Raising Capital Primer for Small Busineses
| Category: Home Based Business - Finance | Date: 2003-06-18 |
Weve helped a number of clients develop business plans and raise capital from "angel" investors, corporate entities and venture capitalists during the last 6-8 years. Its always a challenging process that can be full of pitfalls and require a tremendous amount of work - but it can be done! Here is some perspective gleaned from years of experience.
Competitive Analysis
One of the most critical research processes that you need to go through before you raise capital is carefully researching your market and the competitors in it. Any astute investor is going to ask you about competitors early on in their discussions. Big warning - never tell an investor that you have no competitors; most of them arent going to believe you and in my experience Ive found many/many (countless!) times that the entrepreneur "had no competitors" because they defined their company/technology/branding/positioning too narrowly. Also, competitors in your market dont always send a negative signal to an investor as they legitimize your market focus.
Marketing is Essential to the Process
First and foremost! Think about how you are going to market raising capital for your company as you would any other product or service, blending traditional (fax, direct mail) with interactive processes (web site postings, e-mail, etc.). Its a numbers game, you have to aggressively reach your target audience and be prepared to see a return of only 1-3% versus your output - 1K in direct or opt-in email may only lead to 10-20 casual inquiries, generating 3-5 serious conversations, resulting in 1-3 term sheets (what we will invest for "x" equity) discussions.
Its an Uphill Battle
The most important rule for raising capital to consider is: its never easy to raise capital, especially when you need to - and its much harder to raise seed capital than a later round ("mezzanine" in investment speak). Investors are inherently risk aversive, can be very picky (a real understatement!) and they are looking for the best deal with the greatest upside and minimal risk.
The numbers are not in your favor! An average investor (angel, venture or commercial firm) is typically getting a tremendous deal flow ("number of deals or biz plans to review/analyze). Typically about half of one per cent of all seed capital (early stage) deals get funding. So, bootstrap (self-fund - see rule number two) your company through the early stages, develop referenceable customers, proprietary technology and some market position. It will be much easier to raise capital after your through the most challenging phases of building your company - and, most importantly, you can drive a much better deal for your equity valuation, more capital in for less shares out!
Rule number two - dont raise capital! Self fund your company (called bootstrapping in entrepreneur-speak) by finding customers that will purchase your products and services. This enables you to involve your most important business asset in your business from day one - customers!
Get out the gate anyway you can! There are too many successful companies to name that were started in the bedrooms of their founders - run lean and mean until you can afford to spend more resources.
The most important business processes to address are revenue and customers - everything else is secondary, including technology development. Keep in mind one of my favorite Armand Hammer quotes (the Russian industrialist) - "a product isnt a product until someone aggress to pay a price for it." So, dont waste time speculating about what you can do or how to do it - get out there and talk to customers, they will tell you if you have a real product or company by their ordering processes!
Raising Capital via "Friends and Family" and "VMC" Sources
Rule number three - use the "FAF" or "VMC" methods. Raise seed (early stage) money from your "friends and family" and/or if you are really committed, pull some cash from a Visa or MasterCard ("VMC"). These methods can and do work for many entrepreneurs - be aware it can be very painful on the back end if your company does not make it! Make sure you separate your personal capital from your business capital and dont intermingle these funds - the pain factor can increase exponentially downstream.
Working with Angel Investors
Angel investors can add so much to your company - they can bring "intelligent capital" to the business. Not only do they invest capital but will very often take an interest in helping you grow the company by taking a Board of Directors seat and/or temporarily assuming a senior management role.
But, be aware, every point of refuge has its price - angel investors can very often have strong beliefs in doing things their way and can be challenging to work with. Make sure youve worked out some ways to compromise in challenging situations and/or have a third party (another BOD member) who can help you mediate disputes.
Also, do some "due diligence" on your angel investor just like what he/she will do with you. Ask for some references to CEOs he/she has worked with in the past and then call them and ask some probing questions, with emphasis on what happened when they hit some bumps in the road with the angel investor.
Recruiting Management Team
In my experience finding and recruiting a blue chip management team with advanced degrees and a strong corporate pedigree can sometimes kill a startup as quickly as no cash or revenue - yes, they look great in your business plan and venture capitalists love a "strong team." But, you need "fly by the seat of their pants" manager/leaders who dont need to grind five sets of scenarios (analysis paralysis) before they can take action - hire entrepreneurial types whove excelled in small companies. You should hire/build a management team that excels in different stages of your companys development - your needs from $0-10M will be much different than $10-100M - so, hire people with skill sets who have achieved success in similar sized companies.
Consultants deliver critical Perspective
Weve been hired (small plug) to help clients develop a business plan and raise seed or mezzanine rounds of funding. What does this cost on average? I am not sure if there is an "average" number, but here are some general guidelines. Expect to pay $10-25K (USD) for a comprehensive Business Plan that is typically 25-45 pages long and that includes detailed financials (by month the first three years, then by quarter).
Some consultants will waive part of their fees and take equity (shares or options on shares) in your company, but most will want some significant cash payment. The most important part of your plan that experienced consultants can help you with (other than raising capital) is the Executive Summary (the synopsis of the B/Plan) and your financials - many investors will just skim the plan but study the Executive Summary carefully. "Perspective is worth 30 IQ points" - a good consultant or firm will help to structure your B/Plan properly so it is presented in a format and with the right content for a professional investor.
Raising Capital via Consultants
Raising capital can quickly become a fulltime job for many entrepreneurs, so you may want to consider working with third parties (consultants). In most cases they should be able to shortcut your time to market, and help you negotiate the valuation issues; variances in the valuation process can costs you hundreds of thousands or millions of dollars downstream if you dont know how to negotiate with investors. So, their value add can be significant in this area alone.
Most reputable firms want a "success fee" (or retainer) that is structured for 2-4 months - this is a fee that you pay them typically per month for their time, insight, acumen, etc. Make sure you get value for these services by adding some milestones to your contract that includes some specific actions they will take on your behalf; i.e. 20-30 firms contacted each month, 100-300 Executive Summaries send (fax, e-mail, snail male) to third parties, "X" number of "pitch meetings" (investor presentations) setup, etc.
A standard cost of services for someone that helps you raise capital usually includes the "Lehman Formula" - so named by Lehman Brothers for investment banking activities, typically structured as follows: 5% of the first million in the transaction paid in fees to the firm, 4% of the second million, 3% of the third million, 2% of the fourth million and 1% of everything thereafter. Can you negotiate with an investment banking or consulting firm with these numbers? Of course you can - these firms are sizing you and your deal up just like investors (they do in effect become investors if they take stock), if they think youre a "hot commodity" they will most likely reduce their fees and/or take more of an equity position.
Resources for Raising Capital
There are a broad number of web sites that act as "online go betweens" that help to put an entrepreneur together with investors, or at least help to publicize your B/Plan or Executive Summary. VFinance is one of the best - they have reasonable fees for posting your plan/opportunity ($300. range USD) and seem to generate a great deal of traffic via their site http://www.vfinance.com This Google link will take you to hundreds of sites and/or companies that work with early stage companies to help you raise capital, develop a business plan or by providing related services. http://directory.google.com/Top/Business/Venture_Capital/Resources_for_Entrepreneurs/?tc=1
Summary
Finally, the last and most important rule of all is be tenacious, there is no substitute for absolute commitment to growing your company by raising capital or bootstrapping it! Your vision, guts and passion will very often carry the day when/where others may give up!! I will cover working/dealing with venture capital firms in my next article - look for it in the next 7-10 days.
About the Author
Lee Traupel has 20 plus years of marketing experience He is the co-founder of a Northern California and Brussels Belgium based, privately held, Marketing Services and Software Company, Intelective Communications, Inc. intelective.com Intelective focuses exclusively on providing services to small to medium sized companies that need strategic and tactical marketing services.
Lee@intelective.com
http://www.intelective.com
Competitive Analysis
One of the most critical research processes that you need to go through before you raise capital is carefully researching your market and the competitors in it. Any astute investor is going to ask you about competitors early on in their discussions. Big warning - never tell an investor that you have no competitors; most of them arent going to believe you and in my experience Ive found many/many (countless!) times that the entrepreneur "had no competitors" because they defined their company/technology/branding/positioning too narrowly. Also, competitors in your market dont always send a negative signal to an investor as they legitimize your market focus.
Marketing is Essential to the Process
First and foremost! Think about how you are going to market raising capital for your company as you would any other product or service, blending traditional (fax, direct mail) with interactive processes (web site postings, e-mail, etc.). Its a numbers game, you have to aggressively reach your target audience and be prepared to see a return of only 1-3% versus your output - 1K in direct or opt-in email may only lead to 10-20 casual inquiries, generating 3-5 serious conversations, resulting in 1-3 term sheets (what we will invest for "x" equity) discussions.
Its an Uphill Battle
The most important rule for raising capital to consider is: its never easy to raise capital, especially when you need to - and its much harder to raise seed capital than a later round ("mezzanine" in investment speak). Investors are inherently risk aversive, can be very picky (a real understatement!) and they are looking for the best deal with the greatest upside and minimal risk.
The numbers are not in your favor! An average investor (angel, venture or commercial firm) is typically getting a tremendous deal flow ("number of deals or biz plans to review/analyze). Typically about half of one per cent of all seed capital (early stage) deals get funding. So, bootstrap (self-fund - see rule number two) your company through the early stages, develop referenceable customers, proprietary technology and some market position. It will be much easier to raise capital after your through the most challenging phases of building your company - and, most importantly, you can drive a much better deal for your equity valuation, more capital in for less shares out!
Rule number two - dont raise capital! Self fund your company (called bootstrapping in entrepreneur-speak) by finding customers that will purchase your products and services. This enables you to involve your most important business asset in your business from day one - customers!
Get out the gate anyway you can! There are too many successful companies to name that were started in the bedrooms of their founders - run lean and mean until you can afford to spend more resources.
The most important business processes to address are revenue and customers - everything else is secondary, including technology development. Keep in mind one of my favorite Armand Hammer quotes (the Russian industrialist) - "a product isnt a product until someone aggress to pay a price for it." So, dont waste time speculating about what you can do or how to do it - get out there and talk to customers, they will tell you if you have a real product or company by their ordering processes!
Raising Capital via "Friends and Family" and "VMC" Sources
Rule number three - use the "FAF" or "VMC" methods. Raise seed (early stage) money from your "friends and family" and/or if you are really committed, pull some cash from a Visa or MasterCard ("VMC"). These methods can and do work for many entrepreneurs - be aware it can be very painful on the back end if your company does not make it! Make sure you separate your personal capital from your business capital and dont intermingle these funds - the pain factor can increase exponentially downstream.
Working with Angel Investors
Angel investors can add so much to your company - they can bring "intelligent capital" to the business. Not only do they invest capital but will very often take an interest in helping you grow the company by taking a Board of Directors seat and/or temporarily assuming a senior management role.
But, be aware, every point of refuge has its price - angel investors can very often have strong beliefs in doing things their way and can be challenging to work with. Make sure youve worked out some ways to compromise in challenging situations and/or have a third party (another BOD member) who can help you mediate disputes.
Also, do some "due diligence" on your angel investor just like what he/she will do with you. Ask for some references to CEOs he/she has worked with in the past and then call them and ask some probing questions, with emphasis on what happened when they hit some bumps in the road with the angel investor.
Recruiting Management Team
In my experience finding and recruiting a blue chip management team with advanced degrees and a strong corporate pedigree can sometimes kill a startup as quickly as no cash or revenue - yes, they look great in your business plan and venture capitalists love a "strong team." But, you need "fly by the seat of their pants" manager/leaders who dont need to grind five sets of scenarios (analysis paralysis) before they can take action - hire entrepreneurial types whove excelled in small companies. You should hire/build a management team that excels in different stages of your companys development - your needs from $0-10M will be much different than $10-100M - so, hire people with skill sets who have achieved success in similar sized companies.
Consultants deliver critical Perspective
Weve been hired (small plug) to help clients develop a business plan and raise seed or mezzanine rounds of funding. What does this cost on average? I am not sure if there is an "average" number, but here are some general guidelines. Expect to pay $10-25K (USD) for a comprehensive Business Plan that is typically 25-45 pages long and that includes detailed financials (by month the first three years, then by quarter).
Some consultants will waive part of their fees and take equity (shares or options on shares) in your company, but most will want some significant cash payment. The most important part of your plan that experienced consultants can help you with (other than raising capital) is the Executive Summary (the synopsis of the B/Plan) and your financials - many investors will just skim the plan but study the Executive Summary carefully. "Perspective is worth 30 IQ points" - a good consultant or firm will help to structure your B/Plan properly so it is presented in a format and with the right content for a professional investor.
Raising Capital via Consultants
Raising capital can quickly become a fulltime job for many entrepreneurs, so you may want to consider working with third parties (consultants). In most cases they should be able to shortcut your time to market, and help you negotiate the valuation issues; variances in the valuation process can costs you hundreds of thousands or millions of dollars downstream if you dont know how to negotiate with investors. So, their value add can be significant in this area alone.
Most reputable firms want a "success fee" (or retainer) that is structured for 2-4 months - this is a fee that you pay them typically per month for their time, insight, acumen, etc. Make sure you get value for these services by adding some milestones to your contract that includes some specific actions they will take on your behalf; i.e. 20-30 firms contacted each month, 100-300 Executive Summaries send (fax, e-mail, snail male) to third parties, "X" number of "pitch meetings" (investor presentations) setup, etc.
A standard cost of services for someone that helps you raise capital usually includes the "Lehman Formula" - so named by Lehman Brothers for investment banking activities, typically structured as follows: 5% of the first million in the transaction paid in fees to the firm, 4% of the second million, 3% of the third million, 2% of the fourth million and 1% of everything thereafter. Can you negotiate with an investment banking or consulting firm with these numbers? Of course you can - these firms are sizing you and your deal up just like investors (they do in effect become investors if they take stock), if they think youre a "hot commodity" they will most likely reduce their fees and/or take more of an equity position.
Resources for Raising Capital
There are a broad number of web sites that act as "online go betweens" that help to put an entrepreneur together with investors, or at least help to publicize your B/Plan or Executive Summary. VFinance is one of the best - they have reasonable fees for posting your plan/opportunity ($300. range USD) and seem to generate a great deal of traffic via their site http://www.vfinance.com This Google link will take you to hundreds of sites and/or companies that work with early stage companies to help you raise capital, develop a business plan or by providing related services. http://directory.google.com/Top/Business/Venture_Capital/Resources_for_Entrepreneurs/?tc=1
Summary
Finally, the last and most important rule of all is be tenacious, there is no substitute for absolute commitment to growing your company by raising capital or bootstrapping it! Your vision, guts and passion will very often carry the day when/where others may give up!! I will cover working/dealing with venture capital firms in my next article - look for it in the next 7-10 days.
About the Author
Lee Traupel has 20 plus years of marketing experience He is the co-founder of a Northern California and Brussels Belgium based, privately held, Marketing Services and Software Company, Intelective Communications, Inc. intelective.com Intelective focuses exclusively on providing services to small to medium sized companies that need strategic and tactical marketing services.
Lee@intelective.com
http://www.intelective.com
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