Now that we know how much you need to ask the investor to invest in your company, what do they look at in addition to their investment ask? Well, first of all, they will look at what's called the return on investment. The simplest formula will be how much they actually get at the end of the day, when they have a exit. When someone buys them out, and divide it by the money that they actually put in in the first place. And that's a simple strict ratio of return on investment. Now, that of course is a good indication, but a true number that they're looking at is the annualized return. So what is an annualized return? How do we work it out? Well, you're not far off if you already have the return on investment. You simply look at the number of years. Let's say you put in the money for four years. So you use your return on investment, and then to the power of 1, divided by the number of years. So in our example, we say the return on investment to the power of a quarter. And then, you subtract 1 from that formula, and that give you the annualized return. This means the return that you are getting every year, including the year of exit. Now, this is what we call the annualized return. It's a better comparison than just the return on investment, because it takes time into the formula, how many years has that investment been sitting on this company. But that's not the only rate of return that we will look at. In actual fact, a lot of companies will look at internal rate of return, IRR. Now, to work out the IRR, these days you can just simply plug into a spreadsheet and you use the formula. In fact, the formula is called the IRR. And you sum all the cash flow into the formula, and then that would give you a rate of return. Now, what does that mean, right? Well, you're going to need a concept called the present value. And which means something that is worth some value in the future, you want to discount it back and see how much it's worth today, hence present value. How much something worth in the future and how much does that worth today. If you plug in all the numbers for the future cashflow of that company, and then also include that investment that you're going to put in today, and plug it into the IRR formula, and that would tell you what is the rate of return for the company. And it's called the IRR. Now, why do we need the IRR formula? Well, that's because for an investor, they need to look at the return on this investment. Is it higher than the cost of capital? If you remember, the company itself, I mean the investor may actually have their own investor in turn. And they may have borrowed this money to make the investment. And therefore they must get a higher return than the borrowed money, or than the return demand by their respective investor themselves. And therefore they are looking at the IRR higher than the cost of capital. If you actually passed that test, then you are at least a worthy investment, but that's not the end of the story. Because typically, the investor are looking at multiple possible deals. Whether your investment return, the IRR is higher than the competitor. Meaning the investors are looking at some other ventures that they can invest, potentially generate even higher return. So you must pass these two hurdles before the investor would consider you. Let me summarize again. The first hurdle you need to pass is that your internal rate of return must be at least higher than the cost of capital of the investor. Number two, your IRR must be higher than the other investments that your investor is looking at. So you beat the competitor for the investor's money.
