Angel investors

The Cold Hard Truth About Funding Start-ups

Capital Markets, Issuers , , , , ,

Contrary to what a lot of people seem to believe, it is not that difficult to fund a start-up. Funding a start-up is a process.  It requires a plan and time, effort and money to execute the plan.  The process varies depending upon where you intend to procure the funds. That decision is most often determined by what sources of funding are or are not available .

More often than not the availability of funds depends upon the attributes of the company being funded.  Who you are, how far along your company is and the realistic chances for success are usually the determining factors.

If you believe the blather that successful start-ups must disrupt an existing market or must solve a problem that the market may not know it has, you are making it harder for yourself, not easier. Lenders want the loan principal returned with interest and investors want their capital returned and a return on their investment. You need to adopt that mindset if you want to attract funds.

A great many small businesses receive funds from the Small Business Administration (SBA) which has been making loans to start-ups and small businesses for decades. Like most lenders the SBA wants collateral for the loan and will review your business plan to satisfy itself that you will have the cash flow to make the payments.

The SBA will assist in the process and provides mentoring for businesses before they apply. There are also private SBA loan brokers in every major city in the US. Not every small business qualifies, but many of the SBA loan brokers will provide guidance and assistance if the company is close to the qualifying line.

Venture capital funds (VC) or angel investor groups seem to be the choice for most start-ups. VC’s can provide management and other assistance in addition to funding. The bulk of venture capital money goes into second round financing and many of the funds specialize in tech or bio-tech companies only.

Most venture funds are willing to take a calculated risk on young companies. That calculation includes their ability to recoup their funds with some type of post financing liquidity transaction, like a merger or IPO.  Consequently, a great many companies do not qualify.  In truth, VC’s only fund a very limited number of smaller start-up companies every year.

There are far more companies that are chasing venture capital than there are venture capitalists. Consequently, the VCs usually get to fund the best companies they see.

The world is full of stories of companies that pitched dozens of VCs before they got funded and even more companies who repeatedly pitched VCs and never got funded. There are a great many books and consultants who will tell you how to make your pitch better but the truth may be that your company is just not as attractive as the others competing for the same funds.

I would hope that it would be obvious that it is easier to find funding for a company with a well thought out and well prepared business plan than a for a company whose business plan looks like it was written on a napkin by a couple of drunken frat boys.

Investors will certainly want to know if your product works, whether or not it can be sourced, whether or not people will purchase it and at what price.  You can show them with spreadsheets and marketing studies or you can start selling your product and generate some revenue.  An operating company should always be easier to finance than a company that needs funding to begin operations.

This flies in the face of the idea that all an entrepreneur need do is develop a minimum viable prototype (MVP) and then shop it around to venture capitalists. I have known a lot of VC’s over the years and almost all would tell me that they fund businesses not prototypes.

Investors also legitimately want to know exactly what you intend to do with the funds that they give to you. They also want you to use their money efficiently.

Several years back I met with a young code writer who was working at one of the larger Silicon Valley companies. He and a few of his co-workers had an idea for an APP. They wanted my help to raise $1 million so that they could quit their jobs and spend a year working on it full time.  Once the APP was developed and tested they would have had no money left for marketing and no one with any marketing experience to help them.

I suggested to him that it might easier to raise the money if their plan was to have the code for the APP written in India for a lot less and use the difference to package and promote the finished product. That way he and his cohorts could keep their day jobs and they would have a sufficient monies to hire a real marketing pro to help sell the product once it was developed.

I might as well have suggested that they enlist in the Army. They wanted the entrepreneurial experience paid for by someone else.  A good VC will see through that attitude and as far as I know that particular group never got the funds they were seeking.

Crowdfunding`is the financing tool that is the foundation for my belief that funding any start-up is not that difficult. If you follow this blog you certainly know that I continue to be concerned about the absolute disregard for investors in this market. But executed correctly, a good crowdfunding campaign should obtain the funds it seeks almost every time.

I recently had a beer with a long time friend is a lot more cynical than I am.  His thought was that since you could fool some of the people some of the time, I should just embrace that fact and come around to the thinking that any start-up could get funded if it spent enough money advertising its offering in the right way.

My friend was thinking that a good advertising company could put lipstick on any “pig” of an offering and sell it to investors on a crowdfunding website because most investors in this market really had no idea what they were doing.  While I personally decline to assist bad companies looking for capital, many in the crowdfunding market will simply list any company that shows up on their website.

I have a little experience in advertising and a lot of respect for people who do it well.  Selling securities usually takes a different approach than selling a product but my friend was thinking in more generic terms.  The point here is that selling securities is often referred to as a “numbers” game.

Advertising is about “eyeballs”.  If you want to sell shares in your company to 500 people, then a lot more than 500 people need to see your advertisements for the offering.

When someone comes to me with the desire to crowdfund an offering, I always recommend that a good marketing company is essential.  Several marketing companies that work in the crowdfunding market are careful to follow the rules. Many more are not.

Whether you are selling a loan package to the SBA or equity to a VC, angel or crowdfunding audience the operable word is sell.  Selling is not free. The old saying that it takes money to make money is true here as well. It takes money to raise money.

If you want to fund a new business you should be prepared to spend money for a professionally prepared presentation. I know a company that sent e-mails and their presentation to a list of one thousand VCs and Angels six times before one responded. They then flew cross country, made a presentation and got nothing.

With crowdfunding, I again recommend that you hire someone to prepare a professional presentation, a good lawyer to help you prepare the paperwork and budget enough money to drive potential investors to your offering. If you want to raise funds for your business, it will cost you money to do so.

I speak with a lot of people who essentially bootstrap their business until they are ready to bring it to market and then seek funding. Many are stymied because they are essentially broke at this point and do not have the resources to pay for lawyers, business plans, videos and a marketing campaign.

A lot of people wring their hands and feel sorry for this group. I,however, am not among them.  I believe that any company good enough to seek funding from strangers, should be able to borrow enough from family, friends, neighbors and college roommates to pay for a campaign to raise more funds.  If your Uncle Fred who has known you since childhood is not willing to invest in you, why should you think that my Uncle Fred or anyone else’s would?

 

Feminism in Finance

Capital Markets, Investors, Issuers ,

This article is a response to a discussion on Founders Dating.  A female entrepreneur who was seeking funding for her business had discovered that she was pregnant. She wanted to know if the Founders Dating community thought that it was necessary for her to disclose that fact to prospective investors.

Almost universally, the men who responded thought that she must. They would not trust her, they said, if she had asked them to invest in her company without disclosing the pregnancy to them up front. I thought this response bordered on absurdity and I said so.

If the female entrepreneur had asked my advice, I might have asked if she thought the pregnancy or childbirth would materially impact the business. If she said no, I would have advised her not to disclose it. That is what I posted and virtually all the men and a few of the women took the contrary view.

If I was preparing the prospectus for an IPO of the same company, I would be obligated to do some due diligence about each of the key executives in the company to make certain that their disclosures were accurate. I would never think to ask anyone if they or their spouse was expecting a child. It is not an event that would normally be disclosed. The SEC would certainly not punish anyone for failing to disclose it.

If the issue is that the pregnancy might take this executive away from the business for a period of time, distract her or impede her ability to do her job then I would be obligated to ask every key executive at the company: Do you have a special needs child or elderly parents?  Are you healthy? How often do you drink alcohol? Do you have a prescription for oxycodone?

You can see where this goes. Any of these would potentially have a greater impact on the executive’s time and performance than an average pregnancy and birth.

No one would suggest that a male executive disclose his wife’s pregnancy even if the company had a policy that would give him extended parental leave after the birth. That is the salient point. This is a prejudice against women. It really has nothing to do with a clear business decision.

If anything, it is easier to plan for the “disruption” that a birth might have with the timeline the company is forecasting. Every schedule needs some slack. Once a pregnancy is known, the business can plan for it.

Much of the discussion seemed focused on the fact that the investors, mostly angels rather than professional VC’s, were concerned that the entrepreneur had divided her attention away from the business. They were concerned that she would not be giving 100% of her attention to the business that they were funding.

This kind of thinking is archaic, inappropriate and demonstrates how poorly these angel investors approach the task of evaluating a business that they are considering funding. To me they were signaling their own ineptitude and a foolish approach to investing their own money.

What these angel investors are saying is that they are not confident the business has a team in place sufficient to deal with the absence of a key player. That might be true if this were a concert tour and the primary artist became pregnant. For almost every other business it should never be an issue. With a CEO or senior executive, if childbirth truly impacts their productivity then that loss in productivity can be picked up by another member of the executive team.

Underlying the desire of these angel investors to have disclosure of this pregnancy was a knee-jerk opinion that women do not make good judgments. Underlying was the attitude: why did she get pregnant when she was trying to start a business? Respectfully, it is none of your business, even if it is your money.

Whether you attend business school at Harvard or at a state university, students are generally taught that the CEO and management team should have 3 types of vision; 1) vision on the product (costs and quality); 2) vision on the market (customers and competition) and 3) vision on the bottom line (overhead and cash flow).  It is a good, simple approach that investors can evaluate. It is a standard that does not care if the entrepreneur is male or female.

The implication is that a woman could not have this requisite vision if she also had vision on her infant. That makes no sense. I could not find a reputable study that supported this, nor would I expect to find one. A lot of women have children and return to work.

I graduated for an all male college in 1971. When I started law school that fall, my law school class of 120 students included exactly 12 women, because there was a 10% quota for women.  When I started working on Wall Street after graduation women were mostly secretaries. A handful of women were in middle management, but none were in upper management. The firm had a few thousand stockbrokers; probably less than 20 were women because people did not think women knew a lot about investments and managing money. Throughout the business world the glass ceiling was very real.

It was not unusual to hear what would now be considered inappropriate remarks about women at any time. It was not inappropriate to ask a woman to bring you a cup of coffee, no matter what her job title or expect her to straighten up the conference room after a meeting. A lot of people, including a lot of women, thought that women joined the workforce to find husbands.

Women were treated as second class citizens in the business world. In many respects they still are.  The Founders Dating discussion highlighted how this problem still exists.

Today approximately one-half of college graduates are women and it seems reasonable that one-half of the venture capital would be directed to companies that women own or control. But that is not the case. It is not going to happen unless and until these archaic attitudes about women’s ability and judgment are dispelled.

The problem needs to be approached from both directions.

Angel investors need to get a little perspective. Investors in large companies do not ask about the executives’ personal lives when they make an investment. A small company is no different.  If you cannot evaluate a business as a business and insist upon knowing the details of the managements’ personal lives, I suggest that you keep your money in your pocket.

Steve Jobs had returned from a commune shortly before he started Apple. Should his personal life have been considered by investors or just his product? And to be sure, Jobs is not an anomaly. Back in the 1970’s men could not get jobs, let alone funding, if their hair was over their collars.

As importantly, women need to call out this foolishness whenever it occurs. At least one woman in the Founders Dating discussion supported the idea that a pregnancy should be disclosed. I would have expected many women to tell the men to get real. Few did.

There are more and more successful women stepping up and providing capital to businesses being started by other women. That is laudable but does not touch on the problem.

I found the fact that not a single woman on Founders Dating raised significant objections to the entire discussion to be an indication of why this type of prejudice continues. Ignoring this problem will not make it go away.