The ‘emotional’ vs the ‘rational’ investor – how to take money from the right people for your business

When looking for funding for your business the investment market can look complicated and unclear.

The ‘emotional’ vs the ‘rational’ investor – how to take money from the right people for your business

When looking for funding for your business the investment market can look complicated and unclear. Before you start negotiating you need to work out what type of investor you ideally want and more importantly what type of investor you will be dealing with. 

On a simplistic level the market falls into two sectors: the emotional and the rational. As you progress there is a crossover and understanding that point is important in both the way you deal with those investors, what they expect from you and how they will treat you.  

The ‘emotionals’

The emotionals are easy to understand but the hardest to classify. In a nutshell it’s almost always an individual investor. They come in a variety of forms: seed investors, angel investors and high net worth’s being the most regular descriptors. It’s their own personal money and that’s what makes it an emotional decision. 

One of the things that unites these groups is tax benefits. There are several very well thought through government funded tax schemes, such as Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS). These allow investors to reclaim some of their investment in tax relief and, if it all goes wrong, they can then claim some or all of the losses against other gains and income.   

If you find the right ones, they will be your most loyal supporters, your best ‘foul weather’ friends and will invest again, sometimes when others shy away.

The ‘rationals’

The rational investors are broadly the institutions. These are usually the Venture Capital investors and the Private Equity investors. 

They are rational because they must make rational investment decisions. Their success is measured by the returns they deliver to the investors in their funds. The rational investors have systems and processes that they adhere to when making their investments.

Broadly, Venture Capital is interested if you are successful in generating revenue at a level sub £10m but are not yet profitable. They would look to be making 5-10 x their money in 5-7 years. They will take more risk than Private Equity, hence the word venture.

Private Equity is interested when you are making over £1m of EBITDA (profit) and look to be getting 3x their money in 3-5 years.

What are the key differences between the emotional and the rational investors?

The emotional investors tend to invest at the early stage, rational investors when the business is more established.

Rational investors usually provide the larger investments.

Rational investors have a much more rigorous investment process, and it always takes longer.

Emotional investors tend to get less involved in the business unless they are a chosen adviser. They will almost always demand less information.

Emotional investors are much more likely to accept light touch legal documents.

Rational investors will have a much more clearly defined investment period and expectations around their return on investment. This is entirely driven by the rules of their funds.

Emotional investors often lead with their hearts and rational investors with their heads. Founders often struggle when moving from taking money from an emotional investor to taking money from a rational one.

Remember that rational investors must invest to use all of the money in their funds in a specific time frame, emotional investors don’t have to spend at all. This means that the emotional investors are much more likely to pull out late in the process and rational investors less so.

Emotional investors will want your company to maintain it’s tax benefit status, rational investors less so unless they are a specific tax break fund.

The one thing that unites all investors is that they all only care about one thing, and that is their money and how much money they might make. 

Raising money is never easy. Understanding who you are looking to raise money from is an important starting point in the process. Once you have worked out where the money needs to come from then you can start to decide who is the best option in that sector.

David Pattison
David Pattison

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