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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When Raising Venture Capital For Your Business The Numbers Don’t Lie

December 11, 2009

Business owners looking to raise venture capital for business, that DON’T live and die by numbers – and it is more often than you would think – will be marginalised by investors.

No matter how powerful your vision, or appealing your product, if you are unable to present accurately and effectively the current position of your company, you can say goodbye to the funds from investors.

Here are a few tips that you should consider about your business financials when looking at raising capital:

1) If you, the business owner, are not comfortable with the numbers, then you need to recruit someone who is.

2) Even with a good numbers guy, the numbers need to be presented effectively, clearly, concisely, and without “noise” (=too much detail) ie summarise, as well as have the detail handy just in case required.

3) It goes without saying, your proposition must make lots of money for yourself and the potential venture capitalist. For example – venture capitalists require at least a compound 30% return but depending on the risk may go up to 100% or more.

4) Have an effective framework in place to regularly and accurately demonstrate to your stakeholders (your investors, board, employees, banks etc) that you are on top of your numbers.

Remember trying to attract venture capital investors is all about providing an expectation of a return for a given set of risks. If you can’t demonstrate how you are going to manage the return (that includes producing it)  then you simply wont attract an investor.

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