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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David S. Rose on pitching to Venture Capitalists

April 3, 2010

Pitching to a VC is all about YOU. An investor is investing in you, as much as your idea and business concept.

Thinking startup? David S. Rose’s rapid-fire TED U talk on pitching to a venture capitalist tells you the 10 things you need to know about yourself — and prove to a VC — before you fire up your slideshow.

David Rose is a serial investor and a serial entrepreneur. Here’s his list of what is important in convincing an investor that you are the right choice.

It’s about
* Integrity
* Passion
* Knowledge
* Skills
* Leadership
* Commitment
* Coachable

And of course, it needs to be presented with an infectious enthusiasm!

On presentation techniques, and powerpoint, David says:

“Without question I’ve seen many presentations (both with and without PowerPoint) that are Too Slick, and to me they are at least as much of a turnoff (perhaps even more) than is one that is Too Rough. HOWEVER, that’s not the only choice one has. The slickness is *not* just a function of the slides; it has much more to do with how over-rehearsed, or patronizing, or ‘un-real’ the presenter is. I see hundreds (perhaps even thousands) of presentations each year, including many dozens at conferences like TED, where presentation is often elevated to a high art. And while great presentations are far from common…they do happen.

There’s a wonderful word, first used by Castiglione in 1528, that nails the concept. “Sprezzatura” is “a certain nonchalance, so as to conceal all art and make whatever one does or says appear to be without effort and almost without any thought about it.” That is to say, it is the ability of the courtier to display “an easy facility in accomplishing difficult actions which hides the conscious effort that went into them.”

If you watch the very best presenters at their very best, people like Larry Lessig and Rives and Steve Jobs and Seth Godin et al, there is absolutely NO feeling that they are Too Slick. But all of these guys spend absolutely enormous amounts of time preparing their slides, rehearsing their presentations and mastering the technology…so that the result comes off as “without effort…and thought”. ”

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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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How Ryan Allis raised $5.35 in Venture Capital for iContact

March 13, 2010

Ryan Allis, the author of entrepreneurship book bestseller ‘Zero to One Million’ shares how he raised $5.35 million in venture capital for iContact at age 22 and provides tips on how other entrepreneurs can raise capital. He provides tips for knowing when it’s right to raise venture capital, getting introductions to investors, negotiating a term sheet, increasing valuation by getting multiple term sheets and playing multiple firms’ offers of one another, and how to select the best venture partner.

Ryan Allis, the author of entrepreneurship book bestseller ‘Zero to One Million’ shares how he raised $5.35 million in venture capital for i…all » Ryan Allis, the author of entrepreneurship book bestseller ‘Zero to One Million’ shares how he raised $5.35 million in venture capital for iContact at age 22 and provides tips on how other entrepreneurs can raise capital. He provides tips for knowing when it’s right to raise venture capital, getting introductions to investors, negotiating a term sheet, increasing valuation by getting multiple term sheets and playing multiple firms’ offers of one another, and how to select the best venture partner.«

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Is your goal big enough? (to interest a venture capital investor)

March 7, 2010

Many business owners are satisfied with making a good living, and creating a profitable business. And while many businesses are profitable, this is not really the stuff which will excite an investor.

Donald Trump once said, “if you’re going to think, you might as well think Big”, and it is big thinking that will create a vision grand enough that others will want to join you (staff and management for example). Running a successful and growing company is an exercise in leadership. Part of leadership is having and sharing an exciting vision.

Michael Schrage argues that those willing to invest in and test new ideas based on their hunches will often find their noses bloodied yet this is a risk which is necessary in order to create something which is truly massive. The Economist descibed that from 20 investments:
- 4 would go broke
- 6 would lose money
- 6 would do OK
- 3 would do well
- 1 would hit the jackpot.

So, one in 20 is brilliant, four in twenty do well (or better) and a full 50% go broke or lose money.

If you have run a business, you know that it can be hard work. If you are going to wear yourself out, you need to have a great reason for doing it. As a business owner your reasons might vary from noble, to mercenary, to altruistic. For an investor, it is far easier. It is about the money. If it doesn’t have a huge upside potential, why bother? *

Investors look for – and buy into this leadership and vision as well… for a couple of reasons.

The first reason is that the intended outcome needs to be substantial in order to be worth playing for. Almost no investor wants to play in the shallow end of the swimming pool and watch a million dollars turn into 1.5 million dollars over a few years (or see it shrink). If the predicted outcome was this minimal, then there are plenty of other investments that are more reliable – property for example which will give nice steady returns. There has to be the potential for the company to grow by a factor of ten or a hundred times in order to turn the seed capital into a massive return. This is not to say this will always happen… but the potential has to be there. It is estimated only around 3-5% of all businesses have the potential to achieve the type of growth that will attract a VC.

Venture capitalists expect some failures. In fact, they generally have a higher tolerance for failure than most (The very word “venture” implies some sort of adventure and rocky ride.). This is because they are looking for the big wins to make it all worthwhile. So if you expect to attract this kind of money, show off the potential. Guy Kawasaki makes the distinction between a business that is viable (and that there are many businesses which are viable) and those that are fundable (and very few viable businesses are fundable). Being attractive to fund is about scalability and vision. (Check out his videos also on this site).

The second part is about leadership. Investors are buying into a business idea, but they are also buying into a person, or a few key people who will make this vision a reality. Are you this person? And if so, how can you show an investor you have what it takes? Obviously having some runs on the board already will count – if you have previously built a business, grown a company, or lead a large team. If not, you need to show that you see how important this is, and what your tactics will be – maybe it is to hire a strong GM for example. There is no ‘right way’ – but you need to recognise that you need a plan. Just as an aside, quite often the skills needed to lead and the skills needed to manage, and the skills needed to oversee operations are different. Noone is expecting you to fill all these roles, but it is important to map out how you will deal with thesm. There’s many cases of business owners that are brilliant at inspiring, but know they are not the right person to get involved in day to day operations and therefore they make delegation a priority. Richard Branson springs to mind.

So, when you are writing your business plan, make sure you are conveying the potential of tapping into something significant and understand that your leadership will be as important – if not more important – than your business skills.

“The tragedy is not that we set our goals too high and fail, but that we set them too low and reach them”.

Here are some things that an investor will look at to decide if your goal (and potential) is big enough.

1. Market size
2. Growth rate
3. Market maturity
4. Fragmentation within market
5. Barriers to entry
6. Cost structure (% GP of sales)
7. Changes within market – dynamics of major players
8. Impact of product or service on people’s lives.
9. Nature of purchase (one time v ongoing)
10. Barriers to entry
11. Potential exit strategies
12. Strength of the leadership and management team.
13. Return
14. Differentiation of product or service.

* You may find investors that get involved for reasons other than monetary gain, but these are likely to be other categories of investors – not VCs.

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Options To Venture Capital

January 23, 2010

Venture Capital is a specific term that refers to funding obtained from a venture capitalist. These are professional serial investors and may be individuals or part of a firm. Often venture capitalists have a niche based on business type and or size and or stage of growth. They are likely to see a lot of proposals in front of them (sometimes hundreds a month), be interested in a few, and invest in even fewer. Around 1-3% of all deals put to a venture capitalist get funded. So, with the numbers that low, you need to be clearly impressive.

Growth is usually associated with access to, and conservation of cash while maximising profitable business. People often see venture capital as the magic bullet to fix everything, but it isn’t. Owners need to have a huge desire to grow and a willingness to give up some ownership or control. For many, not wanting to lose control will make them a poor fit for venture capital. (If you work this out early on you might save a lot of headaches).

Remember, it’s not just about the money. From the perspective of a business owner, there is money and smart money. Smart money means it comes with expertise, advice and often contacts and new sales opportunities. This helps the owner, and the investors grow the business.

Venture Capital is just one way to fund a business and in fact it is one of the least common, yet most often discussed. It may or may not be the right option for you (a discussion with a corporate advisor might help you decide what is the right path for you).

Here’s a few other options to consider.

Your Own Money – many business are funded from the owner’s own savings, or from money drawn from equity in property. This is often the simplest money to access. Often an investor would like to see some of the owner’s fund in the company (”skin in the game”) before they’d consider investing.

Private Equity – Private Equity and Venture Capital are almost the same, but with a slightly different flavour. Venture Capital tends to be the term used for an early stage company and Private Equity for a later stage funding for further growth. There are specialists in each area and you’ll find different companies with their own criteria.

FF & F – Family, Friends and Fools – Those closer to the business and often not sophisticated investors. This type of money can come with more emotional baggage and interference (as opposed to help) from its providers, but may be the fastest way to access smaller amounts of capital. Often multiple investors will make up the overall amount needed.

Angel Investors – The main business angels vary from venture capitalists in their motives and level of involvement. Often angels are more involved in the business, providing ongoing mentorship and advice based on experience in a particular industry. For that reason, matching angels and owners is critical. There are substantial easily locatable networks of angels. Pitching to them is no less demanding than to a venture capitalist as they still review hundreds of proposals and accept only a handful. Often the demands around exit strategies are different for an angel and they are satisfied with a slightly longer term investment (say 5-7 years compared to 3-4 for a venture capitalist).

Bootstrapping – growing organically through reinvesting profits. No external capital injected.

Banks – banks will lend money, but are more concerned about your assets than your business. Expect to personally guarantee everything.

Leases – this may be a way to fund particular purchases that allow for expansion. They will normally be leases over assets, and secured by those assets. Often it is possible to lease specialist equipment that a bank would not lend on.

Merger / Acquisition Strategy – you may seek to acquire or be acquired. Generally even a merger has a stronger and a weaker partner. Combining the resources of two or more companies can be a path to growth – and when it is done with a company in the same business, can make a lot of sense – on paper at least. Many mergers suffer from differences in culture and unforeseen resentments that can kill the benefits.

Inventory Financing – specialist lenders will lend money against inventory you own. This may be more expensive than a bank, but might allow you to access funds you could not have otherwise.

Accounts Receivable Financing / Factoring – again a specialist area of lending that may allow you to tap into a source of funds you didn’t know you had.

IPO – this is normally a strategy after some initial capital raising and having proven a business is viable through the development of a track record. In Australia there are various ways to “list”. They are useful for raising larger amounts of money ($50m and up) as the costs can be quite high ($1m plus).

MBO (Management Buy Out) – This tends to be a later stage strategy, rather than a startup funding strategy. In essence debt is raised to buy out the owners and investors. It is often a strategy to gain back control from outside investors, or when investors seek to divest themselves from the business.

One of the most important things to remember across all these strategies is that they all require a significant amount of work in order to make them work – from the way the business is structured, to dealings with staff, suppliers and customers – need to be examined and groomed so that they make the company attractive as an investment proposition. This process of grooming and derisking can take anywhere from three months to a year. It is often costly both in actual expenses (consultants, legal advice, accounting advice) as well as changing the focus of the owners from “sticking to the knitting” and making money within the business to a focus on how the business presents itself.

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De-risking – getting ready for investment

January 23, 2010

Make Your Business More Attractive to Venture Capital Investors By Derisking

Derisking is the process of removing risk factors from your business in order to make it more attractive to an outside investor or to an outside buyer. It is one of the most important factors in the grooming process in order to be an attractive company to invest in i.e. “Investor Ready”.

There are dozens of areas and hundreds of ways in which a business may be exposed without knowing it. In the normal course of business an owner may not worry about these factors, as they are within the “comfort zone” of operation. For an external party to get involved however, they need a much more transparent organisation so they are not confronted at a later date with skeletons in the closet.

It is important because businesses already face uncertainty. And while a venture capital investor may have a reasonable tolerance for risk, they will not welcome unnecessary risk. The goal is to control as many areas of risk as possible, so at least the risks are known. Most companies who have had an internal focus (i.e. have focused on sales, marketing and operations in order to grow) have not thought about all the areas in which they are vulnerable.

The process of derisking limits the areas of exposure, and therefore decreases exposure to uncertainty. It also increases the chance of success through improvements in clarity in almost all areas of the business.

Derisking falls into two areas – one is simply clarification (i.e. creating a contract where an informal arrangement was in place) and the other a change of substance i.e. changing a supplier because it lowers risks.

Some examples include:

  • Formalising employee agreements. This may mean creating contracts for employees that have previously operated without one, or strengthening existing contracts. Particular issues would be with protection of IP, ownership of IP, confidentiality and restraint of trade after employees leave.
  • Creating / clarifying written agreements with suppliers
  • Creating/ clarifying agreements with customers
  • Moving “ad hoc” sales to contracted revenue where possible
  • Formalising and documenting internal processes
  • Protection of IP – patents, designs, copyright and so on.
  • Protection of data by limiting and monitoring access to key systems (CRM, accounts etc)
  • Key employee insurance (including of the owners) in the event of death.
  • Creating or clarifying credit terms and policies. Getting credit offered back within trading terms, and ensuring that all credit offered is documented with the correct application forms and personal guarantees.
  • Removing reliance on key personnel, in particular vulnerability to information or relationships which may be lost on their departure. This may mean adding additional points of contact to key client accounts so individual relationships are less critical.
  • Documenting key processes – getting the knowledge out of people’s heads
  • Ensuring insurances of assets are up to date, and sufficient.
  • Lowering legal exposure (liability). Ensuring insurances are held that cover product liabilities and so on.
  • Ensuring compliance with all ATO and ASIC regulations. Creating systems for their ongoing compliance.

As you can see, this is a lengthy, but not even remotely exhaustive list. The due diligence process will highlight those areas which need further work. This might cost several thousand dollars, and lead on to significantly more expense than that. In some cases the process may take a year, and cost hundreds of thousands of dollars.

One of the important things to remember in raising capital is to build in the cost of raising the capital.

This falls into two main areas:

  • Actual costs – such as hiring consultants – legal, accounting, corporate advisors, strategists etc
  • Opportunity cost and change in focus. The process of raising capital for business can take anywhere from three months to a year (or more) of attention from key owners and managers of the business. During this time, it can be difficult to maintain a normal focus on things which are essential for survival – sales, marketing and operations for example. This cost can be significant, while at the same time be difficult to measure. In fact, this defocusing may have a major impact for any growing company that is pursuing two goals – new business, and business funding (or preparing for a sale of the business).

The need to derisk is apparent if you place yourself in the shoes of a buyer contemplating a purchase of (or investment in) your company. Without going through the derisking process, your company could contain any one of a dozen hidden time bombs (key staff who could leave and set up in competition, unsettled legal issues, poor data security etc). By transparently documenting how you have examined, reduced or been able to totally eliminate risks in your business then you are showing a buyer that you understand their concerns.

The flip side of the coin is that your company is now a far more attractive proposition to purchase or invest in. You will have invested a significant amount of money and time in the derisking process, but the result will be a company that is now sellable (all other things being equal) compared to a mystery. This means first of all that you may achieve a sale when previously none would have taken place, and secondly that you are likely to achieve a far higher sale price than before.

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“Small Business” and other confusing terms

January 17, 2010

You hear the terms ‘Small Business’ and ‘SME’ (small and medium size enterprise) all the time. In some contexts they refer to very small business – a husband and wife team, or a sole business operator. Others would refer to these businesses as micro-businesses. There’s significant differences between what people think they are, and what investors label these companies. If there is confusion, it is compounded by the fact that everyone wants to look bigger than they are, so a business that has grown to a few million dollars in revenue will feel compelled to begin calling itself a medium size business.

There’s also international variations in these terms. In Australia “small business” seems to mean owner operated companies up to thirty or fifty staff. Beyond that, they start to call themselves a medium size company. In the US by contrast, anything less than about $100m in turnover is considered small, and our Australian version of small would be considered “microbusiness” or a cottage industry. The factors seem to be related to size and ownership, but are non definitive.

By way of example, in “Small Giants” by Bo Burlingham http://www.smallgiantsbook.com/ there is a “small” brewing company used as an example which has a turnover of a few hundred million dollars. This is probably small compared to the brewing giants, but it is still a significant company. (In this context it was labelled small because of its structure and because it was still run by its founder).

There are similar confusions over what businesses call themselves at various stages of development. For example… “Startup” for some implies a concept of a company – similar to the companies that popped up overnight in the dotcom boom with almost no plans, just a domain name and a few people with a desire to sell petfood over the internet. For others, “startup” might mean a five year old company that has a reasonable trading history, but has a new strategy that requires funding to get new momentum.

Investment terms are also used somewhat freely, and without a lot of accuracy – private equity, venture capital, angel investment. Sometimes these terms are clear cut and sometimes a deal might come together that is somewhere in the middle. What one person calls venture capital finance another will call private equity. Even investments vary. Even within a given investment, the cash might be contributed as equity or as debt. Or it might start out as debt but be converted to equity. The overarching terms of venture capital and private equity fit all these scenarios.

The lesson from all this is: definitions are less important than actual business plans and people, and actual dollars. What IS important is how you convey your opportunity to a prospective investor with clarity on your market, the opportunity you have, what you want from them, and what they get out of it. The actual terms used are less important than the deal itself.

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Lessons From Guy Kawasaki On Raising Capital

December 24, 2009

(Part 1 of 3)

Guy Kawasaki is famous for his involvement in Apple (small company, has some great products apparently) and is now in the VC space.

He is an entrepreuner and an investor… a great mix.

In this video he covers early stage venture capital, and his thoughts on that. He eloquently covers a wide range of topics from viabiity v fundabiity, teams and “shitty” powerpoint.

(Part 2 of 3)

(Part 3 of 3)

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