Overview of Financial Instruments for Startup Funding

 

This is another awesome Guest blog post from Andre Averbug.

In a previous post I discussed the different types of investors available to entrepreneurs. But choosing the right investor depends also on the types of financial commitment you are willing to take on. Therefore, in this post I will discuss the main financial instruments used to fund startups – equity, debt, grants, and convertibles – and their pros and cons.

EQUITY

Equity fundraising is when a firm raises capital through the sale of shares in the company. For example, a startup raises $50,000 by selling a 10% ownership to the equity investor (e.g.: angel investorVC fund), representing a post-money valuation for the startup of $500,000. The investor gets the return on the investment through an exit event (e.g.: buyout from another investor at a higher valuation, IPO) and sometimes through dividend payments.

Pros:

– No obligation to pay back:  The equity investor becomes a partner and takes on the risk of the business. Differently from debt, you have no obligation to pay back. An equity investment, therefore, capitalizes your firm without limiting your future cash flow.

– Accessibility: Equity investors do not expect you to necessarily have revenues, creditworthiness, or collateral. They are betting on you and your business venture and their dollars should be accessible as long as you have an attractive and solid business proposition. For this reason, equity is often the ideal type of investment instrument for startups.

– Interests aligned: Because these investors become partners, their interests overall are aligned with yours. All parties want to see the business prosper in the medium to long term, differently from creditors, who might only be interested in your ability to pay back the debt regardless of the broader success of the business.

– Non-monetary support: Because incentives are aligned, equity investors often bring a lot more than money to the table. They may help you with mentoring, moral support, connections in the industry, introductions to strategic partners, and pulling in more investors in the future.

– Signaling: Receiving equity investment, especially from institutional investors such as VC funds, serves as seal of approval. It signals to the market that your business has been validated by a professional (and demanding) player. This brings status and opens doors when it comes to sales, negotiations, contracts, and further fundraising.

Cons:

– Loss of control: When you sell shares of your company you are also giving away part of your control. The extent varies according to how much the shares sold represent of the total equity, but first-round investors might typically ask for anywhere between 10-30% ownership. This normally comes with a sit at the Board and the right to participate in key business decisions.

– Share success: Well, this is more of a reminder than a “con” per se, but obviously, the more partners you have the more you will have to share the profits of the business and returns from a potential exit. This is normally not a problem, though, because hopefully investors help you “grow the pie”. As the saying goes, “it’s better to have 20% of the Empire State building than 80% of an old shack” (or maybe I just made this up?)

– Binding relationship: Equity investment is similar to a marriage. When entrepreneurs and investors become partners, they are tied in an open-ended relationship. The investors do want to exit at some point but, differently from a loan, which has clear terms and an end date, one never knows how long and how rough the partnership ride will be. If all goes well, this shouldn’t be a problem. But if the relationship becomes difficult, which is not uncommon given all the risks and stress involved, it can turn into a debilitating factor to the business.

DEBT

Debt is when a firm takes a loan from a backer (e.g.: bank, person, government institution) with the obligation of repaying principal and interest in a defined schedule. For example, a startup might take on a $50,000 loan from a commercial bank, at 10% annual interest to be paid monthly, with principal (i.e., the original $50,000 borrowed) to be repaid in 2 years, after a 6-month grace period (i.e., no interest payment is due in the first 6 months).

Pros:

– Ownership: With a loan you are not giving shares of your company to the creditors, you are simply borrowing money. This means that, differently from equity investors, creditors do not become your partners, do not dilute your ownership, and will not have a saying in how you run your business – you keep the control.

– Predictability: When you take a loan, you know all the terms of the relationship in advance. For example, you will have to pay X dollars every month, for 24 months, and then repay the principal after that. After repayment, the relationship with the lender ends. This makes it straightforward to incorporate the liability into your cash-flow plan and the broader corporate strategy and goals, without major uncertainties.

– Discipline: The obligation to pay back debt tends to make entrepreneurs more careful with the way they manage their resources. When you know you need to honor monthly payments and return the amount borrowed at the end of the period, you become more careful with the way you handle your expenses, procure suppliers, manage your costs, and go after your goals more broadly. This often brings positive lasting results in terms of financial management and corporate strategy.

– Cost: If your startup is successful, and the terms of the loan are aligned with market rates, debt is probably cheaper for you than selling equity. The value of early-stage startup shares can increase multiple-fold over just a couple of years. Therefore, if you believe in your startup and manage to get a loan instead of selling stocks, this will likely (hopefully!) cost less than selling equity prematurely.

Cons:

– Accessibility: Banks and other lenders are notoriously risk averse. This means that they will only lend to companies that can prove they can pay back. This is often a challenge for startups, which may not have steady revenues yet, little or no collateral to guarantee the loan, and limited receivables. Therefore, even if this seems like the best option, it might be hard to get.

– Obligation: With a loan, you either honor your payments “or else”… Depending on the laws of the country and what you used as guarantee, if you fail to pay back you may end up having issues liquidating the business, facing legal consequences, or even losing personal assets such as your house. The lender, differently from the equity investor, is not willing to share the risk of the business with you. Therefore, you must feel confident that you will be able to pay back the loan and understand the legal consequences before embracing this commitment.

– Discipline: The same discipline that can be an advantage can also be a limiting factor. For a startup, depending on how the business goes, servicing a loan monthly can mean that you need to tighten up your budget, cut your expenses, and even reduce investments to ensure you honor your obligations.

GRANTS

A grant is when a firm gets funds, normally to be used in particular functions, without the obligation to pay back or give shares of the company in exchange. For example, a company is awarded a $50,000 government grant as part of a program to support innovation and R&D. The startup’s only obligation is to use the funds as agreed and report on its progress.

Pros:

– Ownership and no obligation to pay back: A grant offers the best of both worlds in terms of the advantages of equity and debt. You don’t have to pay back and you don’t give away any control. Simply put, grant is free money!

– Accessibility: If a grant targets startups, much like equity, it usually does not require the company to prove creditworthiness, to have revenues, or collateral. It should be accessible to most startups that fit the profile the grant is meant to support.

– Signaling: Much like equity, receiving a grant also serves as seal of approval. Grants have highly competitive processes (who doesn’t want free money!) and winners are often praised publicly and receive good publicity. Winning a grant also places you favorably to win future ones from the same or complementary funders, as donors want to see you succeed to justify their programs.

Cons:

– Competitive: As mentioned, a grant attracts a lot of attention and normally gets thousands of applications. It is usually not something you can count on winning and incorporate into your business planning. At the end of the day, depending on the market, it might easier (or at least more predictable) to raise equity or get a loan. The grant would be seen as the icing on the cake.

– Time consuming: Well, nothing is really free. Applying for grants is very time consuming as the application processes are usually lengthy and bureaucratic. It requires a lot of time and focus and therefore it has a high opportunity cost. Also, if you win, usually there are thorough reporting commitments and you need to produce detailed periodic reports and show how every penny has been spent.

– Strings attached: Grant money is usually earmarked to certain types of investments or expenses. Therefore, you may not be able to spend the money as you wish. For example, even if you land a large grant of say $500,000, if it is part of an R&D program, you may not be able to spend a penny of it on what you might need the most at the time, say payroll or marketing and sales.

CONVERTIBLES

A convertible note (or debt, or bond) is a hybrid instrument, with debt and equity features. The firm borrows money from an investor (e.g.: angel investor, seed fund) and the intention of both parties is to convert the debt to equity at a later date. Typically, the note will be converted into equity in the subsequent round of equity investment, at a discounted valuation. For example, a company raises $50,000 in convertible debt, for 2 years, annual interest rate of 5%, and a 20% conversion discount. If a new round of investment (e.g.: VC fund) occurs within 2 years and shares are valued at $1, the convertible investor will purchase them for $0.80, buying 62,500 shares instead of 50,000. However, if after 2 years no new investment is made, the company needs to repay investors the $50,000.

Pros:

– Fairness: Convertibles solve a major problem in early-stage funding: valuation. It is very hard to come up with a sensible valuation for early-stage startups, especially those in ideation and pre-revenue stages. Convertibles solve this problem by pushing the valuation conversation forward in time, for only when/if the business is more developed and a professional investor is able to make a more educated assessment.

– Win-win: This is a financial instrument both entrepreneurs and investors are quite comfortable with, especially given the fairness argument above. Entrepreneurs are not giving out equity sooner than needed and investors are not running the full equity risk.

– Most equity pros: Most equity pros discussed above – except, before conversion, for the “no obligation to pay back” – apply here.

– Some debt pros: The debt pros of “predictability” and “discipline” also apply here.

Cons:

– “Worst” of both worlds: While grants get you the best of both worlds of equity and debt, convertibles, in a way, may get you the worst. This is because, if the business is being successful and you raise more funding, you will be selling your valued equity at a discounted rate. Alternatively, if the business is not going well, or even fails completely, you will still need to pay the investor back. The former scenario is certainly less of an issue because the investor surely deserves the discounted valuation for having backed you early in the process. But the latter might put you in the “or else” situation discussed above for debt, exactly in a moment your company might not be doing well.

– Equity cons: All equity cons apply here in case the note converts.

– Debt cons: All debt cons apply here, except for what regards principal repayment in case the note converts to equity.

Choosing the right financing instrument is a key strategic decision for any startup. Stay tuned because, in the next post, I will discuss the main questions entrepreneurs need to ask themselves when it comes to making this decision.

 

 

Andre portrait

Andre Averbug is an entrepreneur, economist, and writer. He has over two decades of international experience working in the intersection of economic development, entrepreneurship, and innovation. He has worked and lived in multiple countries across North and South America, Europe, Africa, and Central Asia.

Andre has started and run four startups, in Brazil and the US, and was awarded Global Innovator of the Year in 2009 by World Bank’s infoDev. He has extensive experience supporting companies as mentor and consultant, both independently and as part of incubators such as 1776 and the Kosmos Innovation Center, and programs like Shell LIVEWire, StartUp Weekend and WeXchange.

As an economist, Andre has worked in topics ranging from innovation ecosystems, entrepreneurship and MSME development policy, competitiveness, business climate, infrastructure finance, monitoring and evaluation (M&E), and country assistance strategy for the World Bank, the Inter-American Development Bank (IDB), and the Brazilian Development Bank (BNDES). He has also consulted for clients such as DAI Global, the Economist Intelligence Unit (EIU), TechnoServe, among many others. He holds a master’s degree in economics from the University of London (UK) and an MBA from McGill University (Canada). Andre lives in the Washington, DC area.

He writes an awesome Blog called Entrepreneurship Compass and you can sign up here: https://entrepreneurshipcompass.com

DC “Networking Jackpot” – Big Idea CONNECTpreneur Fall Forum, September 13, Tysons Corner

LORE SYSTEMS is pleased to host our quarterly Big Idea CONNECTpreneur Forum, one of the most exciting angel and entrepreneurship networking forums in the DC Region on September 13, 2012 at the Tysons Corner Marriott.

InTheCapital called our June Forum “The Best Networking Event in DC.”

We also appreciate InTheCapital’s latest article on our upcoming Fall Forum: “Three Reasons Why You Should Attend the Big Idea CONNECTpreneur Forum.”

Please come out!  CLICK HERE to Register via the Eventbrite link.

The Big Idea CONNECTpreneur FALL Forum is a “NETWORKING MASHUP” of 210+ of the DC Region’s TOP Entrepreneurs, Business Leaders, CXOs, Angels, and VCs.  Most of the attendees are “INVITATION ONLY,” and we are limiting service provider participation in order to maximize the experience for our Attendees and Sponsors.

Presented by LORE Systems, this UNIQUE EVENT is like NONE OTHER in our region, due to the high quality of our attendees and participants, as well as our program and unprecedented networking.

Come see what happens when you put a group of “A List” business leaders and entrepreneurs in one room for a few hours!

Program Highlights:
  • Over 210 attendees, includng 120+ CEOs/Presidents and 40 angels/VCs
  • Conversation with CEO, VC Advisor, & Angel Investor Christopher M. Schroeder
  • Discussion with UBER Tech Entrepreneur David A. Steinberg
  • SHOWCASE of Emerging tech companies
  • NETWORKING sessions before, during, and after the event
The venue is the Tysons Corner MARRIOTT.  A plated breakfast and unlimited coffee are included.

FINAL AGENDA
7:00–8:00 am – ARRIVAL / NETWORKING
 
8:00 – 8:10 am – WELCOME
 
8:10 – 8:45 am – Conversation with Christopher Schroeder,
Renaissance Man, Entrepreneur, CEO, Advisor, Angel Investor, and Author
Author, Arab Inc(ubate)
Co-Founder and CEO, HealthCentral, formerly DrKoop.com (an InterActiveCorp company)
CEO, Washingtonpost.Newsweek Interactive
CEO, LEGI-SLATE
 
8:50 – 9:25 am  –  Conversation with David A. Steinberg,
UBER Tech and Marketing Entrepreneur
Chairman & CEO, CAIVIS Acquisition Corp.
Founder, Chairman & CEO, InPhonic / Simplexity (NASDAQ:INPC)
9:30 – 9:45 am – NETWORKING BREAK
9:50 – 11:15 am – COMPANY SHOWCASE
11:30 am – NETWORKING
CONFIRMED PARTICIPANTS (partial list):
Over 120 CEOs/Presidents, plus 40+ angel and VC investors including New Enterprise Associates, Novak Biddle, Core Capital, CIT, Blu Venture Investors, Blue Water Capital, Dingman Center Angels, Neuberger & Co. Ventures, Saratoga Investment Corp., Washington DC Archangels, Angel Venture Forum, Fortify.vc, Endeavor DC, Maryland Venture Fund, National Capital Companies, Enhanced Capital, White Hall Capital,  MTECH Ventures, Mosaic Capital, Opus8, VentureCross Partners, McLean Capital, Starise Ventures, Blue Heron Capital, Duncaster Investments, Private Capital Network, Next-Stage Development Group, Berman Enterprises, Grindstone Partners, Next Stage Development Group, Atlantic Capital Group, Lancaster Angel Network, Harrell Partners, Stanford Venture Advisors, MD Center for Entrepreneurship, Skada Capital, Great Falls Capital, Bayberry Capital, Hafezi Capital, Keiretsu Forum, and CADRE.
EVENT SPONSORS:  
 
LORE Systems
BDO
Wilson Sonsini
Deloitte.
Cooley LLP
Meltzer Group
AH&T Insurance
McBride Real Estate
Ryan & Wetmore
Washington, DC Archangels
Dingman Center for Entrepreneurship
Angel Venture Forum
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“The Best Networking Event in DC” – Big Idea CONNECTpreneur Summer Forum, June 6, Tysons Corner, VA

LORE SYSTEMS is pleased to host our quarterly Big Idea CONNECTpreneur Forum, one of the most exciting angel and entrepreneurship networking forums in the DC Region on June 6, 2011 at the Tower Club in Tysons Corner, VA.

InTheCapital calls this Forum “The Best Networking Event in DC.”

Please come out!  CLICK HERE to Register via the Eventbrite link.

EVENT IS NEARLY SOLD OUT!!

The Big Idea CONNECTpreneur Summer Forum is a “NETWORKING MASHUP” of 165+ of the DC Region’s TOP Entrepreneurs, Business Leaders, CXOs, Angels, and VCs.  Most of the attendees are “INVITATION ONLY,” and we are limiting service provider participation in order to maximize the experience for our Attendees and Sponsors.

Presented by LORE Systems, this UNIQUE EVENT is like NONE OTHER in our region, due to the high quality of our attendees and participants, as well as our program and unprecedented networking.

Come see what happens when you put a group of “A List” business leaders and entrepreneurs in one room for a few hours!

Program Highlights:
  • “TURBOCHARGING Entrepreneurship” Discussion
  • “ART OF THE PIVOT” with “UBER” technology entrepreneur Reggie Aggarwal of CVENT
  • 9 Emerging tech companies seeking funding will briefly tell their stories
  • Networking sessions before, during, and after the event
The venue is the Tower Club in Tyson’s Corner, Northern Virginia’s premier private business club.  A plated breakfast and unlimited coffee are included.
AGENDA
7:00–8:00 am – ARRIVAL / NETWORKING

8:00 – 8:05 am – WELCOME

8:05 – 8:45 am – SESSION 1 – “TURBOCHARGING ENTREPRENEURSHIP IN THE DC REGION” with Uber entrepreneur and angel investor Doug Humphrey, CEO and Founder, CIDERA;  Co-Founder, DIGEX

8:45 – 9:20 am  –  SESSION 2 – “THE ART OF THE PIVOT” with Uber entrepreneur Reggie Aggarwal, Founder and CEO of CVENT
9:20 – 9:45 am – NETWORKING BREAK
9:45 – 11:30 am – SESSION 3 – COMPANY PRESENTATIONS (all confirmed)
AthleticMD
DeviceCloudNetworks
Glimpulse
HITCH
11:30 am – NETWORKING (ATRIUM)
EVENT SPONSORS:  

InvestMaryland Wins Big, Raises $84 million for VC program

Last week, the State of Maryland became the first state in the USA to use an online auction to raise funds for a venture capital program.  The auction yielded $84 million, a whopping 20% more than the original forecasted goal of $70 million.  On September 24, 2011, I wrote a brief summary of the InvestMaryland program.

InvestMaryland will invest in the State’s promising start-up and early stage companies, as early as this summer.  The $84 million raised was generated through an online auction of premium tax credits to 11 insurance companies (including Hartford Insurance, New York Life, Chubb, GEICO, and Met Life) with operations in Maryland.  The inaugural round of investments will be made in innovative companies this summer through several private venture capital firms and the State’s successful Maryland Venture Fund (MVF),

Said Governor Martin O’Malley, “Our State is well-positioned to be a leader in the new economy as a global hub of innovation – a leader in science, security, health, discovery and information technology. That’s why last year, together with business leaders from across the State and the General Assembly, we chose to invest in our diverse and highly-educated workforce and the skills and talents of our people for the jobs and opportunity of tomorrow.”  

The InvestMaryland program is being implemented through the Maryland Venture Fund Authority, on which I am very proud to serve, as well as the Maryland Department of Business and Economic Development (DBED).

Earlier this year, the Authority selected Grant Street Group to prepare for and run the tax credit auction and also recently selected Altius Associates, a London-based firm, to oversee the selection of three to four private venture firms to invest the InvestMaryland funds. The private venture firms will be responsible for investing two-thirds of the funds, which will return 100 percent of the principal and 80 percent of the profits to the State’s general fund. The remaining 33 percent will be invested by 17-year-old Maryland Venture Fund (MVF).  The Maryland Small Business Development Financing Authority (MSBDFA) will also receive a portion of funds for investment. Returns on the funds invested through the MVF will be reinvested in the program.

InvestMaryland has the potential to create thousands of jobs in Innovation Economy sectors – life sciences and biotechnology, cyber security/IT and clean/green tech and attract billions of follow on capital.

Maryland has an outstanding infrastructure to support an Innovation Economy. The Milken Institute ranks Maryland #2 in the nation for technology and science assets. According to study results, while Maryland received high rankings in human capital investment, research and development inputs, technology and science workforce, and technology concentration and dynamism, it lagged behind other states in risk capital and entrepreneurial infrastructure, demonstrating the need for InvestMaryland and other programs.

How will Altius select the Venture Capital firms?  Altius will be evaluating venture capital funds based on management experience, firm experience, investment performance and criteria defined in the legislation.

When will the firms be selected?  Venture capital firms will be selected starting June/July 2012 for a projected18-month period and make first round of investments in summer 2012.

What is the investment return to the State? The selected venture firms will return 100 percent of the principal investment by the State before taking any distribution of profits and will then pay 80 percent of the profits to the State.  Any returns on investments made through the Maryland Venture Fund go back into the fund for an evergreen program.

What is the projected average investment with venture capital companies? Investment will likely range from as low as $250,000 upwards to $10M.

Is there investment funding available from MVF?   Maryland Venture Fund will continue to invest in early stage companies (tech, biotech, clean energy) from $50,000 to $500,000 as initial investments.

Maryland Venture Fund Authority (MVFA) will perform a monitoring role to ensure that  investments and reporting meet the legislative guidelines.

In summary, as a member of the MVFA, and as a resident and business owner in Maryland, I am very excited to see this InvestMaryland program being implemented:

  • This program brings great benefit for taxpayers.  It helps create the jobs and companies of tomorrow and builds an economic climate where the most promising ideas and innovations have a chance to mature.
  • This is a win-win for all constituencies within the State of Maryland. Through this initiative, we can:
    • Infuse much needed capital into our seed and early stage companies
    • Recapitalize the State’s successful Maryland Venture Fund
    • Ensure no up-front cost to taxpayers
    • Provide a tax benefit to insurance companies who bid today, who can begin claiming credits in 2015.

Thanks for reading.  I’d appreciate any Comments or feedback you may have on InvestMaryland.

Featured image courtesy of Anosmia via Creative Commons.

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

Stack of 100s at 12most.com

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.

The Angel on Your Shoulder

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.

Scaling a Hypergrowth Enterprise – Part 5 of 5 (Capital)

photo

This is the 5th and final installment in my 5-part series on the five elements of Elements of Scaling a hypergrowth enterprise.  I was the co-founder and CEO of CyberRep, a hypergrowth CRM and call center enterprise which grew annual revenues from $500,000 to over $1.6 billion over a 17 year period.   That’s revenue growth of 320,000% (3200x).

So what are the 5 elements of scaling a hypergrowth company?  Part 1 of this series talks about PeoplePart 2 discusses Culture, Part 3 examines Scalable Customers, and Part 4 delves into Process.  The 5th element is Capital, which is the necessary fuel that every hypergrowth company must have.

While many startups can be bootstrapped with limited capital, the Hypergrowth Enterprise absolutely needs capital.  In order to put in place the foundation for hypergrowth, you need the money to build and perfect your product or service, to hire your awesome talent, and for working capital as you book revenue.

Two Essentials for Raising money are to 1.  Raise money from a Partner, not just an investor and 2.  Raise more than you need, but not too much.

THE INVESTOR PARTNER

To fuel our growth, we raised $20 million in mezzanine capital (subordinated debt with warrants) and $1 million in equity from one partner, Allied Capital, a Washington, DC-based, publicly traded business developement company (BDC).  We did 3 separate rounds over a 4 year period for expansion of facilities, working capital, and the acquisition of 2 complementary targets.  We had multiple term sheets from VCs, mezz investors, and private equity firms.  We chose Allied because, in our opinion, they were more than a capital source, they were a Partner.

A Partner has Deep Pockets – Our partner had a $5 billion portfolio with an average deal size north of $20 million.  While we only raised $4 million in our initial round, we knew we would need to go back to the investor for more money as we grew.  Therefore, we needed a partner who woud readily put more capital into our business.  Raising money is VERY time consuming and disruptive to your business, so by having a deep-pocketed Partner who could fund additional rounds quickly, we avoided having to spend tons of time shopping for new investors for our 2nd and 3rd rounds of funding.

A Partner Understands Your Space – Having made numerous investments in the business services and information services space, including a company directly in our space, our partner brought to us expertise and experience which, inside and outside of the boardroom, proved to be very valuable.  If your investor knows your space deeply, they won’t waste your time with stupid questions and uninformed opinions. Instead, they can focus on the nuances of your industry and add true value.

A Partner Has Operational Experience – Our partner owned outright many of the companies in their investment portfolio. As the owner of these businesses, they had an operational focus on all of their portfolio companies including ours. This was invaluable to us, as we were quite inexperienced and needed all the help and guidance we could get. Too many professional investors have no operating experience, and have never had to hire people, fire people, make a payroll, or close a sale.  Lack of practical experence puts these investors at a disadvantage and, worse, the advice they give you could put you out of business!  Conversely, professional investors who have started and built companies are the best kinds of partners to have because they can share their knowledge and experience with you. They know firsthand how super hard it is to build a business from zero, and they can relate better to you.

HOW MUCH MONEY SHOULD YOU RAISE?

Raise more than you need, but not too much.  What do I mean by this? Whatever amount you think you need to raise, raise a little more.  I know I am generalizing, but in the VAST majority of requests I see, the entrepreneur does not ask for enough money.  Who knows why.  Maybe she’s trying to minimize dilution, or maybe she thinks this current round gets her to a milestone where she can get a higher valuation with the next round.

Regardless, the key thing to keep in mind is that capital is the FUEL for your growth.  If you’re driving from New York City to DC, do you fuel up your car every 50 miles, or do you put enough fuel in your tank to make the entire trip?  Same thing with raising money for your growth.  Be less concerned about dilution and equity give-up and more concerned about having the fuel to reach your destination.  Raising money is a big distraction from company operations, and it’s a real time killer.  Founders need to be focused on wowing their customers and building an amazing team, NOT being in constant fundraising mode.

So how much do you really need?  Think through your scenarios, be conservative on your projections (sales always take longer than you think), and get advice from seasoned pros and advisers as to the appropriate amount.

As for raising TOO MUCH money, this is also a problem.  Why?  Because having the security of a fat bank account can make a startup SOFT and too comfortable. They lose their edge, the bootstrap mentality which is necessary for creativity, scrappiness, and resourcefulness.  Look at all the Dot Com failures that raised too much money, and then wasted it on pricey office space, expensive furniture, ridiculous marketing, etc. because they couldn’t find a better use for that precious resource.  They got soft, then couldn’t be self sufficient when the VC market dried up.

So….raise more money than you need, but not too much.

Thanks very much for reading.  I hope this 5-part series was informative.  What do you think?  I’d love your feedback and thoughts, so please Comment below…and please sign up for my Blog too!  (See the Signup box on the sidebar of my Home Page)

Featured image courtesy of Asthma Helper licensed via creative commons.