The value of an advisor in your capital raising process

April 13, 2010

The value of an advisor

Lets face it, if finding capital for your venture was easy, then there would be no such thing as corporate advisers out there selling you the value of advice.

As I sat with another prospect today, who incidentally became a client at the end of the meeting, seeing what I see time and time again, I thought I would make a record of it formally and talk to you about it.

Lets assume that there is limited capital out there.

Lets also assume that not every capital provider is excited by your sector, you or your style – so matter how exciting this opportunity is to you or another person, there are just some investors who are not interested.

Lets also assume that some investors who might be interested, are busy on something else at the time you are looking, or are fully invested, or are overseas – just not contactable.

The long and short of it, as your pool of investors shrinks the more we think about it, it is no wonder that it is considered a difficult to find venture capital.

SO – if you pitch up to a potential investors office, or send them an email with a poorly laid out information memorandum, business plan, or your numbers don’t add up, or even if you under sold, god forbid, your idea or business as an investment, you will have reduced your chances of getting this investor on board, and your overall pool by 1. Who knows, they could have been the one. When you are dealing with such a scarce resource WHY would you take the chance.

Here’s the crux of it. If you have a great business, a great idea and you want to position yourself for a win every time, then you need to test out your idea, test our how you are presenting it, how it is likely to be perceived, what an investor will think about it, how they will react …. All BEFORE you actually communicate to one!

Someone said to me don’t pitch your services on your blog – people will run a mile – so I won’t then. I will do this for free. With this client above, I spoke with him for an hour on the phone, read through his IM and business plan, and gave feedback over several emails over the course of 2 days, and then had 2 hours in a meeting discussing what needed to be done to position his offer more effectively, …… all for free.

You cant lose!

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Risk Model For Venture Capital Funds

March 30, 2010

How big are your risks? What is the outcome? What can I do about it?

Simply treating all risks that you may be exposed to in your business “as equal” in your business plan doesn’t really help you manage them effectively, nor will it help an investor understand them. Further, whilst you probably know intuitively that some are more likely than others to occur, an investor who doesn’t really know you, will be left thinking you haven’t really thought them through.

I had a lot of exposure to risk in my investment banking career, and have subsequently carried this discipline to business. Of course, the risk metrics used in the investment banking world has been proven to be flawed post GFC, but the framework of assessing risk is a good one.

That is – for any given risk, a bank assesses what is the probability of it happening and what is the likely impact, and what are the mitigating actions to minimize the risk and or address the outcomes if it does happen. I don’t think Lehmans were very good at assessing risk to put it lightly but the framework was there I am sure.

It is pretty straightforward when all we are talking about is numbers – and when you have huge statistical ddatabases at your fingertips:

eg $100,000 invested in a company is a $100,000 at risk.

A) What’s the worst case scenario? $100,000 loss.

B) What is the probability of this happening? Using statistics, the bank would consider that, on average, it should be expected that a loss will occur x% of the time [averages proved to be a very expensive metric to rely upon in the run up to the GFC – as it was not an average event].

C) What can we do to reduce the impact of risk?

a. not take one [and not get a return] or

b.hedge.

Hedging is generally the preferred option.

I am not suggesting that it is necessary to develop the level of sophistication that a bank might have in their assessment of risk, but we can apply similar principals that will add enormous clarity on what the risks are in your business. It is not necessary to get too hung up on the exact score you give something your gut will tell you.

In business and ideally in your business plan, your assessment of risk can follow a similar framework as follows:

  • State the risk – in wordss is fine
  • Apply a score between 1-10 to show the probability of occurrence
  • Apply a score between 1-10 to show the impact of such an occurrence
  • Take the product of the probability and impact scores
  • Rank them
  • Add in a mitigating action to minimise the impact
  • Are there any actions that can be taken to minimse the actual risk of it occurring?

Here are some examples of how risk in your business might be presented – you wouldn’t have all these entries in your assessment only one for the risk of death of the owner for example – the ones listed are only for illustration purposes:

risk-assessment

Assessment of risk is A LOT more subjective in business in general than lending money. But attempting some sort of objective assessment like the above will go along way to demonstrate you have a handle on the overall risk of being in business.

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Michael Porter : The Five Competitive Forces That Shape Strategy

March 28, 2010

Michael Porter is a pioneer in the thinking around competitive strategy. In this interview he outlines his model for an analysis of an industry and the competition within it.

This is an essential part of your business plan.

As an entrepreneur, it is essential that you understand the environment in which you operate. More importantly, when seeking capital, that you are able to convey a summary of your industry and where you sit in it to an investor.

A pdf of the content is also available here.

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Life’s a pitch: Getting your message across to an investor

March 2, 2010

In your search for venture capital don’t expect fairness.

If you’ve ever been looking for a job and eagerly sent your resume off (only to have it ignored), or if you’ve ever been an employer and looked at an in-tray of hopeful candidates (only to flip through them seeking the one that jumps out), you’ll know that evaluation methods are often less rigourous than they should be. It may be a scan for just twenty seconds that has your resume placed back on the desk, and another picked up.

Seeking investment capital is similar. As a business owner, you are often one of dozens, or even hundreds of proposals which are submitted to an investor. The future of your business it seems is dependent upon something as fickle as getting your business plan actually picked up and read.

The truth is that you will often be judged by factors that you don’t even know about. And if your business plan is passed over then you don’t even get to be judged on its merits.

So, what can you do?

1) work on presentation as much as content. If your proposal doesn’t get picked up, then it doesn’t matter how excellent your idea is.

2) acknowledge you will need to get it to a lot of people.

3) follow up. You are selling an idea. You’d follow up a sales call (I hope).

4) ask for feedback. If you get a “no” for your proposal, ask why. This can help you learn for the next one (and the one after that, and the one after that).

5)  forget about what YOU want, except to the extent that it helps an investor get what he wants.

6) consider how you are delivering it. Just as in job hunting, there is more than one way to find the ideal position. If you are sending your resume off in response to job ads, the best you can hope for is to considered equally with other candidates. As they say, the best jobs are never advertised. In raising capital, there are various ways of finding and contacting investors including referrals, networking, and recognised channels such as corporate advisors. Corporate advisors such as us (so yes, I am disclosing my interest!) have the ear of many investors and our opinion is valued.

And remember, there are many stages to your pitch. I am talking here about your initial written submission. When it comes to the next stages, there is even more to consider…more that can go right, and more that can go wrong.

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Guy Kawasaki talks about entrepreneurship

February 20, 2010

Guy Kawasaki The Art of the Start

Guy Kawasaki The Art of the Start

The Big Idea

You have the idea of a lifetime and yet you do not know where and how to begin. It is a dilemma shared by entrepreneurs everywhere – what does it take to turn a great idea into action?

(click to see more)

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Importance of valuation in the venture capital equation

January 26, 2010

Valuation raises its head as a subject after an investor has determined that the business is worth looking at. It is not the first thing that an investor will look at. In fact, considering the number of business plans that don’t get read past the executive summary, it is something which business owners spend far too long dwelling over.

Having said that, once a plan is actually being considered, it becomes an important factor.

There are two sides to the valuation.

For a business owner, it controls the “cost” of the funding that they are seeking ie how much they need to give up (in equity) in order to get money into the business.

For an investor, it controls what they get for their money.

An investor buys into a company (and its potential) so that it can earn some money and then get that money out again. The mechanism is generally an exchange of funds for a percentage of the ownership of the company. This means a calculation must be made about what the company is worth, and what the business owner is prepared to give up to get the funds.

In addition to the valuation question it’s a complex negotiation that has many factors involved:

The valuation of the company, and the method used for this
- How much the owner is willing to give up and how much the investor wants
- How much the investor needs these particular funds
(if cash is low, and there are no other sources, the investor will probably negotiate a better deal)
- How the deal is structured – debt or equity, a mix, or debt that converts to equity.
- What else the investor is putting into the deal – expertise, contacts etc (“Smart money” is better than just money)

A valuation that is too high, and by implication represents a higher cost of entry to an investor, means someone might walk away from a deal. A valuation that is too low means the owner is underpaid for their asset.

At the heart of this are two opposing forces. Generally the owner will want to give up as little as possible, and the investor will want to take as much as possible. With all other things being equal, and hoping that the owner isn’t out of cash (which means the investor will pretty much get whatever he wants!) then the valuation provides a mechanism for structuring a deal.

There are many methods for valuation. Some are explained here.

None of these is completely accurate, and in fact they may give wildly different valuations.

At the end of the day, the business owner has to decide if what he gives up is worth the cost (in equity). So, often the right question is not to look at what you have now, but to look at the potential you can have with this investor on board (with the benefit of the funds, plus the advice).

A few years ago there was a great show on Seven called Dragon’s Den which had budding entrepreuners pitching their ideas to four succesful Australian business people. The question that was often asked, and was foundational to the negotiation was “would you rather have a smaller slice of a big pie, or a big slice of a small pie?”. Venture Capital in prime time was great viewing, and there were some instant lessons on how to pitch and negotiate.

This remains as the question to you as well… what are you willing to give up to get to where you want to be?

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Insights and Inspiration – stories of venture capital successes

January 16, 2010

“Things I Wish I’d Known…”

tiwik

16 Stories of Inspiration from The British Private Equity and Venture Capital Assoc

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Get Anything You Want – selling investors on your business

January 16, 2010

Zig Ziglar said “You can get anything you want, as long as you help enough other people get what they want.”

Of course he was talking about sales. Which makes it perfect for you. (In case you forgot you were in sales!)

Everything you do is a sale, and selling your business idea is no different. Forget about what you want from the transaction, and focus on what an investor wants. Your business plan needs to answer what is on their mind. Namely – Is this a high growth opportunity? How risky is it? Where are you now? What is the exit strategy? What has to happen to get there?

There is a writer’s trick which is worth keeping in mind. The trick is to look back and read what you have written, and ask “So What?” . If your copy doesn’t answer the “So What?” question, then it has failed.

Use this when you are writing your business plan, and put everything through a filter – how does this section or piece of information answer the questions in the investor’s head, or support my case that this is the right opportunity for them.

Figure our how you can help the VC get what they want, and have a much better chance of getting what you want.

Consider this… there are funds available to invest. Your job as a business owner is to make it clear that you are worth investing in.

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Understanding Private Equity and Venture Capital

January 15, 2010

Some Great Definitions

This is a useful overview of some main points, as provided by VentureCapitalSA

Can private equity help my business?
If you are aiming to start up, expand, turnaround, buy into or buy out a business, private equity funding could help you. Private equity investors are seeking unlisted businesses with potential for growth who are willing to trade a share in the company for investment. Private equity funding is provided to businesses in all sectors including food, technology, retail and manufacturing.

Do I need a private equity partner?
For private businesses, finding the money required to achieve significant growth can be the biggest factor prohibiting expansion. If you are willing to trade a share of your business to an experienced private equity investor, you stand to benefit from not only the injection of money but also the experience and skills of your new partner. Private equity investors aim to increase the profitability of their investment companies by providing a stable base for strategic decision making, not by taking day to day control. Think of it this way: you may have a smaller percentage ownership, however in a few years, that percentage should be worth more than the whole of your business was before. However, if you are not willing to release a share in your business, private equity investment is not suitable for you.

Expansion
The company is now established and requires capital for further growth and expansion. The company may or may not have made a profit at this stage. This may be a period of rapid growth and the company will usually require several rounds of capital injection as it achieves the milestones set in the business plan.

How does private equity work?
Private equity investors receive an agreed share of the company in return for the risk of investing. The investor is a business partner, sharing the risks and successes of the company. Funding through private equity is very different than receiving a bank loan. Repayments for bank loans must be made according to a contract, regardless of the success or failure of your business. Private equity investors hold a stake in your company and their return on their investment is dependent upon your business growth. Many private equity investors provide management expertise and experience, contacts and discipline. The investor has to be very careful about their investment because of the high risk in a company failing. They therefore have to check that the information provided is correct (due diligence) and they seek returns that are very high. In general, private equity investors are interested in companies which have the potential to significantly increase turnover within 2-5 years.

How does the investor realise their return?
The investor will want an eventual exit, there are a few ways they can exit the business and it is important to have an exit strategy agreed as early as possible. Ways for an investor to leave a company and realise the return on their investment include: 1. Sell the shares back to you for a profit 2. Sells shares to another investor 3. Sell when the whole company is bought by a larger company 4. Help list the company on the stock exchange

IPO (Initial Public Offering)
The sale or distribution of company shares to the public for the first time (i.e. listing on the Stock Exchange).

Management Buy-in (MBI)
These are funds provided to enable a manager or group of managers from outside the company to buy in to the company.

Management Buy-out (MBO)
These are funds provided to enable current operating management and investors to acquire an existing product or business from a public or private company.

Pre-listing (or pre-IPO)
Investment into a company where it plans to list on the Stock Exchange, usually within a period of a few months to two years.

Pre-seed / R&D
Refers to funds used to expand the concept and advance product development, usually during the research and development phase of the business.

Seed
Provided to companies which have not yet fully established commercial operations, and may also involve continued research and product development.

Start-up
The company is in the process of being set up or may have been in business for a short time. Such firms have not yet sold their product commercially and have no track record. Investee companies have completed the product development stage and require funds to initiate commercial manufacturing and sales.

What do investors look for in a company?
In order to gain private equity investment a company must be able to demonstrate: – A product or service with a unique selling point – A business plan showing growth prospects and the ambition of the company – An effective management team with relevant experience Efficient financial management – A planned strategy for offering a share in the company in return for investment

What is a Business Angel?
“Angel” investors tend to be wealthy individuals who may look to invest in a high-growth company that has synergy with their own business or competes in a market where they have succeeded. “Angel” investors generally invest in small businesses in deals considered too small for private equity firms. Typical “angel” investments are around $10,000 to $1 million. As “angel” investors generally invest in companies within their own expertise, the investor may seek a hands-on role in the management of the company or will look to act as the company’s mentor.

What is a private equity firm?
Private equity firms are fund managers who invest capital on behalf of institutional clients such as superannuation funds and insurance companies. They are exposed to the risk of the company failing and as a result, look to invest in companies which have the ability to grow very successfully and give higher than average returns to compensate for the risk. When private equity firms invest in a business they become part owners and generally require a seat on the company’s board of directors. They usually do not take day to day control.

What is private equity?
Private equity is finance provided in exchange for an equity stake in a company. Private equity is provided on a medium to long term basis and provides a capital base for future growth. Investors can provide strategic operational and financial advice based on experience with other companies in similar situations.

What is the difference between Private Equity Firms and Angel Investors?
Private equity firms are professional investors who dedicate all of their time to investing and building innovative companies. The angel investor is an individual who invests in companies for their own interest. Typically angel investors invest less than $1 million in any particular company, whereas private equity firms usually invest more than $1million per company. Angel investors are usually successful business people who have spare cash that they see achieving comparatively little in their bank accounts. The value of angel investors is that they often back and finance small businesses. Angel investors expect a return on their money of at least 30% and want equity as a security for risk. Angel investors generally invest in companies within their own expertise; the investor may seek a hands-on role in the management of the company or will look to act as the company’s mentor.

What is venture capital?
The term Venture Capital refers particularly to the private equity investments made at the very early stage of a business in order for the business to grow and develop. The terms Private Equity and Venture Capital are often used interchangeably.

What rate of return do Private Equity Firms expect?
Private equity firms tend to favour high growth companies that are likely to provide them with a high rate of return. The rate of return sought will vary with the risk: seed and start-up deals are considered very high risk and the minimum rates of return sought over the life of the investment will generally be around 30-40 percent per annum and above. As the perceived risk diminishes with the early expansion stage, expansion stage and management buyout and buy in deals, the minimum annualised rates of return may reduce to the 20-30 percent range. Investors generally look to exit the investment after three to seven years. The private equity firm only realises a return on their investment if the company goes public (IPO) or is merged or purchased by another company. In some cases the investment will be sold to another private equity firm.

Where do Private Equity Firms get their funds?
Most private equity firms raise their funds from institutional investors such as pension funds, insurance companies, endowments, foundations and high net worth individuals.

Who provides private equity?
Private equity is provided by private equity firms and by business angels

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Venture Capital & Private Equity Outlook 2010 (Video: 56 min)

January 15, 2010

See what industry heavyweights see on the horizon for 2010.

If you are seeking capital, this kind of insight from investors will help you see how you need to present yourself to be attractive to investors, and win over VCs.

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