Equity Investors and Risk/Reward
Why do investors expect others to put in so much money toward a project? If the principals actually had all that money, they wouldn’t need (or probably want) the investors!
If this approximates how you think about equity-to-debt ratios and debt service coverage ratios, then this explanation is for you.
As you make further investments in your company or project’s success, others are more likely to join you. Few things are more important than your commitment. How committed are the project’s principals? How “invested” are you?
Investors expect principals to take on a meaningful share of the risks, because of the promise of commensurate reward, usually some mixture of financial, social and environmental returns. Debt funding sources stand to gain very little (return of principle plus interest, which is likely quite a modest “reward”), so they are very careful and calculating about risks. Ratios are their guide and exceptions to this formulaic approach are rare.
Equity investors, however, stand to gain much more upside — “home run” investments can pay for any number of base hits or foul balls (so to speak) — and can thus tolerate higher risks.
But all investors rely somewhat on momentum — there is strength in numbers — and the principals’ ability to attract sponsors or equity partners, grants or other “in kind” support is often the deciding vote. How else can you demonstrate your commitment to your own success? What prudent measures will show others that you’ve done your homework and are now well-prepared to bring a project forward? [ Coming in 2025: Find out more about what it takes at RAIN and receive a free financeability report. ]