Funding a new business is one of most perplexing and frustrating challenges that entrepreneurs face. Like many other things in life funding your business is a process that requires focus.
One of the paradoxes of the information age is that there is so much bad information readily available. If you approach financing your business using the ideas that you read in an entrepreneur’s book or from a guru whose presentation you sat through at a conference, you are not likely to connect with most investors.
I have been involved in various aspects of corporate finance for a long time. I think I have a pretty good idea of what investors want and expect. My approach is decidedly old school. I approach finance in the way it has been traditionally taught in well respected business schools. I advise companies seeking investors to do what I have seen work time and again.
I especially shun the advice that suggests that you need to set forth the problem that you are solving or that what you are doing is “disruptive” or will change the world for the better. (Yes, I actually saw that advice in an article in an otherwise well reputed financial publication). This may describe some businesses, but only a very few. Businesses that are not disruptive also deserve to get funded.
Funding is a business relationship between you, your company and your investors. It certainly helps if you can understand the transaction from the investors’ point of view. Investors will give you money if they believe that you can make money and they will receive an adequate profit for the risk that they are taking. You do not have to be disruptive; just profitable.
Here are 3 things that investors know about any business that approaches them for funding:
1) Most start ups fail. I know that you have heard this before but people who invest in startups need to be convinced that you will beat the odds and have a very good chance of succeeding. Most professional investors get pitched by a lot of companies. You need to convince them that you are the cream of the crop, period.
2) Not every person is cut out to be an entrepreneur. Just because you have a great idea or product does not mean that you understand what it takes to run a successful business. Most businesses have a lot of moving parts. There are essential tasks, like finance, sales and marketing that cannot be left for you to figure out after you have been funded.
3) Never forget the golden rule of finance: the person who has the gold makes the rules. I am always amazed when an entrepreneur tells me that they will only sell 10 or 20% of their business for the million dollars they need. It is a valuation that they got from listening to the “smart and savvy” crowd. If you need a million dollars to succeed and are not willing to forget your ideas about what your business is worth and hold out for the deal that you want, you are likely to end up owning 100% of nothing. Investors do not grow on trees.
I look at a lot of pitch decks. There are a great many people who will tell you how to pitch your company to investors. Some will tell you to keep it short. Some will tell you to load your pitch with charts and graphs. Some people suggest that you cannot pitch your company without a video. If your product moves and is best presented in operation in a video, then by all means include one. If your video is essentially talking heads, graphs and the product sitting on a table, then I would tell you to save your money.
I personally believe that nothing beats a well thought out and well written business plan. Most investors feel the same way. It should not be too much to expect a company that is seeking funding to be able to set forth exactly what they propose to do with that money and how they will use the investors’ money to earn a profit.
You should be able to present financial projections of your company’s operations for 3-5 years. No projection of the future operations of a startup is totally accurate but you should have a reasonable basis for the projections you make.
It is easy to draft a projection that says something like “the company will sell 1 million units in year one, three million units in year two and 5 million units in year three” but you must be able to support that assumption. I always recommend more detail; enough to fill up a comprehensive spreadsheet.
These projections can make or break an investor’s decision to fund you. They should show how your expenses will ramp up and how you will achieve economies of scale. These are important indications of how well you are in command of your business.
Any investor can take their money to the mainstream stock market and buy shares in an established company that will pay them a dividend and the shares are liquid. They will earn a profit if the shares go up and are protected from catastrophic loss if the shares start to go down because they can sell them at a moment’s notice. The investor that puts money into your company takes a much greater risk and expects a much greater reward. That model, income and liquidity, is what you are competing against.
I always caution entrepreneurs not to promise that their company will cash out investors in an IPO or will sell out to a competitor. No one can predict that either will ever happen. Both events are rare.
Investors do expect some idea of how you will get their money back to them and when. You can structure your offering with preferred shares that pay an annual dividend. You can agree to buy the shares back from investors or give them the option of selling them back to you at a profit at some point in the future.
When you make your pitch you must be confident. Self-confidence comes from the knowledge that you know what you are doing. The message that you want to deliver is that if they give you the funding you seek, you will make it happen.
I always recommend that you bring your product or prototype with you rather than pictures or a video. Let the investors handle it and if possible, operate it. Show them that the design is pleasing; the craftsmanship is good and the functionality excellent.
One presentation that I sat through stands out in my mind. After the group of investors had looked at the product and listened to the entrepreneur describe exactly why it was better than its two established competitors, she went on to say the following:
“We expect our product to sell for $299 retail. The two competitive products retail for $50 and $100 more than our retail price. We intend to source our product from an established manufacturer in the Far East and land it at Long Beach for $95 per unit. That will drop to $85 per unit when we reach a critical monthly volume. We are projecting sales to reach that level within 12 months. We have set the initial wholesale price at $150 per unit.
Our marketing plan was developed by a marketing pro with 20 years experience working in this industry. Our sales manager has 10 years of experience selling similar products to many of the same customers that we intend to reach. The sales manager intends to hire 3 sales professionals who will be highly incentivized to open new accounts. We would be happy if the salespeople were the highest paid employees in the company because that would mean they are opening good accounts at a higher than projected rate.
Both the marketing manager and sales manager are prepared to give their notice to their current employers and join us full time once we are funded. We have taken care of all our packaging, patents and trademarks. We therefore can hit the ground running.
We are offering investors a preferred stock issue that will pay an annual dividend of 8%. We will agree to redeem your shares, at your option, for 200% of face value after 3 years and 300% of face value after 5 years. As you can see from the projections, we will be able to fund those redemptions internally, even if our sales are 25% less than projected or if we need to cut our margins by 25% to boost sales. We hope, however, that you will stay with us for the long term.
We have 3 founders on our Board of Directors and 3 outside advisors who have helped us get to where we presently are. There is a seat on the board for you, if you want it. I issue monthly reports to the board which you will receive in any event.
You should note that we intend to run pretty lean. With our small workforce, we will use a part-time bookkeeper and an outside payroll service. There is no HR or Customer Service department. If a customer needs service, they can speak with me. It’s my name on the door. Problems get resolved while the customer is on the line. Any questions? “
The group that I was a part of did not fund this company but it did get funded a few months later. The entrepreneur was self assured, had covered her bases and had that intangible attitude that stuck out from the crowd. Funding your company is a business transaction. This entrepreneur was all business.