(ninth of a series)

By Frank Demmler

This week’s topic is private investors.

Private investors

Thus far in this series of articles, much of the discussion has been focused on institutional investors and their attitudes toward investment in entrepreneurial concerns. On the one hand, this provides some context for you as to how the “professionals” address such investments.

But on the other, the vast majority of companies are funded by private investors. In a “normal” year, venture capital will invest in 2,000-3,000 companies in the United States. Of those, about half will be receiving their first round of institutional investment. This is in contrast with the total of about 14 million businesses in the United States of which well over 13 million have less than 100 employees. Every year, close to one million new businesses are launched. It has been estimated that private investors provide ten times the capital for small businesses as compared to that invested by institutional venture capital.

The bottom line for most of the entrepreneurial readers is that your funding is much more likely to come from private sources than from institutional venture capital. For the next few weeks, I will focus on the private investor.

Not all the same

Private investors are not all the same. Quite often a first-time entrepreneur gets focused on raising money from an “investor.” This “investor” becomes the sole focus of the entrepreneur as he seeks the “answer” to how to access and successfully solicit funding from that “investor.” If only it were that simple.

The private investor is as varied as your neighbors, as your classmates in the various schools you attended, as the drivers in all the cars fighting the traffic with you each day. Private investors are individuals first and foremost, with the same human differences that each of us has.

As such, some may have an interest in your company and some won’t. Some you’ll want to be interested in your business and others you’ll want to avoid. Some will have investment expectations that you consider to be reasonable, and some won’t. Your challenge will be to identify the intersection of potential investors in your company out of the universe of all investors with the deal structures that that are acceptable to you out of the universe of potential deal structures.

The Role of PERCEIVED Risk

The first thing you need to understand as you consider approaching potential investors is that their perception of the risk involved with your business (and their potential to receive a return) is the initial hurdle you must overcome. Their perception of risk is likely to be much different than yours. You need to be sensitive to that and responsive to that.

A corollary to this is that this screen if pretty much binary. By that I mean the potential private investor will have an initial reaction to you, your company, and the investment opportunity. If that initial reaction is one of, “it’s too risky,” you can scratch that person off your potential investor list.

Only if you pass this screen will you have an opportunity to try to convince the individual to invest and to influence the terms under which such an investment would occur.

As you proceed down the path of seeking private investment, the potential investor will be making a series of decisions. The outcome of each decision will be “no,” or “maybe.” Your goal is to get, “maybe,” each time until you finally get the coveted, “YES!”

Advice to Entrepreneurs

In all probability, your funding is going to come from private investors, not institutional venture capital.
There is no single “private investor.” Each is an individual with his or her own views and sensitivities. Attracting an investment from such sources is not a “one size fits all” proposition.
The potential investor’s perception of risk will greatly influence whether he has an interest in investing in your company under any circumstances.
If you approach a potential investor prematurely or inappropriately, you will lose that investor unnecessarily and for the wrong reasons.
Surround yourself with professionals, mentors, and advisors who can help you level the playing field.

Next week we’ll look at how these issues affect private investors and how you can use this knowledge to improve your chances of successfully raising the desired capital.

Frank Demmler (fd0n@andrew.cmu.edu) is Associate Teaching Professor of Entrepreneurship at the Donald H. Jones Center for Entrepreneurship at Carnegie Mellon University. (http://web.gsia.cmu.edu/display_faculty.aspx?id=168)