Can you defend your plan without being defensive?

When meeting with investors or even your board, during the period devoted to feedback after your presentation, you will hear comments and recommendations that don’t resonate with you. Some will be from a misunderstanding of your explanation. Some listeners will challenge your assumptions.  Some will seem to ask just plain show-off questions, in which the questioner wants you and others in the room to know that s/he knows more than you do.

Are you the plan’s salesperson?

You are in a vulnerable position in that room, the salesperson looking for money or approval to proceed with your plan before individuals who have nothing to lose but risky profits far in the future.  You cannot appear to be standoffish, or above responding to some of these inappropriate questions.

The right way to defend

Defend your position when appropriate. But listen carefully.   Although you may be completely right, the questioner’s comment may indicate that you are not getting your points across.  That’s just as valuable for feedback as hearing a good, new idea.

Learning from the experience

[Email readers, continue here…]    If you are looking for investors or need to present to ever-higher levels for approval, sometimes, you will have an opportunity to present to several levels of the organization. Plan to incorporate the appropriate responses to earlier questions in the presentation to avoid those being repeated. Show that you are both humble and adaptable.

And gaining insight from feedback

Investment groups including venture capital fund managers will tell you that the very process of defending your plan will help you better think through the rough spots, better launch the business with fewer holes in reasoning, and better connect with resources that can be used to accelerate your growth to breakeven and beyond. The process is always time-consuming and grueling.  But approached correctly, the time is well spent and the results almost always positive, even if money doesn’t come from the present effort.

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Don’t get hung up on early stage valuation.

Here’s the “what.”

I can’t tell you how many times I’ve walked away from deals where the entrepreneur insists on a start-up pre-money valuation that is so high, no angel could expect to make a return upon the investment, even with a reasonable sales price for the company down the road.

And here’s the “why.”

There is always another attractive deal at the ready, and most have reasonable expectations of valuation.  Why fight about valuation, or disappoint the founder at the outset?  The real focus should be on smart planning, finding ways to launch and build the business with smart but frugal use of money.

More of my stories

Let me tell you two stories that are linked.  The first is of a 2004 startup that I cofounded and led the investment group for several early rounds, then VC rounds. The company had grown to forty employees and a healthy eight figure gross revenue run rate but has absorbed over $36 million of angel and VC money to do so, and without yet reaching breakeven.

[Email readers, continue here…]   The second story involves the same founder.  This one is using outsourced development, support, outsourced customer relations and more.  The total capital raise was under $600,000, and the founder retains majority control of his baby through this and even one optional future round.

Lessons founders learned

For the first, company, the founder’s remaining portion is under 4% after all the subsequent rounds, and not yet at breakeven. The second company, with the same founder, finds him with majority control even if the original raise is not enough.  For the founder to see any return at all in the first company, the ultimate selling price must be above $40 million.  In the second company, better planned, the founder would be made pleasantly wealthy at a selling price of $10 million.  The chances of the latter occurring are much greater than the former.  This founder was not hung up on valuation for the second company, just upon efficient use of capital.

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Please don’t overestimate your audience’s knowledge

Ask the important question first

When making a presentation to a new audience, the smart thing to do, if there is an opportunity, is to ask your audience by show of hands, if they have some knowledge of your industry or space.  And if you are making a one-to-one presentation, don’t start without a conversation about the other person’s knowledge of your space.

Asking the important question creates a connection

With that question you create an immediate connection with your audience even before beginning to present, and you know better how much explanation you will need to accompany your most elementary statements.  And you will not insult the industry experts by appearing to talk down to them.

How I ask the question

When I give a keynote address, I often start by asking my audience, by raise of hands, to tell me how many of them are angel or VC investors, how many are entrepreneurs, and how many are service providers such as attorneys.  Immediately, I can tell how to orient the explanations behind my pre-cast slides, based upon the response.  It always works, and the audience should appreciate that the speaker takes the time to orient the talk to the audience, not the other way around.

 What to do with a split audience

[Email readers, continue here…]   If your audience is composed of PhD’s in organic chemistry, would you want to explain the most elementary teachings in the field?  On the other hand, it is most often true that only one or a few of your audience members might be knowledgeable in your area of expertise.  Address them directly with “I hope you will put up with me as I spend a few moments explaining some of our elementary knowledge to the others.”  That makes these experts a part of your presentation, able to nod their heads when you do explain these things to the others, instead of looking a bit disdainful that you don’t recognize that there are experts in the room.

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Raising money? Find your champion.

Increasing your chances of success

If you seek funds from an organized investment group such as an angel fund, venture capital entity, or even an investment club, the first thing you want to do is to find one person to buy into your vision, become excited by your enthusiasm and be willing to become the internal champion for your fund-raising effort.

Finding the gatekeeper for your funding effort

In some groups, if you cannot find such a person, you cannot even find the way to apply for funding, as some groups make it imperative that any introductions come from the inside, from a member or partner.   In others, if you cannot find such a champion after initial presentations to a subset of the entire group, you will not be permitted to move from initial application to the next stages of due diligence and final funding.

How to waste your fundraising effort

And in all cases, simply sending in an executive summary of the business plan via email or filling in an application for funding on a website lowers the chance of success to near nil.  If you cannot find someone on the inside, network with accountants, attorneys and bankers to find a name of an influential member or partner.

Differentiating yourself from others

[Email readers, continue here…]    You may have the most impressive plan in the world, but these organizations see tens of these each week, and often cannot be expected to understand the vision and potential of any at first glance at a document.   I receive three hundred unsolicited executive summaries a year, and my investment group, Tech Coast Angeles, sees over one thousand.  Together we fund, maybe, twenty-five of these.  Although much more than half are disqualified because of geographical location, industry, or amount of money needed, that still is a small percentage of funding to applications.

Even bankers aren’t exempt

Banks and lenders often are the same way. Although anyone can walk into a bank and apply for a loan, those who are recommended by a trusted source are treated much more personally and have a greater chance of success.

Spend time finding your champion.  Create time to network with members of these groups at their public events.  Seek out names from your trusted sources.

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Have you heard the rule of the thirds?

It starts with sharing the opportunity and upside

Think of startups and early stage businesses whose entrepreneurs you know. How many of them, particularly in technology, were able to start a company, supply all the funding, and share no management tasks or equity with others, and still grow the company to any significant size, worthy of a multi-million-dollar opportunity to cash out at exit?  Nearly none, if statistics and experience are key to the answer.

The sum of three parts

We should think of the creation and growth of a high valued company as the sum of three parts, with three distinct classes of participants helping to make real value out of a raw start-up.

One: The entrepreneur

First, there is the entrepreneur, the visionary, and force behind the venture from start to finish.  The reward for the entrepreneur, after years of effort, time and sacrifice, is measured by what portion of the total pie s/he retains at exit, how much the person continues to participate through that time, and how many other resources are brought in to get to that point.  Most importantly, the reward is measured by how much added value the total process creates over time.  It is the old story of “100% of nothing is worth far less than 10% of a large number.”

Two: Co-management

Few entrepreneurs can do it alone, with subordinate hired help and no expert management to share the burdens, skill sets, and efforts involved in growing the enterprise. So, co-management is the second group to share in the bounty upon a liquidity event.

Dividing equity among those that fill the management gap

[Email readers, continue here…]    Often, if not co-founders, this group is rewarded through issuance of stock options from a pool of available options that usually totals 15-20% of the total company’s equity divided among all employees.  Those who receive options but leave the company before a liquidity event may either purchase those shares represented by the options upon exit from the company, or lose the right to those shares, often 60 days after their exit.

Three: Outside investors

The third group is made of the total number and types of investors, other than the founder(s).  From friends and family early on, to angels that are not related to the founder(s), to venture capitalists for larger opportunities, these investors have risked their money in the venture for only one reason – to eventually profit from a liquidity event.

How much equity to early investors?

It is normal for the first round of organized angels to expect to purchase between twenty and thirty-five percent of the company with their investment.  Second rounds, if needed, often drive the founder(s) into a minority position, unless the company has grown significantly by that time and can command a higher pre-money valuation, giving less stock for the same amount of investment.

Reward for early risk

Investments in small companies involve a much greater degree of risk than investment in public companies, which provide immediate liquidity if needed and a ready measure of value at any time.  That risk deserves reward if there is a profitable sale or even an initial public offering, rare as that event is.

So, remember that there are three slices to the pie to consider when creating your company and again when considering a sale or liquidity event.  All three deserve recognition for the risk, time and effort in driving the company to its ultimate value.

Think of it as the rule of the thirds.

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Financing with grants, not equity or debt

First, an example of grant-based financing          

I was chairman of a company that, for twelve years never took a dollar of outside investment.  The company was funded entirely by grants from the National Institute of Health, amounting to millions of non-dilutive dollars in all.  The company created a product that could be delivered as a service to medical clinicians anywhere in the world, enhancing their ability to understand their patents’ problems and needs in less time, using the expertise built into an AI expert system created by the best minds in many medical specialties.  And we should not forget that non-profits of all types depend upon grants for a significant amount of their funding, often employing professional grant writers on staff or as consultants.

No dilution to shareholders or the founders

A company like this grows in value to its customers and to prospective buyers of the business, but without any dilution of control or ownership for the founders.  How refreshing!

How grants are considered

In general, grants are made to individuals, companies, businesses, organizations or institutions that are working toward serving the greater good or a greater cause.  These grants include funding to educational institutions, researchers, research centers, colleges and universities, or private companies that are researching or developing leading edge solutions in several categories including agriculture, education, energy, health, medical, space, science and technology to name a few.

The effort to write a grant request is not trivial

[Email readers, continue here…]   Grant writing takes skill and immense amounts of time.  Often, grants require that you partner with other organizations to deliver the results or measure the effectiveness of your special project.  And often, grants come with detailed accounting and reporting requirements.  If you can finance your enterprise through grants rather than equity or debt, you retain control and when it is time to sell your interest in the business, a lower sales price will create a higher return on your personal investment.

Other sources of grants

There are some grants available even for one person shops, from cities, corporations and even non-profits for just your type of business, especially if you support a social cause, can employ more people, or help turn around a geographic area in need of upgrade.

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Use creative fundraising instead of equity or debt?

Use creative fundraising instead of equity or debt?

By Dave Berkus

First, my story as an example

Let me tell you the story of how I raised $100,000 to fill a gap needed to purchase a new home for my young family years ago.  I had located a beautiful home that would be a stretch to finance and had arranged for a first mortgage from the bank, and a second from the seller. Home values were rising so fast that I knew I had to move quickly.

So, I went to visit several customer CEOs, told them my story, and asked them to advance some amount against their future billing from me.  In return, I said, I would give them more time than originally contracted for, and certainly would treat the relationship as special from that moment on.  Corny?  Every one of the CEOs said “yes.”  And I closed escrow on a home I could not otherwise afford, and which I continue to live in, after its value shot through the roof during the subsequent years.

Out of the box ways to pay the bills

I sometimes counsel CEOs to consider consulting to their prospective customers or in their industry while they are simultaneously developing their product for market. Consulting fees pay the bills, reduce the stress, and give people confidence in the business.

How about your suppliers as partners?

[ Email readers, continue here…]   If you are already purchasing raw materials or services such as development or programming, consider asking your supplier to be a paperless partner, showing confidence in you and your future business by granting you deferred payments.  You might be surprised at the positive results, if your needs are real and you treat the relationship well by following through on your promises.

A common way to “eat your meal before its time”

How about offering prepaid licenses to your product or a package of prepaid hours, or a discount for prepayment of purchase?  All of these create special relationships with your customers, who show their faith and trust by advancing money to you before receiving products or services.  Just remember that you must deliver as promised, and you are eating your meal before its time.  You will have later expenses to pay when the revenues have already been received and presumably spent.

How about strategic partnerships?

Strategic partnerships with suppliers, customers and others sometimes are an attractive way to share the risk and fund an operation.  Creating a new company to do this is often a time and money drain, even if it seems easier to do this than to create a relationship within existing organizations.

These are just some of the ways to creatively raise funds without offering equity or taking on new debt.  Since some entrepreneurs are completely averse to sharing equity, and some greatly fear taking on any form of debt, creative fund-raising is certainly worth considering.

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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.

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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.

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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.

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