Bringing in an investor: what to prepare before the first conversation

Most business owners only go through an investment process once. Investors, by contrast, assess businesses as part of their work. That imbalance is one reason owners find the process stressful, and one reason good businesses sometimes end up with a worse deal than they deserve.

We sit on the investor's side of the table, and this guide is our attempt to even things up. It sets out what an investor will typically want to understand about a business, and what an owner can prepare in advance to make the conversation faster and fairer. It is general information that does not take into account any owner's objectives, financial situation or needs. It is not legal, tax or financial advice, and an owner considering a sale should always take advice of their own.

Start with what you want

Owners bring in investors for different reasons. Some want capital to grow: a second site, new equipment, a larger team. Some want to take money off the table after years of building, while staying involved. Some are planning for succession and want a partner who can take on more over time. And some want help running the business as much as they want money.

Each of those leads to a different deal. Selling a minority stake while staying in charge is very different from selling a majority and working alongside a new owner. Before the first meeting, it is worth writing down the answers to four questions:

1. How much of the business am I prepared to sell, now and later?
2. What role do I want in five years' time?
3. What do I need from an investor besides capital?
4. What would make me walk away?

Clear answers save time for everyone, and they stop an owner from being drawn into a deal that does not fit.

Get the numbers in order

Every assessment starts with the financial records, and the quality of those records shapes the investor's confidence in everything else. The Queensland Government's guidance for owners selling a business lists what buyers typically ask to see, and it is a good checklist for an investor conversation too.

Beyond the list, three things make a real difference.

Management accounts. Annual statements show where the business has been. Monthly management accounts, prepared consistently, show where it is now and how it behaves through the year. An investor is more likely to trust a business that can produce last month's results quickly.

Clean separation. Personal expenses run through the business and family members on the payroll who do not work in it make the true profit harder to see, and each one has to be explained. Income that is not recorded is a different matter: it is a tax compliance issue, investors will generally give it no value, and an owner should take tax advice before any process begins.

Debts and obligations. The Queensland guidance notes that buyers focus closely on debts, including tax and superannuation. Any arrears are worth identifying early, with advice on how best to resolve them.

Understand what drives the profit

Once the records are in order, an investor will try to understand why the business makes money and whether it will keep doing so. It helps to have thought these questions through:

• How concentrated is the revenue? A business that depends on one customer, one contract or one supplier carries more risk than one with a broad base.
• How much of it recurs? Memberships, contracts and loyal repeat customers are worth more than one off sales.
• What are the margins by product or service? Owners often know their overall margin but not which lines carry the business and which ones it carries.
• How much depends on the owner? If the key relationships, the know-how and the decisions all sit with one person, an investor will want to see a plan for sharing them. In a small business this can be one of the biggest issues of all.

Contracts, leases and people

Due diligence covers far more than the accounts. Before an owner starts conversations, it is worth asking a lawyer to check a few documents that commonly cause delays.

• The lease. Many leases require the landlord's consent to a change in the ownership of the tenant company. Know the remaining term, any options to renew, how the rent is reviewed and what the make good obligations are.
• Key contracts. Some supplier, customer and franchise agreements contain change of control clauses that allow the other party to end or renegotiate the contract if ownership changes.
• Employees. Contracts, award classifications and payroll records should be in order. The Fair Work Ombudsman notes that underpayments often happen because of a mistake or a payroll error. They are far better found and fixed by the owner first, with advice, and where an underpayment is long running or large, the Ombudsman asks employers to report it.
• Intellectual property. The business name, trade marks, domain names and social media accounts should be registered to or held by the company, not by an individual.

Price and structure

Most owners focus on the valuation, and it matters. Established private businesses are often valued on a multiple of their maintainable earnings, adjusted for risk, growth and the quality of the records. Clean accounts, a broad customer base and a team that does not depend on the owner can support a better multiple, which is why the preparation above can affect the price.

Structure matters just as much, and owners often give it less attention than it deserves.

• New shares or existing shares. An investor can subscribe for new shares, putting money into the company to fund growth, or buy existing shares from the owner, putting money into the owner's hands. Many deals combine both.
• Staged payments. Part of the price may depend on future performance, through an earn out, or be paid over time.
• The shareholders agreement. This sets out how the company will be run after the deal: board seats, the decisions that need both parties' approval, how profits are distributed, what information each shareholder receives, what happens if a shareholder wants to sell, and how disagreements are resolved. A good agreement protects both sides and is far easier to negotiate before the deal than after.
• Tax. The way a deal is structured can change the tax outcome significantly for the owner, and small business capital gains tax concessions may be available in some cases. This is an area for an accountant's advice early in the process.

How the process usually runs

The details vary, but most investments follow a similar path.

1. First conversation. A discussion about the business, the owner's goals and whether there is a fit. No confidential information needs to change hands yet.
2. Confidentiality agreement. Before detailed figures are shared, both sides sign a confidentiality agreement.
3. Information and meetings. The owner shares financial and operating information, and the investor visits the business and meets the team.
4. Indicative terms. If both sides want to proceed, the investor sets out the proposed price, structure and key terms in a term sheet. A term sheet is usually not binding on price and terms, but it can include binding clauses, such as confidentiality and a period of exclusive negotiation, so it deserves a lawyer's read.
5. Due diligence. The investor and its advisers review the business in detail: finances, tax, legal matters, employees and operations.
6. Agreements and completion. Lawyers prepare the share sale or subscription agreement and the shareholders agreement. Once they are signed and any conditions are met, the deal completes.
7. The first months together. The real work starts after completion, with agreed reporting, decision making and a plan for the business's next stage.

Questions to ask any investor

An investment is a long relationship, and owners should assess the investor as carefully as the investor assesses them.

• What do you bring besides capital, and can you show examples?
• How involved will you be day to day, and who will we work with?
• How do you make decisions, and how quickly?
• What happens if the business has a difficult year?
• How long do you intend to hold the investment, and how do you expect to exit?
• May we speak to owners of other businesses you have invested in?

A readiness check

Before any conversation, it helps to see the business the way an investor will. The check below covers the areas where most questions concentrate. Mark each one honestly as ready, close or needs work.

Keep it confidential

Information about a business can do real harm in the wrong hands, whether competitors, staff or customers. Share sensitive material in stages, only after a confidentiality agreement, and only with people whose identity and intentions are clear. On our own website, we ask owners not to send financial documents through the enquiry form for exactly this reason. Those come later, in a more suitable way.

Conclusion

Bringing in an investor is as much about preparation as about price. An owner who knows what they want, keeps clean records, understands what drives the profit and has dealt with the obvious legal and compliance questions will have a faster and fairer process, and more choice about the partner they end up with. The preparation is worth doing even if no deal follows, because almost everything on the list also makes the business easier to run.

The best time to prepare is well before a sale is needed. Owners who start a year or two ahead can tidy their records, reduce their dependence on themselves and fix small problems at leisure, rather than under the pressure of a live negotiation.

We set out how we assess and structure investments in our approach, and what we look for in a business in beyond the balance sheet. If you own a business and are thinking about bringing in a partner, we would be glad to have a first conversation. A first conversation commits neither side, and nothing in this article is an offer to invest in or acquire any business.