Small companies require capital. Small companies’ starting up especially innovation-based companies that present high risk and reward frequently need considerable more capital than the founder's wallet holds. This means that small business entrepreneurs have to seek other investors - and the success of the business will be heavily influenced by the extent to which they take account of the needs of these investors when drawing up a business plan.

Investors need a return on their investment. The return they can expect is largely governed by the amount of risk the investment presents: the greater the risk, the greater the reward.

Investors usually measure return using based on IRR or internal rate of return. This shows the return in terms of the annual percentage over the lifetime of the investment.

Oversimplifying slightly, an IRR of 60 per cent means investors receive the sum of the original capital for each year of the investment.

Smart investors do not rely solely on IRR, though, because it contains assumptions that can be misleading. Also, and much more importantly, most of the variables upon which IRR depends are hard to know in the early stages of investment - especially how long the investment will last and what the selling price will be.

It’s important to realize that investors are never merely making an investment in your company. They are building a portfolio of investments, which they view as a group. They know that the vast majority of the small companies will fail, that some will succeed and that only a few will be very successful. So every small company in a portfolio has to be potentially a big winner, because those big winners are covering the losers.

Some simple arithmetic illustrates the investor's hurdle. Let's say an investor intends to put £1 million into each of 10 companies for five years. The investor requires a return equal to the average return for early stage investors in venture capital in the USA, which is an IRR above 20%. That means his total fund must double in size in five years. Assuming six of ten companies fail and two companies achieve a 20% IRR, the other two must each return IRR of 140%. In other words, they must be worth £8 million in five years. That is breathtaking growth.

While smart investors may not depend on IRR, smart entrepreneurs will ensure that their proposition shows the potential for an IRR of the sort that investors want to see.

In the UK, the difficult for start-up small business entrepreneurs is compounded by the fact that the types of capital available for investment are variable, and not necessarily targeted at them. There is, for instance, an abundance of low-risk capital, such as bank loans.

There is also an abundance of funding for the purchase of companies or for management of an established division of a large company to buy the division. Once again, the risk of such a transaction is lower because the business already exists and can be analyzed.

There is a third category of capital available for innovation companies that establish themselves. They have already built a product or service (thereby diminishing technical risk), they have made some sales (diminishing market risk) they have an effective management team (diminishing people risk), but have not yet hit the fast-growth curve. Although these companies are still put in the high-risk category, they present an attractive balance of risk and reward from the investor's point of view.

It is very hard to find investors for start-up small companies that do not have the finished product or service, have not sold anything and have not hired the people who will be critical to running the business. It is harder to find investors when they are most needed.

In this situation, the only way for a small business start-up to get capital is for the entrepreneurs to focus their attention on demonstrating to the investors that they understand the risk factors, and present a robust business plan with whatever data they can find to show that the risk will diminish.

Not having the finished product should not stop a small business entrepreneur from illustrating what the likely demand for it will be when it is ready to sell. Prospective customers can be approached; their problem or need can be analyzed, the cost of the problem can be measured, and their willingness to purchase a product that is designed to solve it can be properly established.

In short, although there is not easy way to get venture capital for small business start-ups, it can be done. Those entrepreneurs who succeed are those who can empathize with the investor - they understand and support the investor's needs as well as their own.

Summary of Wooing Investors:

1. Try to empathize with prospective investors: if you understand what they want, you are more likely to succeed in the long run.
2. Ensure that your business can deliver investors with a good internal rate of return. That means an IRR of 20%.
3. Make clear to investors that you understand the risk factors of your business
Prepare a robust business plan showing how the risks will diminish over time.