Business Owners: Avoid Strategic Investor 'Junk'

Michael Franks

Finding the right investment partner for your business can be the difference between success and failure. And here's the big problem: The landscape of potential strategic investors is littered with garbage. The vast majority of the firms in the market create no value, generate minimal returns at best, and often post nothing but losses. You need to navigate around the junk to find the right partner.

I've worked with venture capitalists, private equity, and I am a founding board member of the Angel Capital Association, so I'm familiar with all of the types of investment relationships. Some work, some don't, but all require a lot of effort.

Investment partners often make poor decisions, so it's your job to choose wisely. Here are six important best practices in finding an investment partner for your business that have served me well over time. A few are common sense, all are critical to ensuring your success.

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1. Do Your Due Diligence

Take the necessary time to get to know the potential equity/funding partner and ask for references. Do extensive diligence on the firm—the people, the limited partners, past portfolio performance and the experience that existing and prior portfolio companies' management have had with the firm's leadership. They will do a background check on you—so do one on them!

2. Remember, Scarcity Is Not an Issue

I have always said there is no shortage of funds—there is just a shortage of good deals. As critical as the funding firms are on management performance, management needs to be on the funding firm. You need to make sure your arrangement is well documented and you agree on many management elements up front—including governance, legal spend and ongoing fees. In today's business environment, debt and equity triggers and legal agreement are extremely important.

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3. About Your Gut

If you get a bad gut feeling about the firm—walk away—don't be shy about this! There are plenty of other choices.

4. Plan for the Worst-Case Scenario

You also need to think through the downside scenarios and what triggers are in the agreement to protect you and the firm from decisions in the tough times. Talk to the partner about this. Find out how the investment partner leadership has been run in the past during tough decisions and also how they conducted themselves in the good times. Speak to other portfolio companies about their governance and working relationship.

5. Form an Advisory Panel

If you are new to an investment partnership, form an informal advisory group around you to help you make the decision. There is nothing wrong with bringing a lot of formality to your process for choosing an equity partner.

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6. Be Patient

If you get it wrong, it will most likely be you and your team who suffer (if minority interest) and not the investment partner—even if the poor decisions leading up to change were theirs and not yours.

—By Michael Franks.

Michael Franks is CEO of First Med, a private ambulance transportation company, and a member of the CNBC-YPO Chief Executive Network.

CNBC and YPO (Young Presidents' Organization) have an exclusive editorial partnership. A key component of this partnership is regional Chief Executive Networks in the Americas, EMEA and Asia-Pacific. These Networks are made up of cross-sections of YPO's unrivaled global membership of 20,000 top executives on the frontlines of the economy, running companies that collectively generate $6 trillion in annual revenues and employ 15 million people in more than 120 countries. These top executives provide must-see point-of-view commentary about the news and issues affecting the global economy.