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The New Rules for Funding Today

By Marilyn J. Holt, CMC, Holt Capital

If you thought starting the company was hard, wait until you try to raise money.

The rules of engagement have changed for every company seeking investors. For all pre-IPO companies, especially early-stage companies, the screws are tightening; the bar is high; and money is scarce. This means early-stage companies have to be better prepared to compete for investment dollars. Preparation on paper will not be enough. Early-stage companies will have to have a track record that proves, or at least supports the underlying assumptions. The pitch, the executive summary, and a ten-minute power-point slide show no longer cuts it.

Start-up companies, for the most part, have no place at the funding table. The new rules say that start-ups need to advance to being early-stage companies to be considered for investment. The new rules look a lot like the old rules, but allow far narrower leeway for deviation and exceptions. Venture capitalists and angel investors alike are looking for a stable three-legged stool: the legs being management, finance, and time.

MANAGEMENT THAT LEADS AND FOLLOWS
The management team is the most important element of any venture. Unfortunately, your start-up probably has incompetent management, and you are going to have to compensate for that. Every morning you need to look into the mirror and ask, “How can I be the best person to lead this company?”

Find The Best People

If you are not the best person, go out and find someone who is, or surround yourself with fabulous people. Years ago, and I was told by a successful businessman that his goal was to be the weakest link in his team. He meant that he always hired people who were better than him in their areas. He had a vision of the outcome he wanted and surrounded himself with people who could make that happen.

In early-stage companies, look to your friends and family and find out what expertise and talents they have. These are the people who most want to see you succeed, so let them help you as much as possible. Other places to look for help are your trade associations, Rotary club, and church or temple. Advisors and people who can make introductions for you are important, so be strategic and get the best involved. Surrounding yourself with these people is not enough: you have to listen to them and implement their ideas in a timely manner.

With good management and advice, you need to develop your business and financial models. Good management and advisory teams have the potential to develop good business models, but this only happens when there is mission, vision, and need.

Create a Well-developed Business Model

No matter what your idea, product, or service is, someone else can always find another use for it. If you can develop ten alternate uses or markets for your core product, and determine which of these will produce early income, you will be successful in terms of normal business. If you have several products, do this for each of them, then develop a roll-out schedule, a plan for delivery, and operational methodology to deliver a consistent product and experience to millions of customers or clients. You will have created a company that can be venture capital backed.

I have heard it described many times that investors are looking for a company that has customers and a revenue stream than can flow into a river, and a river that flows into a ocean. Jeff Bezos said that he had this metaphor in mind when he named his company Amazon.com. You, too, need to keep the metaphors in mind as you lead your strong management team to develop the other two legs of the stool.
MONEY PROVIDES WAYS AND MEANS

To receive angel and venture funding, early-stage companies are going to have to be more than an idea — whether on a napkin or a in a slick business plan, ideas are not even worth a dime a dozen. Your own savings and your spouse’s income and are the best way to access cash, services, and stuff (office furniture, space, base-product, R&D). Spouses have long been recognized as the greatest source of angel and early-stage investment.

Unlike angels and venture capitalists, your business does not have to be a going concern for “friends and family” financing. Your friends and family are investing in you, not your business. While you may need some of the documentation that banks and other lenders and investors require, your good idea, your good standing in the family and community, and your enthusiasm, counts more with them than anyone else. Nevertheless, keep your friends and family investors informed or they will lose patience with you. You have to keep records. Appropriate written contracts are very important to have or you will have problems later when you go to the bank, seek venture capital, or need to dissolve the company.

Construct a Well-developed Financial Model

Your management team, investors, and advisors have to take all the good ideas and put them into a financial model that tells that story of your company. A well-developed financial model is storyboarded™. Creation of a storyboard is a movie-making activity where every scene is drawn on paper and hung up on a board in sequence. If you want to be successful, do this on paper that you can hang on your office (garage) wall and study every day looking for leaps of faith, pitfalls, and other traps. Ascertain the costs and the revenues of each element of your company, and record these. This activity is commonly a part of strategic planning.

Once you storyboard your company™, describe this in a sophisticated spreadsheet (the latest edition of Excel is the most accepted tool). The spreadsheet needs to be completely “live.” This means that there can be no “hard coded” cells. Every thing must be done with formulas that allow the entire spreadsheet to reflect a change in your assumptions. When you get interest from investors, including angel investors, they will examine your assumptions by requiring a copy of your spreadsheet into which they will “drill-down.” “Hard coded” information is considered suspect, and gives them a reason to reject your company as an investment.

You need to study your spreadsheet and work with your assumptions. If you know from a financial standpoint why you are doing something, how much money it costs you (fully loaded costs), how much money it nets you (earnings before interest, taxes, depreciation, and allowances: EBITDA), and how much remains (profit large enough to pay back the investors 5 to 10 times their investment or more in 3 to 5 years), you will be able to construct a compelling reason for investors to put their money in your company.

The financial model must be a working document out to approximately 18 months, which tells how you will navigate from the stream to the river. For months 18 to 60, it must describe a most-likely path from the river to the ocean.

TIME FOR A LONG RUNWAY

Time is a company’s most valuable resource. It is also a resource that is badly abused, misused, and wasted.

Make The Company Self-sustaining Early

Money is the only thing that buys a company time, and it is management’s responsibility to put procedures and processes in place that create basic operating money. The business and financial models provide information that will allow you to use your money, plus your friends and family finances to create a revenue (income) stream. By this I mean, you have customers who buy your products. In addition, investors want “proof of concept.” This does not mean that you can sell a handful of your products at a loss; this means that you can create a large enough market that your early-stage company can pay its current operating expenses at its current level of operations. There will be no money for rapid, large-scale growth, then again this is the reason of the investment dollars, and investors know that it is their job to provide these expansion dollars.

Be Prepared For The Whole Investment Process

Repeatedly, I have had potential clients want me to get investor dollars into their companies to make the payroll on Friday. This is impossible.

In today’s market, getting angel dollars in the door may take as little as two or three weeks, but don’t count on it. The average time for a larger investment, over $250,000 by a single individual or small venture capital company can take as long as six months after they tell you they want to move forward with the deal. It could take two or three months to find an interested investor.

For this reason, you need a long runway paved by paying customers, and self, friends, and family financing. If you already have investors, you probably will have to go back to them for additional investment if you cannot survive to the end. Plan for this event, too, and offer them a real deal to extend your time.

In addition, you need to be able to turn on a dime, and not be the time waster in the investment process. You must have your information ready and available at all times.

IN CONCLUSION

The funding process is brutal, expensive, and time consuming. Whatever you think it will be, multiply that by ten times and you should be approaching reality. Keep in mind that it has always been tough; investors are still looking for good companies; and, if you have the diligence to follow the three key steps, you can succeed.

If you create a company that is, at its heart, sound, with the three legged stool of management, money, and time, and use this to create a revenue stream that will grow into a river and then an ocean, you have created value for yourself, your shareholders, and your stakeholders. To be successful, keep the two metaphors and the three keys in mind. Under the new rules, this is essential. [24×7]

Marilyn J. Holt, CMC, is CEO of Holt Capital, a Registered Investor Adviser, broker of debt and equity for small and medium sized businesses, and mergers and acquisitions. Holt Capital develops Business Lifecycle Solutions to answer startup, expansion, turnaround, and exit stage needs. She may be reached at 206-781–7196, by e-mail at [email protected], or by visiting www.holtcapital.com