After friends and family…

Once a company founder has tapped the funds available from his or her resources and from friends and family, if the company needs more cash for growth, the most obvious next step is to look for money from angel investors and venture capitalists, typically in the $300,000 TO $3,000,000 range.

And the restrictions upon your freedom to operate…

This money comes with restrictions a founder may not expect, including restrictions upon the sale of founder stock, clauses that require the investor be allowed to sell an equal proportion of stock upon any other person’s sale of stock, anti-dilution provisions that protect the investor from a subsequent offer of stock at a lower price, and much more.

A seat on your board? 

[Email readers, continue here…]    Almost always, professional investors, including angel groups and venture capitalists, also require at least one seat on the corporate board.  The investor organization is granted the seat if the investment remains, and the documents often name the first representative assigned by the investor group to the position.

Why these restrictions?

In later insights, we will explore the legal and ethical responsibilities of board members.  But the intent of these “forced” placements of a representative on the board is obviously to watch over the company’s use of invested funds and to help grow the company in value.  The combination of restrictive covenants in the investor documents and the new dynamic of board members with an agenda make for a change in the culture of the corporation, certainly one for the CEO.

However, outside professional investor board members can be a very good asset to the corporation with the skills, experience and broad relationships many bring to the boardroom table.

We’ll get to my heartbreak in a minute. But first… There is a relationship between timeand money that is more complex than most managers think.  Fixed overhead for salaries, rent, equipment leases and more make up the majority of the “burn rate” (monthly expenses) for most companies.  Since this number is budgeted and pre-authorized, managers tend to focus upon other things such as sales, marketing and product development issues.

The art of good management.

There is an art to efficient management of a process, whether that is the process of bringing a product to market from R&D to production or developing a new product’s launch program.  What most managers miss is that every month cut from the time it takes to perform such tasks cuts the cost by the value of a month’s worth of fixed overhead or burn.

How about young or pre-revenue companies?

Although young companies rarely measure profitability this repeatedly, more mature companies usually can bring from five to ten percent of revenues to the bottom line in the form of net profit.  Ignoring the cost of product for a moment to make a point,  saving a month’s fixed overhead by making processes more efficient, could easily double profits for the year.

Time and fixed overhead:

[Email readers, continue here…]   That relationship between fixed overhead and production time is as critical as any other factor in the success of a young company.  Many of the start-ups my various angel funds have financed died a slow death, not because of poor concept but because of poor execution, wasting fixed overhead and draining the financial resources from the company coffers.

The financial pain of unplanned delays.

In the technology sector where I most often play, extended unplanned software development cycles account for the majority of these corporate failures.  We often accept that development schedules for young companies are almost always too optimistic.  But we investors often allow too little slack in our estimates as well.

Underestimating time to completion:

The great majority of young companies developing complex products such as semiconductor-based products, new software-based systems and technologies based upon new processes greatly underestimate the time needed to bring the product to marketable condition.  So, the CEO comes back “to the well”, asking for more money from the investors to complete the project.  It is not a strong bargaining position for the CEO to ask for money to complete a product promised for completion with the previous round of funding.  And professional investors often penalize the company with lower-priced down rounds or expensive loans as a result.

Now: my story of investor-product-market misfit:

I have one story that remains as vivid in my mind as when it happened several years ago.  Helping the founder create a company and build a much-needed product in an industry I knew very well, I served as chairman for the newly formed company, and along with my several rounds of early investment, led rounds of other angel investors in what I knew as a successful opportunity to fill a need in an industry I understood.

Growth before the VC arrived was not a problem.

The company grew to be well known in this limited niche and was operating at slightly above breakeven, when the Board and CEO decided to seek venture investment from what we hoped would be a first tier VC firm in Silicon Valley.  And we were able to secure that investment along with a partner from that firm joining our board.  It did not take long for the partner to become impatient with the relatively small size of the opportunity.  Dreaming of a company many times the size, he led the board to approve a complete reversal of course, even stating that the company should ignore the existing market niche completely and redesign the product for the broad Fortune 500 corporate market.

My role as chairman and acceding to the VC’s plan:

Every one of us on the board expressed our concern that the time to make these product changes and position for the new, broader market, would eat away all the company’s capital.  Promising the full weight of his VC firm’s resources, the board voted to make the change against the best judgment of those of us who knew the original market niche so well and thought that there was growth to spare in that niche alone.

…and the result of not listening to our gut?

So, the company turned the ship, slowly it seemed, as R&D worked to develop an appropriate product using the base of the original design.  Time slipped; fixed overhead continued.  And exactly as you’d expect, there came the time when the company ran out of money as it ignored its original market.

Surprise? 

Since the company slipped in its R&D schedule, the partners of the VC firm voted to not add new money to the company for the project.  Not long after, the company was sold in a “fire sale” amounting to slightly less than the debt on the books. All investors, including the VC firm, lost everything.  Do you remember a previous insight, that “the last money in has the first say”?  That is what happened within the dynamic of the board, and the result is that the board was completely at the mercy of the “last money” VC to save the company in the end.  Yes, there were other issues such as a protracted patent rights fight that drained cash, but the largest problem, inefficient use of R&D time burning fixed overhead, led to the demise of the company.  Lots of good jobs were lost and many investors including me were left with the question. “Why did the company abandon a profitable market, even if it could not generate $100 million a year in revenues?”

We will revisit the relationship between time and money again in future insights.

We have previously made the case that professional investors demand more in the form of restrictive covenants and lower valuations.  Now we explore the other side of that coin.  Professional investors usually bring “smart money” to the table, defined as money that comes along with good advice and great relationships for corporate growth.  Often, that money is worth more than the cash invested, because the investors who often become members of the board bring a wealth of experience, insight, relationships and deeper pockets to the table.

Smart money at the table…

I have served on the boards of several companies with just such VC talent at the table, partners in firms that made subsequent investments in companies where I either made early investments or led a group of fellow investors in early rounds of finance.  Each of these companies needed more cash than professional angel investors were willing or able to provide, and we turned to the venture community for larger investments.

Finding your champion investor…

[Email readers, continue here…]   Attracting a VC investment means finding a partner in a VC firm who is willing to champion your opportunity before their partnership and then represent that firm with a seat on the board once the investment is made.  In a number of cases, these VC partners have made the difference between success and failure or at least growth vs. stagnation.  These VC partners have relationships with later stage investors further up the food chain, with service providers, with potential “C” level senior managers, and with other CEO’s with great timely advice or partnering opportunities.

Recalling a case where this worked…

In one such case, the angels were tapped out at $6 million invested, an amount far above their usual taste, but for a company we thought had a billion-dollar potential.  The VCs subsequently invested $18 million, well beyond what angel investors usually can project from their own resources.  Without the VC guidance there would have been little opportunity to even dream of a billion-dollar valuation goal.  There is no question that the company took smart money and leveraged it for maximum growth, using the money, guidance, contacts and more from these large VC investors.

So now, in this series of insights, we have explored the early stages of formation and finance.  It is time in our next posts to turn to fine-tuning the business and its strategic plan to exploit its maximum potential, finding the ideal niche for a company and its core competency.

If you have been following our recent insights, you’ll be up to speed knowing that professional investors negotiate tough terms, from provisions of control over asset acquisition, eventual sale of the company, future investments, forced co-sale when others attempt to sell their shares and more.  And yet, in an earlier post, we spoke of the problems that come when taking unstructured investments from friends and family.

So how does this fit into this sandwich of alternatives?

Trusted, close resources include sophisticated relatives, friends and business associates who know how to structure a deal as a win-win for you and for them, while allowing you to retain control over your vision and execution.  Their investment should be structured with the help of a good attorney who understands the mutual goal of maximum leverage of funds with minimum interference in your business decisions.

Protect the investor as well as yourself.

Remember the admonition that investment from such close sources carries an additional burden for you – to protect your investors and their investment as if they were your alter egos, offering money as if from your own pocket.  Such money should never be taken without clear understanding of the terms, whether a loan with a reasonable interest rate and strict repayment terms, or an investment valuing the company at an amount considered reasonable by a third-party professional, even if as a sanity check as opposed to an appraisal.  This money is personal, an investment in you as much or more than in your company.  The degree of care you take increases with the reduced distance between you and your investor.

A personal story as an investor…

[Email readers, continue here…]    My very first investment as a professional angel was in a small startup where the entrepreneur’s vision fueled my imagination in the audio market niche where I had run a business in an earlier life.  I was so enthusiastic that I coached the entrepreneur to approach his mother, who invested $50,000 under the same terms as my investment.  A small venture firm and a few more angels rounded out the total investment.

Building the business with investors and board members

As the company grew and became profitable, it became more visible to others in the market niche.  Two of us who invested served on the board of the company, advising the first-time entrepreneur with our business and industry experience.

A liquidity event opportunity

Several years later, with the approval of the board and entrepreneur, I was able to engage a very well-known potential acquirer of the business who offered an attractive price for the still young but successful enterprise.

The shock I didn’t see coming…

After weeks of negotiation, the entrepreneur suddenly disengaged, claiming that he was no longer interested in a sale of his company.  The rest of us were shocked and disappointed that after weeks of work and a fair price, we were left with nothing but to follow his lead and disengage.

My reaction and proposal to the entrepreneur…

Shortly thereafter, in a board meeting, I brought up the issue of starting to pay board members for service in cash or in stock options, typical for outside board members but rarely for venture investors.  The entrepreneur was angry, abusive, in his negative reaction to even bringing the issue to the board for a discussion.  Five years had passed since my original investment in what I now clearly perceived as investment into a lifestyle business, one where the entrepreneur had no interest in selling or sharing.

So, I made my move…

I resigned from the board on the spot and negotiated a sale of my stock to the entrepreneur at five times the earlier investment, a fair return for both, since the company was by then worth much more.  It is now years later, and his mother along with other early investors are still in the passive game, not likely to see liquidity from this mistaken investment in an entrepreneur unwilling to take money in exchange for the eventual promise of liquidity.

Why tell this story at all?

Mother is surely satisfied as a passive investor who probably would have given her son the money without structure.  The other investors are probably in the unhappy never land of not being able to see liquidity after a decade and unable to write off the investment as a loss for tax purposes.   This story would probably have ended in a lawsuit if a larger professional investor had been involved, since the entrepreneur did not follow the rules and seemed to have no desire to do so.

Trust works both ways.

Take money from close resources but treat it as if the responsibility is even greater to protect the investors and their money than from a professional.   These investors trust that you will do the right thing for them if at all able.

Taking in angel or venture money requires a setting of an entrepreneur’s expectations that may come as a shock at least at first.

From the moment such an investor looks seriously at your company, the investor or VC partner is thinking of the end game, the ultimate sale of the company or even of an eventual initial public offering.  There is no middle ground.

Resetting your priorities

Taking money from these sources involves resetting priorities over time.  There is no such thing as a lifestyle business with outside investors. To protect against such an event, almost every professional investor includes a clause in the investment documents which allow the investor to “put” the stock back to the company after five years, requiring the company to pay back the investment plus dividends accrued during the term of the investment.  This sword hanging over the company is not often used but is a constant reminder that an outside investor is serious about getting out, hopefully in less than five years, at a profit, usually from the sale of the company.  Many companies find themselves at the five-year point completely unprepared for a sale and without the cash resources to carry out such a repurchase of investor stock, making the clause moot.

Investor-friendly clauses in agreement

There are also clauses in many such investor documents that allow the investor to override the founder and force a sale of the company if a proposed sale is attractive to an investor for liquidity, even if the founder feels that there is much more potential if the business is not sold at the present time.

The newest investor has the power.

[Email readers, continue here…]    Finally, it is an unfortunate fact that when a company needs money and has not met its original planned targets, the newest investor prices the round at a level below the last or last several rounds of financing, angering and frustrating previous investors who took what they perceive as the greatest risks by investing before the business proved itself.

Draconian terms?

The last money has the first say – in valuation and in sometimes forcing draconian terms that require prior investors to contribute a proportional new investment to retain a semblance of their original rights and avoid dilution or worse yet, involuntary conversion to a lower class of stock.  As the years progress with typical VC firms seeing lower returns than expected by their limited partner investors, such terms are more common in secondary rounds of financing, causing a real riff between angel investors and their former close allies, the VCs, with whom they had once coexisted as suppliers of deals at expectedly higher valuations at each stage of investment.

We know why investors “join” your company…

So be aware that professional investors are in your company for the eventual large profits at the liquidity event.  They are your friends only as long as you meet or exceed planned growth and value.  They tolerate you and your management when the numbers are a bit murky but with an explanation that is believable and correctable.  They act in their own best interests when things go south. That’s just the facts.

The subject of raising money is critical to many businesses and a passing option to others, depending upon the capital efficiency of the enterprise.  Some businesses require very little capital and the founder can self-finance the enterprise and retain 100% of its ownership and control from ignition through liquidity event (startup through sale).  For those of you who fit that description, nice work.

When the need is high…

For the rest of us, desiring to build large, valuable enterprises quickly, the need for outside capital is high on our list of requirements and even the source for some sleepless nights as we worry over the availability and cost of capital.  It is for this group that we explore the implications implicit in raising money for growth.

It might be useful to list some of the ways in which you can raise money for growth with and without outside investors.

Bootstrapping: 

This term describes your ability to start a business with little investment and grow it using internally generated funds.  Certainly, bootstrapping is a preferred method of funding growth if it does not hold back the speed of growth or hobble the quality of product or service to the extent that better-funded competitors can overtake the business.  There is a lot to say about retaining control.  You will realize much more from the ultimate sale of your business even if at a considerably lower price than if splitting the proceeds with investors.  You will have more control over strategy and execution than with an outside board overseeing planning and performance.  But few businesses grow into the sweet spot of $20 million to $30 million in worth to an ultimate buyer without the injection of outside capital.

Friends, family and fools: 

[Email readers, continue here…]   This term, although pejorative, describes the typical mix of early investors in a small, young growing business.  Money from these sources is relatively easy to come by, and most often comes with no strings as to oversight by a formal board composed of these investors and management.  However, most often, these funds are solicited by a well-meaning entrepreneur from investors who are not qualified as accredited investors under the law (currently requiring a proved income of $200,000 a year or $1 million in net worth for an individual investor).

My experience with early valuations by founders for friends…

I’ve arrived at a significant number of companies that were looking for additional growth capital after a “friends and family” round and had to “clean up” the cap table more than a few times over the years.  Taking this kind of money has several pitfalls you should be aware of.  It is most common to greatly overprice such a round of financing, valuing the enterprise well above what it may be worth at the moment for friends or related investors who do not have the sophistication or willingness to challenge the valuation.

The result of early over-valuation…

When professional investors look at such overvalued prior investments, they may refuse to become involved with a company, knowing that there will be, at the very least, universal disappointment and anger from prior investors when a new round is priced lower than the earlier friends and family round.   Sometimes this money is just too available, and the risks seem so far away; so, an entrepreneur will take the money and put off the worry over the eventual consequences, all in the hope that no more investment will ever be needed and everyone will be richer for the effort.

Using your bank credit line and credit cards: 

Even with the credit crunch signaled by the recent threat of recession, many banks will issue business credit cards with a $50,000 limit if the entrepreneur is willing to personally guarantee the balance, and has the net worth to do so.   And even with the significant cost of credit card debt, many entrepreneurs aggressively use existing cards to finance a startup.  It’s an option, even though an expensive one.

 “Strategic partner” investors:

If you can find a strategic partner willing to invest in your enterprise, consider it a blessing. Whether the partner is a supplier looking to gain a lock on your business as it grows or a customer looking to create a competitive barrier through use of your product, such an investment typically carries fewer restrictions than from a professional investor and less oversight.  Better yet, the valuation of your enterprise is often higher than if the same investment were taken from a professional investor.  Strategic investors validate a business, by their presence creating the very value they pay for with increased price per share purchased.  It is most often a win-win for both you and the strategic partner.

Professional angels:  

This is the arena where I work and play.  This class of investor, once quite disorganized, has become much like the venture capital community, creating a process including due diligence (careful examination of a business before investment), terms of investment that match those of venture capitalists, and a process that sometimes takes months from introduction to investment.  Yet, professional angels are usually willing to take active board seats in a young enterprise and act as cost-free consultants to the CEO-entrepreneur, giving freely of their individual and collective years of experience, often in the same industry as the investment target.

Do not expect grand valuations of your enterprise from these professional angels. They have been burned too badly during the last decade by overvaluing businesses and finding themselves like friends and family, “stuffed” into a down round of lower valuation when a company takes its next round of financing from the next step, venture capitalists.  Professional angels, often organized into groups, usually invest from $100,000 to $1 million in a young enterprise.

Accelerators:

This relatively recent combination of coach and limited investor is available to some early-stage businesses, usually in major cities, and requires that the entrepreneurs spend from weeks to months being coached by the accelerator team.  In return, the accelerator often invests $25,000 to $100,000 in the young enterprise and takes from five to ten percent of the equity in return.  At the conclusion of the acceleration period, the company participates in a “demo day” in which institutional investors are invited to review the company in a live pitch session.  Many accelerators have come and gone during these past five years.  Several are well-known and professional investors pay special attention to their graduates. These include Y-Combinator and TechStars, among others.

Venture, private equity and more: 

Here we lump a large number of investor classes into one.  Venture capital comes with a cost, and there are no bargains for the company when taking such an investment.  VC’s value an enterprise lower than others might at the same stage of investment, always aware of the need to create opportunities for “home run” profits at exit, since over fifty percent of their investments typically are lost when companies die before an opportunity to sell to others.  Further, as a class, VC’s have not done well for their own investors over the past decade except for several first-tier entities, making it doubly important to fight for low valuations and high profits at exit.

VC’s do not even engage in discussion with most of those entrepreneurs seeking capital. By some estimates, 95% of contacts are ignored unless they come as referrals from trusted sources such as known lawyers, accountants, or fellow VC’s.  And just for measure, VC’s fund less than 2% of all deals they do investigate.  Typical VC investments begin at $2 million and quickly rise to $5 million and above, depending upon the size of the fund and stage of investment.  Terms are much more restrictive than from strategic or angel investors, often requiring the entrepreneur to escrow his or her founder stock for a number of years to prevent the founder leaving, and restricting the sale of prior stock without the VC also being allowed to offer a share of its holdings in the same sale.

Micro-VC’s:

This is a recent class of venture investors, often with smaller funds, and willing to invest from $1,000,000 to $2,000,000 on average, filling a gap between professional angels and VC’s.

Private equity investments are available from firms created for this later stage opportunity, but typically are available only for businesses that have achieved revenues well above $50 million.  Often private equity investors will want control of the business as well.

Bank lines of credit are often available to businesses that are profitable, most often personally guaranteed by the entrepreneur, but available at a cost in interest less than most any other source.  Small Business Administration (SBA) federally guaranteed bank loans are available again after years of limited activity.  With some restrictive provisions, these loans are favored by many banks as carrying much less risk than loans without the guarantee.

But it is the outside investor that validates a business, often influencing growth with shared relationships, experienced guidance and providing a gateway to needed resources.  In the next weeks, we will investigate several insights that relate to these money resources, all to help you to determine what is right for you, and how to prepare and succeed in securing funds.

Hold it! These are confusing terms. When does a budget become obsolete? Do we rely upon constant changes and call it a forecast?

This is a budget:

A budget should be created each year after a series of negotiations between departmental managers and their superiors all the way yup to the CEO, all in support of the next year’s tactics previously agreed upon (which in turn support the longer-term strategies leading to the next goal beyond).

Here is the punch line: a budget sets the limits upon spending for the next year – limits negotiated between the players.  An important part of the budget is expected revenue for the coming year, a critical factor in setting hiring and resource expectations for the year.

…and this is a forecast:

[Email readers, continue here…]    But during the year, if the forecast revenues fall short or are greatly exceeded, it is fair to revise the budget and rethink your hiring and resources.  Otherwise, it is the expectation of the board of directors of a company that each year’s budget be approved in advance and adhered to as long as revenue goals are met.

Note that I used the term “forecast” for revenues for the next year.  The term is also used when projecting revenues for succeeding years.

The term “forecast” is a bit confusing, because it is also used by some as a measure of expected revenue and expenses to the end of the current year, found by taking actual performance year-to-date and adding best estimates of remaining revenues and expenses for the rest of the year to obtain an expected or “forecast” outcome at yearend.  Both uses of the term are common.  Just be sure all who participate understand which use of the word is the current one.

The punch line:

The real point here is to create a financial plan to support the strategic plan, marrying them in harmony one with another.  Many entrepreneurs are impatient by nature, not the best of detailed planners.  Yet, with the assistance of those in support such as the CFO, everyone in management must be aligned in a single direction, with the budget reviewed and updated annually as accomplishments, the marketplace, and even the competitive landscape change.

There may be more choices here. But the most important ones for any size business, including start-ups, is: Do you believe it should be the quality of your management team, or the plan you execute so brilliantly toward your success?

Do you want a unanimous answer right away?

Checking with professional investors from angels to VC’s, the answer appears to be near unanimous: the quality of the proposed or actual management team comes in a strong first before the attractiveness of the business plan itself.  The quest for a great management team is not a fluke, but rather a result of backward looks at the failure rate from past investments by those same angel investors and venture capitalists.

Here’s a test:

Several weeks ago, we published statistics of start-up and company failures. If you read that analysis of statistics for startups and early-stage businesses, you have learned the truth that at least half of the businesses backed by professional early-stage investors will die within three years or less.

And it’s a tough test at that.

[Email readers, continue here…]   That reality is a tough one for the professional investor, almost as tough as for those entrepreneurs who lose their businesses.  The latter can start new businesses, flush with the experiences gained from the previous effort and much the better for it.  But the investor’s cash is lost forever – and the experience gained usually is just another notch in their investor belt.

And here is the conclusion:

It is the management team, most often led by a passionate entrepreneur with experience in the industry, which makes the biggest difference between success and failure, even for businesses built upon less than sterling basic ideas.  Among professional investors, almost all would rather back a great team with an average idea before backing a great idea and inexperienced team.  It comes back to coachability and flexibility, also our insight from several weeks ago.

Great teams always have the advantage.

As a reminder of that conclusion: Great teams are flexible and have the advantage of experience in seeing the pitfalls before them from their past.  They are coachable in that they have taken advantage of the vast experience of others in overcoming obstacles and finding ways to speed a product to market faster or create a service whose quality exceeds that of the competition.

Of course, you could be the exception.

None of this is to say that an inexperienced entrepreneur cannot lead a great new business.  But it would be foolish to try without being surrounded with as many experienced co-leaders as possible from the outset.   As a start, that smart entrepreneur will soon “know what they don’t know”, an important qualifier for success in any business endeavor, when combined with the willingness to fill gaps in knowledge with help from those who have the experience to do so.

Even if you are not considering taking in money from professional investors, this advice would serve you well in protecting your own monetary investment.

Let’s start with a restaurant -not our thing. But…

I read several years ago that the average startup restaurant lasts only about a year.  Ouch! Here I am a professional investor in early-stage companies, and I attempt to find those with the greatest chance of success and growth in value over time.  Restaurant startups would not top my list.

Data does not lie.

We have years of real data to call upon: data that impacts both investors and entrepreneurs. There are two reliable sources of reasonably recent data for us to examine.  The Angel Capital Association recently published a study contributed to by several of my friends quoting that seventy percent of investments made by angel investors to date return less than the amount invested – upon a sale or closing of the business – the great majority of these outright losses as businesses die.

Fortune Magazine and Harvard studies

Attempting to get to the number of real failures for all startups, not just those with angel group investments, Fortune Magazine published an article claiming that 90% of these startups do fail.   The U.S. Census Bureau reports that 400,000 new businesses are started every year in the USA, but 470,000 are dying. What does THAT mean?

Even more credible statistics

[Email readers, continue here…]   John Chambers, former CEO of Cisco, stated that “More than one-third of businesses today will not survive the next ten years.”  And this includes all businesses, not just startups.  Harvard University recently published a study that shows three of every four venture-backed firms fail.  And the U.S. Bureau of Labor Statistics states that 50% of all businesses survive five years or more, and about one-third survive ten years or more. Remember that this includes the Fortune 500…

Here comes the SBA and its analysis.

The Small Business Administration (SBA) claims that 66% of new businesses survive their first two years (and that 50% fail during their first year in business.)  Although these are not parallel studies or similar statistics, most seem to refute Fortune’s claim that 90% of all startups fail.

How about the early-stage investors?

You might be interested in this data as viewed from the early-stage investor’s viewpoint.  Angel investors hold their average investment for 4.5 years before a liquidity event (positive or negative.)  That buries the real data that – if you strip out the short-term company failures or investor losses, the number of average years to a positive return is between eight and nine.  And that is after investment, not after a company’s start-up.  Would you be willing to invest a significant portion of your wealth in “deals” that are completely illiquid for almost a decade on average?

But there is a pay-off for early-stage investors.

And yet, these same early-stage investors – if they diversify into enough companies and wait long enough – see an average annual return on their investments of 22%.  Way above market investment returns. But those returns come from the 3% – yes only 3% – of their investments that pay out more than ten times the amount of the original investment.

Starting up a new company is risky. Investing in a young company is risky.  But the potential returns over time for investors makes this an attractive diversification.  And we hear of successes like the over 1,000 unicorn companies that make us all want to jump in and try our luck – even if the odds are well below 3% for ultimate success.

We are a cadre of optimists and that is unlikely to change.

Entrepreneurs will always start new enterprises. Angel investors will always finance many of them.  We all look forward to the lottery win, and hope to be well-rewarded over time.

Finding your strategic partner, investor or business buyer is not something you do haphazardly.  There are many steps to take, each closer to assuring a success.  Research is paramount, and sources are everywhere, especially for public companies and large investment firms.

Start with the “matrix method.”

You and your advisors, board or partners should start by completing what you can of the matrix shown on this page.  It will help you to focus upon the most likely candidates and save lots of time.  Here are the steps to take.

Find up to ten likely candidates that fit your business.

You can list companies you know, have contacts within, or that fit your industry segment.  Think of those who might need what you have to offer.  In fact, that leads to the most important part of this process.

Examine the four columns in the matrix.

[Email readers, continue here.]  Column one is your list of your candidates in no particular order, usually the result of a brainstorming session where you participate or lead.  For corporate boards, even those not looking for a buyer at this time, I often help to manage this exercise in board meetings once every few years. It keeps the board and CEO focused upon an ultimate exit.  That’s important when you’ve taken money from investors and have outside shareholders.  When taking their money, you made a promise to “make them liquid” someday, not to build a lifestyle business where they would be trapped forever, unable to see a return on their investment.

Column two is the golden ticket.

“What would the candidate want from your company in a transaction?”  Think carefully.  Some potential buyers or strategic partners might want your intellectual property, or revenues, or profitability, geographic advantage, or sale force, or your employee base.  Select the most likely reason you’d find if you could “get into their heads” and see what they might value most.  We’ll come back to this column in a moment.

Column three is important for you and your stakeholders.

Here you state in a few words what your company would want for the candidate – other than cash or investment which seems obvious.  Your definition of a great fit might include their distribution capability, their brand, dominance in your field, their sales force, their access to growth capital or more.

Column four is the easiest but also important.

Here, on a scale of 10 to 1, is your best guess of the likelihood of making a favorable deal with the candidate.  A 10 means that you are absolutely sure there is a need and a fit and the ability of the candidate to pay in a range you anticipate.  A 1 is tantamount to a complete waste of time.

Now return to column two.

You will surely notice that a majority of your estimates of the candidate’s interest or needs are the same, one to another.  This may surprise you and the team because this is your (sometimes hidden) core competency as others see you.  A wise board and management would take their own hint and strengthen that core, whether it is your development team, your geographic dominance or other trait.  And strengthen that at the expense of other areas of your enterprise which may easily be outsourced or reduced in scope.

The net result of this exercise.

You will have focused upon your real value, identified a list of companies with executives you need to know soon, even if long before any suggestion of a transaction.  Even a five-minute introductory call to the CEO with no agenda works for later name recognition.  And the exercise of researching through search engines, friends, financial sites or trade publications will begin to help you develop a picture of each candidate’s needs and strengths.

This exercise is time well spent and should pay back in multiple ways in your future if not immediately.