04.07.2009 20:01:26

Investors Network Team

There really is not minimum or maximum amount that you can or should be asking for. A better question here may be how much money do I want to ask for or how do I decide on the amount of investment needed for my business?

Let’s imagine for a moment that the company will make money soon after launch. Irrespective of whether we’re talking about profits or just high revenue here, I would caution that it almost always takes longer to ramp your top-line than you think it will. Everybody walks into a venture pitch with their three year financial projections that have a lousy first year, a strong second year, and a monster third year. The truth is that even most ultimately successful tech start-ups have a slow first year, a slow second year, and then you get your spectrum of third year results ranging from really-taking-off to continued-doldrums. It just always takes longer than you think to launch, grow, ramp sales, close deals, etc.

That’s a good consideration for the rest of the question – how much to raise and how long should you expect the money to last. Everybody has different thoughts on this subject, but I would say there are two helpful guidelines. First, raise enough money to last about a year or a good six months after your next big milestone. Some people like to say “raise just enough to get you to and then you will be able to do a B round at a bigger valuation”, etc., but you want to give yourself some reasonable stretch of time to be product and strategy focused after the A round before you have to hit the road again to raise more money. It’s no fun having to think about starting to raise money again only a few weeks on the heels of closing the previous round. Second, you always need more money than you think you need, especially if this is your first start-up. You can have a nice detailed spreadsheet that accurately reflects market salaries, rent, and more, but you will still require more money than you think.

 Let’s look at two scenarios for a very promising start-up with technology that may be of strategic interest to several profitable public companies (note to self - write a future post about the importance of not planning for or even thinking about exits like this):

Scenario 1: You raise 1 on 3 pre in an A round, so you’ve sold 25 percent of your company for a million bucks and you have a co-founder with whom you’ve evenly split equity, and you have a 15 percent options pool from which you quickly allocate 5 percent that fully accelerates on a change of control.

Scenario 2: You raise 10 on 40 pre in an A round, so you’ve sold 20 percent of your company for 10 million and you have a cofounder with whom you’ve evenly split equity and you have a 15 percent options pool from which you quickly allocate 1 percent that fully accelerates on change of control.

Six months into your post-A round, you are approached by Awesome Corp and they would like to buy your company for R20 million. Company that pursued Scenario 1 is in the following situation: founders each own 35% of the company. Founders each make R7 million dollars, investor takes out R5 million for a speedy 4x, and the options holders pull out the remaining million dollars. Ignoring taxes for the moment (much like ignoring friction in freshman physics, this is impossible and problematic, but humour me), this is a nice outcome for everybody. Your investors, it might surprise you, won’t be particularly thrilled, because it’s important to keep in mind that they are not in this business for IRR, they are in it for multiples, and a 4x on a fantastic new company with only R1 million invested is not that exciting. Still, at a 4x after six months, they’re probably not going to block the deal. It’s nice to make 400% returns in a short period of time. Now let’s look at the same offer if the company pursued Scenario 2. Do you think our founders are going to be cashing in any Awesome shares anytime soon? No, they are not.

But wait, don’t the founders actually own MORE of the company? Won’t they actually make MORE money individually? Why yes, they do own more of the company, but that was just a little trick I played on you. It makes no difference, because the investors, who have put up R10 million dollars, stand to take out R4 million dollars, and investors have this thing where their LP’s get very mad at them if they invest 10 and get 4 back after only 6 months. If our founders go look at their Articles of Incorporation and the term sheet they undoubtedly signed from the investors when they raised this round, they will see that the investors have blocking/veto rights, and the investors will veto this deal in a heartbeat. More likely, the company would never even get to this point, because the people at Awesome are going to look at the company cap table and realize that this deal doesn’t get done. The founders have set themselves on a course in which the only two possible outcomes are home run or failure.

At the end of the day you know that the more money you have the more you will spend. Unfortunately, money spend does not always equal level of success achieved or whether there will be success at all. What is the absolute least that I can spend to get this business of the ground? Now there is a question that perhaps not enough entrepreneurs are asking of them selves.

I acknowledge the contribution of Dick Costolo this post and take responsibility for my changes and additions.

How much can I ask for from the inv | FAQ

04.07.2009 19:41:28

Investors Network Team

Well you may as well be asking how long is a piece of string? Depending on the investor, the questions you may come across will vary hugely. Here are a few of the questions most commonly asked.
1) Who else have you spoken to?

I believe every single investor asks this early on and I’m not completely sure why they care so much since they should be basing their judgment and strategy on the strength of the idea and not on its popularity. 

2) How will you make money?

Where will the money come from? As simple as this may sound, entrepreneurs, especially those in the service industry are sometimes surprisingly unfocussed on this issue. If you have the - if we build it they will come attitude, then don’t be surprised of the investor does not share your enthusiasm. 

3) How will your company grow?

Investors want a return on their investment, and they naturally want to see you grow your market. I believe going over this question with your co-founders is a great exercise, because your company in three years is going to be very different from what it is right now. Always good to have everyone on the same page about how things should pan out. It doesn’t have to be detailed, just think about whether your growth strategy is going to be achieved by creating new product lines, reaching foreign markets, or adding some nifty features.

4) What technologies do you use?

If you are in the IT industry or your business is web based make sure that you have this question covered and you have either have sufficient information to stand your ground here or have your IT guy with you as backup.

5) How easily can you be copied?

If you’re writing a web app, chances are there are a lot of other teams who could create a similar program (if you’ve got no competitors you might be working on the wrong thing). Just be as honest as possible when answering people on this and make sure that you are clear on what your Unique Selling Proposition is. - What makes your business different?

6) Can we see the demo?

If you're attending one of our investor pitching events you may find a good mix of fairly interesting and useful ideas to compete with. Investors want to see the goods. Basically, always assume they haven’t seen your online public demo and have that local host version on your laptop ready to go.

7) Who are your competitors and how are you better/different?

Unless you just invented a teleportation system, research your competitors and be ready to answer what you can do better than everyone else out there. Don’t even try and avoid this question because about two days after any meeting, you’re going to receive an email asking you to detail how you’re better than 20 other companies the investor just Googled.

8) Who are your customers?

The trick to this question is to be specific. You’ll want to have examples of who is using, who will use, and who wants to use your product. Remember that an investor may be parting with a large amount of money to get your business of the ground. Don’t be surprised if they contact companies you mention as potential customers during the due diligence period to verify their legitimacy as a customer.

9) How will you market your product / service?

This is a favourite question amongst investors. Investors understand the power of word of mouth marketing, and you win bonus points if you can demonstrate the ability to quickly spread the word. As I often tell audiences at seminars and workshops, you can have the best product in the world, nothing will happen if people don’t know about it.

10) What will your market penetration be? 

This was actually only asked of us once, but I had to add it to emphasize that you don’t need to spew out a bunch of BS to impress investors. We could have made up something you probably heard in an MBA class, but instead just said, “We honestly don’t know.” And that’s the truth, because I can’t even begin to guess what percentage of the available form building market we are going to get. The investor was a little bit shocked with the answer, but it definitely wasn’t a deal breaker.

What will Investors ask me?10 quest | FAQ

04.07.2009 19:08:41

Investors Network Team

When it comes to the length of time it takes to secure an investor, it almost impossible to predict. It mostly will depend on the relationship created between entrepreneur and investor, whether the entrepreneur has done his/her feasibility study and marketing research to a sufficient level for the investor to be sufficiently secure that the business idea can be developed into a profitable business.

A few steps that you as the entrepreneur can take to support you with the process of providing information to an investor are:A few things that you as the entrepreneur can do to ensure that time is not wasted is:

1. Do a feasibility study and market research to ensure sufficient demand for the product or service
2. Create a business plan identifying the strategy
3. Determine a sensible valuation of the business and be realistic with this. Make sure you can justify the valuation. Don’t be too greedy – remember that if you fail to secure any funds you may not have a business that can go forward
4. Define the unique selling points (USP)
5. Research the competition and put yourself in the mind of the competition to figure out how they will react to you entering the market
6. Have an exit plan
   
   In addition also read our article on how to find investment to further ensure that you are ready when the you meet a potential investor

How long does it take to secure an | FAQ

04.07.2009 18:46:56

Investors Network Team

Entrepreneurs looking for funding today face a number of challenges. In the current climate it is  becoming increasingly hard to find credit. Debt finance, which was once an attractive option, is now an expensive burden. Businesses left struggling to find working capital or replacement to bank debt can instead turn to the rising prominence of angel investment as a viable alternative. Here are some top tips to help steer them through this sector:

1) Put in place a strong management team

Few early stage businesses have complete management teams and very few can claim to hold all the skills required to maximise the potential of a business. Entrepreneurs who can recognise their weaknesses as well as their strengths and plan accordingly are well placed to raise investment.

Top tips:

Consider what skills you and your existing team have and what needs to be brought in
Be broadminded about your relationships with employees – putting someone on the payroll is not the only option

2) Create a business plan identifying the strategy
A solid business plan that identifies the strategy is crucial. The plan must contain a commercial idea which will provide an eventual profit for investors or, as a minimum, sufficient profit to repay the interest and the principal on a loan. However, not all plans need to be unique as many ‘me-too’ but better businesses are established to take advantage of a niche or to stake a claim for a share of an existing market.

Top tips:

Always have a business plan
Only include as much within the business plan as is necessary to keep you on track and to give investors a clear idea of where you are taking the business and how you are going to get there

3) Determine a sensible valuation of the business
Early stage businesses are notoriously difficult to value. One rule of thumb is: a solid business idea alone, R100,000; a solid business idea with a reasonably presented business plan, R500,000; both of the above, plus a good management team with relevant CVs, £2 500, 000; all of the above, plus a sale - any figure upwards of R5, 000,000. A perhaps better approach is to apply the rule of thirds, with the valuation split between the inventor, the management team and the investment.

Top tips:

Be realistic
Make sure you can justify the valuation
Don’t be too greedy – remember that if you fail to secure any funds you may not have a business that can go forward

4) Define the unique selling points (USP)
Aside from coming up with a compelling business proposition, the entrepreneur must ensure that nobody else is offering exactly the same product or service or have a particular USP which makes it different and potentially more profitable than competitors. It is then necessary to consider how easy it would be for another business to replicate it, assuming that it is not patented.

Top tips:

Research the market
Research the competition and put yourself in the mind of the competition to figure out how they will react to you entering the market

5) Have an exit plan
Businesses that are a lifestyle plan for the entrepreneur often find it difficult to attract investors. One example is a business that will provide the entrepreneur with long-term employment and remuneration but which they will want to continue with until retirement. However, in these instances, a secured loan may still be viable. Having a well thought through exit plan is therefore a key element of obtaining investment. In many ways, the actual form of exit is less important than the principal that there will be an exit at some point - generally within three to seven years.

Top tips:

Always have an exit plan in mind
Ensure that the route to exit is front of mind when speaking to any potential investor

6) Find an investor
Arranging investments is a category of regulated activity which can only be carried out by firms authorised to do so by the Financial Services Authority (FSA). This must also be done with information authorised by a FSA-approved firm. It amounts to acting for a business with the expectation that they will be introduced to an investor. Direct approaches to potential investors by individuals can be a criminal act and result in the individual making the approach becoming personally liable for any losses incurred by an investor. This is unless the individual has received certain certifications from the investor before seeking investment.

The FSA aims to protect consumers; both companies and investors. It does this by regulating the way in which financial service providers operate, paying particular attention to the integrity, skill, care and diligence with which they are run and to the competence of those people delivering services.

Regulations under the FSA lay down, in some detail, the framework within which approaches to investors must operate in order to comply with the Financial Services and Markets Act (FiSMA) as well as subsequent UK and European modifications to it such as the EU’s Markets in Financial Instruments Directive (MiFID). Obligations are placed upon all business angel networks, their Directors, employees and associates by the wider law, particularly by the Companies and Data Protection Acts.

Top tips:

Take heed of the legal requirements when seeking investment
Find a reputable business angel network or corporate finance house that has a proven track record

For business owners that get it right, the rewards from private investors can be high and, with the backing of cash and experience, they will be in the strongest position to succeed in the downturn.
About the Author

Thank you for the contribution of Michael Weaver to this article. Michael is Chief Executive of Beer & Partners, the UK’s largest business investment agency. Visit their website here.

finding business funding | business funding | How to Get Business Funding | FAQ