This post will be perhaps a bit longer than usual, but certainly of great interest for those with interest in or have need for more capital…<\/p>\n
This stage is critical to many businesses and a passing option to others, depending upon the capital efficiency of the enterprise.\u00a0 Some businesses require very little capital and the founder is able to self-finance the enterprise and retain 100% of its ownership and control from ignition through liquidity event (startup through sale).\u00a0 For you who fit that description, nice work.\u00a0 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.\u00a0 It is for this group that we explore the implications implicit in raising money for growth.\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0<\/p>\n
Before we explore the next insight, it might be useful to list some of the ways in which you can raise money for growth with and without outside investors. [Email readers continue here…]<\/em><\/span><\/p>\n \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Bootstrapping:<\/em>\u00a0 This term describes your ability to start a business with little investment and grow it using internally-generated funds.\u00a0 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.\u00a0 There is a lot to say about retaining control.\u00a0 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.\u00a0 You will have more control over strategy and execution than with an outside board overseeing planning and performance.\u00a0 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.<\/p>\n \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Friends, family and fools:<\/em>\u00a0 This term, although pejorative, describes the typical mix of early investors in a small, young growing business.\u00a0 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.\u00a0 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).\u00a0 I\u2019ve arrived at a significant number of companies that were looking for additional growth capital after a \u201cfriends and family\u201d round, and had to \u201cclean up\u201d the cap table more than a few times over the years.\u00a0 Taking this kind of money has a number of pitfalls you should be aware of.\u00a0 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 friend or related investors who do not have the sophistication or willingness to challenge the valuation.\u00a0 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.\u00a0\u00a0 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.<\/p>\n \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Using your bank credit line and credit cards:<\/em>\u00a0 Even with the credit crunch signaled by the recent 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.\u00a0\u00a0 And even with the significant cost of credit card debt, many entrepreneurs aggressively use existing cards to finance a startup.\u00a0 It\u2019s an option, even though an expensive one.<\/p>\n \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u201cStrategic partner\u201d investors: <\/em>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.\u00a0 Better yet, the valuation of your enterprise is often higher than if the same investment were taken from a professional investor.\u00a0 Strategic investors validate a business, by their presence creating the very value they pay for with increased price per share purchased.\u00a0 It is most often a win-win for both you and the strategic partner.<\/p>\n \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Professional angels: <\/em>\u00a0This is the arena where I work and play.\u00a0 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 often takes months from introduction to investment.\u00a0 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.\u00a0 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, \u201cstuffed\u201d into a down round of lower valuation when a company takes its next round of financing from the next step, venture capitalists.\u00a0 Professional angels, often organized into groups, usually invest from $100,000 to $1 million in a young enterprise.<\/p>\n \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Venture, private equity and more:<\/em>\u00a0 Here we lump a large number investor classes into one.\u00a0 Venture capital comes with a cost, and there are no bargains for the company when taking such an investment.\u00a0 VC\u2019s value an enterprise lower than others might at the same stage of investment, always aware of the need to create opportunities for \u201chome run\u201d profits at exit, since over fifty percent of their investments typically are lost when companies die before an opportunity to sell to others.\u00a0 Further, as a class, VC\u2019s have not done well for their own investors over the past decade since the bubble burst, making it doubly important to fight for low valuations and high profits at exit.\u00a0 VC\u2019s 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\u2019s.\u00a0 And just for measure, VC\u2019s fund less than 2% of all deals they do investigate.\u00a0 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.\u00a0 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.\u00a0<\/p>\n \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 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.\u00a0 Often private equity investors will want control of the business as well.<\/p>\n \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 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.\u00a0 Small Business Association (SBA) federally-guaranteed bank loans are becoming available again after years of limited activity.\u00a0 With some restrictive provisions, these loans are favored by many banks as carrying much less risk than loans without the guarantee.<\/p>\n \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 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.\u00a0 There are a few insights that relate to this money resource, and you should know and respect these.\u00a0 We will cover these insights in the next several posts. So stay tuned…\u00a0\u00a0\u00a0<\/span><\/p>\n","protected":false},"excerpt":{"rendered":" This post will be perhaps a bit longer than usual, but certainly of great interest for those with interest in or have need for more capital… This stage is critical to many businesses and a passing option to others, depending … Continue reading