be rushed during negotiations.

Ms. Gagnon regrets sharing with the media the percentage of her business she sold (she did not disclose the dollar amount). What are your thoughts on how openly entrepreneurs should talk about such deals?

Dan MacDonald: While it is very tempting to share the details of an investment – especially one involving an investor whose name or brand can improve the credibility of the entrepreneur – it is not advisable. With the investor's permission, simply stating that they are an investor is all anyone should know. Depending on the market the entrepreneur is addressing, customers might request financial information looking to ensure solvency. This should be handled carefully, again without disclosing details of the investment.

Once the deal is signed, what's your advice on managing the investor-entrepreneur relationship?

Dan MacDonald: Regular and clear communication is key. Understand the investor's expectations for communication and involvement, and exceed these expectations without overdoing it. Communicate sales won only after the deal is truly closed. Whether it is good news or bad news, communicate the impact and your plan to capitalize on the good or manage and minimize the not-so-good. If there is neither good nor bad news to share, then call with a regular update anyway.

If you have set an expectation that for good reason is no longer achievable, or that you discover is not feasible, then reach out and explain yourself. Suggest a new go-forward plan and ask for their advice. Follow up in writing with the new agreed path.

Should entrepreneurs be prepared in case things go unexpectedly bad between them and their investors? If so, what can they do?

Dan MacDonald: Like most relationships, there are bound to be some rough spots. If things go unexpectedly bad, and you have regularly communicated and tried your best to keep things on track, then the investor-entrepreneur relationship may change but should be manageable.

If things go unexpectedly bad, and you have not regularly communicated and you surprise the investor with the bad news, you should expect – and maybe deserve – a rough ride.

Dan MacDonald