Are You Ready to Raise Capital? - A Series of Posts on Raising Capital

Are You Ready to Raise Capital?

Entrepreneurs continually tell us how difficult starting a new venture is in the current economic climate.  Newsflash!  Talk to every entrepreneur who has ever started a new company, it has never been easy.  You have a brilliant new idea, surround it with the right management team to make it a success, and acquire your first customers.  Lots of hurdles along the way, but the most challenging of all for most entrepreneurs is finding the capital required to launch and sustain the company through to positive cash flow.

The idea that investors will quickly grasp the brillance of your idea and eagerly write the checks to finance it, is a fantasy common to many entrepreneurs until faced with the stark realities and challenges of raising capital.  If you hope to be among the ten percent (1 in 10) of entrepreneurs seeking early stage capital that obtains funding, it is important that you approach it in a disciplined and professional manner with an understanding of what is required to be successful.

The intention of this series of posts is to assist entrepreneurs in self-assessment of their readiness to raise capital.  Entrepreneurs seeking early stage funding for their new company will learn how to prepare for seeking capital.

There are three primary areas to consider prior to seeking funding:

• 1.     What stage of development is the company currently seeking to fund and what types and sources of funding best match that stage?
• 2.     Completion of a comprehensive and professional business plan for presentation to investors.
• 3.     Understanding what investors are looking for and being certain to address those concerns and interests.

Follow the above links to the posts on each of these topics

Are You Ready to Raise Capital? - What Stage of Capitalization is the Company Seeking to Fund?

What Stage of Capitalization is the Company Seeking to Fund?

It is important to understand the stage of company development you are seeking to fund and making sure it is well matched to the type of funding sought and the sources you intend to approach.  Experienced investors have a preference for funding particular stages of a company’s growth recognizing well that company’s in earlier stages of their development many afford higher returns but are accompanied by a much higher degree of risk.   These investors will expect the type of financing sought and the uses planned for the capital to match the stage of the company’s development.

While there may be exceptions the following stages of capital generally match the stage of development of the company:

·     Embryonic capital may be sought for concept research

·     Seed or development capital may be sought for concept and business plan validation

·     Startup capital is generally sought for launch of a new company and initial operations

·     Mezzanine or growth capital is generally sought at multiple levels for expansion of mature and growing companies

Most entrepreneurial ventures find it difficult to obtain debt financing of either a traditional or no-traditional nature.  Having said this, we often encourage our clients to consider the use of convertible debt in very early stages of capital raises as it may be quite difficult to establish a realistic valuation for equity investment at this stage.  Conversion terms for this debt may be established that are tied to a discount or preferences to the valuation established in future financing rounds.  We also often suggest that interest on this convertible debt be capitalized to principal at the company’s option for a reasonable period of time or until the company reaches a certain level of positive cash flow.  This preserves the company’s cash in critical early stages of development and launch.

We also encourage our clients to be sure to consider all financing options including customer revenues and deposits, supplier financing terms, leasing rather than purchase of assets, and asset based financing (factoring) among their plans.  We find that entrepreneurs often overlook these options in developing their financing strategies.

The remainder of this article will deal with the traditional forms equity financing most commonly employed by entrepreneurial ventures.

Investors typically balance two considerations in their investing decisions:

·     Risk – the measurable probability of losing or not gaining value on an investment, and

·     Return – the expected or necessary return on investment (ROI) expected by the investor to compensate for the degree of risk associated with the investment

Most sophisticated equity investors are willing to assume a reasonable degree of risk in return for the higher returns associated with equity investments in early stage companies.

Traditional Sources of Equity Investment

Equity investors are the owners of the company.  A point often overlooked by some entrepreneurs in the way their investors are regarded.  Hearing entrepreneurs continually refer to “my company,” rather than “our company,” or speak disparagingly on the company’s investors distresses me.  Equity investors have bought ownership in the company with their investment, in exchange for the hoped for opportunity to sell that investment as a later time when the company’s value has significantly increased.  It is important to understand the investors’ expectation of a future sale of their ownership at a higher price and address this issue when seeking investors.  While they may be pleased by returns on their investment in the form of dividends, they most often are seeking long-term capital gains and the more favorable tax treatment these receive over dividend income.

The most common rounds or sources of equity investment are as follows and should be approached in this order:

• 1.     Founders
• 2.     Friends and family
• 3.     Suppliers, business vendors, relationship partners, and customers
• 4.     Angel investors and wealthy individuals (accredited or qualified investors)
• 5.     Venture Capital – A and B rounds

Founders:  Unless those closest to the company and responsible for its launch and development have “skin in the game,” it will be very difficult to attract money from any other sources.  We generally advise that Founders be responsible for all embryonic funding.  Typically, they will also be responsible for much of the seed or development capital as well.  It is extremely difficult to find funding for these stages of a company’s development from outside sources.  Additionally, when the later startup stage capital is sought, those potential investors approached will want to know that founders have already placed their own capital at risk.

We often hear from entrepreneurs that they consider their “sweat equity” as their investment.  Sophisticated investors respect the effort of the entrepreneurs they back, but assign little monetary value to it in their decisions.  This is often a harsh reality for many entrepreneurs, but a reality nonetheless.  Sources of founders “bootstrap” capital can include personal savings, self-directed IRAs, home mortgages, credit cards, and small bank loans.

A good general rule of thumb we find helpful is that by the time the entrepreneur commences the search for startup capital, the company should be able to demonstrate that the founders and/or friends and family have already contributed a minimum of 20% of the investment funding sought.  While this may not always be the case, a lower level of funding from those sources closest to the opportunity will significantly decrease the odds of successfully obtaining the startup capital sought.

Friends and Family:  Most entrepreneurs also turn for funding to friends, relatives, business associates, and other non-professional investors and acquaintances who have personal connections to the company’s founders.  These investments, generally made in the early stages of capitalization of the company are made primarily based on the relationships of the investors to the founders.  There is typically a lower level of due diligence preceding the investment than for more sophisticated angel investors.  Therefore, entrepreneurs should be careful to assign realistic valuations or use the previously suggested approach of convertible debt for these investments to avoid later ill feelings caused by unrealistic valuations.  Also, entrepreneur should not be lulled into a sense of complacency by the ease of raising these monies.  Later investors will exercise much greater due diligence and may well negotiate for more favorable terms to contribute their capital.  We often find that entrepreneurs the terms and valuations assigned in the founders or friends and family rounds are unsupportable when seeking investment from sophisticated angels.  This can easily result in either an unsuccessful startup capital raise or dilution or a “down round” for the early investors and consequent ill feelings.  If is for this reason that we always suggest the assistance of a professional and experienced capital advisor in any capital raise, even those amongst founders or friends and family.

Suppliers, Customers and Other Relationship Partners:  Most entrepreneurs totally ignore these important potential sources of financing.  Often larger companies amongst the list of suppliers have internal venture groups established specifically for the purpose of investing in up and coming young companies that could assist in expanding their business.  Such suppliers will understand your business vertical and markets well and can help ensure a steady supply of their products or services on attractive financial terms.

This same concept also applies to other potential relationship partners such as Original Equipment Manufacturers (OEMs) or Private Label partners, Value Added Resellers (VARs), Licensors, and channel distribution partners.

Early customers can also be excellent sources of funding.  They have a special interest in the success of the company, can provide market validation for your value proposition, and are often among the most committed supporters of a young company’s offerings.  Such companies are generally early adopters, always seeking an edge on their competition, and may be great sources of funding.  In return they may expect “favored nation” pricing, input on product or service development, and a close relationship with the company and its offerings.  Strong support and commitment from early customers is also a strong endorsement of the company and its prospects from the viewpoint of professional investors.

Angel investors and Wealthy Individuals:  Angel networks or groups and individual angels defined under securities regulations as accredited investors are high net worth individuals who typically allocate a portion of their investment portfolio to early stage opportunities.  A true angel investor will generally commit from $250,000 to several million dollars of their investable net worth to early stage opportunities in return for the higher potential returns.  Generally these angels will invest in 10 or more such opportunities with individual investments ranging from $25K to $250K.  Individual angels may band together into an Angel Network or Angel Group to pool their investments in early stage companies and take on opportunities of as large as several million dollars.  Angels typically expect an exit opportunity in three to seven years and ROIs ranging from 25% to 100% depending upon the degree of risk and anticipated term of the investment.

Venture Capital - First and Mezzanine Rounds:  Venture Capital and other sources of institutional investment capital are typically available only to companies having reached 3 to 5 million in revenues and now requiring growth capital.  Although there are rare exceptions, usually in the case of entrepreneurs with whom the VC has a prior record of success, VCs do not invest in early stage companies.  Also, it is rare to find a VC or institutional investor making investments of less than several million dollars – although the funds may well be advanced in multiple draws or stages based on performance benchmarks or hurdles.  Often VCs expect that several rounds of financing may be required to reach the agreed growth targets and exit point.

VCs are investing monies from funds they manage.  The VCs obtain those funds through raises from their limited partners who may be wealthy individuals, pension or retirement funds, endowment funds, or other forms of institutional investors.

VC funds have particular investment interests and guidelines for each fund they manage.  It is important when approaching a VC to be certain that the offered investment matches their interests and meets their guidelines.  Generally, these can be found on the VCs website.  Seldom does an investment opportunity “coming in over the transom” receive much serious attention from a VC.  Those most likely to receive serious attention are introduced to the VC from a source with which they have experience.  There are many such introduction sources.  The point for entrepreneurs is that blindly sending business plans to dozens of VCs is unlikely to generate any serious interest in funding your opportunity.

Often times VCs will bring strategic value as well as money to an investment opportunity.  In fact, their strategic may well be much more important than the capital they contribute.  Examples of strategic value may come from potential relationships and other synergy with their other portfolio companies, operational expertise, particular industry knowledge or experience, relationships with the market and potential customers, or other strategic value.

VCs typically seek 7x to 10x returns on their investments in a three to five year period.  This is because their typical experience is that of 10 investments, 3 to 5 will show few if any returns, 2 or 3 will produce moderate returns, and the remainder will deliver the home runs they seek.  Therefore, they need and seek the home runs to reach the levels of return anticipated by their limited partner investors.

Investment Banking Firms:  Another source of funding at the growth stage may be through an investment banking firm who may assist with a securities placement.  Investment banking firms range in size from boutique firms to very large global firms.  It is important to seek a reputable firm, with a successful track record in placements of the size being sought.  Generally, these securities placements will range in size from a low of $7 million to $10 million and up to very large raises.  The securities offering may be a registered or unregistered offering depending upon the size and nature of the raise.

Companies experiencing rapid growth and well into profitability often require significant investment to expand their sales and marketing efforts, enter new markets, launch new products, open new facilities, etc.  Later stage investments can be particularly helpful in financing these types of endeavors that may not lend themselves well to debt financing.  These later stage investors will all be of the institutional or professional investment categories and have the capability to infuse the larger amounts of capital that may be required.

Uses of Capital and Stages of Investment:  Investors will carefully consider the planned uses for capital being sought when making their investment decisions.  Planned uses will vary depending upon the nature of your company’s business and its stage of development.  However, it will be important to investors that the intended uses are well matched to the company’s stage of development.  We frequently speak with entrepreneurs who have ignored or misunderstand this important consideration and have done a poor job of matching the intended uses with the type of capital being sought or the stage of the company’s development.  The following table summarizes our thoughts on this topic.

Overview of Capital Raise Uses of Funds

	Rapid Growth	Steady Growth	Source of Funds
Embryonic	·     Research and development ·     Raise seed round of capital ·     Building prototype and pilot ·     Hiring initial management ·     Market research ·     Legal assistance ·     Writing business plan ·     Raising startup capital	·     Concept research ·     Writing business plan ·     Raising startup capital ·     Confirming market assumptions ·     Legal assistance	Founders
Seed	·     Research and development ·     Building prototype and pilot ·     Hiring initial management ·     Market research ·     Legal assistance ·     Writing business plan ·     Raising startup capital	·     Writing business plan ·     Raising startup capital ·     Confirming market assumptions ·     Legal assistance	Friends and Family
Startup	·     Operating and refining pilot ·     Equipment, facilities, and inventory ·     Sufficient working capital requirements through to positive cash flow plus contingency factors from worst case analysis	·     Launching business ·     Hiring of management and staff ·     Equipment and facilities ·     Inventory ·     Sufficient working capital requirements through to positive cash flow plus contingency factors from worst case analysis	Angel Investors
Mezzanine or Growth Capital	·     Additional capacity to support growth and scale business ·     Marketing and sales ·     Additional working capital ·     Facilities, equipment, and inventory to support growth	·     Working Capital ·     Facilities, equipment, and inventory to support growth	Venture Capital or Private Securities Placement

Understanding the company’s intended growth path and timing allows for development of a capital plan matching the company’s capitalization plans with appropriate stages of growth and uses of funds.  Capital raises should not be undertaken before building achieving appropriate stages of growth and maturity so as to optimize valuation at the time of each raise.  It is also important not to raise less capital than may be required to deal with unexpected developments.  Running short of capital prior to reaching performance targets and stages of the company’s growth will likely impair the company’s ability to successfully raise additional capital on favorable terms.

Are You Ready to Raise Capital? - The Importance of a Comprehensive and Professional Business Plan

The Importance of a Comprehensive and Professional Business Plan

A business plan serves as more than a tool simply to raise funds.  A comprehensive and professional business plan becomes the roadmap showing the plan for the company’s journey to its planned success.  It also serves as a basis against which the company’s progress toward its willed future can be measured.  The business plan should describe clearly and precisely what you expect to achieve, in what time frame, how you intend to get there, who will lead and execute the plan, what challenges need to be overcome, what risks can be expected, how those risks will be contained or mitigated, and why the business should succeed.  This business plan will become the foundation of all decisions made by the business, describe the performance targets against which the business will be measured, and for which the management team will be held accountable.

Everyone understands that businesses exist in dynamic and changing environments.  Changes will not only be made along the way, but should be expected.  The plan should not be immutable.  However, changes should result from measurement against the plan and its assumptions combined with thoughtful and purposeful shifts in strategy and tactics to adapt to change and seize opportunities as they are presented.

Here are some essential questions every entrepreneur should ask and answer in a business plan.

1.     Who are we and what do we want to do?
Define what the business intends to do, what customers it intends to serve, why they will need its products or services, what markets it will target to find those customers, and why they will want to do business with the company.  Be sure to define your product, your intended markets, revenue targets, and margin objectives.

2.     Why do we think we can be successful?
Conduct a thorough competitive analysis of your company versus all other competitive alternatives and make the case that you have a unique and compelling value proposition that will attract customers from your targeted markets in sufficient quantities to make the company successful.  Please remember that every company and every value proposition has competition.  If you have no competition, there is likely no real market for your product or service.  I also constantly remind entrepreneurs that whatever a customer is doing today to address the perceived need is competition.  Prospective customers can always decide to continue whatever they are doing today or endure whatever pain you may perceive they have.  Why will they choose your product or service over every other competitive alternative?  What makes you different, unique, and compelling?

3.     What actions are necessary to achieve your goals?
This is a description of the strategies and tactics necessary to achieve the company’s objectives.

4.     How much will it cost and over what time frame?
This includes the resource planning for all the required company assets and resources including capital, people, facilities, equipment, inventory, raw materials, development, etc.  We typically suggest the inclusion of three budget scenarios best case, most likely case, and worst case.  The worst case scenario should stress test the business plan and financial forecasts to make certain that the company’s capital plan is sufficient to deal with unexpected developments and their consequences.  All sophisticated investors will want to see the entrepreneur has addressed this consideration.  It is best to have it prepared for presentation when asked, even if the worst case scenario is not included in the business plan.  It will also be of help in building the risks section of the business plan.

5.     Can the business meet the objectives and financial plans that have been presented and what value will be achieved as a result?
It is important to be realistic in answering these questions.  The founders and management team will and should be held accountable for these results.  We find most business plans we review are overly optimistic on the planned targets and assign excessive valuations to their achievement as well.

Steps in Preparing a Business Plan

The following steps should be followed in development of the business plan:

• 1.     Identify the company’s objectives
• 2.     Outline the business plan
• 3.     Review the outline with your advisors or mentors
• 4.     Research the outline topics thoroughly
• 5.     Write an initial draft of the business plan
• 6.     Review and edit the plan with the help of your advisors or mentors
• 7.     Have the plan reviewed by several outsiders
• 8.     Update and finalize the plan
• 9.     Develop the Executive Summary

Structure and Key Components of a Business Plan

While there are many templates and suggested formats for business plans, most sophisticated investors will expect the following basic components at a minimum.

       1.   Cover Sheet

       2.   Table of Contents
       3.   Executive Summary
       4.   Description of the Company - intended activities, target markets, and distinctive competencies
       5.   Market and Competitor Analysis
       6.   Products and Services
       7.   Operations
       8.   Management and Ownership
       9.   Funds Required and Their Uses
       10. Financial Data
       11. Risk analysis
       12. Supporting Appendices

As there is much underlying detail behind each of these topics, we will not attempt to deal with that within the scope of this article.

The important point is to understand the need for a thorough and complete analysis of the opportunity and planned business.  We urge particular attention to the go-to-market plans and market and competitive analysis sections.  We find most business plans particularly weak in these areas that are so crucial to the success of any business.

Presentation of your Business Plan:

While a comprehensive and professional business plan may well go into even a triple digit number of pages, it is important to be able to present your opportunity succinctly and clearly to prospective investors in 15 to 20 minutes.  Your presentation should be compelling enough to cause the investor to spend enough time to wade through the entire business plan in order to more thoroughly understand the opportunity.

We always counsel entrepreneurs to focus on the analysis of the target market, the intended customers and their unmet needs, what makes the company’s offering unique and compelling, and how potential buyers will be attracted and acquired for the company’s products or services.  Perhaps one of the most common mistakes made by entrepreneurs in these presentations is focusing too much on the company and its offerings, describing their technology, innovation, or value proposition in great detail, or spending too much time on the history of its development.

We always suggest rehearsing these presentations extensively with objective reviewers who know nothing about the company or its intended business to be certain they can be delivered smoothly and professionally and most importantly be easily understood and compelling.

The Importance of a Sound Business Model:

Does your intended business have a sound business model?  Have you carefully addressed pricing and margins?  Does the business have strong sources of recurring revenue or does it depend on constantly earning new customers for one-time purchases?  Are you early to market with a new, unique, and compelling offering?  Have you significantly improved an already proven product or business proposition?  Or, are you simple the next to market with a slightly better version of an idea or product others have already successfully positioned in the market?  Are you approaching a rapidly growing market opportunity?  Is your value proposition market ready?  Do you already have your first customers or market validation of the product or service?  All of these are questions that prospective investors will be considering.

We always suggest that entrepreneurs try to think from the investors’ point of view.  Why would they be attracted to this particular investment opportunity?  Is your company a good risk?  Have you thoroughly analyzed its strengths and weaknesses?  Do you have not only a unique and compelling value proposition, but also a go-to-market plan likely to succeed in attracting customers in sufficient volumes to achieve the projected financial results?

Are You Ready to Raise Capital? - What are Investors Seeking?

What are Investors Seeking?

Investors are seeking risk-adjusted returns on their own funds or those they manage for others.  They understand this well and expect entrepreneurs to appreciate their perspective.  The relative attractiveness and attendant valuations they assign to prospective investments may vary widely from the views of the entrepreneurs.  However, it is their capital that is required to your opportunity.  This is a perspective entrepreneurs should keep in mind.

The basics that investors are seeking and upon which they are evaluating opportunities include:

·     Potential for Growth and Expansion
Investors are seeking opportunities that have the potential for significant growth and expansion.  They are not seeking to build a nice, comfortable small business.  Entrepreneurs need to realize the often the management team and talents required to launch a new company may be different than those required to transition the company to more rapid expansion and a more mature set of corporate disciplines.  Founding entrepreneurs should carefully consider this matter when presenting the long term plans for growth of the company to prospective investors who well understand this reality.

·     Capable, Proven Management Team
Sophisticated investors are like handicappers, they understand and value highly experience and past performance.  They prefer a good opportunity and a great, proven management team to a great opportunity and a good management team.  Poor management has destroyed the value of many good companies.  We cannot overemphasize the importance to investors of the right management team.  It is also important that the experience of the management team is relevant to the industry in which the company intends to compete.  If the founding entrepreneurs do not have this proven experience, we highly recommend expanding the founding team to include this experience.

·     Preparation and Thoughtful Planning
Has the business opportunity and the intended market and competition been thoroughly researched.  It is highly likely that potential investors most attracted to an opportunity will be those with some experience in the relevant business or intended market.  They may know as much or more about the target markets or industry as the founders.  They will instantly spot a poorly researched opportunity or week planning.

·     Board of Directors or Advisors
Investors will find companies with a strong Board of Directors or Advisory Board more attractive.  Members should bring strategic value to the company in the form of industry knowledge, leverage with suppliers, strong relationships in the company’s target markets, and the ability to help the company achieve its intended growth.  Early stage companies in particular benefit from an Advisory Board with the ability to provide warm introductions to prospective customers, and strong relationships and credibility in the company’s the target markets. In addition, the Advisory Board should be able to assist the entrepreneur in evaluation of strategic and tactical alternatives and provide a great sounding board to assist in key business decisions.  We generally recommend the formation of an Advisory Board early in the launch of a company but suggest deferring the formation of a Board of Directors until the company is ready to conduct an outside capital raise.  Advisors carry no corporate liability and it is easier to attract a strong Advisory Board.  Once a Board of Directors is formed it is necessary for the company to provide full General Liability coverage as well as Officers and Directors Liability Insurance coverage.  Directors carry significant liability as a consequence of their service and both the Board and management should take corporate governance responsibilities very seriously.

·     Forthright Integrity and an Honest Assessment of the Opportunity and Its Risks
Experienced investors seek entrepreneurs who are open to honest and forthright critique of their business plans.  They want to be certain that entrepreneurs they back are open to ‘two-way communication with their investors.  Most investors will wish to back not only sound and attractive business propositions, but also those in industries in which they have an understanding.  Often the investors in a young company can contribute much more than simply their capital toward the growth and success of the company.  We always urge our clients to seek out investors who bring strategic value to the business as well as capital.  We strongly urge entrepreneurs to include in their business plan and present to investors a carefully thought through and honest risk assessment.  Be honest, tell potential investors of the challenges and hurdles the business will face.  The investors may well be the very people who can help with those challenges.  Many investors have a broad set of relationships that can be very important in assisting entrepreneurs in solving problems and resolving issues as they are encountered.  When identifying risks be sure to describe the risk, the likelihood it will be encountered, what the potential impact may be on the business, and how it will be avoided, mitigated, or cured if encountered.

·     The “Been There, Done That” Factor
Investors are more attracted to propositions surrounded by experienced and successful management teams.  This is particularly true when considering previous entrepreneurial success.  Launching and growing a young company requires a much different set of core competencies and energy than being successful within a large corporate infrastructure.  Nothing is a better predictor of future success, than prior performance.  Those opportunities most attractive to experienced investors are ones presented by entrepreneurs with whom they have had prior success.  Experienced entrepreneurs are more likely to anticipate problems and take corrective action early to avoid dire consequences.  Investors love people who have the Know What, Know How, and most importantly the Know Who relationships get things done expeditiously and to make the opportunity successful.

Conclusion

A successful capital raise requires effectively dealing up front with valuation and control issues.  We have seen so many entrepreneurs fail to raise the capital sought due to unrealistic valuations and stubborn refusal to retain absolute total control.  We have heard time and again – “Why should I have to give up that much of my company to someone whose only contribution is their money.”  This is a key genetic marker to identify entrepreneurs who will fail to accomplish not only a successful raise, but also likely trying to launch a company doomed to fail.  As angel investors ourselves, we never back entrepreneurs who fail to understand the value contributed by their investors.

We urge entrepreneurs to think like investors when dealing with issues of valuation and control.  It is indeed the wise entrepreneur who carefully researches similar opportunities successfully funded by investors to understand both valuation and control.  We often suggest an approach that reserves a significant percentage of the equity the founders might otherwise claim and tie it to performance.  Investors are happy to have entrepreneurs earn a significant portion of their equity stake.  This reinforces the perception of shared risk and reward.  Likewise this same approach can be used to deal with control.  As milestones are achieved the founders earn a greater stake in the enterprise and increase their control.  This approach is fair to both the entrepreneur and the investors and often viewed favorably by potential investors.

Concerns about valuation and control can be dealt with through the use of warrants and options tied to performance objectives.  We always urge entrepreneurs to consider the potential increase in the value of their ownership, than the percentage of their ownership, when pondering the issues of valuation and control.  If you fail to raise the capital today, can you still launch the business?  How much faster would the business grow with the availability of the capital sought?  Will the opportunity window remain open long enough to achieve success if the current capital raise fails?

It always comes down to the decision of would you rather have 100% of a failed company, 80% or a company worth $2 million, 20% of a company worth $8 million, or 10% of a company worth $800 million?  Easy decision.

We also advise entrepreneurs not to use the approach of starting out negotiations and their offer to potential investors with more favorable terms to the entrepreneur than they think will be required to raise the capital and then settling for less favorable terms during negotiations.  This is unlikely to be successful with potential investors.  The entrepreneur will likely get only one shot at a potential investor and if the investor is not attracted to the offer the negotiations will never take place.

Finally, you are ready, you have made the pitch to an investor, he has expressed interest, but have some concerns about some of the terms.  Don’t fail to land the catch.  The terms may not be ideal, but you need to remember, particularly in today’s economic and investment climate, you not get another chance.  If you have to alter any of the terms of the offer, remember in any one raise, all investors must get the same basic financial terms.

So, are you ready to raise the capital you need to launch your business?  Has this article been helpful and allowed you to think through some of the issues?

There is just one last piece of advice we will emphasize.  Entrepreneurs should never attempt even a friends and family raise without the advice and assistance of an experienced professional advisory team.  This professional team will include at a minimum your business advisors, an experienced securities attorney, and a trusted accountant to potentially assist with and review your financial projections.

Now, prepare thoroughly and then go get the money you need to launch your dream.  If we can help you as we have so many others prepare for and conduct a capital raise, please get in touch with us through the Harbour Bridge Ventures website at www.HBVinc.com.  We wish you success.

Tips for Attracting Angel Investors

Tips for Attracting Angel Investors

Entrepreneurs often find financing their vision is one of the more difficult challenges in launching a new venture.  While bootstrapping is available as a means for many to develop the idea and perhaps even launch the company, most entrepreneurs quickly recognize the need to find investors who believe in their vision and are willing to invest the funds necessary to finance the company’s continued development and growth.  For most early stage ventures, the most likely investors after the friends and family route has been exhausted are angel investors.

Angels are a distinct class of investors.  They are individuals who can financially afford to indulge their love of risk in exchange for the potential of higher returns on early stage opportunities.  Frequently, they seek out early stage investment opportunities that match their individual passions and interests.  To be an angel investor, one must be an “accredited investor.”  Accredited investor is a term defined by various securities laws that delineates investors permitted to invest in certain types of higher risk investments.  In the United States, for an individual to be considered an accredited investor under definition in the Securities Act of 1933, they must have a net worth of at least one million US dollars or have made at least $200,000 each year for the last two years ($300,000 with his or her spouse if married) and have the expectation to make the same amount in the current year.  In Canada, the same prerequisites apply, however one’s net worth must be a minimum of one million dollars not including the value of equity of the principal residence.

It is important for entrepreneurs utilizing angel investors to finance their venture to be certain that they are only approaching and accept accredited investors.  We strongly suggest to entrepreneurs seeking investor capital to use competent legal advisors to assist them with proper documentation and compliance with all securities laws and regulations.

While there has been some contraction of angel investor dollars in the current economic climate, there has been little change in the number of investments funded.  Total angel investments in 2008 were $19.2 billion, a decrease of 26.2% over 2007, according to the Center for Venture Research at the University of New Hampshire.  However, a total of 55,480 entrepreneurial ventures received angel funding in 2008, a modest 2.9% decrease from 2007, and the number of active investors in 2008 was 260,500 individuals, virtually unchanged from 2007.  This significant decline in total dollars, coupled with the small decrease in investments resulted in a smaller total deal size for 2008 (a decline in deal size of 24% from 2007).  In contrast to venture capital, in which money must be invested during the life of the fund and is in part based on the size of the fund, angel investing is an individual decision and angels invest from their net worth.  This data suggests that while angels have not significantly decreased their investment activity, they are committing fewer dollars resulting from lower valuations and a cautions approach in the current economy.

Angels often provide additional value beyond their investment dollars; indeed we encourage entrepreneurs to seek out angel investors with strategic value to the investment being funded.  Strategic value can come in the form of industry experience, executive knowledge, creative ideas, relationships with the target markets, or other contacts that can prove helpful to the company.  When targeting angles we suggest entrepreneurs consider the following guidelines.

•  Build a convincing case – Angel investors may be willing to take on more risk than most, but they still need to see a well thought out plan with a product that has a documented “must have” need and a competent management team surrounding it.  It is rare that an entrepreneur can raise money from angels without clearly defining the competitive landscape of the business and how the product has a clear and unique advantage over competitor’s offerings.  Investors will want to know how the company will create and exploit barriers to entry.  Namely, how you will keep competitors from being in the same exact business or markets.  Some barriers to entry might include patents, trade secrets, and proprietary processes.  Additionally, it is not enough to have a strong value proposition and attractive market opportunity; entrepreneurs must have a winning go-to-market program that explains how the desired market share will be captured.
• Create a prototype and line up beta customers to provide validation – Angels do get involved in the early stages of a company, but not usually before there is a working model of the product and potential customers have committed to test the product.  Having a prototype and initial customers signed will greatly increase your chances of attracting angel investors.  Demonstrating that you can get paying customers in the real world puts you far ahead of entrepreneurs who simply have a business plan and an idea.  Later stage companies need to show they have accomplished revenue growth matching target assumptions and have paying customers who validate their pricing strategy.
• Founders need to have “skin in the game” – If you want to start a business, be prepared to invest your own money.  Entrepreneurs, who expect angels to risk money in their venture, better throw something into the pot themselves.  Those entrepreneurs who are not willing to assume such risk are not considered serious by investors, and will most likely not receive funding.  We generally suggest that the group of founders surrounding an opportunity be prepared to contribute twenty percent of the funding sought.  If the current founders cannot show that this investment has already been put into the business by the founders or are not prepared to make such investment, the likelihood of receiving the investment sought is considerable lessened.
•  Be prepared to have “sweat equity” disregarded by investors – While investors appreciate the idea, effort to bring it to the current state of maturity, and any intellectual property that has been created, they often assign little if any real value to “sweat equity” in their opinion of valuation.  This is often at distinct odds with the view of entrepreneurs who tend to assign great value to their efforts to date and the idea.  However, we remind entrepreneurs of the “Golden Rule” – he who has the gold, makes the rules.
• Focus your search for investors - Identifying angels who are suitable for your opportunity up-front will increase your chances of success.  To help you identify appropriate angels when pitching, ask them what they look for in a company, how much they typically invest, and what kind of return they expect on their money.  In addition:
•  Concentrate on your industry vertical - Angels like to invest in companies whose business they know something about. Many angels, having previously been successful entrepreneurs, will tend to lean toward their prior industry experience.
• Target investors interested in companies at your stage of development and your deal size - Some angels will only invest in seed or start-up companies, while others seek later stage ventures looking for expansion capital.  Angel investors will have a dollar range they are comfortable investing.  This can range from $25,000 to several million dollars.  We suggest limiting investments to a minimum of at least $25,000 and actually prefer a minimum of $50,000.  Truly accredited investors can meet this criteria and it is simply too hard to complete a raise of any size when taking smaller minimum investments.
• Look close to home - Angels frequently want to be actively involved in your business and prefer to invest in companies they can easily keep an eye on and communicate conveniently with management.  Make it easy for them to do it in person by looking within a 50-mile radius of your corporate headquarters.  You may have to expand your horizons, but try to stick as closely as possible to your home community or region.
• Look for risk takers – Since there's no such thing as a national directory of angels, you've got to put together your own list of prospective angels.  Look for other interests that might indicate a risk taker, such as skydiving, motor sports, sailboat racing, or adventure travel.  But remember just because someone is a risk taker, it doesn’t mean that they won’t do a lot of homework to control those risks.
• First ask people you know – The most likely angel investors for your opportunity are people who already know and trust you.  Once you have obtained some of the funding you seek from these people, they may well know others they can refer to your opportunity.  The first dollars raised after the founders’ money is often the hardest.  Momentum is important and early dollars will help to convince others of the soundness of the opportunity.
• Be prepared for no’s – Experience shows that amongst qualified accredited investors with a history of making such angel investments and assuming that your opportunity is an attractive one, an average of only ten percent (1 in 10) of those approached will say yes.  So, be prepared for the nine no’s for every yes.  Don’t be discouraged but be realistic.  You will likely need a list of ten times as many potential investors as you require at the minimum investment amount in order to complete your raise.
• Make connections and network constantly - While some investors do read business plans that come over the transom, plans referred to them by a trusted source, such as a business associate, lawyer or accountant get far more attention.  Other options to meet people with deep pockets are to present or at the very least attend a venture capital conference or angel club meeting.  Network to find out about these opportunities.  Look for local entrepreneurial network and support groups and attend meetings and network aggressively and constantly.  If you have a local university or college check to see if they have an entrepreneurial support program and seek out contacts there.  SCORE, Economic Development Associations, and other entrepreneurial support resources should be approached and networked as well.
• Connect personally - Angels spend a lot of time with entrepreneurs especially in the early stages of building a company so getting along is crucial.  Chemistry covers whether you like, trust and are in sync with each other.  To have good chemistry you have to personally connect, and have similar expectations, vision, and objectives for the company.  Being able to answer angels’ questions without feeling threatened is also crucial.
•  Be persistent and patient - Entrepreneurs must be committed, passionate, and thick-skinned.  Raising capital is a time-consuming, ego-challenging process.  It is not unusual for a startup entrepreneur to spend 50%-70% of his time raising capital from angel investors, a process that used to average 3-6 months at a minimum and in today’s more challenging economic climate is more likely to take even longer.
• Do due diligence on the investors - Entrepreneurs should be just as choosy about who they take money from as the investors are about their investments.  Make certain that you really know your investors.  This is a partnership with a long life and it is important that it is a good one.  Understand his motivation and expectations for exit strategy and expected ROI (return on investment).  Know what added value they can bring to the table and make sure they understand this also and are prepared to offer us that value along with their dollars.  Knowledgeable angels with good connections can jump start a company and help it to thrive.  Well-connected angels can even make it easier to get additional rounds of financing from other angels or even venture capital groups with whom they have a relationship.
• Don’t haggle over terms - Efforts to hoard stock and inflate valuations will make the company less attractive to investors.  Let experienced professionals – capital advisors, valuation experts, lawyers, and accountants - handle terms and valuations.  Heed their advice.  We often encounter entrepreneurs who are reluctant “to give away so much of their company to people who only contribute money.“  This is an extremely unhealthy and unhelpful attitude and often results in entrepreneurs who own 100% of a failed company.  If the company is a success, everyone will be a winner.  We often suggest placing stock in a “bonus pool” to be awarded to management or founders based on performance and results.  This often helps to make the investors more comfortable and retain a larger potential equity share for the entrepreneur if the company succeeds.
• Communicate with your investors regularly and openly - Angels want to know how the company is doing whether the news is good or bad. Staying in touch by phone, email and even a monthly newsletter will keep investors happy.
• Think like an investor – We always suggest the entrepreneur try to “think like an investor.”  Keep your investors interests and their perspective in mind.  They have placed their funds and trust in you.  The more you can successfully maintain their perspective the more likely you will maintain an excellent relationship with your backers.

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