1,000 Word Essay APA Format
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abrams_2012_ch08-2.pdf
Chapter
8 Looking for Money 170 Debt vs. Equity 171 Sources of Money for Entrepreneurial Ventures 173
Venture capitalists 173 private or “angel” investors 174 Banks 175 Government agencies 175 Small business investment companies 176 Commercial finance companies 176 Friends and family 177 Crowdfunding: a novel way to raise money 177 Other sources of funds 178
The Process of Securing Investors 179 researching investors 179 What makes a business a good investment prospect? 183 the right market 184 What information and documents will investors want? 184 Negotiating the deal 186
The Process of Securing Lenders 187 the three big questions 187 What information and documents will lenders want? 188 Dealing with co-recipients 191
The Best Source of All: Raising Money through Revenue 191 Start-up Costs 192 Real-World Case
tactus tackles Fund-raising 194
Critical Thinking Exercise Building a Financing Strategy for Your Building Business 196
Financing Your Business
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Looking for Money You have a great idea for your new business. You’ve done initial research, worked on your business plan, and identified some talented people you’d like to work with. There’s only one problem—you need money to make it all a reality. Where will you get the funds you need to launch your entrepreneurial venture?
Getting the financing you need won’t necessarily be easy, yet there are a great many sources of funds for new companies. Some sources may provide financ- ing because they think your idea and business plan are strong; others may finance you because they believe in you (your rich grandmother, for exam- ple). But unless you do have that rich grandmother, or money of your own, you’ll need to approach the process of raising money as you would any other aspect of starting your business—thoughtfully, with planning, and with the commitment and drive to make it become a reality.
Raising money is a skill that successful entrepreneurs learn; it’s part of the start-up and growth process. Although it may be one of the more intimidat- ing aspects of running a business, raising the funds to grow your business— whether from investors, from lenders, or from sales—is a skill you should master. But remember, not all money is equal. When you start looking for money for your entrepreneurial venture, you may be tempted to take any type of financing you can arrange. Be careful! The various sources of money seek different types and rates of return on their loans or investments, have varying levels of sophistication and comfort with risk, and provide you with significantly different advantages and disadvantages.
In this chapter, you’ll learn how to: n Understand debt financing and equity financing and the differences between the two
n Determine the various sources of money available to entrepreneurs
n Conduct research on investors and lenders
n Recognize what investors and lenders look for in investments
n Understand what documents potential funders expect to see
n Evaluate the benefits and challenges of bootstrapping
n Define how much money will be required for launching and what it’s meant for
learning objectives
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Angel investor a private individual, rather than a professional invest- ment firm, who invests in early-stage entrepreneurial companies.
Bootstrapping Starting a business with little or no outside financing, generally raising the money necessary through personal savings and sales of products or services.
Collateral assets pledged in return for loans.
Crowdfunding the funding of a business, typically a start-up, by a large group of individuals who each invest small amounts of money online.
Debt financing raising funds for a business by borrowing money, often in the form of bank loans or equipment financing.
Debt service Money being paid on a loan; the amount necessary to keep a loan from going into default.
Dividends a portion of company profits. Investors may receive dividends, usually quarterly or annually payments, as a return on their investments.
Due diligence the process that venture capitalists, investment bankers, or others undertake to thoroughly investigate a com- pany before financing; required by law before offering securities for sale.
Equity financing raising money for a business, by selling a portion of the company—typically in the form of “shares”—to investors.
Funding rounds the number of times a company goes to the investment community to seek financing; each funding round is used to reach new stages of company development.
Liquidity event the point at which investors can pull their money out of a company in which they have invested. this occurs when the company is sold, merges with another company, or begins publicly selling stock.
Return on investment (ROI) the total financial gain an individual receives in return for putting money in a company. typically expressed in terms of an annual percentage.
Seed company a company in the early stages of development, refin- ing its prototype and business concept, hiring initial personnel, locating facilities, and conducting market research.
Term sheet a nonbinding proposal by an investor outlining the terms on which they will make an investment in a company.
Valuation the worth, or value, of a company. In the first round of financing a new business, this is usually a negotiated figure with the investors. In subsequent rounds, the val- uation is determined by the amount and terms of the investment.
Venture capitalist a professional individual or firm that invests money in entrepreneurial ventures; typically this is not their own money but money raised by them from other, often insti- tutional, investors.
en.tre.pre.neur.ship key terms
Debt Versus Equity No surprise here: Everybody who gives you money for your business wants something in return. In particular, they want to make money. They want the money they invest to make money for them, not just for you. How they’ll get their money back—and make more money—has crucial implications for the management and ownership of your company.
Understanding the differences as well as the advantages and disadvantages of the two types of financing—debt and equity—is crucial as you grow your business.
The right source When looking for financing, keep in mind that you’re going to have an ongoing relationship with your money source. You’ll save yourself a lot of time and grief if you seek money from sources that are right for you.
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Debt financing Financing based on the concept of borrowing is called debt financing. You borrow money from a lender who gives you a loan, line of credit, financing for your equipment, and so on. In return, your lender makes money based on the interest they charge you for using their money. Overwhelmingly, you owe the lenders their money back—whether or not your business succeeds.
Debt financing gives you the advantage of retaining complete ownership of your business. You keep control, and you keep all the eventual profits. You borrow a specific amount, and you have to repay only that amount, plus interest, regardless of how profitable your company becomes. The lender doesn’t share in the profits or the ownership of the company.
Because lenders do not reap the benefits of substantial profits, they have to reduce risk as much as possible. To do so, they’ll likely ask you to secure the loan by pledging your own personal assets as collateral. Using debt financing may jeopardize these assets if your business income is insufficient to pay back the loan; and if the business fails, you may still have the debt. This is a major risk, especially for a new entrepreneur.
Debt financing is generally not an option for start-up businesses. Loans from banks and other lending institutions (often referred to as conventional financing) are difficult to secure for new enterprises. Many banks and other lending institutions will only finance businesses that have been operating for more than two or three years, and very small businesses may have difficulty at any time.
In many instances, though, debt financing is a far better choice than equity financing. This is especially true for purchasing expensive fixed assets, such as property or large equipment; for managing short-term cash flow; or for expansion for ongoing, healthy businesses.
Equity financing Financing based on the concept of investing is called equity financing. You receive money from an investor who believes your company is likely to suc- ceed. In return, your investor receives equity—or a share of ownership—of the company. The investor makes their money based on your success. Once you succeed, they may receive a share of the profits, and if you sell the com- pany, they get a share of the proceeds. If your company later offers shares of stock to the public—in other words, “goes public”—the investors will eventually be able to sell their shares, typically for substantially more than they invested.
Equity financing allows you to avoid the personal risk of taking on debt. Instead of committing to repay a specific amount of money, you give the investor a piece of the eventual profits and ownership. If your company becomes highly successful, an equity investor may end up receiving many times the amount originally invested. However, if the company fails to pro- duce sufficient profits, these investors may never get their money back.
What kind of money do you want? As you begin your search for financ- ing, ask yourself these questions:
n Are you willing to give up some amount of ownership of your company?
n Are you willing to have debt that you must repay?
n Are you willing to risk property or other assets?
n How much control of the direc- tion and operation of your company are you willing to relinquish?
n What other help do you want from a funder besides money?
n How fast do you want to grow? n How big do you want your com-
pany to be? n What do you see as the long-
term relationship between you and your funding source?
Keep in mind that you’re going to have an ongoing relationship with your money source; make sure it’s someone you can live with.
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Thus, equity investors often want to participate in decision-making to ensure that the company operates in a manner that will produce profits. They may take seats on your Board of Directors or even play an active role in management.
In some cases, you may have to give up so much equity that others actually end up with controlling interest in your company. Investors might even be able to remove you from management altogether. Still, a capable investor can bring you sound business advice, useful business contacts, and maybe even links to additional future financing.
Sources of Money for Entrepreneurial Ventures So where do you go to find the money you need? And what are the obliga- tions and benefits you receive from each source? When choosing a financing source (and you do choose them, just as they choose you), pay close atten- tion to the advantages and disadvantages of each option. If working with an investor, be certain to assess the personal qualities of the individual or the reputation of the venture financing company you use, to determine whether that’s a good long-term fit for you.
Ideally, in addition to money, your financing source should also bring you sound business advice, excellent business connections, and the ability to help secure financial support in the future. These qualities are especially important when looking for an angel investor or venture capitalist. Such an investor is likely to play an active part in your company; make certain that it’s someone who offers your enterprise other benefits in addition to money.
Venture capitalists As you search for money, you probably will hear the term venture capitalist quite often, but those who use the term may be referring to different entities. True VC firms are among the most sophisticated investors available, typically providing an entrepreneur with more than money. Their knowledge, experi- ence, and connections may prove to be as important to your company as the dollars they bring.
Venture capital firms invest large sums of money pooled from various sources such as pension funds and institutional investors. These private firms are established expressly for the purpose of investing in new and fast-growing companies. Their partners and associates generally have a background in business management or the industries in which they invest.
Typically, venture capital firms invest only in companies they believe can grow to be extremely large: often in the hundreds of millions or even billions of dollars in eventual value. As such, they generally invest large amounts of money at one time to help these companies grow quickly. They’re not appro- priate vehicles for companies with more modest goals or financial needs.
Equity financing and start-ups Equity financing is a usual and prac- tical method of funding start-up companies. Most well-known entre- preneurial high-technology firms received equity financing.
The popularity of investing in start-ups—thus the availability of money—goes through cycles. It’s far easier to get a new venture funded at a time when the market- place rewards new entrepreneurial endeavors, particularly through growth, increase in the valuation of the company and its stock, and the ability to take new companies public.
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Venture capital firms specialize in particular industries or stages of a com- pany’s development. If your company is merely in formation, you need to look for a venture capital firm that invests in early-stage or seed companies.
Private or “angel” investors A frequent source of capital for new or smaller entrepreneurial companies is the private investor, typically referred to as an “angel” investor. Private investors are usually well-to-do individuals, investing their own money and seeking investments that provide more personal satisfaction and the potential of greater financial reward than are offered by conventional investments like stocks and bonds. Private investors can be an excellent source of financing.
Being an angel investor has become more popular over the years, and now there are even organizations and groups of angel investors. These groups help facilitate meetings between entrepreneurs and potential investors. Often, angel investors who are part of an angel network can provide a broader range of assistance (in addition to money) than can a single private investor. Other methods of finding angel investors are through professional financial advi- sors, accountants, attorneys, and the like, who often know of wealthy indi- viduals seeking investment opportunities.
While some private investors may bring expertise to your business, others may have little to offer besides money. And less-sophisticated investors often have unrealistic expectations regarding the amount and timing of profits. Fre- quently, they’re unfamiliar and uncomfortable with risk, and they may apply pressure for producing profits far earlier than a business can reasonably man- age or than is healthy. If you do pursue private investors, make certain that the investor understands the nature of your business, and be particularly conser- vative in your projections of how much profit you will produce, and when.
How much control do VCs have? Expect venture capitalists to take a highly active role in the growth and development of your company, such as by sitting on your Board of Directors, selecting key execu- tives, perhaps even determining the nature of your own role in the business. Because they will have such influence, if not control, over the fate of you and your company, before you ink your final deal, spend as much time as possible get- ting to know your potential venture capitalist and their reputation with other entrepreneurs.
Key Differences between Angel investors AnD venture cApitAlists
Angel Investor venture CApItAlIst
Investment Criteria Growth company extremely high-growth company
source of Investment Dollars personal assets Other people’s money; institutional funds
Investment range $25,000–$2,000,000 $2,000,000+
expected return 3–10 times the original investment 5–10 the times original investment
typical stage of Investment Seed, start-up, or early high-growth start-up and expansion
What they Bring to the Deal early funding and hands-on expertise
Large amounts of money, team building, industry-specific strengths
extent of Due Diligence Some to significant Significant to huge amount
Will they replace Founder as Ceo? Less likely More likely
number of Deals 1–3 per year 15–18 per fund per year
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Banks Famed bank robber Willie Sutton, when asked why he robbed banks, sup- posedly answered, “Because that’s where the money is.” Banks are, in fact, where a lot of money is, and eventually, as an entrepreneur, you’ll probably turn to a bank to help you finance the operations of your growing company.
But just because banks are in the business of lending money, it doesn’t mean they’re eager to lend money to your new company. Banks are critically con- cerned about minimizing their risk, and therefore do whatever they can to ensure that the loans they make have a high profitability of being repaid.
Realistically, banks loan money only to companies that have been in business for two or three years and that have proven to be successful.
Banks may lend you money in a number of ways. The two most typical are:
n term loan. A loan for a fixed amount that you pay off over a specific period of time, perhaps many years. This is a good choice for purchasing significant fixed assets, such as real estate or large equipment. Typically, you begin to make payments on the loan within a month or so of taking out the loan.
n line of credit. An amount that you can borrow to use to manage short- term cash flow, such as purchasing inventory or materials to fulfill an order. Generally, the “line” must be paid down to zero at least once a year, and you can borrow any amount up to the total amount of your credit line.
If you do get a bank loan for a new business, you’ll almost certainly have to provide a lien against any property you purchase, give a personal guarantee, and often have to put up your own personal assets (such as any real estate you may own) as collateral.
You should be extremely cautious before risking your home, your savings, your college education fund, or any other funds on which your lifestyle depends. However, if the business is incorporated, the company itself may be able to take on the loan debt, thus shielding the owners from personal liabil- ity. That’s an ideal situation, as only the assets of the business, and not those of the business owners, are at stake. Still, in most new and small companies, professional lenders like banks require a personal guarantee from the owners.
Government agencies To encourage banks to make loans to smaller businesses, and to reduce their risk, the Small Business Administration (SBA) in the United States and the Canada Small Business Financing Program (CSBFP) in Canada provide guarantees to lenders who make loans to qualified small businesses. These agencies guarantee loans—they do not make them directly.
In the United States, if you’re seeking financing, the SBA can provide you with a list of lending institutions active in giving loans to small businesses in your area. Remember, these banks and institutions must approve your
A friend of a friend Overwhelmingly, the best way to get in front of an investor is to have someone they know introduce you. That can be tough, of course. But it should be part of your fund raising process to identify people who might know funders who would be willing to make an introduction. Once you’ve been introduced, get to know those funders. Most VCs end up funding companies that were introduced to them by entre- preneurs they’ve previously funded or otherwise respect.
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application, so you must meet bank criteria to qualify. Typically, new busi- nesses have a very hard time qualifying for SBA-guaranteed loans. The SBA guarantee, however, sets interest limits and may make a difference if the lend- ing institution is on the fence about your loan. Expect to provide a personal guarantee for any loan you’re granted.
The SBA has many loan programs. The two main ones are:
n a 7(a) loan, which can be used for operating capital and expansion as well as other business expenses
n a 504 loan, which can be used for purchasing fixed assets, such as property
The SBA has created additional loan programs that may be more accessible for new or very small businesses. Its “microloan” program offers very small amounts of money to companies; these are administered through nonprofit and community organizations. Check out the SBA’s loan programs at www. SBA.gov.
In Canada, the CSBFP provides loan guarantees only for purchasing and improving land, buildings, equipment, and vehicles. It doesn’t guarantee loans for operating capital. Find out more at www.ic.gc.ca/csbfa.
Small business investment companies Small Business Investment Companies (SBICs) and Specialized Small Busi- ness Investment Companies (SSBICs) are private firms that exist to provide both investment financing and long-term loans to small businesses. Some SBICs provide only equity; others rely on debt; and some provide either. Each SBIC has its own policy.
SBICs are licensed by the U.S. Small Business Administration and may receive funds from the government for the purpose of investing in small businesses.
SBICs are good vehicles for financing a small business. However, most of them maintain rigorous evaluation procedures, and you’ll have to meet some of the same criteria required when applying for conventional financing or funding from venture capitalists. These days, many of the SBICs only make loans, and they’ll seek the same type of collateral and evidence of creditwor- thiness as banks.
Commercial finance companies For existing companies that have a hard time getting financing from other sources, commercial finance companies may be a source of last resort. You may be able to borrow money more easily from a commercial finance com- pany, as they’re regulated to a lesser degree than banks, but it will cost you more to do so. Moreover, these companies generally make loans to exist- ing businesses with significant collateral—typically collateral that can fairly quickly be converted into money. They will require significant collateral as a condition for making the loan. Given these factors, they’re not well suited for start-ups.
Your credit score Often the first thing a lender asks for is your credit score, which is based on your credit reports. Banks often use these scores as a simple first line of defense in determining whom to lend money to. In the United States, no other single factor is as important as your FICO score in determining whether you’ll qualify for a loan, how much you’ll qualify for, and what interest rate you’ll pay.
FICO stands for Fair Isaac Corpora- tion. Fair Isaac uses mathematical modeling to come up with ways of predicting who will most likely repay their obligations.
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Commercial finance companies may be an option for an existing business seek- ing funds to buy equipment, inventory, or assets highly secured by collateral.
Such finance companies also have their disadvantages. The business collateral they’ll expect you to put up will have to be fairly liquid, so they can easily get their money out of those assets if you fail to repay the loan. Because they tend to take on more risk, they charge higher interest rates. Finally, be sure to examine all the terms of the loan carefully.
Friends and family When you’ve got a great idea, the people likely to believe in you most are those who know you best. Friends and family frequently help finance new entrepreneurial ventures, whether in the form of investment or loans. Money from friends and family members may be the easiest money to raise—it’s unlikely you’ll have to go through a bunch of meetings or undergo due dili- gence from Grandma.
Be careful, though, when financing your business through family or friends. This money may be the easiest to secure, but may cause you to risk personal rela- tionships. By mixing your personal and business affairs, you may find you make both your business and your personal life more difficult. Unsophisticated inves- tors are often nervous about money—they don’t understand that it takes time before profits are realized, and view every natural delay or setback with alarm.
If you do take a loan from a personal source, later repay it with the required interest, and subsequently become very successful, the friend or relative may not understand why he or she does not participate in the profits. And, if you’re unable to pay back the loan, the relative may never forget and may remind you of your failure at every family occasion for the next 20 years. If you take an investment from a personal source, and your business goes under, your friend or relative may feel that you still owe them money, even though their investment wasn’t strictly a loan.
One thing’s essential: Put everything in writing! Make all the terms crystal clear. Deal with family and friends the way you would with other funding sources—present them with a business plan, provide detailed information about your venture (including all the risks), and have each document signed.
Crowdfunding: a novel way to raise money Once again, the Internet has democratized another area—this time, raising funds for start-ups. The concept is called crowdfunding and, as the name implies, it’s the ability to raise money from a “crowd”—strangers who believe in your idea and are willing to put some of their money into your new busi- ness. While venture capitalists invest millions, and angels invest hundreds of thousands of dollars, individuals can “invest” small amounts of money to help you get launched.
Imputed interest A zero-interest loan from a friend or family member may face what’s called “imputed interest” by the U.S. Internal Revenue Service. The IRS will impute interest on a loan and collect taxes from lenders, regardless of whether the lender actually charges interest. All lend- ers must charge an interest rate that reflects a fair market value. If the IRS views the loan as a gift, the lender must pay taxes on the money if it’s more than the maxi- mum allowed by law.
Sources of funds for entrepreneurial ventures The many different sources of funds for new businesses include: n Venture capitalists n Private or “angel” Investors n Banks n Government agencies n Small business investment
companies n Commercial finance companies n Friends and family n Crowdfunding n Other sources, such as your
own assets, credit cards, fran- chisors or vendors, and strate- gic partners
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Before the law was changed, only “accredited” persons could invest in entre- preneurial ventures—people with high net worth, who theoretically could afford to lose the money and who were sophisticated investors.
But the Internet has created a way for entrepreneurs, artists, musicians, inven- tors, and others to reach out, tell their story, and gain support from people who want to back their vision with relatively small amounts (from less than a hundred dollars to thousands). Due to legal limitations, these “investments” were considered “donations,” so investors could only get gifts or rewards in return. They could not acquire equity in the new company.
For example, when Eric Migicovsky couldn’t raise money from venture cap- italists for his new watch concept—the “Pebble,” which runs smartphone apps—he used a popular crowdfunding site, Kickstarter, and raised over $10 million from people who received first-generation watches in return for their donation of $99 or more. They could not, at that time, get equity. Migi- covsky not only raised more money than he then needed (without giving up equity), he also proved that there was tremendous market interest in the Pebble—so he was able to launch his business with a huge customer base.
Naturally, a whole raft of sites grew up to serve the interest in crowdfund- ing and provide a platform for connecting those seeking funds for their new projects with those willing to help support the launch of these endeavors. The best of these sites help entrepreneurs stay within the law as new regula- tions are adopted. Sites also specialize in the types of projects they feature— some focus on the arts, some on technology and science, and so on. If you’re considering going the crowdfunding route, look for sites that are a good fit with your type of business or project.
As with other forms of funding, you’ll have to be prepared—and do your homework. As “investors” get more sophisticated, they’ll want more than just a great video to motivate them to part with their money. They’ll want to see that you have a team that can execute, plus a reasonable business plan. And that they’ll have a good chance of making their money back—or that at least you’ll use the money as intended. Simply because the amounts of cash exchanging hands is smaller, that doesn’t mean you won’t face some of the same scrutiny you would from established investors.
Other sources of funds Additional funding sources for starting a new business or expanding an exist- ing one include:
n your own assets. Forget the old saying about using “other people’s money.” It’s better to start or grow a business with your own money. If you have sufficient assets, particularly savings or other income that doesn’t require you to take on additional debt, you’re in the best position. That way, you don’t go into debt, and you don’t give up equity. If your savings are owned jointly with a spouse or partner, be absolutely certain to get their acceptance and understanding of your plans.
Using credit cards wisely Credit card use can make sense in the following situations:
n To pay for expenses that will generate income and improve cash flow, such as inventory, materials, or services needed to complete a job (e.g., lumber in construction, printing in graphic design); or for other short-term manufacturing expenses
n To pay for small items such as office supplies, travel expenses, and meals and entertainment
Depending on which card you choose, other benefits of using credit cards wisely may include:
n Extended warranties on equip- ment and technology; addi- tional travel insurance and auto rental insurance
n Expenditure tracking and docu- mentation
n Discounts on certain purchases n Building your credit history
Some crowdfunding sites to check out: n Kickstarter
(www.kickstarter.com) n IndieGoGo (indiegogo.com) n Angelist (angel.co) n Crowdfunder (crowdfunder.com) n Wefunder (wefunder.com)
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n credit cards. Most entrepreneurs use their own credit cards at some point to help finance their growing business. But be cautious! Credit cards are generally an extremely expensive and risky form of financing. You can incur very high charges and hurt or ruin your personal credit rating if you’re even a day or two late on your payments. Credit card debt can also easily get out of hand.
n franchisors or vendors. If you’re planning on “buying” a franchise, the franchising company may help you arrange for some financing. It may provide loans itself, or have finance companies it works with. Likewise, some vendors—especially large-equipment vendors—may have financing arrangements. These kinds of loans may be easier to obtain than traditional bank financing, though you may face higher interest rates or less-favorable terms.
n strategic partners. Other businesses that want you to succeed may be willing to help you get under way. If you provide an innovative, highly specialized product or service, a large customer may want your offering, to help them become more competitive. Perhaps it’s a company serving the same market that sees your operation as complementary to its own. In some cases, such companies may directly invest in your business or give you loans. At the least, they might be willing to let you use their offices or equipment, or otherwise help offset some of your expenses in return for the benefits you bring them.
The Process of Securing Investors You can substantially increase your chances of getting funded by investors by first doing your homework and legwork. The process of raising investment funds takes time, and it helps if you’re realistic, if you understand how the funding process works, and if you know how to make yourself an attractive prospect from the investor’s point of view.
Researching investors A little research can save you a lot of time. If your potential funding targets are established venture capital firms, these institutions are used to answer- ing questions about their funding patterns and have definite procedures and guidelines. Start by visiting their websites. Many VC firms outline exactly what types of companies they fund, cite the criteria for their investments, and include a list of companies they have already funded—their portfolio companies. If you can’t find what you need on the Internet, don’t hesitate to directly contact these professional financing sources for information; they’d much rather answer your questions now than waste their time having to process a business plan in which they have no interest.
With other sources, such as private or angel investors, it may be somewhat harder to get information. If they’re members of an angel investing network, they may list the types of companies they’re interested in. They are far less
Questions to ask When researching potential fund- ing sources, these are the questions you want answered:
n Do they fund businesses in your industry?
n At what stage of business development do they provide funding?
n What are the minimum and maximum amounts of funding they consider?
n What are the minimum and maximum potential sizes of the businesses they fund?
n What other criteria do they use to make their funding decisions?
n On what basis do they generally provide funding: equity or debt?
n What other companies in your industry have they funded previ- ously?
n What kinds of information do they require you to submit with your plan? For instance, how many years of financial projec- tions do they want to see?
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sources of Debt finAncing
WhAt they look For ADvAntAges DIsADvAntAges
Banks and lending Institutions
ability to repay; collateral; steady current income from business
No dilution of your owner- ship; no profit-sharing; no obligation for ongoing relationship after repay- ment; definite preset amount to repay
Best For: established companies; funding fixed assets, such as property; short-term cash flow man- agement
Difficult to secure for new businesses; must often risk personal assets; finan- cial obligation regardless of business’s success
Worst For: highly risky ventures and new compa- nies lacking assets
loans from Family or Friends
Your personal character; other personal consider- ations; likelihood of repayment
easier to secure than insti- tutional loans; specific amount to repay; no dilu- tion of ownership or profit- sharing
Best For: Companies with no other option; companies with a very secure future
Jeopardizing personal relationships; nervous lenders; unsolicited advice and frequent queries
Worst For: Very risky enterprises; entrepreneurs with difficult family cir- cumstances
Credit Cards, Including Cash Advances
personal credit score relatively easy to secure; immediately available
Best For: Businesses requiring small amounts of money for a limited time; short-term cash-flow management
Very high interest rates; limited amount of money; ties up and risks personal credit
Worst For: Ongoing, long- term financing
likely to offer specific criteria than venture capitalists. Nevertheless, it’s quite businesslike to send a letter of inquiry to ascertain the kinds of investments they’re willing to consider before submitting your plan to them.
Make sure your type of business and financial scope fall within the interest areas of your potential recipient. Don’t send a plan requesting an investment of $50,000 to a venture capital firm that funds only companies seeking a minimum of $1 million. (Many do.)
If possible, you also want to find out less-tangible information about your funding sources. What is the potential funder really like? When deciding on funding, does the funder tend to place more emphasis on the experience of management, the product or service, or the market potential? Does the funder take a very long time making decisions, or do they respond quickly?
Why join a networking group? You can get a great deal of informa- tion about funders by joining entre- preneurs’ groups in your community or industry. Many larger cities have organizations in which entrepre- neurs help one another get started, and members often have first-hand experience with funding sources.
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sources of equity finAncing
WhAt they look For ADvAntAges DIsADvAntAges
venture Capitalists Businesses in their area of interest; companies with high growth potential; experienced manage- ment; new technology
Large sums available; sophisticated investor familiar with industry; expertise, connections, and future funding; understand business set- backs and capital risk
Best For: potentially very large companies; sophis- ticated entrepreneur or industry wizard
Difficult to secure; must have exit possibilities in 3 to 7 years; take substan- tial equity in company; may oust founders
Worst For: Small and medium-sized businesses; inexperienced entrepre- neurs
private (Angel) Investors Good business opportuni- ties with better potential rewards than other invest- ments; appealing concept
Interested in start-ups; easier to secure than pro- fessional venture capital; may have industry knowl- edge or contacts
Best For: Companies with high growth potential; companies with appealing business concept
May be involved in decision-making without adequate expertise; long- term relationship; may expect profits soon
Worst For: Companies requiring extremely long development time before profitability or exit; companies with limited growth potential
Investment from Family and Friends
Interest in you and your business concept; chance to make money
easier to secure than other investors
Best For: Companies with no other options; entre- preneurs having friends or relatives with signifi- cant business or industry expertise
Jeopardizes personal relationships; long-term involvement; unsophisti- cated, nervous investor; makes friend or relative a decision-maker in your business
Worst For: Very risky enter- prises; companies requir- ing long development time before profitability
Once they’ve financed a company, how does the funder perform as an ongo- ing partner? What’s the funder’s reputation in the industry?
Of course, this information is difficult to glean. The best way to get it is to speak to founders of companies the funder has previously invested in. That also creates a connection that may help you actually get a meeting with the funder. You can also research a funder online through a search engine, or a
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Build-Your-Business Worksheet
research prospective Investors Fill out this worksheet to help you gather information on potential investors you might consider having invest in your business. Make a copy for each investor you evaluate.
name of prospective investor: _____________________________________________________________________
Geographic area they serve: _______________________________________________________________________
size of investment they make: ______________________________________________________________________
industries they invest in: __________________________________________________________________________
Portfolio of companies invested in: __________________________________________________________________
Any potential referral or reference sources: __________________________________________________________
Formal application procedures, if any: _______________________________________________________________
Any comments or evaluations from other entrepreneurs: _________________________________________________
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site like www.thefunded.com. Additionally, if they’re particularly receptive to entrepreneurs, you can request an informational interview with the funder.
What makes a business a good investment prospect? Once you’ve found an investor, what will make them actually invest in your company? How will you get them to notice you and convince them that yours is a company they don’t want to pass up? Remember that investors see a great many deals. They have a number of other, much safer, options for investing their money. So they don’t need a specific reason to turn you down. That’s why you have to make yourself, your business opportunity, and your business plan compelling.
The best way to do that is to be prepared. The stronger your presentation and the better prepared you are, the more an investor will be confident in your ability to build a company.
Use the worksheet on page 189 to help you prepare for some of the really tough questions you’ll face.
return on investment (roi)
You’re a good catch if investors believe your business will provide them with a high return on the money they’ve invested with you—that is, return on investment, or ROI. The ROI that investing in your business offers has to be higher—much higher—than what an investor could obtain by putting their money into other, less-risky investments, such as stocks, bonds, or real estate. Investors want to achieve a high return on investments in new ven- tures because such investing is risky. Some companies fail altogether and bring them zero return. So their other investments have to balance those losses.
ROI is the total amount of money owing to the investor as a result of helping fund your business venture. It’s expressed in terms of an annual percentage— that is, the percentage of their investment earned each year of the investment (for example, a 30 percent ROI). This is calculated by dividing the amount of money investors make by the amount they invested, divided by the number of years it took to receive their gains. Investors will closely evaluate your busi- ness to determine the rate of ROI they’re likely to receive. This helps them compare their potential return against other investments they might make, whether invested in other entrepreneurial companies, or in the stock market, bonds, or bank accounts.
For example, in a highly simplified scenario, let’s say an investor has invested $1 million in your company, and received 20 percent ownership of your company in return for that investment. If you sold the company five years later and realized a profit of $10 million on that sale, your investor would be entitled to 20 percent, or $2 million. Their profit would be $1 million—or a 20 percent ROI ($1 million is a 100 percent return, divided by five years).
Generally, venture capitalists and experienced angel investors expect to real- ize their ROI from your company when you have a liquidity event—such
Got competition? If you’re meeting a genuine market need, there are—or will be—other companies who’d like a piece of the action. Investors want to see that you have a thorough understanding of the competition you face, both direct and indirect. Questions they’ll ask:
n What differentiates you from the competition?
n What barriers to entry do other companies face in entering your market?
n Who holds patents, trademarks, and/or copyrights?
n What are the start-up costs of similar companies?
n How well funded is your compe- tition?
n Does a successful model for your business already exist? In short, is your idea proven?
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as selling the company to another company or selling stock on a public stock exchange. Another way investors can receive return on their investment is through receiving a portion of profits, or dividends. For example, if your company is highly profitable but continues as an independent company for a long time without going public, you could distribute quarterly or annual dividend payments to investors.
The right market You may have come up with a great idea, but if the market for what you offer is too small, too hard to reach, or otherwise uninteresting to a funder, you won’t find an investor. That’s because it takes a substantial-size company to provide sufficient potential financial return to create a worthwhile invest- ment for your angel or VC.
Before sending money your way, investors will examine both your revenue and profit projections and the overall size of your potential market. You’ll need to produce research and hard data to prove that your market actually exists—and to demonstrate that it is both substantial and growing.
To prepare a market analysis for potential investors, use the same methods discussed in Chapters 3 (Research) and 5 (Target Market). Investors want to know the answers to the same questions you answered when you first researched your business concept—who is your target market; how big is it; where is it located; what motivates it to buy your product; what are some key trends in your market; and so on.
What information and documents will investors want? Working with an investor means you no longer run your company alone. Before you enter into this partnership, making sure your business is in order both legally and financially prevents potentially unpleasant surprises. So make sure you have your documents in order.
If the documents checklist on page 185 looks daunting—and even if it doesn’t!—consider getting professional assistance to help you sort through the paperwork that you need. Lawyers and accountants can help ensure that your finances and legal matters are in good shape.
A Killer business plAn
“Send me your business plan.” These are likely the first words you’ll hear from a prospective investor. A strong business plan is an absolute necessity if you’re seeking investor funds. It’s the one document that will be used to judge the quality of your idea, your market, and your team. Without an impressive business plan, you won’t be able to get past a first conversation.
Your business plan tells the story of your company by presenting your vision for the company’s future and explaining how you’ll achieve it. The first parts of a business plan an investor will read are the executive summary and the financial statements. Think of these two sections as an ad for the rest of
What’s on a term sheet? No two term sheets read exactly the same, although they share a basic format. Your term sheet will be drafted to address the specific needs of your company and your investors’ situation. At a minimum, your term sheet will include:
n The agreed-upon company valuation and proposed capital- ization table (which will show the total amount of securities issued by your company)
n The key financial and legal terms
n The rights of the parties n All legal obligations of the
parties
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the plan. They need to be concise, compelling, and irresistible to investors. Investors want to see immediately that you have a strong business idea, a large and growing market, and a solid grasp of financials. When they review your entire business plan, they’re looking for the “secret sauce”—the key business ingredients no one has but you.
Developing a business plan also helps you think through all the key issues in your business and better prepares you for the probing questioning you’ll get from potential funders.
For an in-depth discussion on business plans, see Chapter 4.
Build-Your-Business Worksheet
the right Documents Before meeting with an investor, make sure the following documents are in order:
Financials ¨ Forecast income statement, cash flow statement,
and balance sheet
¨ Current profit and loss and cash flow statements
¨ list of any major accounts receivable
¨ list of any outstanding loans or major debts/ accounts payable
¨ list of assets
Legal ¨ Corporate structure—that is, incorporation, llC,
or sole proprietorship
¨ ownership: list of all current shareholders or those with ownership interest
¨ Promised equity, including any to current or former employees
¨ Contracts
¨ regulatory compliance
Intellectual Property ¨ intellectual property (iP) protection received to date:
patents, trademarks, copyrights
¨ Pending iP filings
¨ Agreements with employees and third parties (including “work for hire” contracts)
¨ ownership of core technology
¨ licenses to use others’ technology
Employees ¨ Compensation table
¨ key personnel/functions
¨ equity awarded/promised
¨ stock option plan
Advisors ¨ Board of directors
¨ Advisory Committee
¨ key outside consultants—attorneys, accountants, other
Red flag alert: inflated numbers Most investors will be wary if you predict a market share of more than 1 to 2 percent of a total market for your company’s first year. And they won’t expect higher than 5 percent in years three through five. Inves- tors look favorably on entrepreneurs who underpromise and overdeliver.
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Negotiating the deal After you find an investor who believes in you and has decided to invest, you’ll begin the stressful and complex process of negotiating price and terms.
The most visible thing you’ll be negotiating is your company’s valuation, or what you agree to peg as the worth or value of the total company at the time the investor provides you funding. This will be determined by how much money they give you and what percentage of the company they receive in return. For example, if an investor gave you $1 million and received 10 per- cent of the company, the valuation of the company would be $10 million.
Be careful not to get stuck on a preconceived idea of your company’s worth or the percentage you’re willing to give up. Nothing makes an investor less likely to invest in a company than dealing with an entrepreneur they view as irrational and unwilling to compromise. Remember, this is a negotiation. You’re almost certainly going to have to give up more than you would like or expect.
Besides valuation, the ownership and control of the company will be the other major factor you’ll negotiate. This has great consequence for your personal future involvement in the company. Additional issues you’ll negotiate include how the investors will get paid if the company is sold. This will have implica- tions on how much you’ll actually make even if the company is successful.
Unless you’re dealing with a novice investor, your angel or VC will give you a term sheet—a nonbinding document that summarizes all the terms on which the investment will be made.
Over the years, as angel investing has become more sophisticated, term sheets have grown more complex and more detailed. Their increasingly wide range of terms reflects the ever more diverse ways in which investors choose to structure their participation in the investment and the variety of investment securities they opt for, including debt, equity, hybrids, and warrants.
Deal terms are complex—so complex that this book couldn’t possibly cover them all. And terms change as investors devise new ways to protect their interests and rights. Moreover, many tax implications go along with issuing securities and establishing a valuation for a company.
You absolutely need an experienced securities attorney on your side. This means your own attorney, not just the investor’s lawyer. That’s not to say an attorney recommended by your investor can’t represent you—adept investors will know experienced lawyers. But make certain you consult with, and pay, an attorney yourself, to review any deal with an eye to protecting you and your interests, not merely the interests of the company or the investor. And you’ll need patience and flexibility because the process takes time. You’ll want to make sure you protect your rights and interests, but you don’t want the angel to decide you’re impossible to work with and walk away.
Key issues to negotiate n Valuation n Equity division n Employee (equity option) pool n Anti-dilution provisions n Employment contract n Vesting schedule n Liquidation preferences n Control n Milestones and performance
measures
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The Process of Securing Lenders Getting a loan for a new business is always a challenge, often a much more difficult one than finding an investor. After all, investors exist to help start and grow businesses. They’re comfortable with the amount of risk that is involved in young companies. In return, they expect high rewards based on taking that risk.
Banks have far different goals and far different purposes. They exist to help companies (and individuals) make large purchases and manage the ups and downs of their cash flow. As a result, they’re oriented toward minimizing risk. They make a smaller amount of money (the interest you pay on loans) and do not participate in the rewards if you’re successful.
Banks and other professional lenders must minimize risk. They’re far less impressed with your great idea than with your personal ability to pay the money back on your loan, whether or not your business succeeds.
Once your entrepreneurial venture has a track record and you’re profitable, you’ll definitely want a banking relationship. Loans and lines of credit help you manage cash flow and purchase equipment, inventory, and real estate. A great banking relationship can help your business grow. But it’s not easy to get when you’re starting out.
The three big questions No matter how much money you want to borrow, no matter who you want to borrow money from, the loan process comes down to answering three main questions.
1. How much money do you need?
This is the very first question any lender will ask you. The answer immedi- ately gives them an idea of whether they’re an appropriate fit for your needs. You should have a fairly clear idea of how much you want to borrow before you approach any lender, whether a banker or Grandma.
This is where a business plan comes in. It helps you to understand how much money you need and for what purposes. Bankers are likely to want to see a business plan when they start to do business with you or approve larger loans.
2. what do you need the money for?
Answering this question gives lenders, especially bankers, an idea of the type of loan you need. You’ll need—and qualify for—rather different types of loans if you’re using your loan proceeds to finance inventory, buy a busi- ness vehicle or equipment, purchase real estate, hire new employees, open an additional location, and so on.
Obviously, this question is closely related to the first one. You know why you need the money. But you must do your research and articulate your needs clearly before you talk to a banker.
It takes money... There’s an old saying that banks only want to loan money to people who don’t need it. That’s not true. What is true is that banks—and other lenders—loan money to peo- ple who are able to pay it back. If you’re unable to show the capacity to pay your loan back, you’ll have a very hard time getting a loan.
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For example:
n If yours is a start-up, you need to produce a “Sources and Uses of Funds” statement (as well as your total business plan and financials) for lenders as well as investors.
n If you need new vehicles for your business, for example, figure out which models will work best for you, and how much they will cost. Do your homework and present solid, specific information with your loan proposal.
n If you need money to tide you over between paying for large inventory shipments and collecting money from your customers, prepare a spreadsheet with real, historical data, showing examples of the timing and the amounts involved in specific transactions. If possible, make a chart of future needs as well. Show when you must pay for the inventory, when your customers will pay you, how long the time gap will be, and how much money you need to carry you through that time.
3. will you pay it back?
The majority of the loan application process centers on answering this ques- tion. When a banker asks for your credit report, tax returns, financial state- ments, and other documents, the banker is really trying to determine three things:
n Are you the type of person who pays your debts?
n Will you have the money to pay future debts?
n Do you have other assets to cover your debt in case you aren’t able to pay?
Of those factors, lenders focus most on your ability to repay the loan. The main issues they’ll look to are your personal credit history, your business’s credit history, your business’s financial performance, and your personal net worth.
Factors that will also affect your ability to qualify include:
n Length of time you’ve been in business
n Which lender you apply to
n Previous relationship and history with your lender
n Personal guarantees from you and any other owners of the business to repay the loan
What information and documents will lenders want? When it comes to making business loans, lenders want to see many of the same company financial statements as investors. The checklist on page 185 outlines these documents. In addition, because lenders often make loans to
The three big questions The loan process comes down to answering three main questions: 1. How much money do you need? 2. What do you need the money
for? 3. Will you pay it back?
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Build-Your-Business Worksheet
Questions Investors Will Ask, and your Answers What’s the most compelling aspect of your business? ___________________________________________________
Why will people will buy your product/service? ________________________________________________________
What’s the size and growth of your market, and how do you know the market is truly that size? ___________________
What evidence do you have that you’ll be able to capture that percentage of market share? _____________________
Who else is doing this? how do you differ from them? ___________________________________________________
if this is a novel idea, why hasn’t it been done before? ___________________________________________________
Where did you come up with your financial projections? how do you know they are realistic? ___________________
What’s going to keep a competitor from stealing your idea? do you have any intellectual property protection in place?
Can you explain your marketing strategy? What makes you think it will be effective? ___________________________
Can you provide greater detail regarding the production requirements for your product? how about other aspects of
logistics and distribution? _________________________________________________________________________
What are the potential exits for your company? have any similar companies been acquired or gone public? how much
have they been acquired for? ______________________________________________________________________
What in your past has prepared you to be Ceo of a company like this? ______________________________________
What weaknesses do you currently see in your management team? _______________________________________
Can you provide best, worst, and expected case scenarios for future funding needs? __________________________
explain the status of your personal lives. What else is going on that will distract you from giving this company your
complete attention? _____________________________________________________________________________
Why do you think i/we would be a good choice of funder for you? __________________________________________
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existing businesses (while investors may be investing in new companies), they’ll want to see current and historical financial accounts. These include:
n Income statement
n Cash flow
n Balance sheet
n Business tax returns
n Accounts receivable
n Accounts payable
Lenders will also want to review your personal financial statements and per- sonal tax returns. They will ask for this same information from any and all other signatories on the loan and owners of the company.
Build-Your-Business Worksheet
research prospective lenders Fill out this worksheet to help you to gather info on potential lenders. Make a copy for each lender you evaluate.
name of prospective lending institution: ______________________________________________________________
Geographic area they serve: _______________________________________________________________________
size of loans they make: __________________________________________________________________________
types of loans they make/for what purposes: _________________________________________________________
industries they typically lend to: ____________________________________________________________________
What types and age of businesses they lend to: _______________________________________________________
What kind of collateral they require: ________________________________________________________________
What kinds of forms and documents you must provide: __________________________________________________
Where the decisions are made: ____________________________________________________________________
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Dealing with co-recipients In almost all cases, anyone who owns more than a minimum percentage of the business—typically 10 to 20 percent—will be treated as a co-recipient of the loan. They will have to:
n Provide personal financial statements
n Provide personal tax returns
n Authorize the lender to conduct a credit check and obtain their credit score
n Sign a personal loan guarantee
n Have the loan appear on their future credit reports, including future payment history
Banks and other lenders will look at the credit history of anyone else on the loan, as well as yours, when deciding on whether to make the loan and deter- mining the interest rates to charge.
It’s quite possible that anyone who owns a portion of your company may not want to take on financial responsibility by signing a personal guarantee or having their credit record intertwined with your business. If you’ve given— or sold—stock to key employees, they too may be unwilling to take on the financial obligation of being a cosigner for the loan, and this added burden could affect your working relationship.
Ideally, you considered this fact long before you took on a partner or investor, or gave shares of stock to employees. In any case, sit down with anyone who owns more than 10 to 20 percent of your company and have a frank talk with them before you begin the loan process.
If an investor or other shareholder is unwilling to participate fully in the loan process by providing financial statements or signing a guarantee, expect to have to explain this situation to a lender.
The Best Source of All: Raising Money through Revenue Finally, when looking for money to start or grow your business, never forget the power of making sales. The very best money of all comes from making actual sales to customers.
Think of the benefits: You neither have to give up a piece of your company (as with investors) nor do you take on debt (as with a loan). So, in the pro- cess of thinking how you’ll get your business off the ground, look seriously at whether there are ways for you to find money through sales—also known as bootstrapping.
Bootstrapping There’s a term for growing your business through sales: bootstrap- ping. Like the name suggests, you pull yourself up by your bootstraps rather than depending on others. Of course, certain types of businesses, such as retail stores, restaurants, and new manufacturing plants, all require significant financing up front, and it’s unrealistic to think you could make presales sufficient to fund your start-up expenses.
Still, you can start some new busi- nesses less expensively, especially if you’re a new entrepreneur. For example, many technology prod- ucts don’t require high start-up costs if a team of technology-wise entrepreneurs starts it together and works for sweat equity (or earning stock through work) until they’ve established a sufficient customer base. If you develop a new product, you can build a few prototypes and start selling imme- diately online and at trade shows. Although you’ll require some fund- ing even for these initial steps, you take a much smaller risk.
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Raising money through sales is attractive for several reasons:
1. no investors. Investors not only take a piece of any future profits, they also have a say in decision-making. That may be a benefit if you have knowledge- able, patient investors, but it can often be a distraction and source of tension.
2. no monthly loan payments. If you secure a long-term business loan, you’ll have to start making monthly payments right away. That translates to higher overhead and increased stress.
3. it focuses your attention on your business. Raising money takes up a lot of time. By growing your business through sales, you can spend your time and energy improving your product or service and finding paying customers.
4. you learn a lot about your market. When you or your salesperson hit the pavement to make sales, you get vital, real-life, real-time market informa- tion. This is the very best kind of market research. It helps you improve your product or service, refine your pricing, and learn about new opportunities.
If you’re fortunate enough to land a big order when your company is still young, you may not have the resources to fill that order. Luckily, this is a bet- ter time to approach financing sources. You may find a bank or other lender much more receptive when you have a contract in hand. You may also learn that investors are much more willing to meet with you when you have cus- tomers, especially if any of those customers are companies that demonstrate to potential investors your ability to land important deals.
Start-up Costs One of the first financial challenges an entrepreneurial company faces is fig- uring out how much money it needs just to get the business up and running.
If you’re starting a business with a physical location, whether a retail, manu- facturing, or service business, or even one with an office, you’ll have costs associated with leases, equipment and furniture purchases, raw material, inventory, and supplies—all before opening your doors. You may have con- siderable expenses before you see any income, and you need to account for those costs in your financial projections.
Even if you start on a shoestring, you’ll still have start-up costs. You’ll need some supplies, you’ll require a variety of professional services (such as a law- yer and an accountant), and you’ll probably want to pay yourself something. Of course, if you work with others to get your idea off the ground, you’ll have those costs as well.
As with most financial projections, you may not get your start-up costs right—especially if this is your first business. But do your homework to assess likely costs, be realistic in your projections, and estimate high.
What are your start-up costs? How much will it cost you to make your busi- ness operational? Use the worksheet on page 193 to determine your costs to get up and running.
Funding and cash management for growth Growing through sales is tough when sales are slow, but it’s also a challenge when facing very fast growth. And it’s tough to finance fast growth from income alone. Typically, you’ll spend money faster than it comes in: hiring staff, pur- chasing materials or inventory, rent- ing facilities, buying equipment.
You may need a lender to help with cash flow, but to seize substantial growth opportunities, it may be time to consider an investor as well.
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Build-Your-Business Worksheet
start-up Costs List the specific details of your start-up cash requirements. Remember, these are expenses you plan to incur before you launch your business. Post-launch expenditures should be entered in your income statement.
Cost
Facilities land Purchase
Building Purchase
initial rent
deposits (security/utilities/etc.)
improvements/remodeling
other:
other:
Equipment Furniture
Production Machines/equipment
Computers/software
Cash registers
telephones/telecommunications
Vehicles
other:
other:
Materials/Supplies office supplies
stationery/Business Cards
Brochures/Pamphlets, other descriptive Material
other:
other:
Fees and Other Costs licenses/Permits
trade or Professional Memberships
Attorneys
Accountants
insurance
Marketing/Management Consultants
design/technical Consultants
Advertising/Promotional Activities
other:
TOTAL
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r e A l - W o r l D C A s e
challenge Find funding for a killer start-up
idea in a volatile economic climate
solution alter the funding strategy
as necessary and seek out different sources
tactus tackles Fund-raising Craig Ciesla and Micah Yairi had an incredible idea: What if the flat screen on your iphone, atM machine, or car dashboard could suddenly display real, three-dimensional buttons when you wanted them and stay flat when you didn’t? Wouldn’t that make it easier to type on a smartphone, use electronics if you’re blind, or reach a button while you’re driving? how cool would that be? Ciesla and Yairi, both phDs with advanced physics back- grounds, had a way to make this seeming miracle occur: they would be the first to make physical buttons rise from a flat touch screen or panel.
“the concept was solid. the market was huge. anywhere there’s a touchscreen, there could be a need for physical keys. We thought we’d get funding—no problem,” said Ciesla. “We were wrong.”
they began with a classic case of bootstrapping. While working full- time in other jobs, Ciesla and Yairi toiled nights and weekends at the dining room table or in the garage, working on the core technology and pouring their own money into the business.
“We discussed whether we should have a round of ‘Friends and Fam- ily’ money, but we shied away from that,” said Ciesla. “even if you tell your friends and family that there’s a 90 percent chance they’ll lose their money, they won’t believe you.”
“You don’t want to damage those relationships,” added Yairi. So they started looking for professional investors.
“We put together a business plan and that took a lot of work,” he con- tinued. “Based on that, we created powerpoint presentations, and pitched and pitched and pitched to investors. But we were lucky. We had connec- tions to well-established venture capital firms here in Silicon Valley. One was sufficiently excited about our concept that they helped us craft our VC presentation.”
things were going great; an investment in their company—now called tactus technology—from a top-tier venture capital firm was virtually assured.
Yet forces outside their control were at work. this was September 2008. Days before their final presentation to VCs, the investment bank Lehman Brothers declared the biggest bankruptcy in U.S. history. america was now in serious financial crisis.
Venture capital was suddenly paralyzed. a new funding strategy had to be developed for tactus. the intrepid duo lowered the amount of money they hoped to raise, and targeted angel investors.
to make that work, they decided to trade part of their equity in the company to bring in the appropriate type of people to meet their needs. they would give stock instead of cash, or to supplement it, so that they would need less money. By good fortune, Ciesla and Yairi were introduced to a patent attorney who liked the idea so much that he took equity instead of cash. that allowed tactus to file critical patents, an important prerequi- site before engaging with potential customers.
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C h a p t e r 8 F I N a N C I N G Y O U r B U S I N e S S 195
questions 1. Craig Ciesla and Micah Yairi
eventually turned to friends and family for funding. Should they have done that first? What are the risks with raising money from such individuals?
2. What were the risks and benefits of waiting until they had been granted patents to ask for customer feedback?
3. the partners gave up equity in their company—part of the ownership—to get help they needed. Was this a good idea? Why, or why not?
4. Why do you think Ciesla and Yairi stuck it out, even with such bad luck? What would it take for you to be so persistent?
the new strategy was paying off. In the first week of March 2009, the guys got a “term sheet”—an offer—from an angel invest- ment group excited about the technology. they would get the money they needed to go to the next level.
But once again, timing wasn’t on their side. On March 6, the Dow Jones plummeted. the stock market had dropped more than 50 percent in less than 18 months, with no bottom in sight. private investors overwhelmingly get their investment funds from their stock portfolios, so Ciesla and Yairi’s investors vanished overnight.
It took a few weeks to figure out where to go next. “We realized this is something we hugely believed in. We needed more money to protect our intellectual property, to engage with prospective customers, to get a design firm on board to create an improved prototype,” said Ciesla. at that point, they turned to friends and family. they also brought on board Nate Saal, a friend and serial entrepreneur, who had founded and sold two prior companies.
In early 2010, they launched an angel investment round and landed their first significant seed investor. the founders now went full-time with tactus. It was risky to give up full-time jobs, so they told themselves: “We have to raise this amount of money by this date, or we’re done.”
With an angel round and several patents in place, they started talking to prospective customers. Without getting customer feedback, receiving Series a funding (the first round from VCs) would have been very difficult.
During the bootstrapping phase, the partners put less than $100,000 into their fledgling business. they raised about $200,000 in the friends- and-family round. In the angel round, they raised around $1 million. When they finally got venture funding in 2011, they raised $6 million in their first round.
Stage of company, market focus, size of investment, and level of risk all need to be aligned to find the right VC, they learned. “We spoke with doz- ens and dozens of venture capitalists. We heard ‘no’ a lot,” said Yairi. “We’re a hardware company, and VCs have shifted to a more conservative investing philosophy—investing in software, which can get great returns with less capital outlay. they want established revenues.”
“there’s tension, figuring out how much to postpone the next phase of raising money,” said Saal. “the longer you can stretch funds in your existing stage, the more value you can build, and the more equity you’ll keep in the next funding round. how long do you bootstrap? Do you go to friends and family, find an angel investor? Will you do that big round with a VC? every entity needs to think about the right transition points—and how to maxi- mize value without putting the company at risk.”
“raising funds took longer and required more effort than we expected. It’s basically nonstop. It’s a constant part of building a company,” said founder Ciesla. n
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e N t r e p r e N e U r S h I p a r e a L - W O r L D a p p r O a C h196
BuIlDIng A FInAnCIng strAtegy For your BuIlDIng BusIness goal: Find a way to fund a growing business.
What to Do: Working either alone or in groups, imagine that you’ve started a business specializing in finding and selling recycled decorative building materials, pri marily for the wholesale construction trade. These are items such as wooden doors, reclaimed hard wood flooring, windows, and such. Your business has taken off, as environmentally conscious home owners and corporations increasingly seek to incor porate such recycled materials into their homes and buildings, for both quality and cost savings. Your business has been growing very fast—demand has outstripped your ability to source such products, and you have been approached to open locations in addi tional cities as well as develop an online wholesale marketplace for such goods. You are barely breaking even as you finance your current growth.
So now you need money to finance your growth: to expand your sourcing operations, and potentially to open additional locations and develop an online
marketplace. You estimate that you’ll need at least $100,000 simply to increase your sourcing, a mini mum of $500,000 to add an additional location, and another $1 million to develop a robust marketplace that could become a dominant leader in the field of recycled building materials.
1. Discuss the advantages and drawbacks of each of the following ways to finance your growth, including your sense of the real possibility of securing such financing:
a. Securing a line of credit from the local bank
b. Securing a term loan or an SBA loan
c. Getting loans or investments from friends and family
d. Finding an angel investor and giving up equity in the company
e. Finding a venture capitalist and giving up equity in the company
f. Looking for sourcing of funds—such as grants—to finance “green” businesses
g. Going public
2. Present your financing strategy to the class. Be prepared to explain why you chose the route you did for financing growth.
exercise: c r i t i c a l t h i n k i n g
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