12 Most Critical Questions for Raising Capital for Your Startup – 12most.com Guest Post

This was my August 16, 2011 Guest Post on 12most.com.

Right now – RIGHT now – is the BEST TIME to start a business, and there’s never been a better time to start raising capital. I firmly believe this. Why?  Because tough economic times cause tremendous dislocation in almost every market. Established companies are playing defense, trying to figure out where the economy is heading, laying off people, cutting costs, and trying to protect their turf. Fear is in the air.

Fear spells opportunity for new startups that can compete because they are small, nimble and agile.  Using creativity and resourcefulness, entrepreneurial startups can improve the way things have been done in the past, or attack brand new markets with new technology.  Startups are not encumbered by the baggage of their larger competitors.

However, raising money in tough economic times is, well, tough!  Angels and VCs seek to cherry pick the very best ideas, those that are most likely to succeed.  Money is still available for the best ideas and teams, but you have to be tuned in to what these investors need in order to make an investment in your startup.

Based on my experience as an entrepreneur, mentor, angel, VC fund LP, and board member, here are the 12 most important questions you need to answer when raising capital for your startup:

1. Money

How much do you need and what is the use of funds?

Investors want to know that you have thought through your capital requirements and where the money will be put to use.  Is it for product development, marketing, building out your sales team, etc.?  You must be ready to justify this request, and talk about how this gets you to the next stage in your startup’s development, as well as how much more money you may need in the future.  Know what kind of deal structure (preferred stock, convertible debenture, common stock, etc.) and valuation you are proposing to your investors.

2. Pain – What pain are you fixing?

Your product or solution must fix somebody’s pain, whether it’s making life easier, saving money, or making a customer more efficient.  Talk about the severity of the pain you are addressing, as well as how much money your customer will pay for it.  Show some basic market research, ROI analyses, and, ideally some 3rd party customers who are already happily using your product or service.

3. Raising Capital for Your Solution: What is it, exactly?

Exactly what product or service are you offering and how does it work?  Too many times, I have seen wishy washy descriptions of the solution because the idea is being matured, or in Alpha mode.  I have seen many super smart engineers with grand plans that are completely unfocused trying to be everything to everybody. Few have been funded.   Investors want to see certainty and simplicity in your proposed solution to the above-mentioned pain.

4. Customers – Who, exactly, is your customer?

You need to know WHO will be buying from you.  Are you selling B2B, B2C, B2G, all of the above?  Are your targets Fortune 500 companies, SMBs, NGOs, the Federal government, etc.  At what level are you selling (CEO, CFO, VP of Marketing, etc.)?  What kinds of situations will they need to be in to absolutely must buy from you?  The more precise the better.  And bring some testimonials or anecdotal evidence from these targets.

5. Execution Plan – What’s your plan for selling and delivering?

One of the biggest questions and concerns investors have is HOW you plan to win customers.  What’s your strategy, who’s leading the sales effort, and so on. Be prepared to discuss not only your marketing & sales plans and customer acquisition strategy, but also your customer retention strategy.

6. Raising Capital, as a Team – Who are the players and what are their backgrounds?

Angel investors are not only investing in an idea or a market space.  We are investing in a team of people with, preferably, a strong and experienced founder.  Talk about your key executives and your advisors too (lawyers, accountants, Advisory Board members), anyone who is adding considerable value to your venture.

7. Culture – What kind of culture are you building?

Culture is the DNA of every organization, and good culture is a requirement for success.  Culture can even be a differentiator against your competition.  The best investors know this.  Talk about your culture, your approach and philosophy towards business operations, leadership development, hiring, customer care, product development, and other key parts of your business.

8. Competitors – Who are they and how will you compete?

Competition is one of the most important questions to answer.  I have met with countless entrepreneurs who claim that they have “no competition.”  This is a particular pet peeve of mine, because every company has competitors, and all customers have choice.  Believing that you don’t have competitors is not only naive, it is a recipe for disaster.  So talk about all your competitors, both direct and indirect, and show how you are better and how you will beat them.

9. “Moats” – How are you special and what are your differentiators?

Warren Buffett likes to invest in companies with high barriers to entry, or “moats,” as he calls them.  Startups are risky enough for investors, and they want to invest in ventures which have a higher probability of success.  Moats include IP, patents, unique skills or knowledge, proprietary methods, unique brands, unique culture, etc.

10. Raising Capital for Pivotability – What will you do if your Plan “A” fails?

One thing is absolutely certain in a startup: your original plan will not happen the way you initially envisioned it.  Investors want a team that’s resourceful, agile, and creative enough to pivot, if necessary.  A sailboat in a regatta does not go from Point A to Point B in a straight line.  It gets there by “tacking, ” or making a series of rapid and opportunistic turns in order to maximize the wind in its sails.  Startups have to do the same thing, and investors want to see that you have thought through your contingency plans.

11. Commitment – How much money did you personally invest? Is this a full time job for you?

The best investors take a “partner” approach to investing, and they want to invest alongside their entrepreneurs.  I’m not so much looking for huge sums of cash invested, but rather whether the amount invested is a “significant” percentage of the entrepreneur’s net worth.  If a founder has put a good chuck of her net worth into the company, or taken out a second mortgage on her home, the investor will feel more comfortable about the founder’s putting her money where her mouth is.  As for working “full time,” this is essential.  I have never seen a startup succeed that didn’t have full time (80 hours a week) commitment from its founding team.  Be ready to field questions about how much your team is willing to sacrifice in order to win.

12. Exit – How are you going to make your investors money?

Investors are not looking to put their money in forever.  You have to paint the picture of how they will get their money and profits out within their expected timeframe (generally 4-7 years).  Be ready to talk about how you’re going to exit (for example via IPO, sale, recap, or refi).  How is the market for your proposed exit options?  Talk about recent deals in your space and get some data from the experts (M&A specialists, deal lawyers, etc.).

I hope this helps you as you think through your approach to pitching angels and VCs.  If you believe in your startup, then be persistent. Don’t give up!  If you can’t get funded initially, then prove out your business model by getting traction, i.e. happy customers, and figuring out other creative ways to raise the capital you need, whether it’s by getting equipment leases, vendor financing, customer deposits, or even money from “FF&F” (friends, family and fools).

Good luck out there!  It’s a great time to pursue your dreams!

Photo courtesy of amagill. Some rights reserved; used under creative commons license.

3 Types of Startup Founders – a Cooking Metaphor

What do chefs and entrepreneurs have in common?  Both try to use great ingredients, and apply their energy and experience to create masterpieces.

I love to cook, and I love to watch cooking shows.  Maybe it’s because I worked in my Dad’s restaurants as a young kid.  Anyway, I have found that there are 3 basic types of chefs:  1.  Scientist, 2. Magician, and 3. Artist.

To make a meal, the Scientist is the left-brained chef who meticulously measures and weighs ingredients, and follows religiously a 50-step recipe.  The Magician has no recipe and, in fact, has no preconceived idea what kind of meal she’s going to cook. Instead, she goes to the market and sees what’s fresh and in season, then she goes back into the kitchen and conjures up a creation on the spot.  The Artist is a combination of the first two. He has a general sense of what he wants to make, and how he wants to make it, and works within these guidelines to create his meal.  He dosen’t work off an exact recipe, but instead relies on instinct and creativity to work within his themes.

Having observed, invested in, and worked with dozens of startups over the years, I theorize that Startup Founders also fall into 3 categories, each one similar to those in the cooking metaphor above.

For example, the Startup Scientist may have a super detailed business plan and 30 pages of financial projections including a dozen pages of assumptions (ok maybe I’m exaggerating, but you get the drift).  Some years back, a good friend of mine sold his company for a tidy sum and used the 12 month noncompete period to develop a detailed business plan for a consumer-oriented startup.  He raised $10 million in venture capital. His business plan was amazing, and every possible contingency and possibility was covered, this even before his company earned Dollar One.  What happened?  Within 2 years, he burned through all of his cash and folded the venture.  Why?  I think the Scientist and his team were enamored by his plan, they hired too many executives too soon, and failed to be flexible and responsive to clients needs.  I really think his “awesome” business plan worked against him, and he stuck with it even though he should have pivoted and iterated. The bottom line is that startups are not a “science,” and this approach works better for large companies than startups.

The Startup Magician has NO PLAN.  He has a business idea, and gets to work, whether it’s developing a killer app, or acquiring customers and adopters.  He is open to change and creativity, and pivots and pivots until he finds something that works.  This kind of startup has no real business model per se.  Can this kind of company succeed? Remember Google? They had no business model until a year or so before they went public.  What was Facebook’s business model 2 years ago?  Does Twitter have a business model today?  Most would say it is undefined, but it has to be considered a very successful startup.  These are exceptions.  My personal feeling is that it’s very difficult to build a hypergrowth enterprise in this manner.  Some Startup Magicians create successful businesses, some create nice lifestyle businesses, but most either stagnate, or fail, usually because of a lack of direction.

What about the Startup Artist?  This entrepreneur has rough guidelines for what she wants to achieve in her business.  She knows her product or service, her company culture, the kinds of people she wants to hire, and the markets in which she will compete.  She has a general mission and vision for the startup, and a set of core values which serve as guiding principles.  Maybe she doesn’t have an awesome business plan, or a 10-scenario DCF analysis, but those things are not only NOT NEEDED in a startup, they will in fact inhibit growth and innovation. Ideally, she and her team work off a one-page plan with a couple of key areas of focus, and then they concentrate on EXECUTION.  I believe this type of startup has the best chance of winning because it allows for flexibility and adaptation to changing market and business conditions.  The company also has a general sense of its direction, culture, and style, which will keep it from meandering aimlessly.

The lesson here, I think, is that it’s best for a startup NOT to be to be too exact, nor too free form.  Planning is great, but the plan itself should not be Gospel. The benefit of preparing a business plan is in the planning process itself, where you and your team think carefully about your capabilities and differentiators, your customers, your competitors, financial assumptions, and markets.  But, it’s imperative to keep in mind that the one true thing about any startup’s business plan is that things will NEVER turn out as planned.

To build a hypergrowth company, you must be ready to pivot, to develop new solutions, to move into markets you didn’t originally foresee, and to take on other opportunities without being beholden to some preset plan which was made in theory to begin with.

Thanks for reading, and please leave a Comment below.  What style of Startup Founder do you think has the best chance of succeeding?  Am I being too critical of the Scientist?

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Note:  This Post is dedicated to my good friend Derek Coburn (@cadredc), Founder of CADRE, the UN-networking organization of remarkable advocates.  Thanks D, for suggesting I write a Post about this topic!