New businesses require money – equity investment. Virtually all start with personal equity from the owner.
Owners like you want to invest in their businesses because they believe in the opportunity and they expect to reap the financial rewards. From the funder’s perspective, both lenders and equity investors want to know that the owner is financially committed and has money at risk (skin in the game). This is an indicator that the owner is dedicated to making the project work and won’t bail out during difficult periods.
However, owners do not usually have all the required equity available, and it makes good business sense to spread the risk. As a result, virtually all new hotel businesses incorporate equity from investors. According to the Global Entrepreneurship Monitor 2019/20, 6 percent of US adults have informal investments in other people’s independent businesses with a median investment of $5,000. That’s not a large percentage, but it means that a very large number of households are small business equity investors.
So, how do owners of new hotel businesses raise equity from investors?
Making the ask is a skill. It takes planning and improves with practice. For many people, it also takes overcoming fear and reticence. Millions of business owners do this and you can too.
Equity investors are likely to be people you know. When you are identifying potential investors, consider who will make the most sense for your unique circumstances. Investment partners bring important things to the table in addition to money such as referrals to other investors, business experience, connections to potential customers and advice. Investment partners can improve performance and help you run a smooth investment.
Investors also represent a risk. They can add to stress, “noise” and create challenges within the company. Investment can strengthen a relationship or ruin it. The right partners are critical to your success so you can focus on the business and not be distracted.
Friends and family are the first source owners tap. It makes sense to do business with people that you like, trust, respect and see frequently. Putting a personal relationship on the line is a powerful tool to keep the best interests of the business first.
Making it work
As the project lead, you manage investor expectations. If your investors are realistic and understand the risks as well as the upside potential of the investment, your operating relationship should be pleasant and more productive. The first rule of working with investors is to be positive, but also realistic, transparent and honest. You should communicate regularly because this engages investors, builds trust, and “a problem shared is a problem half solved.”
The second rule of working with investors, particularly friends and family, is to keep your working relationship professional. Investment is business, it is not personal. Their belief in you and their desire to see you succeed are decision factors for friends and family who invest with you. This is a beautiful thing. It would be wrong to reward that belief and desire with anything less than the most competent management, on time communication, complete financial reports, and professional courtesy about everything related to the business. Be very clear about business goals and professionalism. Of course your personal relationship is still – personal.
The third rule of working with friends and family is that investment is risky. You don’t really know who has money and who doesn’t, who is willing to invest and who isn’t, until you ask. But if losing the investment would affect the investor’s life, he or she should not be investing in this.
A high level of attention to structuring the agreement in a family business leads to a fair understanding of who does what, what to expect, how performance will be evaluated and where the enterprise is going. When it’s business, it’s about business (not family) – they shouldn’t ask for favors and freebies, any more than you should. For this reason, contracts are vital to investment relationships – whether or not friends and family are involved.
When friends and family invest with you, your relationship will be tested. Can you work through disagreements? Can you separate emotions from logic together? Are you willing to damage the relationship? If the answer is “no”, you can still invite them to invest but recognize that you may have to sacrifice to retain the relationship.
Prepare for tough love – a lot of advice, and recognize that their point of view may be exactly what you need. Bringing friends and family into a venture that excites you and gives you the opportunity to bring financial returns to them is a gift. It’s a new direction for a relationship and it can be deeply rewarding personally and financially for you and for them.
Whether you are presenting to friends, family or strangers, you are building trust through the process of setting up the investment and bringing them into the business as investors. To build trust, you keep the opportunity fair and equal between investors and also between you and the business. Your work, hours, money you pay yourself, work the hotel staff does for you outside the business, things you buy through the business, distributions to investors including yourself and other benefits should be fair and by the book. Doubt and distrust creep in whenever there is an information void. So, to sustain trust, communicate on a regular basis, exactly as promised, and keep documents and communications business-like.
Your strategy for your equity raise includes:
- How much you are soliciting: this is the amount of equity you need, in addition to your personal contribution, to complete your capital stack
- How many investors you want: your equity raise could involve lots of small partners, a few large investors or even one. More investors are more complicated to manage, require more reporting, and take more time. The smallest investor takes as much time to manage as the largest. However, one large investor can be very controlling.
- Who you want in your business: would you want a family member who puts in $500 to be supportive – and feels entitled to give you advise, demand information, and ask for free rooms?
- Minimum investment: the smallest investment you will accept.
- Maximum investment: this is limited by how much ownership you are willing to give up. Each equity investor owns a pro rata piece of the property.
- Structure of the investment vehicle: once you have a general idea of the size of the investment, number of investors and who they are, you can consider financing structure (specialist attorneys can advise you)
There is no way to know who will decide to invest after listening to your pitch. You can be sure that some people you expect to invest, will pass. You can be sure that some people you don’t expect to invest, will.
Investment is a business proposition and the best strategy is to treat it that way. When you invite someone to invest in your business, it isn’t a favor. However you feel at the moment you ask, whether they accept or reject your offer, it’s business. Although, love is a fine motivation, and they may be inclined to give you a chance because they know you, their decision isn’t a question of love.
If you believe you are offering them an excellent opportunity, if you believe it is a good investment, if you are fully committed yourself, then make the ask.
The pitch you develop is about the opportunity. When you pitch a potential investor – including your dad – give thought to their motivation and their investment criteria – what they expect from you. To prepare for your first pitch, you should have a plan for your deal structure because it will affect the information you include, how you deliver the pitch, and who you pitch.
Your pitch will include three documents. In addition, potential investors may ask for other information and you want to be prepared to fulfill their requests within 24 hours.
- Pitch deck: This is a PowerPoint (or similar format) sales presentation. It is a tight presentation with pictures and numbers and is 8 to 12 slides. If you haven’t done this before, you might have your attorney look at the pitch deck so you don’t make illegal representations.
- Contract/Operating agreement: To enter into the investment, each investor signs a contract with your company and gives you a check. This is the same contract for all investors, except for their name, investment amount and the calculated share of ownership their investment buys them. It is the legal operating agreement that defines your responsibilities, and theirs. Among other things, it covers conflict resolution, if needed, between your company and the investors. You engage an attorney to write the contract/operating agreement to be prepared for the unexpected and to set yourself up for success managing a business relationship with friends and family. Your attorney should prepare the contract or operating agreement with you.
- Business plan: While the pitch deck offers decision points, the business plan goes into more detail about the project, market, operating plans, projected financial performance and potential returns. This is a longer written document with appendices covering additional relevant detail. You should also have your attorney review your business plan.
When you have all three documents prepared and reviewed, you will be ready to present to investors.
Introducing your investment to friends and family can follow this pattern:
- When your deal is taking shape, talk about it. Share your excitement and enthusiasm. Let people know that you will be looking for investors at a future date.
- When you are ready to raise equity, introduce the possibility of investment.
- This can be a casual “kitchen table pitch” in-person in which you ask for an in-person or virtual meeting to present the investment opportunity – keep it light and accept that “no” is a fair response to your ask. If they are open to a meeting, send an email promptly after your conversation to set a time. Attach or include brief highlights about the project in the email.
- You can send them an email with highlights about the deal and ask for a meeting. Include time options for a call or meeting. You can follow the email with a phone call to set a time, if you don’t get a scheduling email back.
- Don’t be offended if they turn down the meeting. Instead, thank them for their consideration. Always be respectful and appreciative, after all they are people you care about – and they may invest with you later.
- At the meeting, present your pitch deck. This is a PowerPoint deck of 8 to 12 slides that describes the project, the principals, the market and the investment opportunity.
- If they are interested in investing, present the agreement (written by an attorney) and talk it over with them.
- If they are open to the idea but not ready to commit, follow up with them at a specified time within a week (for instance, “I’ll follow up with you next Tuesday”). This gives them time to review with pitch deck, business plan and contract.
- Whether you are following up about collecting the signed contract, or following up about a commitment, don’t be surprised if it takes several, reasonably spaced, courteous, emails and calls before you get an answer.
- Whether they say “yes”, “maybe” or “no”, follow up with a courteous thank you email.
- Expect them to do due diligence – be prepared to help and provide additional information.
- Collect a check and signed contract at the appointed time.
- Say THANK YOU so they feel good about the possibility of being invited to invest in the next deal. And, importantly, so you keep your relationship strong.
Your pitch deck has a slide for each major point you want to make – usually 8-12 slides. You can use the deck as an attachment to introductory emails, in print form for presentations and handouts, and on screen for virtual or in-person laptop presentations. A typical pitch deck looks good and has one slide, including a picture or graphic, to make each of these points:
- Investment opportunity – name of project, name of company, your name, phone, email, address
- The hotel/deal – the product, brand, features, market orientation, competitive advantage
- How this makes money/path to success
- Competition – existing and anticipated future competitors (detail is not on the slide, but be prepared to talk through price position, facilities, competitive advantages and disadvantages for each hotel, if asked)
- Management team – company principals (you and any partners) and management approach or team for the hotel; people working for you should add to your credibility
- Financial projections – highlights on the slide (rooms, occupancy, average rate, revenue, summary expenses, net income) with detailed Excel file available
- Potential return on investment analysis – stated on the slide and in your discussion that this is potential but not guaranteed
- Sources and uses of funds statement
- Sources: debt and equity with your personal equity investment clearly identified and tapped first
- Uses: acquisition, construction, soft costs, FF&E, working capital, contingency, etc. – with a more detailed Excel file available
- Timing: a schedule of future advances, particularly for deals that require equity to be funded after closing
- Term sheet – transaction conditions, funding terms and conditions, key points from the contract/operating agreement
Loans versus equity investment
Equity investors buy a piece of your business. The value of their investment goes up and down with the value of the hotel. They earn a pro rata share of the profits each year and a pro rata share of the proceeds of the eventual sale of the hotel. These are long-term investments and investors expect to own their share until the asset is eventually sold. By its nature, equity expects high returns and is high risk.
Sometimes potential investors would rather make a loan than invest equity. This may be thoughtful on their part, but is not a replacement for equity. Loans can be secured and lower risk because they can be backed by collateral – in this case the collateral is the hotel. You cannot use the hotel as collateral for another loan and also use it for collateral for your primary mortgage. So, unless your friend or family member is offering a loan large enough to be the primary mortgage (say 70 percent or more of the total project cost), you cannot do a secured loan. Whether or not you can do an unsecured loan depends on the terms of your primary mortgage. With an unsecured loan, you pay interest and principal, but there is no recourse if you fail to make payments. This may or may not restrict your primary mortgage opportunities – and the appeal of your opportunity to investors.
Human beings carry baggage about money. Some baggage is based on difficult experiences – financial insecurity related to job loss, health care expenses, recessions, social pressure or family demands. Some baggage is cultural – banks could legally discriminate against women until 1988 and have a history of discriminating against Jews, Muslims, Indians, Native Americans, Black people and others. Those expectations linger in cultural memory and is one reason investment in women-owned and minority-owned businesses remains a fraction of total business investment. Cultural discrimination also means that many people, possibly including you, receive strong cultural training to be circumspect about money.
Making the ask is the opposite of being circumspect about money. It breaks with cultural training, which means it requires unaccustomed behaviors. It can be hard to get the words out while you learn to make the ask. Remember that these are not rude, inappropriate or embarrassing behaviors – they are simply new skills.
Recognize that everyone has baggage about money and you can manage yours. You might talk to your siblings or close friends about it and find that they picked up different baggage from experiences you shared. There are two reasons to identify your baggage:
- Doing a deal navigates stressful financial situations. Odds are good that your responses will be triggered by your baggage about money. (It’s pretty common.) Being mentally prepared lessens the impact and improves your recovery.
- Making the ask may be contrary to your accustomed behavior. Understanding your money beliefs removes barriers to stepping up.
You may have practice making the ask for funding for church projects or non-profit organizations. Or this may be new to you. Making the ask for business venture is structured. It should be rewarding for you, as the deal comes together. And it should be rewarding for your investors as the project reaches fruition.