Questions an Investor Should Ask
This information is intended as a general guide
to the investor contemplating an investment in a
"private company or project". It summarizes
key questions to ask and issues to deal with before
investing. This type of investment does not typically
have approval by a securities regulatory body nor
There is a wealth of information available on investing
in public companies and mutual funds. There is also
an abundance of capable professionals who dispense
advice on these matters. Much of what follows is
applicable to evaluating any type of investment
opportunity. This fact sheet is written with private
company investment in mind and is referred to as
"a private venture" investing.
Nothing contained herein is to be construed as specific
investment advice regarding any investment opportunity,
nor should the reader rely on the contents of this
fact sheet for any purpose other than as general
information. Investing is, by its nature, risky
and anyone contemplating any form of investment
should seek out qualified experts to advise on specific
matters. Therefore, the interpretation and use of
this material rests solely with the reader.
The development of this fact sheet was jointly funded
between Alberta Agriculture, Food & Rural Development
and Manitoba Agriculture. It was written by Cam
Crawford from Coakwell Moore Chartered Accountants-Management
Consultants of High River, Alberta, with the assistance
of Sue Bannerman from INT Associates Inc.-Management
and Training Consultants of Olds, Alberta.
A special Manitoba review committee made up of Manitoba
Agriculture Specialists and Staff, along with representatives
from Industry reviewed the material to ensure its
applicability in Manitoba.
In cooperation with: Alberta Agriculture, Food and
Venture Investing - An Overview
There are a number of factors that have contributed
to an increased interest in private venture investing
in recent years.
- money market returns are at historical low levels
and many investors are seeking out higher returns
with private venture investments.
- a consolidation of equity is occurring as the
parents of baby-boomers transfer accumulated wealth
to their sons and daughters.
- certain local and regional economies are vibrant
and growing; apparent opportunities abound. Interest
and enthusiasm among entrepreneurs is very high
in some locals.
- public equity markets have produced significant
gains for investors, some of whom are looking
to diversify by investing profits into private
- significant amounts of labour sponsored venture
capital funds (e.g. pension funds) have built
up in recent years encouraging entrepreneurs to
pursue ideas in the hope of attracting this and
other sources of venture capital.
This article will help you answer the following
- Why am I considering this investment?
- Who is making the sales pitch?
- Is there a business plan?
- Who will manage the venture?
- What is the legal structure of the investment?
- Who will own and control the venture?
- What is the investor liquidity strategy?
- What is the current financial position?
- Have you completed a formal review of the details
of the opportunity?
Like so many areas of knowledge these days, private
venture investing has specific jargon and terminology
that have different meanings and connotations. The
lexicon at the end of the fact sheet is intended
to clarify certain meanings, and at least provide
the context in which the terms are used. The reader
may wish to start by reviewing the lexicon and refer
back to it while reading through the publication.
Terms that are contained in the lexicon are identified
in bold italic type throughout the fact sheet.
1.0 Why am I
considering this investment?
Beware of the lament of the once burnt, twice shy
investor, "Why did I ever get involved in this
mess?" The romance of venture investing fades
rapidly against a backdrop of investor cash calls,
poor results, overly optimistic projections, and
unmotivated management, just to name a few. In
all cases, the full amount of a venture investment
is susceptible to loss. Security over assets
(such as land, buildings and equipment) is often
granted to a financial institution to cover loans.
This means those assets are not available to secure
the venture investment. If a venture's assets are
liquidated in the future, in theory, investors are
entitled to receive a return of their capital, but
only after priority ranking creditors are paid.
In reality there is seldom enough cash to go around,
equity investors are often left on the short end
of the stick.
1.1 Points to consider
- What are my objectives in making the investment?
Are these objectives consistent with other shareholders?
- What do I expect to gain? What is the probable
return on my investment (ROI)?
- How much could I stand to lose? Is the risk
of loss offset by the potential for return?
- is there a balance between risk and return?
- Have a clear set of objectives in considering
- Write your objectives down, if only to force
you to seriously address this aspect.
- Beware of "can't lose" deals which
just happen to find you. Remember, an experienced
venture capitalist will review all ten deals before
considering one, and only one in ten of those
is likely to be pursued. That works out to roughly
one-in-a-hundred investments made from opportunities
Who is making the sales pitch?
Often the founders of an opportunity will
engage intermediaries to act as agents in
raising project financing, other times the founders
will attempt to raise funds themselves. Make sure
you know who you are talking to, and if a commission
is being paid to an intermediary. You should know
the terms of engagement. Often the party "pitching
a deal" is called the promoter. Securities
law in most jurisdictions restricts the ability
of intermediaries and promoters to charge commissions
on certain types of private investment offerings.
The prospectus, if available, will disclose
the method used to calculate any commissions. However,
this document does not comment on whether the commission
is fair or not.
2.1 Points to consider
- Are there any fees being paid to the people
making the sales pitch?
- Are those fees contingent on success of the
money raising efforts?
- Why are they talking to you?
- How long has the opportunity been offered to
- Who else is contemplating an investment?
- Can you team up with other investors to review
the opportunity together?
- Never respond quickly to an investment proposal;
high pressure tactics that suggest a tight time
deadline should be avoided.
- Find out who else is considering an investment
in the project and ask to talk to them. This may
not always be possible, but if the promoters of
an investment will let you talk to other potential
investors, do so. If they won't let you do this,
at least find out why they won't.
Is there a complete business plan?
The business plan is the blueprint for the business
venture. Stay away from business plans that are
"in my head". By the same token, don't
be fooled by a glossy, polished presentation that
3.1 Points to consider
- What are the key aspects of the business
- What are the competitive advantages of
the business or project?
- What is the stage of the business or project:
concept only, start-up, growth, turn-around, buyout?
- How much money is being raised?
- What will the money raised be used for? What
amount of this money will be spent on tangible
vs. Intangible assets (e.g. operating and start-up
- How much income will the company make if the
business plan is successfully implemented?
3.2 Key Business Plan Contents
A detailed discussion on business plans is beyond
the scope of this document; but generally a business
plan should contain:
- a one or two page executive summary of the entire
- history of the business/project to date.
- people profiles and an indication of their status
(i.e. Board members, management, full-time and
part-time employees, etc.) And company culture.
- a clear description of the product or service,
how competitive advantage will be established
in the marketplace, and an analysis of the competition.
- details of the marketing plan:
- target market segments (groups of people that
are potential customers), customer profiles,
- market size (potential number and size of identified
segments), geographic location,
- penetration strategies (how will the product
or services be advertised and promoted to a new
or expanded market), integration, company size
- start-up and promotional costs, etc.
- have all regulatory requirements been met (environmental
regulations, zoning requirements)?
- is there an independent study of the technology
or product? SWOT (Strengths, Weaknesses, Opportunities
and Threats) analysis may be appropriate.
- full details of legal structure and ownership.
- full description of the ownership structure
after the investment is completed.
- details and sources of project financing requirements.
- an analysis of risk.
- full projected financial information
for the venture including balance sheets, income
statements and cash flow statements for at least
- details of the assumptions utilized in the projections
(particularly the basis for revenue projections);
this could be compared to some industry standards.
- There are numerous books and other informational
material on business plans, including some excellent
brochure-type publications provided by financial
institutions and professional firms. Learn what
a good business plan should contain.
- Prior to being provided with a detailed business
plan you may be asked to sign a confidentiality
and non-disclosure agreement. This is a standard
practice, but if you are not sure exactly what
you are signing, ask your lawyer to review it
with you and get a legal opinion.
Who will manage the venture?
Although the profiles of the management and employees
are a part of the business plan, this aspect is
so important that it warrants separate attention.
4.1 Points to consider
- Who are the key implementers of the business
- Do they have significant accomplishments in
- What are the terms of employment for these people?
Who makes up the management team? (I.e. who is
actually going to be running the business and
how much experience and background do they have?)
What is their level of management ability?
- Are they full-time? Part-time?
- Are there or will there be employment contracts
in place with key people?
- What will be their remuneration?
- Is any of their pay made up of contingent
- Who are the current shareholders, officers and
directors of the company?
- Who are the key professional advisors
to the project? Consultants? Lawyers? Financial?
- These are important people to a venture.
The best idea in the world is likely to fail by
poor management, and excellent management can make
the best of even an ill-conceived plan. Don't underestimate
the importance of the people involved in the project.
Check them out ... ask your lawyer, accountant,
and financial advisor, they can probably find someone
that knows something about the people behind a project.
5.0 What is the legal structure
of the investment?
In Canada, all provinces have detailed securities
laws that prescribe the manner in which investments
can be sold. Frequently, offerings are improperly
structured, contravening laws that are primarily
designed to protect the investor. Generally,
securities law requires that a prospectus
or some other form of offering document be prepared
by those promoting an investment, unless certain
exemptions from those requirements are applicable.
The prospectus does not comment on how good the
investment is but rather it ensures securities law
has been met. If you are subscribing to an investment
under such an exemption, make sure you understand
what you are doing.
There are a number of different ways the ownership
of a venture could be structured, including:
- limited company
- limited partnership
- joint venture
Each of these possible structures has significant
implications for the investor and you should obtain
qualified professional advice in order to understand
what these implications are for your particular
5.1 Points to consider
- How is the investment legally structured?
- Is there a formal offering document?
- Are there upper and lower limits for the offering?
- What happens if not all the required investment
capital is raised?
- Are you investing in debt or equity?
- If equity, is it subordinated debt? Convertible
- Is some or all of your investment going to be
secured by assets?
- Could you be legally required to put up more
money in the future?
- Do you know all classes of ownership and how
shares are paid?
- At a minimum there should always be a subscription
form for an investment.
- Never simply hand over a cheque to someone promoting
- Have the subscription form reviewed by your
legal and financial advisors before you sign.
In addition, there is some protection available
by paying your investment into a lawyer's trust
account, pending the closing of an investment
and possible other conditions. This practice is
often followed, but make sure you understand the
conditions of trust placed on the lawyer who receives
the funds. The lawyer is often working for the
company raising the money and once the trust conditions
are met, the funds can be released from trust.
Or an investor may want clarification when they
deposit the money in trust and have their own
conditions placed on the funds or they may want
to have their own independent legal advice involved.
- Make sure that you understand what will happen
if all of the funds are not raised. Will you get
your money back, or will you become an investor
in an underfunded project? In addition, make sure
you understand whether you will have a legal obligation
to put more money into the project in the future.
Who will own and control the venture?
Ability to control the direction of the project
is an important issue. In many cases the founders
remain in control of project direction as long as
the business plan is being followed to the satisfaction
of the investors. However, if the business plan
is derailed or serious problems encountered, often
the investment structure provides for the investors
to have a bigger say, and in some cases, even to
take control of the business. For investments in
companies (i.e. as opposed to partnerships or other
forms of investment structure), this matter is often
dealt with through the makeup of the board of directors.
Corporate law provides for rights of minority shareholders
and these shareholders should be aware of these
In most cases, the founders of a project are entitled
to a carried interest in the equity of the
business or project as compensation for getting
a project where it is warranted to seek out investment
capital. There is no standard approach in dealing
with this aspect of a venture investment structure.
Each situation invariably has its own unique circumstances
that impact the extent of the carried interest for
- Founders of early stage projects are usually
entitled to a lesser carried interest than founders
of more mature projects.
- The greater the potential for return from a
project, generally the greater the entitlement
of the founders to a carried interest.
6.1 Points to consider
- How much cash have the founders invested in
- Are the founders getting ownership in the business
to compensate them for their non-cash investment
of time and effort?
- How much will your investment be diluted as
a result of the founders getting an interest for
their sweat equity?
- Who will control the venture after the money
has been invested?
- Is there room for negotiation in the project
structure, or is it fixed?
- Will you be entitled to representation on the
board of directors?
- Do you want to be on the board of directors?
- Are you expected and do you want to make a contribution
beyond money (e.g. professional advice, time,
- Do you have valuable contacts or knowledge that
could improve chances of the project's success?
- Do the founders have warrants and/or provisions
on the investment and how do these affect control
of the investment?
- Many of the above and other related issues are
dealt with in an unanimous shareholders agreement
in a private venture investment. This is a critically
important document that details the agreement
(in advance) by the shareholders as to how certain
important issues will be dealt with.
- Seek out competent professional advice if you
do not understand the exact workings of the provisions
of the Unanimous Shareholders Agreement.
- Being a director can be a great way to know
everything that is going on and possibly influence
direction. But directorship also has a significant
potential downside. Make sure you understand this
downside before accepting an appointment as a
- Often it is a good idea to structure the investment
such that founders start out with a lower relative
equity position, but can earn a higher proportion
of ownership, usually via a share option arrangement,
if an when the business produces profits. A founder
may want full value for their investment and anything
beyond this through a "bonus".
What is your liquidity strategy?
An often forgotten aspect of a venture investment
is the investor liquidity strategy. Having
the business or project succeed is one thing, getting
your money and gains back out is a separate issue.
Often the interests of the founders can be at odds
with the interests of other investors. Founders,
who depend on the business for their livelihood,
may be motivated to reinvest profits in growth;
investors on the other hand typically want some
or all of their investment returned at a point in
time. The liquidity strategy should also deal with
two other issues: (1) a disaster in an investor's
family (i.e. death of the investor or a real need
for the investment to be returned) and (2) the ease
of sale of the investment down the road if an investor
wants to realize on the investment.
7.1 Points to consider
- How and when will you get your money back out
of the investment? Is this disclosed in the shareholders'
- Have you analyzed the investment from the viewpoint
of investors exiting and newcomers entering?
While it is often difficult to establish an exact
liquidity strategy at the time of investment, there
are certain measures that can be put in place as
part of the structure to ensure investor interests
are protected in this regard. In some instances,
structuring an investment as preferred shares with
a requirement that the shares be redeemed by the
company after a specified level of net earnings
has been reached is just one example of how this
matter can be dealt with.
8.0 What is the financial position?
Financial information dealing with the past is generally
referred to as historical financial information.
Information dealing with the future is typically
called projected financial information. Both
are extremely critical in assessing the opportunity.
Historical information will portray the financial
path taken to date and results realized. It can
give you a good sense of current financial stability
or lack thereof. If an individual is investing a
significant amount of money, he/she may wish to
delve a little deeper into the company's historical
financial information to look at the past financial
stability as an indicator of management.
Projected financial information needs to be very
cautiously reviewed and analyzed. With the advent
of computer modeling, extensive financial projections
can be readily developed and presented very professionally.
But beware, the accuracy of computer financial models
can easily be distorted by even the smallest flaws
in the logic of the assumptions that go into the
model, or the calculation methods used. It is also
perhaps too easy to build a model on assumptions
that go something like this: If I could only get
« of 1% of the market for this product, look what
I can do!" Too much effort goes into the
math and not enough attention is devoted to developing
the plan to capture the market share. This reinforces
the fact that investors need to understand the assumptions
for projections made in the business plan.
The projected financial information is also the
cornerstone of a detailed value analysis
which the investor should perform to establish the
upside potential from the investment. Quite simply,
the value analysis extrapolates a future value for
the business assuming it is able to achieve the
anticipated results and calculates the individual
investor's share of that value based on what percentage
the investor owns. One method to calculate this
out is to take the investor's share of value and
divide it by the amount originally invested to get
a rate of return on the investment. Divide that
rate by the numbers of years from date of investment
to the effective date of the value analysis, and
you have an annualized return on investment (ROI),
expressed as a percentage (see Lexicon for example
calculation). The anticipated ROI must be high enough
to justify the investor assuming the risk of loss.
Internal Rate of Return (IRR) is another
value analysis technique which is slightly more
complex than ROI but it reflects the time value
of money (see Lexicon for example calculation).
Projected and historical (past 5 years) earnings
per share and price-earnings ratios (plus other
indicators) will also assist in the analysis of
8.1 Points to consider
- Are audited historical financial statements
- What is the current financial position of the
- Is it operating now?
- Is it making money?
- If it is losing money, how much money is being
lost each month? What is the burn rate?
What is the turn-around strategy and who controls
- Has a reputable firm of accountants issued an
accountant's report on the financial statements?
- Is the venture up to date on tax and other required
- When is the business expected to become profitable
- What is the expected return on investment (ROI)?
- What is the payback period for the investment?
- If the business plan is successful, how much
will my investment be worth? How will profits
be paid out (e.g. retained earnings, etc.)? How
does the business compare to industry standards
for (1) returns; (2) leverage; (3) and payables
and receivables? (Industry standards publications
are available at your local library.)
- Look for a report appended to historical financial
statements by independent accountants, recognizing
that the credibility added by independent accountants
varies based on the nature of their report on
the statements, as well as from firm to firm.
- The above points have been simplified for purposes
of illustration, there are many additional factors
that can impact the completion of a value analysis
on an investment. You should seek out qualified
assistance in analyzing and interpreting all financial
information pertaining to a prospective investment.
Have you completed a formal review of the details
of the opportunity?
Prior to making the final commitment to an investment,
a formal due diligence review should be completed.
Have a lawyer conduct corporate and personal searches
on those involved in the opportunity. Have a financial
expert check out historical financial information,
projections and the like.
This final, formal review can uncover deal-breaking
information that you should not ignore. Above all
else it will help substantiate the character and
trustworthiness of the people you are investing
9.1 Points to consider
- Have you formally confirmed representations
made during the sales pitch and investigation
- Have you been lied to or have claims been exaggerated
by the promoters?
- Have all legal documents (contracts, agreements,
leases, etc.) been reviewed?
- Are all tax filings (income tax, payroll, GST,
etc.) up to date and have these filings and related
assessments been reviewed?
Seek independent verification from reliable sources
of representations made to you during your assessment
of the opportunity.
About the author
Cam Crawford is a partner in High River, Alberta based Coakwell
Moore Chartered Accountants - Management Consultants.