For investors, return follows risk perception

Soon:

You are interested in knowing the investor’s conditions for a loan. Why can’t they give you details, just general guidelines for interest rates, time period and conditions or other ‘terms’. It’s about your perception of risk.

You are interested in obtaining the commitment of an investor so that you can create the great business you have dreamed of. Often the first thing entrepreneurs want to know is the ‘terms’ of the investor’s commitment: What interest rate will they charge? How many years to repay the loan? and Can I have an interest-free period at the beginning, so that I can relieve the cash flow pressure of my business?

Many entrepreneurs fall into this trap and get frustrated when they can’t get a commitment from an investor. What is this frustration due to? Genuine investors cannot legally commit to the ‘Terms’, because that is only possible after their due diligence.

Worse yet, they can be duped by unscrupulous people offering them a ‘Term Sheet’ too early in the process. The ‘Term Sheet’ can be the ‘bait’ used to ensnare the inexperienced entrepreneur into committing to a scam posing as an investor. Do not fall in the trap!

However, genuine investors may give you a letter of intent. That has a lot of legal clauses that give the investor a way out of the commitment. The true investor MUST protect themselves with due diligence. This leads to the investor’s risk assessment. The risk assessment dictates the terms that can be offered to you. The reason is that when it comes to investing, it is universally stated that “return follows risk.” Which means that the higher the rate of return [interest] the greater the risk of the investment.

When you seek to borrow someone else’s money to build your business, you are inviting the lender or investor to label your business as a “risk” because the interest rate and terms they want in exchange for allowing you to use their money relate to your perception of risk in putting your hard-earned money into your company.

Whether you like it or not, when you ask someone to invest in your great business, you are inviting them to judge you and your business. This is unavoidable. The investor cannot assess the risk posed by his business until he has completed his due diligence. This critical judgment cannot be made a moment before. The reason is that the purpose of due diligence is to uncover all the risks and proof of risk protection that has been built into the business.

Be patient. An international investor can probably give you some guidance on terms, but not a ‘term sheet’ until after the risk has been discovered, after your plans and arrangements for the business have been scrutinized with due diligence.