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Revealed: Five red flags that equity investors look for

by , 11 December 2013
If you're looking for financing for your business, it's important to be aware of what potential debt funders will look at in your financial statements when determining if you can repay the debt or generate returns on the investment. Read on to discover the five red flags that equity investors look for.

Normally equity investors are concerned with sustainable longer term operating profit growth. Although they're concerned about the risk of not getting capital back, they're willing to take a higher risk if the future profitability is handsome.

BUT, this doesn't mean they won't scrutinise your financial statements.

Equity investors will look for these red flags if you're looking for funding

The Practical Accountancy Loose Leaf gives you the five red flags they'll look at:

Red flag #1: Hockey stick forecasts

Many companies prepare forecasts that take the shape of a hockey stick when graphed. That's significant losses in the first couple of years and then 'knockout' profits in future years. If the business has been recording losses with forecast profits, this would be a red flag for investors.

Red flag #2: High price relative to the net value of the business

This would be indicated by a very high price earnings ratio, a very low internal rate of return and a negative net present value.

Red flag #3: Liquidity and solvency of your business

Since equity investors are the last in the chain of claims if your business went under, he'd be very concerned that your business could go bankrupt.

High debt compared to the assets of the business and high short-term debts compared to the short-term assets of the business are an immediate red flag to investors.

Red flag #4: Sustainability of cash flows

Equity investors are concerned with the sustainability of your business. If your business has ad hoc or non-recurring income, this generally is a red flag to equity investors.

Major customer or supplier contracts that are about to end would be a concern. Equity investors prefer annuity based income.

Red flag #5: Limited voting rights with no exit

This happens when a minority (i.e. less than 50%) shareholding is available and there's no exit mechanism for the equity investor to make a profit.

Now that you know the five red flags equity investors look for, make sure address these issues to increase your chances of getting the funds you require for your business.

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