Archive for the ‘Fundraising’ Category

Intrigue your investor

March 31, 2008

Vijay Anand muses about building “businesses that don’t make money”.

It poses a question – why are VCs insisting on a business model?  Clearly the stress here is on investing in intuitive ideas that drive user base for everyone to benefit from. The trouble is in getting investors to fund it early when revenue visibility is poor or seemingly non-existent.

So, how to get around that?

I think the trick is in seeing things that lot many others don’t. Often opportunity comes in coveralls that look like work. Get around to work on some idea that isn’t good now because the infrastructure just isn’t there, but will be good five years from now. Capture your imagination in a logical sequence, spread it across a visual format to be evaluated by investors. Go easy on them. Most VC pitches fail not because the idea was bad, but founders didn’t know how to sell it.

Be passionate. Be always-on. Recognize likely problems and figure out ways to solve them.  Does work feel like work?  Ask yourself. If the answer is yes, you failed the test of passion. Don’t go further. 

If you’ve passed it, all that is left is to intrigue an investor; make her see right through you!



Early stage Boards

November 24, 2007

In the startups, this is a particularly touchy issue. 

So long as the founders are the only investors in the business, the Board of Directors (BOD) normally are the founders except the odd independent director nominated by them – either in an advisory capacity (also good corporate governance) or to embellish the Board with luminaries.  Regulatory whips don’t surface in this stage.

Normally it shouldn’t be such a pain, if Board seats can be reserved on the basis of proportional investments made by the investors.  But founders sweat it out with their time and effort too besides money,  while the outside investors may just have the financial stake. Now how to split the board seats between founders and financial investors, if “quantum”  is the only criterion? Can you disregard the value of founders’ sweat? 

Unless a method to quantify the value of founders’ sweat is devised, to arrive at the Board composition ratio is not easy.  This again depends largely on what is more critical to the business in a relative sense, sweat or finance.  If it’s a technology company, it’s always loaded in favor of sweat.  What if it’s a financial services business, where capital is the raw material and finished product?  What if both are equally critical, as is normally the case?

I have always advised my clients on a consensus route. I call it as “iterative calibration”.  It’s not important to decide on the split ratio of BOD all at once.  Start with some fair basis of representation between the founders and other investors and keep tuning it as we move forward. It’s fairly simple to define – set milestones of performance and keep measuring it on a periodical basis.  If the founders are constantly hitting the milestones or are over-delivering, they shall have the majority (why not when they are doing a good job?).  Financial investors are happy since their investments are managed well, and the risk levels lower.  

If it’s the other way round, the founders may see their position compromised and investors should have the freedom to have more say, including bringing in superior talent at the helm.  So far it has worked very well, but I would like to see more perspectives.

Here I get another perspective from FeedBurner CEO Dick Castello.  Good friend Dan Primack of PE Hub has clued me in.  Thank you, Dan…!



Making the VC cut

December 31, 2006

“ You are not VC ready “ – Startup founders often get this baffling censure from VCs ( or worse, none at all ) after they submit their Business Plan. At times, it gets on founders’ nerves and infuriates them no end. Founders like to say “ hey, now what…? We’ve developed a bug-free prototype, been thro an extensive beta,  got a brilliant team of people to work, a tried and tested mentor,  set of high quality advisers and what the hell, we’re  into year two with a good set of paying customers too…what more do you expect from us …a Microsoft rolled back in time ? ” 

Where the hell does it suck…?

I am letting you in on some inside metrics.  Too bad if you’ve tried this already.  

Uptight with strap :  Burn less capital to finance overhead before generating revenues. In other words, suck cash only if it makes revenues grow.  Stick with Top Ramen noodles for lunch, Sushi can wait. 

Burn rate is usually quoted in terms of cash spent per month.  It’s bad if the burn rate begins to exceed forecasts or revenue fails to meet expectations. The usual recourse is to reduce the burn rate by reducing overhead or by looking at ways to improve profit margins.  

Lead earnings : Companies with high operating leverage ( lower cost of incremental sales ) can make more money from each additional sale if they don’t have to increase costs to produce more sales. The minute business picks up, your assets as well as existing workers can do a whole lot more without adding to costs. Profit margins expand and earnings soar faster than revenues. ( imagine Consumer internet like travel portals, online DVD rentals etc.) So get your business to recover its fixed costs early and keep adding to the bottomline with every additional sale. This can be achieved by keeping the initial development costs low by scheduling a faster go-to-market. Secret here is to quick-brand staged product development and serializing it.  Features can be added later  which can be released as V 2.0 followed by V 3.0 etc. Take a leaf from Google and Microsoft who are masters at it. 

Strong tailwinds :  VCs have a commitment to the investors ( limited partners ) in their funds for realizing a rate of return well in excess of the market average. VCs rankings go up if they could achieve their ROI targets fast and return the money to the investors early enough.  As such, VCs prefer to lock-in $$ for as short a duration as possible. Closer your venture is to a liquidity event ( like IPO, buyout, M&A ),  more attractive it is to the VCs.  You stand a better chance of getting noticed by acquirers ( or lapped up by investors ) if your venture is highly scalable with the momentum provided by the VC money. Sooner you position yourself in the eye of the acquisition storm to get swept by it, the better.  Approach the VCs with a clear roadmap for them to exit quickly thro such events and get invited to dance. 

Be the current flavor : VCs are paranoid by nature and fear to tread alone. They prefer to move in herds.  If your venture belongs to a sector which is currently funded by some VC, you stand a fair chance unless you screw it up hopelessly. So belong to the sector which is the current flavor. Conversely, time your approach to VCs as soon as your competitor got funded. Technology / Internet / Semiconductor wave of the 90’s, followed by Biotech and Clean Energy wave are all examples you can relate here.   

Suck up to a dud : This is sure to work. Just be a bit charitable. If you know of any dud among the VC portfolio that could be useful to your early development efforts, it’s a great favor that you’re doing to him.  There are quite a few in almost every VC portfolio. Seeing an opportunity to recoup his dead investment in the dud, VC will make the dud offer everything it has including its IP for a song. So while you zoom in on a VC to pitch, remember to scan its portfolio for complementary duds. Better still, find a dud to build your idea upon. VCs are quick on the uptake,  just tell him the story nicely.  He wouldn’t miss it.  If he’s desperate enough,  you might even escape from draconian  multi-x liquidity preferences or anti dilution clauses in the term sheet.

Fundraising yardsticks…

October 8, 2006

On of my readers in Germany sent me an email the other day asking if I would describe what the funding cycle looks like…timing, amounts, valuation, etc. While there are millions of permutations of this, I’ll try to give a general framework and set of principles. 

Start at the End : You need to understand what self-sufficiency looks like for your business. Until you can support yourself (CF positive), you will be reliant on the kindness of strangers and will be in perpetual fundraising mode. Your knowledge of your business model is key here.  

Layout the Steps : How much capital does it take to get to self-sufficiency and what are the key milestones in the business. Some that VC’s use are:

1) getting your beta launched
2) getting the production version launched
3) getting your first “high profile” customer that others in the industry take notice

4) hitting $3-5M in sales (usually means you have figured out pricing)

5) hitting $10M in sales (usually means your direct sales force is working)

6) hitting $20M in sales (usually means you have channel down)

7) EBITDA positive

8) CF positive. 

How much capital do you estimate it will take to hit these and when?  Then double each amount and the time (law of 2). That is a rough estimate for your needs. I would say that you generally have a three round cycle at a minimum.  #1, #3, #4 and #6 are possible funding events (probably either #1, #4 and #6) or (#3, #4 and #6). We joke about companies running out of letters in the alphabet for rounds (Preferred Stock Series Y) because they have raised so often, but it is usually rare to go past F or G (6 or 7 rounds).   

Determine Funding Sources: For each stage mentioned, it will be clear what options you have given the milestones hit and the amount needed. For amounts below $1M, bank debt, customer financing (prepaids), angel or venture are all possible. For amounts, $1-3M, angels and venture are possible and for amounts above $3-5M, you are dancing with the VC devil. Usually, you see bootstrapping and angels to get to beta or first customer, and either angels (if really capital efficient) or VC’s from there. 

Set Expectations Around Valuation: Entrepreneurs are optimists by design/necessity. Unfortunately, this often leads to huge discrepancies regarding valuation expectations. You should expect: 

Pre-product VC seed rounds: $1-3M pre-$ valuation for (this bumps probably to $2-6M for angel).
Beta/Initial customer: expect $4-7M pre-$ valuation (angels as high as $10M)

Revenue $3-5M: expect $7-15M depending on growth, story, sizzle, etc

Revenue $10M: expect $10-25M same caveat

Revenue $20M+: expect $30-60M same caveat

VC’s target 10x for the early stuff (including $3-5M in rev) and 3-5x for later stuff ($20M+ in revenue). So, the visibility of your growth and likely outcome will determine valuation. Can they get 5 or 10x at that valuation? 

Avoid Surprises: Fundraising is only as successful as the accuracy of your capital needs estimates. In the worst case, you run out of capital either a) suddenly or b) before you have reached key milestones. In these situations, you lose all leverage in the process and it does not end well. We have CEO’s who develop hives if they have less than 1 year’s worth of runway. Assume it will take you 6 months to close on a round…give yourself 6-8 months to get it done. 

Two’s Company: The optimal situation is to get three funders to the table for your process. Assume that one of them will drop out unexpectedly which will leave you with two.  This creates a built in stalking horse/forcing mechanism. Nothing like urgency/scarcity to accelerate the process. You are  in the risk mitigation business like an insurance company. You are only as successful as you are accurate in identifying risks that get in the way of your plan. Put buffers and contingencies in place (cost reduction or other funding sources) to address surprises. And let ‘er rip…