When should you go for equity financing?

Let’s take a few minutes to examine the kind of equity financing available to small or early stage businesses. In most cases, these applicants for equity funding  must be rooted in technology to apply to this limited discussion.

Friends and family investors

Here is a class of investor we’ve covered before, one usually focused upon you and less upon your business case.  We’ve worried together about the moral obligation implicit in taking such investments from people so close, even with their promise never to expect a return.  And we’ve spoken openly about your fear that you must succeed and perhaps even cover any losses – even without a formal promise or requirement to do so.  We’ll call these “inside angels.”  There is an exemption from the requirements that these investors be accredited with net worth or income minimums to qualify legally to invest in your company.

There are other classes of equity investors for small or early stage businesses that we have not yet considered.  Often grouped into formal organizations, these investors are sophisticated, helpful, and connected.

Angel investment groups or funds

First, angel investment groups and organized angel funds come in all sizes from a few organized angels to large groups of four hundred or more.  Each has a process in place to accept applications or recommendations for investment into new companies, and to review these and make decisions based upon their exploration, previous experience in the field, knowledge of the company or industry, or about individual entrepreneurs.  Angel groups invest from $250,000 to $1,000,000 or more in qualified investments.  Some can supply more when syndicating with other such groups.

How many angel groups are there?

[Email readers, continue here… ]   The Angel Capital Association (ACA) lists over four hundred member groups, located throughout the USA. The European Business Angel Network (EBAN), and similar organizations in other countries including Canada, all have web sites with directories of angel groups that are local to you.  And even though angel groups syndicate their best deals within their respective associated networks, it is always best to apply to the angel groups nearest your physical location.

If you have a virtual company with your employees working from home locations, as many startups do, it should be the location of the founder.  All angel groups will want to see the founders in person or by Zoom at sometime early in the process. Being in a distant city greatly reduces the chance of funding success.

Your expectations regarding time to funding and more

With angel groups and funds, you should plan of spending months in the process, from application through funding.  You will have to hone your story well, down to fifteen minutes and perhaps fifteen slides in your presentation.  Your opportunity becomes real when you are invited to present to the entire group via Zoom or hopefully soon at a lunch or dinner meeting, after which time one of the members or a paid group leader begins to seek commitments from the members to invest in your company.  You will be given a “term sheet” during the process, calling out the terms proposed for the investment.  These terms have become much more homogenized over the years, with many organizations adopting the same general form and terms offered to new investments.  Your principal focus may be on the valuation of the company before the investment is made, which determines the amount of the company you will retain after the investment.

Individual super angel investors

There is a rather new term for those large, individual investors who are usually former entrepreneurs made rich through sale of their previous ventures.  These “super angels” act alone or in informal groups and require that you find your way to them through personal introductions from their trusted associates.  The advantage to getting the attention of a super angel is that most operate informally and make quick decisions with little due diligence.  This class of investor typically writes checks from $50,000 to $250,000.

Accelerators

Accelerators are organizations that usually invest small amounts in startups and require the team to go through a process of from one to three months in which the accelerator staff helps to hone the message, train the team, and make introductions to larger investors – all in return for a relatedly small amount of equity, sometimes five percent.

Venture farms

This newest class of investor is most interesting but there are so few that they are hard to find and very picky in their choices of which companies to accept.  The strong advantage is that these organizations will stay with a company from acceptance to ultimate IPO or M&A sale, helping financially and with education, encouragement and introductions along the way.  These firms will continue to finance the company without VC money required, and in return keep the capital structure simple for the life of the company.

Then there is venture capital

Venture capitalists, rarely invests in startups, usually reserving their investments for companies that have star entrepreneurs they have worked with before, or companies brought to them by angel groups or other trusted sources.  VCs often invest no less than $2 million in a single deal, finding it difficult to put less money to work and still spend time on boards and coaching entrepreneurs to a successful liquidity event.  VCs need much higher exit values to justify their higher amounts of investment, and often want companies they invest in to be worth more than one hundred million dollars at exit, not a riskless task.

And the one thing in common?

The one thing in common with all professional or organized investors is the focus upon the exit, or liquidity event, in which the investors can realize a sale of their interest and a profit from their investments of time and money.  For early stage investors, the usual expectation is seven years from investment to expected liquidity.  When you take money from any of these sources, you make a pact to build, with their help, a business that can be sold or taken public, hopefully within that time period.

And the common expectation of your potential investors?

These professional investors look for at least ten times their invested money back upon the liquidity event, knowing that the odds of achieving that are only one in ten, and that half of their investments will probably die before any liquidity event at all.  They look for businesses that are in large markets, that can grow fast, and that can achieve revenues in excess of $20 million within five years of founding.  Those are difficult goals for most entrepreneurs, making this form of financing unavailable to most, but attractive to those that fit into these criteria.

Facebooktwitterlinkedinyoutubemail
Posted in Raising money | Leave a comment

Three Important Issues for Your Business Plan

Some professional advice           

Here’s more advice from professional investors for aspiring entrepreneurs.  Each of us has a list of things we look for early on when identifying whether we want to go to the next step in analyzing a plan.   Come to think of it, these are good for challenging any business plan.

Size of your total available market

First:  You must address a big market, large enough to allow you to have a shot at making a dent with a great product or service and growing to a size that will make the company valuable at the exit.

We often draw the line at believing that a company can capture enough of the market to generate at least $20 million in revenues by the fifth year in the market.  But many, many businesses will never be able to obtain this kind of market size or share.  Your big market can come from having a dominant share or just by being in a very large space.  Both work – with the dominant share preferred by most investors.

Your message must be simple

Second, you must have and be able to tell an easy to understand story to your prospective customers, suppliers and investors.  If your product is too complex to describe in a few words, your opportunity to sell it will suffer, and investors will quickly lose interest or the ability to follow your explanation.

Create a “mantra” for your business

[Email readers, continue here…]  I’ve often repeated that entrepreneurs must construct a short, single sentence “mantra” that explains what you do in as few words as possible, sometimes using the name of a well-known company as a proxy for your activities.  “We are the next Zoom of Internet one-to many interactive broadcasting.”

Your secret sauce

And third, you must have some “secret sauce” that is unique and makes you and your offering stand out among the thousands of possible competitors. If up against a monster like Zoom, tell us your secret sauce early to avoid us tuning out before you begin. So what gives you a head start, a barrier to entry, an extra value that others cannot easily emulate?  Secret sauce is important to investors and to you in competing against a company with more money, a brand name, or a head start.

A big market.  An easy-to-understand story.  Secret sauce.   Why not spend a few minutes right now, and explain to yourself how you address each of these.

Facebooktwitterlinkedinyoutubemail
Posted in General, Ignition! Starting up, Raising money | 2 Comments

Are you innovating because of need or inspiration?

Most innovations come from responding to a customer’s needs, or finding a niche where products need improvement or extension.  It is rare to innovate using a blank sheet of paper in a room with bare walls and no other contributors.

A thought exercise

Imagine the room in which several graduate business school student groups have gathered, tasked with coming up with an idea for a business plan competition.  The group starts with a blank sheet, and toils through idea after idea, trying to come up with a product or service that might become the next FedEx.  That is tough work, and not a very productive way to start a process.  Sometimes, the result is spectacular.  Most of the time, this form of thinking produces a plan that requires real work to imagine success.

The thought exercise with injected insight

I’d advise the students to do it differently.  I’d advise them to pick a growing industry.  Then find a short list of users, customers, and consultants in that industry who are known to be advanced in their thinking as demonstrated by their prior work.  Then I’d advise them to visit the CEO.  And ask, “What is it that bothers you most about your operation?”  “What is you biggest problem, other than working capital?” “Where’s your bottleneck in production or sales or development?”  “If you could invent a solution, what would it be?”

Find the pain…

Now that’s how to find pain in an industry.  And yet, few think to use this form of investigation.  Yes, you can argue that probably Fred Smith might not have thought of FedEx if he had just interviewed rail or postal customers.  But maybe someone would have given Smith the bare idea from which he could imagine a much bigger opportunity.

Then remove it

[Email readers, continue here…]   If you have a better way to do something, create something or market something, you have a head start.  But if you’re trying to think of what you want to produce, start with finding the pain in the marketplace, and set out to remove it.

Henry Ford famously said, “If I asked my customers what they wanted, they would have said ‘a faster horse.’”  As a mechanical genius, even that comment might have led Ford to envision a way to provide reliable, fast, inexpensive, mechanical horsepower.  It is the process of leaping from a need to an eloquent solution that creates demand and ultimately success in the marketplace.

Facebooktwitterlinkedinyoutubemail
Posted in Finding your ideal niche, Positioning | 1 Comment

Is it your brilliant plan or your execution?

Mike Tyson: brilliant business savant

“Everybody’s got a plan – until they are punched in the face,” famously stated boxer Mike Tyson.  My experience personally reviewing over three hundred executive summaries each year, all sent to me unsolicited, seems to bear out the truth in Tyson’s statement.

Anyone can build a good – or great – plan.  Investors have to look behind the plan and at the entrepreneur and his or her team, knowing that, over time, most of us have come to the conclusion that it is the execution of the ever-changing plan, not the plan itself that makes a company a success.

Tyson’s insight into the realities of the market

Tyson’s statement also addresses change.  The ‘punch in the face’ is analogous to dealing with the business plan when it intersects with the realities of the market.  Wham!  I can’t recall any of my companies hanging onto its original plan after some level of market feedback.

A personal story of a pivot – Tyson style

We built one of our companies upon forecasted metrics for a specific class of retail consumer base but found that there wasn’t enough money in our universe to pay for the amount of marketing to create that much dedicated traffic to our site.

[Email readers, continue here…]   So, we switched to distribution through partners which already had massive amounts of traffic and concentrated in providing great content and great offers that more than made up for the sharing of revenues. Tyson was right again. “Punched in the face” meaning our plan’s intersection with market reality.

Celebrate our versatility

We should celebrate entrepreneurs and managers who recognize the need to pivot when a plan fails to gain traction in the marketplace. And credit Savant Tyson for the insight

Did we just (once again) bet on the jockey, not the horse?

And most of us who invest in so many companies have concluded that our greatest profits over time come from investments in great management, groups that we are confident are able to execute even on average plans.

Facebooktwitterlinkedinyoutubemail
Posted in Finding your ideal niche | 2 Comments

Have you heard? Eyeballs aren’t everything.

Remember when?

Back when we were all trying to figure out the real value of traffic on the web, investors – and acquiring companies – got a bit crazy with metrics used to value acquisitions and investments.  Since in most cases, there was no revenue in many of these companies, all trying to gain market share at any cost, we had to invent the metric to use.  And the most logical one seemed to be “eyeballs” or number of unique monthly users finding their way to the site or registering for the service.

Remembering the insanity before 2000

And the numbers were staggering.  Microsoft paid $9.00 per registered user for Hotmail.  AOL paid $40.00 per registered user of ICQ, the early messaging service.  I was the original investor and helped to grow GameSpy Industries, attracted to the fledgling company because of its million users each month, even though at the time there was no monetization to the traffic.

Did the eyeballs suddenly disappear?

But, when the bubble burst in 2000, most of us quickly grew up.  Revenue models became more important a measure than traffic, although market share was and still is an over-weighted part of the value of any Internet-based entity.

Bringing us to today – Viewers or profit?

[Email users, continue here… ]   That is the quandary which entrepreneurs face today in building models for new companies around a web presence.   Great revenue projections from a small user base lead to worries over sustainability.   Low revenue projections but demonstrated (or projected) impressive numbers of unique users lead banks and investors to think that there may be a future method of monetizing the user base that makes the company attractive, even while currently losing money.

I am an investor and advisor to one such “eyeballs” company.

Gaining users at a rate of 50% a month, the company has yet to find a revenue model that will pay for the increased costs of infrastructure needed to support the growth, let alone the fixed cost of operating the enterprise.  And yet, users rave about the service, and spend long durations of time on the site.

Revenue experiments (and failures)

Once we had what we thought was the answer, in allowing for display advertising on these sites. But the competition among sites has overwhelmed available inventory of paying advertisers, greatly reducing the cost per thousand views, and making display ads no longer a preferred revenue source for marginal sites.

We experimented with subscription-based charges – hoping that ours were indispensable services.  In every case, those prototype subscription models failed, as users found free alternatives.  Another of “my” companies had four million free beta gamers registered on the site, but lost all but 10,000 when attempting to charge $9.95 a month for a subscription.

What is the answer? 

Newer forms of advertising have been created to force user views, including pop-ups, pre-roll ads containing video content, and click-through display ads before allowing content views.  Major newspapers and magazines, trying to reinvent themselves, are using the subscription model, as well as all of the above methods in their attempt to become relevant to a new and growing mobile and Internet-focused user base, with varying – but not too satisfying results.

How about charging by the bite (not byte)?

Micropayments, in which services and information are delivered for pennies, requires an infrastructure for collecting, accumulating and billing that is still being experimented with, but showing promising results.

Of course, giants like Facebook, Instagram, and Google have such large eyeball numbers that they can use display and positioning ads to achieve great profits.  Most of us are still searching for the combination of monetization devices that work best for us.  Free sites without and relevant form of monetization will disappear over time, and we will lose services we take for granted today.  It is in the best interest of both Internet users and providers to find an acceptable way to charge for valuable services or information.

Facebooktwitterlinkedinyoutubemail
Posted in Finding your ideal niche, Positioning | 1 Comment

Create a great product – the three-step dance method

Can you create a product in a vacuum?

Creating a new product in a relative vacuum is an exercise in complete trust that you know what’s best for the customer, perhaps even without interaction with such a customer.  It’s probably happened, but not often enough to trust this method as a formula for success.

The three-step dance method

So, I’ve developed the three-step dance in order to help form a repeatable method of how to create a great company from an early idea.

The first step: Involve potential customers early.

Even if you know it all – wouldn’t it be an excellent plan to try your idea out on enough actual or potential customers to measure reasonable feedback?

You can use or discard the information you receive.  We now know that Steve Jobs created several of his products in relative secrecy that became massive industry drivers of change.  The iPad probably would have failed before production, had he used feedback and research from past failures of tablets in any previous form as a guide.  On the other hand, most products or services are created in response to a real or perceived need.  And most of us are not Steve Jobs.

The second step: Take feedback seriously

[Email readers, continue here…]  Making the effort to gather metrics from the field in any form and then ignoring it, takes guts and determination – and in most cases a measure of stupidity.  As I analyze business plans, I usually ask the entrepreneur early in the process whether s/he has tried this idea or prototype or mockup out on potential users.  And if so, what was the response?  And from how many people?  In what related universe?

I want to know that potential paying customers have been queried using enough information or a good enough model to get a real response worth taking seriously.  Without this, any information received is suspect.  And failure to make use of the information is a red flag for investors.

The third step: Reiterate and return to customers for comments.

Seeking, then analyzing responses allows you to make changes to the plan and product in response.  But what if the changes create other problems for the customer, or miss the mark, or don’t drive these same customers to more positive responses?

The best possible second round feedback should come from the very same people who took the time to review the offering the first time. They have context and should see effort and progress.  Their comments should therefore be more valued than those from first-time respondents.

Summarizing the three-step dance: 

  1. Involve your customers early.
  2. Take feedback seriously.
  3. Reiterate and return to customers for comments.

So, why not design your product using your real and potential customers as consultants?

Facebooktwitterlinkedinyoutubemail
Posted in Finding your ideal niche, Positioning | 1 Comment

Ready, fire, aim. Really?

You’ve surely heard the variations on this theme.  “Ready, fire aim” was popular in the 1990’s, accredited to any of several authors.  I used the term to describe my efforts in the artificial intelligence field, experimenting with new devices, the lisp programming language, and our first trial installations.  It seemed an ideal way to describe a scrappy, entrepreneurial activity.

What happens to careful planning?

So why do so many business authors stress this behavior? Ready, FIRE, aim. What happens to careful planning, sure-fire metrics, quality test scenarios, market research, a good business plan – all in place before pulling the trigger of a new opportunity.

And who is right here?

If you’re seeking investment from anyone other than friends and family, you’re probably going to have to navigate through the exercise of careful planning, documentation and execution.  Investors are a fickle bunch.  They want to know that their money is not just being thrown at an idea that will become a trial by “fire.”

But speed and iterations are attractive benefits

[Email readers, continue here…]   On the other side of the argument is the truth of the claim that numerous iterations in the form of rapid prototypes and execution of new ideas in the field quickly refine the product or service to meet the needs of the customer, and at a far faster and cheaper pace than with careful pre-planning.

Cowboy coding in software and Internet development

In the software and Internet arenas, there is a term for this: “cowboy coding.” Without the need to carefully document the architecture and elements of a proposed application, a single programmer can much more quickly just code, test, and create revised code.  And today, “no code” or “low code” applications can be created much more quickly without careful testing of the integration with cowboy-coded portions of an application.

Either way, without even pausing to document the process internally, no-one can easily take over the job, if for any reason the cowboy coder is no longer in control.  And the result? Typically, we call that “spaghetti code” to signify code that is so often changed that it no longer looks clean and traceable.

Our conclusion to this dilemma

The conclusion is that the best process depends upon the product, its critical core nature to the business using it, and the way in which the entrepreneur approaches the need for outside investors.

Critical components of any operation or business must be carefully constructed, tested and inserted into the operation of the business.   On the other hand, if a new free app has bugs, they can be corrected in the next automatic update, and probably without much customer noise.

So, which is better for you?

Which is better for you: rapid iteration or careful planning?  What is your case for defending your method of creating new products or services?  Have you ever been stung by releasing a “ready fire aim” project into the marketplace?

Facebooktwitterlinkedinyoutubemail
Posted in Depending upon others, Hedging against downturns, Protecting the business | 1 Comment

Can you build a company, not just a product?

Some businesses are built around a single idea.   

And sometimes that idea is just too small a slice of the big picture to be interesting to investors.  There was a recent investor event where I was keynote speaker, on stage only after several panels of experts had wowed the audience with their predictions and observations.  One of the panelists made a point that resonated with me.

“Just a button, on a feature, in an app”

She stated that she had rejected the investment being discussed, because in her mind the entire company was “just a button, on a feature, in an app.”  That comment sent me thinking about relevance, about longevity, and about market size for some of these entrepreneurial applicants looking for funding.

Can you envision round two?

So, what is your goal? If you have invented a game that will be marketed as a new app in the app store, have you created enough of a model to create an ongoing company, or just another app that will compete with the millions  already in the store?  Is your game using a unique engine, or series of animated characters, or method of play that will break ground with potential players, inducing them to look to you for more and more unique games over time?  Or higher and higher levels with more purchased items for play?

How does an investor react?

[Email readers, continue here…]   Far too many companies have been created around a button on a feature, and not upon a solution to a need in answer to a void in the market.  Investors have seen this game before.   We match what we see to what has succeeded for us in the past.  And rarely do we see a plan for a single product that is not part of a larger vision and remain interested long enough to ask for more information.

There are exceptions. 

The famously popular iPad throw-away app, “Draw It,” might at first seem an exception, until you dig deeper to find a dense plan around a series of social engagement products planned to follow.   Can you extend your product into a planned series?   Plan to create apps, not buttons, and not features.

Facebooktwitterlinkedinyoutubemail
Posted in Finding your ideal niche, Ignition! Starting up | 2 Comments

My dad said: “Never take on a business partner.”

My dad was a smart businessman, even if not formally trained. He occasionally gave me advice that turned out to be more than wise, looking back at subsequent experience and events.  His personal teaching event was a typical experience, as I reflect now upon the tens of partnerships I have counseled over the years.  Most often, one partner remained active as another partner drifted away from the business, no longer carrying the weight anticipated at start-up.

So, what could happen with a partnership over time?

It’s just one – the most prevalent – of the many things that can happen to well-meaning partners after time changes plans, and after the business passes through phases of growth or contraction.  The assumption at start-up is that all partners will carry their assigned weight for the foreseeable future, as percentages of ownership are divided accordingly.

Rarely is there any formal written agreement memorializing these initial expectations and stating the consequences of non-performance or inability to make capital calls when required.  In fact, rarely are issues discussed involving downside protections, even including key-person insurance benefiting the partnership in case of an unfortunate event.  And how about a buy-sell agreement if one partner wants to sell their interest to a third party unacceptable to the remaining partner(s)? How about non-compete agreements?  Non-disparagement clauses?

It is always wise to have an attorney help memorialize a partnership agreement, even if painful conversations must take place to do so.  Here’s an example of what not to do…

A personal story about a partnership gone bad

[Email readers, continue here…]   I recall one very personal situation when I was young, that reinforces Dad’s advice. Through my college years, I managed a phonograph record production and manufacturing business that I created as a senior in high school, using independent contractors in local venues to record tapes from musicals and performances from schools, colleges, churches and organizations throughout the USA and Canada – and then to sell the records to the appropriate audiences.

Partnerships are strained with growth and troubles

The business grew to significant size during my college years, and I informally associated myself with an equally young partner, of course without any written agreement or discussion of downside throughout those years, ceding to him all recording work throughout the large home territory and other helpful technical work. The agreement was that he would retain all the revenues generated from those activities and that I would finance the company and manage it.  We received lots of press, even nationally, as we managed our teenage business.

Changes of circumstance often ignite pressures

A year after graduation from college, I left for six months to serve my active duty obligation in the US Navy, while others – not the partner – took care of accounting and customer relations.

And shortly after I left for my military service, my partner left the company without notice and set up a competing company in my absence, never saying a word to any of us.  I was bitter, but unable to do anything about it, since there was no written partnership agreement.  Luckily, after my return from active duty, my company flourished, even went public later, and his remained a small, one-person operation for the rest of its existence.  But, as they say, everything he learned, he learned from me.

Dad was right, even if I learned the lesson years later.

Have you a partnership story to tell?  Lessons learned to be never repeated? Or do you have a harmonious relationship to recall, one that could even be ongoing?  My friend, Rich Sudek called partnerships “a marriage without sex” and reminded us that we often spend more time with our partner(s) than with our family.

Facebooktwitterlinkedinyoutubemail
Posted in Depending upon others, Ignition! Starting up, Protecting the business | 8 Comments

Should you include your sweat equity in a business plan?

Investors love it when entrepreneurs draw little or no money from their startups.  It extends the cash available for research and other necessary fixed costs and gives the fragile, young company more “runway” to get to breakeven.

What are you worth to the business?

But when forecasting the ultimate viability of a business, many times an entrepreneurial founder uses a low, unsustainable salary rate for him or herself in order to show early breakeven.  And that is the quandary for investors.  If you had to replace yourself with a professional hired to duplicate your skills, what would you have to pay in salary and incentive today?  That amount is almost always higher, much higher, than the amount budgeted for the entrepreneur.

A “messy” solution

[Email readers, continue here…]   You could start by charging more for your executive salary, then paying out less in cash, accruing the rest into a payable amount due to you in the balance sheet or plan.   But that is a messy way to demonstrate that you are taking less than market wages from your company.  Ultimately, the accrued difference will amount to a large enough liability that several things could happen, all of them negative.

What would the IRS think?

The IRS could see that you are not paying yourself interest on the accrued debt, and consider it invested capital, eliminating your ability to repay yourself in the future. Worse yet, the IRS would then consider the accrued amount to be taxable income upon which no tax was paid, since the accrued labor as an investment has value that was not accounted for from previously taxed earnings.

Another “trick you might use – wrongly

Or you could voluntarily convert the loan into stock with a single journal entry and a stock certificate. But the tax effect would be the same if audited – you would owe tax on the booked value even if not paid in cash.

What is the solution?

The solution is to explain to potential investors that you are projecting under-market wages for yourself or the founder(s) for a period of time, perhaps until breakeven, and then  to agree with them that you will move to market rate at that time.

Facebooktwitterlinkedinyoutubemail
Posted in Ignition! Starting up, Raising money | Leave a comment