This may be informal with some friendly advice, or a complicated agreement and ownership structure with a venture capitalist. Regardless of the arrangement, these sources can provide the financial backing you need to be a success.
Friends and Family
Friends and family are the most common source for early seed financing. Atthe outset of your business, they are making an investment in you as much
as in your company.
You may need funds prior to actually incorporating your business, in
which case the investment may take the form of borrowing from friends or
family.
In that case, you will need a simple promissory note to evidence the
borrowing. You may want to include a provision in the note that the principal
(and possibly the interest) can be converted into equity in your company
at the option of the lender. You will probably not know the terms of
investment yet, so you may wish to state that the conversion rate would be
some percentage—for example, 80%—of the price the company will offer
to new investors once it is organized and ready to legally raise capital.
Friends and family investors can be a mixed blessing.
If you think it would be best to take out family and friends as early as possible to eliminate
future problems, then you can merely pay back the promissory note
when you have raised sufficient capital in your company. It is far cleaner
for tax purposes if you organize the entity you are going to use and then
have the new entity be the borrower rather than you personally. A variation
on this theme would be to pay the notes back and give the lender
a small equity kicker (shares of stock or membership units) in appreciation
for their early support.
Angels
Angel investors are high net worth individuals who invest in emerging companies.Like celestial angels, they can be tricky to find. Typically, they tend to invest in companies in their own geographic area and will conduct varying
degrees of due diligence on the company.
There are numerous angel clubs or gatherings around the country. These
groups meet monthly, sometimes weekly, to hear presentations of emerging
companies. In the meetings, the companies make their pitch in a twenty- to
thirty-minute presentation with a few minutes for questions and answers
afterwards. If any of the angel investors are interested, they follow up with
the companies individually. In the height of the tech boom, some of the
angel groups formed investment clubs that would review emerging companies
and then invest as a group, usually through an investment partnership.
There are different kinds of angel investors. Target those that fit your
current needs.
ANGEL INVESTORS
A sampling of the types of angel investors follows.• Retirement Investor. This type of investor comes from senior management
of a larger company and may be looking to contribute to the new company
at the same level. They may be using their early retirement or pension
funds to invest.
• Value Added Investor. These are seed investors who generally remain in
the background but are very active when problems arise. They tend to
invest in the $250,000 range.
• Professional Angels. These investors come from the traditional professions—
lawyers, doctors, and accountants. Normally, they rely on the
due diligence (investigation) of other parties for their investments, and
tend to invest in companies that have a product or service in their professional
arena. They generally do not get very involved with the business.
• Manager Investors. These investors may be available because of corporate
downsizing. They are interested in contributing to the active management
of the company with their skills. In effect, their investment is like
buying back their last job. If you are short on the management side,
these investors are valuable.
• Entrepreneurial Investors. This category is the classic angel investor who
are successful entrepreneurs and want to reinvest those profits in a variety
of companies. They tend to be the largest and most active of the
groups of angels.
• Socially Responsible Investors. The socially conscious investor tends to be
a nurturing investor whose values align with those of the company to
create a melding of values. This type of investor may use screens to evaluate
his or her investment. For example, they may have a screen for
environmentally friendly products and services.
• Family Investors. This type of investor represents a family unit that makes
selective investments. Usually, there is one person representing the
family who negotiates the investment on behalf of the group. (Familytype
investors are common in the Asian community.)
• Barter-Based Investor. Many start-up companies need equipment and
services that they will have to purchase in the marketplace from the
capital they raise. You may be able to barter for the necessary equipment
by exchanging equity for the goods or services. This arrangement
works particularly well where you are designing an application
to run on a device like a Nokia cell phone or a PalmPilot. An investment
by the manufacturer of the target device could be a natural fit as
barter investor.
Venture Capital
Venture capital sources are easier to identify than angels, but harder to close.Many firms and individuals call themselves venture capitalists, but they are
in fact brokers who present deals to individuals or companies who invest.
True venture capitalists are individuals who manage a fund that invests in
particular types of businesses.
Typically, a venture fund will raise money from high net worth investors,
usually in the form of a private equity fund, and then invest that fund in
promising businesses.
The fund has its own money, and in order to receive
funding, you and your company must go through an extensive due diligence
process. If you pass muster, the fund will offer you a term sheet, which can
be negotiated up to a point, and then you will proceed to the signing of a
stock purchase agreement in order to complete funding. Venture capital
firms tend to specialize in industry sectors and some may only fund companies
beyond the start-up stage.
Venture capital money is expensive and relatively hard to get. A venture
fund expects a return, of five to ten times its invested money. It needs this
type of return, because 70%–90% of the businesses it funds will fail or only
be marginally successful.
The advantage of dealing with venture capital is that
is tends to attach other venture capital and provide funds for subsequent
stages of growth. It also can provide interim management talent and quickly
ramp up a company for the public offering—if the market is available.
A listing of venture capital funds is available in Pratt’s Guide to Venture
Capital Sources, Thompson Financial Services at 800-455-5844, or the
Dictionary of Venture Capital, by Catherine Lister and John Harnish, John
Wiley & Sons, 1996.Your company will have a distinct advantage in obtaining
venture funds if you have a contact with the fund you are approaching.
Always check to see what kind of companies the venture fund invests in
before you submit your business plan.
Investor Funding Range
The funding ranges for various categories of investors look somethinglike this:
Friends/Family.............................. . $100–$200,000
Business Angels.............................. $200–$500,000
Venture Capitalists............................... $500,000–$2M
Private Equity Fund Managers.............. $5M+
IPO/Investment Bankers........................ $20M+
Potential Evaluation Factors from Investors
Here are some of the factors that angels and venture capital firms may usein evaluating your business. Even if you are not seeking venture capital
funding, you should consider these factors.
• Feasibility. Do you have a sound product, a defined market, and a
means to bring the product to market? Some companies define their market too broadly or cite volumes of meaningless industry market size
and growth data.
• Scalability. Is the business scalable? What is the company’s potential for
growth? Can the business be ramped up to a larger market or is the
market small by definition? Is it a lifestyle business like a small restaurant?
(You can still raise capital but not from a venture capitalist.) What
is the size of the market and will it accept your product?
• Experienced Management. Does the management have sufficient experience
to implement its business plan? Is this a situation of running vs.
learning? Is the inexperience of management partially offset by the
depth of the board of directors or advisory board?
• Market Risk. Is the market risk of the business acceptable? What are the
risk reducers that come into play here?
• Viable Exit Strategy. Does the company have a viable exit strategy?
How are the investors going to realize a substantial return and how
long is their investment going to be illiquid? For example, is the company’s
exit strategy to have a public offering or merger within five to
ten years?
• Value Engine. What are the basic economics of the business? How conversant
is the management with the industry and its economics? What
is the channel of distribution? Is the distribution channel already established
or is missionary selling necessary to establish the channel?
• Intellectual or Human Capital. What is the raw intellectual capability of
the company? There has been a recent trend to assess the human capital
in an organization. Remember that, notwithstanding your beautiful
business plan, smart investors invest in people, not plans.
• Commitment. What is your commitment to the project? Do you have
the ability and the motivation to give the intense focus necessary to
make this company happen? If not, all the other factors are irrelevant.
How are you sharing in the risk? Do you have your own money in the
company?
FUNDRAISING: A REAL WORLD EXAMPLE
 |
| Eric Delisle |
firm that provided websites and e-commerce solutions to small businesses.
In raising capital for his company, this is what he learned.
One of the most important things I learned in fundraising was to focus on a
few primary things.
The early stage investors buy YOU. Focus on integrity and knowledge. Tell
the TRUTH always. ESPECIALLY when you don’t know something. Be proud
of the fact that you, at least, know it is something you don’t know but are
willing to learn.
Know what you are talking about. Do your study and research so you are
confident. It will show through in your presentation. If you are not good with
numbers, have a business accountant hold YOUR hand through building
your projections and use as much detail as you can muster.
Be sure to understand your risks. I recommend writing your own risk analysis
document. This is a big list of What if... questions that you answer to the
best of your ability. When you begin making presentations to investors, they
will typically ask the same questions repeatedly from one investor to the next.
If you already have their questions written down BEFORE they ask them, and
you can show them your best guess of how you will handle the challenge,
they will not need to ask many more questions.
Know what your exit is. One of the most important things is to have a
planned exit. Whatever your planned exit is, be sure you begin with the end
in mind. All investors have one thing in common—they invest expecting a
positive return on their investment that they can use for something else. They
don’t invest because they want to tie their money up in something where they
can’t get it back out!
Be committed, not desperate. Don’t EVER put yourself in a position where
you only have one investor that you are counting on to come through without
having other prospects. Investors want the best deal that others want too.
The best way to accomplish this is to have at least five solid investor leads
being juggled at the same time and try not to fall below that number. When
one falls out, even if you still have four active, go out and start two new
prospects.
Don’t give presentations to anyone who can’t write a check. There is no free
lunch or easy way to get someone else to raise the money for you. So, if you
are constantly looking to present your offer to people who would like to hear about it, or think they know someone they can talk to, or haven’t told you they
could invest personally if the deal was right, DON’T waste your time presenting
to them or handing out business plans. Generally, business plans
don’t sell your investment. YOU sell your investment.
And finally...
ASK for the money. If you give a presentation, ask for the investment. I can’t
count the number of investor presentations I have seen where the business
owner gets to the end and says, Well, that’s our company. Thank you for
coming. And everyone in the room gets up and walks out. Try this
phrase...”Mr. Investor, I don’t know if you will invest in my company, but IF
YOU DID, how much would you be interested in investing?”
If you follow all of these points, you are head and shoulders above the average
person asking someone to invest in their business and you will most
likely earn those investors because of it. Good luck.
Valuation
The subject of valuation has elements of science and art. There are formulisticmodels for valuation that are quantitative and other models that
are qualitative. The qualitative general factors include (roughly in order of
importance):
• quality of management;
• size of the market;
• strength of the product;
• possible market growth;
• competition;
• stage of development; and,
• relevant industry.
In an early stage company, a quantitative valuation has less relevance
since there is little hard financial information. If your company is on the fast
track for launch, the longer you wait, the more you increase the valuation.
You should at least have a passing familiarity with a quantitative model for
valuation.
ENTREPRENEURIAL VALUATIONS
Tarby Bryant, Chairman and CEO of Anasazi Capital Corporation(www.gatheringofangels.com), provides the following guidelines
on entrepreneurial valuations.
Proper valuation of the entrepreneurial business is the seminal event in the
corporate maturation process, and it becomes an absolute requisite when
the entrepreneur wants to raise private or public capital. Once the company
is properly valued, then the entrepreneur can determine how much of the
company can be sold for the capital injection provided by the investor or
venture capitalist. Valuation is highly subjective and is art and not science.
The return that an investor requires is commensurate with the perceived risk
and his investment objectives.
Let’s imagine that Terabyte Technologies, Inc., a New Mexico high tech startup,
is projecting that by its fifth year, it will earn $1,000,000 after taxes on
sales of $10,000,000. Suppose that the initial funding request in their business
plan is estimated by Terabyte management at $800,000 and that the
interested private investor requires a 50% annual compounded return on
investment (ROI).
Anasazi Capital’s suggested methodology of valuation is as follows:
The private investor will estimate the value of the company in the fifth
year based on a multiple of earnings for companies similar to
Terabyte’s. We will assume that similar companies are selling at
approximately 15 times earnings. This would give Terabyte a value
in year five of $15,000,000. (15 x $1,000,000).
Employing this earnings multiple and the required 50% rate of
return, one can calculate the present value of the company using the
following formula:
Present Value = future valuation
(1 + i)n
Where future valuation = total estimated value of company in five
years
i = required rate of return for Private Investor
n = number of years
The present value of Terabyte Technologies would be calculated as
follows:
Present Valuation = $15,000,000 $15,000,000 $1,975,000
(1 + i)n (1 +.50)5
Based on the initial required funding of $800,000, the private
investors’ share of the Terabyte Technologies’ equity would be 41%
which is calculated as follows:
Initial funding = $800,000 = 41%
Present value $1,975,000
Valuation of the entrepreneurial company has as many variables as noted
above. The more accurate the revenue and income projections, the higher
the valuation of the company, and the lower the private investors’ share of
Terabyte. The early private investor should require dilution protection on his
stake as a first round early stage investor.
At the premoney stage of your company, do not spend endless amounts
of time on valuation. It is more important for you to demonstrate to
investors your strategy to bring your product to market, rather than showing
them an arbitrary assignment of value for your company.
Angel Networks and Entrepreneurial Forums
A source for angel networks exists at the Access to Capital Electronic Network(ACE-Net) which is a nationwide secure database accessible via the Internet
at http://acenet.csusb.edu. In addition, MIT Enterprise Forum has eighteen
chapters worldwide and offers networking opportunities for both investors and
entrepreneurs.Visit their website at http://web.mit.edu/entforum.
Another outstanding resource for entrepreneurs is IBI Global. IBI Global
seeks to promote resources and networking among entrepreneurs and help
develop capital and customer markets.
IBI Global is the only known course designed to teach you what you need
to know to get your business idea off the ground. It will teach you to protect
and promote business ideas, formulate strategy, define markets, build a
team, raise money, and meet contacts who can help you.
IBI Global hosts a seven day accelerated management training program
and CEO retreat and provides free ongoing graduate support through
weekly meetings across the nation to network and develop contacts.
You can learn more about IBI Global on their website at www.IBIGlobal.com. In addition, examples of IBI Global training are available at www.IBISuccessChannel.com radio and television network.
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