In this video, Carl Allen discusses the “five killer questions” that equity investors consider when evaluating a business deal, especially when assessing the need for equity investment. He emphasizes that while some deals require equity for leverage with debt financing, not all do. Investors look for specific qualities and factors in a deal, starting with its unique selling points and differentiation. A standout deal should have a compelling story that captivates investors, rather than being a generic, undifferentiated “me too” deal.

The first key question investors ask is about the “big idea” or story behind the deal. Carl shares examples of two of his own ventures, one focused on women-owned health and beauty businesses and another in the online education space, each with a unique angle that resonates with investors. These types of well-defined and innovative concepts help attract investor interest by presenting a clear narrative and competitive edge.

Next, investors focus on the strategy to scale the business profitably. It’s crucial to outline not just growth projections but also the specific methods for achieving them, such as organic growth, bolt-on acquisitions, or partnerships. Investors expect a solid forecast model detailing how growth will be achieved and margins improved over time, showcasing a deep understanding of the deal’s financial trajectory and justifying the scaling strategy.

The third question revolves around the team’s capability to execute the strategy. Investors want to see a competent team that possesses industry experience and relevant skills, which ensures effective execution. Carl emphasizes staying in one’s lane and partnering with people who have complementary expertise, as a strong team inspires confidence in an investor’s likelihood of success.

The final two questions cover exit strategy and risk-adjusted ROI. Investors want a clear plan for exiting, whether through a trade sale, larger investor buyout, or cash-out refinancing. Finally, they assess the deal’s potential ROI in relation to the perceived risk, aiming for an investment where the ROI significantly outweighs the risk. Carl concludes by underscoring the importance of having a unique idea, a clear growth strategy, a strong team, multiple exit strategies, and a solid case for risk-adjusted ROI when pitching to investors.

Full Transcript:

Hey, guys. Carl Allen. Wanted to do a really quick video for you and walk you through what are the five killer questions that an equity investor really needs to know? What are they thinking about when they’re looking at your deal?

So some deals need equity, some deals don’t. So if you’re putting down a closing payment on a deal, typically, you’ll need a little bit of equity that you could use to leverage some debt financing, whether it’s SBA or whether it’s traditional bank debt or all those different things. Even family offices provide debt financing now. They always wanna see a little bit of equity going into the deal.

And the beauty of that is it doesn’t have to be your equity. Right? You can partner with somebody else that can be your equity partner, and they can buy a percentage of the deal and sit alongside you in the business and in the cap table. So when you’re pitching an investor for equity, there are five killer things that they think about.

Only five things. Right? What are they, and why do I know what these are? Because I used to be a private equity investor in a large fund, and I’m obviously a private equity investor these days through my my private fund with my partners, doing deals with a lot of my protege students.

So let’s go through the five questions real quick. So the first question that is gonna be top of mind for them and this is in order. Right? So these are the questions they think about in this order.

So the first thing they’re gonna look at when they see your deal is, you know, what’s the big idea? Like, what’s the story behind this deal? And if you think about it, investors get pitched, you know, every hour of every day with deals. And a lot of the deals, they’re like what I call a me too deal.

Right? It’s nothing differentiated about that deal. So they’re looking for something that really stands out. So I’ll give you two examples of two roll ups that I’m doing that I’ve raised capital for.

So the first one is a big health and beauty roll up for women. We’re buying women owned businesses, online ecom businesses, so owned by women for women. Women are the customers of these businesses. And then once we’ve bought enough of these companies, me and my business partner, Ross, we’re gonna get out of the way, and we’re gonna put in a full female c suite to run this business.

And when we take this business onto the Nasdaq to an IPO, me and Ross will be in the Irish pub down the street. It’s the female c suite that’ll be ringing the bell on the Nasdaq. So that’s a really kind of big idea. We’ve been sponsored by Venture Miami, the city of Miami, and there’s a lot of investment capital these days flooding into, you know, female founder, female owned type businesses.

So that’s a really big idea that’s resonating with a lot of equity investors. The other role that I’m part of is, a role up in the online education space, but then we’re also acquiring professional services companies that we can plug into our students that can help accelerate their journey.

So I’ve just bought a real estate coaching company, and then I’m gonna buy a, a title company that can help my real estate investors close their deals faster by having a plug in solution for the title and the escrow and the paperwork and all those different things. So having big ideas, having stories that are different and are unique or what really attract investors to deals. The second thing is once the investors kind of solve on your big idea, your big story, then it’s all about, well, what’s the strategy to scale this business profitably? Is it gonna be organic growth? Is it gonna be, bolt on acquisitions?

You know, how are they gonna take this business from a to b? Because that’s the only way an investor is gonna make money. It’s not like a bank that’s putting debt financing into a deal. They just want their money back over time with interest, and then they likely want security, either from you or from the business, to make sure that that money is protected.

Investors don’t think like that. An investor, if they’re putting two hundred thousand dollars into your deal, it’s like, can they get a million dollars out? Right? Can you five x their money for them over three, five, or however many years?

So, really, investors, all they care about is scale. Right? What’s the scalability of this business that you’re buying, and can you scale profitably? It’s really, really important that you spell that out for them.

And it’s not just explaining what the numbers are. You’ve got to provide the justification around it.

So it’s fine saying we’re gonna grow the business twenty percent per year, but how are you gonna do that? Right? What’s the marketing strategy? What new customers are you gonna find?

Are you gonna bring new products or services into the mix? Are you gonna go and buy another company and then cross sell? So you’ve got to have not only the numbers, but the justification of what those numbers mean. And and this all comes down to sort of called the forecast model.

So I did a couple of videos for you recently where I walked you through a forecast model, and you can download that model and use it as well on your own deals. But in a forecast model, the first thing you wanna do is you wanna look at the existing trends in the historical numbers. So let’s say this was your deal, twenty twenty one, twenty two, twenty twenty three. Those were the historical numbers.

You’re looking for growth. You wanna understand what the current growth is. Can that growth be replicated? And then you’re looking at your margins.

What’s the gross margin in this deal? How can I improve that gross margin as I grow and get economies of scale?

And then what are my operating expenses as a percentage of sales, and can I reduce those as I grow? And if you look at this business, growth slowed down a little bit, but the margins have got stronger, both the gross margin level and the EBITDA level as well. And then you can take all that analysis and plug that in to your forecast model. So let’s say this was our deal.

Let’s do four million now, making seven hundred and twenty five thousand dollars of EBITDA, so eighteen percent. But as we scale, if we can grow up fifteen percent per year and we compound that right the way through to twenty twenty eight, at the same time, we can improve our margins at gross levels, say, about half a percent per year to economies of scale. And then we can take half a percent per year of our overhead, our operating expenses as a percentage of revenue. Then by twenty twenty eight, we’re forecasting we’ve got a business doing eight million and change in revenue and one point nine million and change of of EBITDA.

So, again, really important. You don’t just understand these numbers, but the science behind this. Explain how you’re gonna grow. Explain how you’re gonna improve the margins.

Investors wanna know these things. It’s really important.

Okay. And then when you’re looking at the growth, it’s looking at all the different ways to grow. So you might organically grow the business, more customers, more leads, new marketing channels, new products, all those different things. You might do a bolt on acquisitions. You might buy a complimentary business, and that’s gonna instantly add to revenue and margin and market share or joint ventures. You might partner with somebody in the marketplace and offer something together. So rationale is really important.

Next, question number three is the investor’s gonna say, well, that’s great. I love the big idea. I love the story, and I’m sold on your strategy of how you’re gonna grow this thing and make me money. But who’s the team?

Right? Who’s the team that’s gonna execute on this? Who’s actually gonna get the job done? Right?

So this is why it’s always really important for you to stay in your lane when you’re doing deals. Stay in your lane and do deals in areas that you know, you understand, you’re passionate about, and that you can add value to. And if you don’t have all of those different skills, go and partner with people. Put people onto your board.

Put people into your team that have got the chops, have got the skills, have got the experiences, and I’ve got the network to make this happen. Execution, guys, is is everything. Right? So you’ve gotta convince the investor that you’re putting a team together that’s gonna absolutely knock this out of the park.

And then number four, it’s all about the exit strategy. So the investors sold on your big idea. They they love the strategy to scale. They believe the numbers.

They think you got a great team that’s gonna execute. That’s all well and good, but the only way an investor is gonna get their money back typically is if the business is sold. So they wanna know what the exit strategy is. How are you gonna return the capital back to that investor, obviously, with a large premium that they’re expecting?

And there’s four ways that you can exit your investor. Number one is a trade sale. So you and the investor as partners, you grow that business, then someone comes in and they buy it, obviously, for a lot more money than what you paid for it. So that’s an exit with you.

You could sell the business to a larger investor. So private equity, they’re rolling up businesses across the world in lots of different sectors. So it might not be a trade buyer or a competitor that buys it, Might be a larger PE firm that wants to come in and take it to an even higher level. Number three is you can sell to the same larger investor, but you stay.

The investor wants you to stay and continue to execute. They’re just buying out the investor that came in with you when you did the deal. Or number four is if you generate a lot of cash flow and you’ve, you’ve paid down the original debt you’ve used to buy the business, you can go and raise another bunch of debt and then buy the investor out. So you’re swapping equity for debt, which is great because then that means you end up owning all of the business if you’re buying the investor out with debt financing.

And then the fifth question is so the investor loves the story. They love the strategy to grow and they believe it. They love the team to execute, and they know there’s multiple ways that you can exit them out. The final thing is the risk adjusted return on investment, r a r o I.

And it’s combining what is the return on investment that you’re forecasting, you’re promising, subject to the risk that’s implied in this particular deal. And there’s two types of ROI. One is just a cash on cash return. So if if an investor puts two hundred k into your deal and you exit them for a million, they make five times cash on cash return.

But then they’re also interested in something called the internal rate of return, the IRR, which is the compounded annual growth rate of their money in your deal. You might have seen that, listed as CAGR, c a g r CAGR and IRR, internal rates of return, mean the same thing. So let’s look at it. So let’s look at our business model, our forecast predictions.

As we saw before, four million revenue, seven twenty five k in EBITDA in twenty twenty three. We scale this up. We make this work eight million and forty five thousand dollars in revenue in twenty twenty eight, one point nine three million in change of EBITDA. Now and let’s say we decide in twenty twenty eight to sell this business at a six times multiple.

Right? We we’ve bought it at a lower multiple, obviously, but as we’ve scaled it up, we’ve made the profit bigger. We’ve made the business more sophisticated. We can now sell that business for a much higher multiple.

And at around one point six, depending on the industry, you probably sell for a six times multiple. So look at a three year average of EBITDA. It’s one point six one five million. Six times multiple, that gives us a nine point six, nine point seven million dollar enterprise value.

Then let’s say there’s a bunch of surplus cash and working capital still left in that business that we’ve not dividended out to us and the investor. We add that to the valuation. So this is a ten point seven million dollar exit for all concerned. So now we can forecast what the returns are.

Right? So when the valuation was two point eight million, say, two hundred k buy in, the investor bought nineteen percent. That same nineteen percent upon exit, nineteen percent of ten point seven million is two million dollars and change. So that’s generating a ten point one six cash on cash return for an investor, which is absolutely insane.

Right? That’s a phenomenal return that you’re forecasting and you’re promising just by that gentle organic growth and those improvements in margins. So two hundred k goes in, two million and thirty two thousand comes out, ten point one six r, return on investment. And then what is IRR?

So it’s the compounded growth in that equity. And there’s a very, very simple formula.

You know, Excel, Google, Cheats, they have it. But let me walk you through it. It’s the cash on cash return on investment. It’s the power of one divided by the number of years that the money is invested minus one, and then it’s a percentage.

So the cash on cash ROI in this example is ten point one six x. Five year investment period, twenty twenty four through to twenty twenty eight. So the IRR is ten point one six to the power of one over five, which is point two, minus one gives you fifty nine percent compounded growth. And that’s crazy.

Right? Because if that investor has has got their money in real estate, they might get five percent a year. They’ve got their money in the bank. They might get half a percent a year.

They got money in crypto. They might lose it all depending on what goes on. Obviously, putting it into your deal, they’re gonna make fifty nine percent annual return on their money, which is absolutely incredible. Right?

Anything north of twenty five percent, that’s a pretty solid IRR that you’re promising.

And then the whole risk portion goes something like this. So what investors do in their mind is they plot in their brain what’s the forecasted return on investment linked to the perceived risk of doing the deal. So, obviously, if the deal is extremely low risk, there’s no risk in that deal. They might just be happy doubling their money, making a one x return.

But if you’ve got a really high risk investment, they’re gonna want very high potential returns or they’re not gonna do the deal. So if you look at that log curve, right, when deals are inside that log curve, so the ROI is a lot higher than the perceived risk and it’s green, they’re gonna do that deal with you. On the contrary, if you’ve got a weak investment case and the ROI is not as high as the perceived risk, then it’s gonna be the other way around. So, guys, those are the five things that investors think about.

Just to summarize, gotta have a big idea, gotta have a solid growth strategy to scale profitably, gotta have a world class team or a great team that’s gonna help you execute and get the get the job done. Number four, gotta have a, an exit strategy that’s believable and ideally multiple exit strategies to return investor capital. And number five, you’ve gotta have a solid case of risk adjusted return on investment. Hope you found that useful.

Don’t forget to like and subscribe to this video and to this channel so you get all of my amazing content in real time, and I will see you soon on the next video. Until then. Bye for now.