If you run a website for startup financing you see a lot of startups over the course of a week. Every last one is convinced that it is doing something unique or that at the very least it is only the second company in the space. Meanwhile, it's the third company with the same basic idea that I have spoken to just that week.
How to Raise Startup Capital: Lessons From Deal-makers
From working with entrepreneurs since 1986, I have noticed one
glaring problem most have. Most have no idea how to sell their startup
or deal to investors. Instead they just write a business plan and shotgun it out
to everyone. Then after a few months, when no one has jumped on it, they
start complaining that investors are "too stupid" to see how wonderful the investment opportunity really is.
What rookies fail to take into
consideration are tangible economic incentives and psychology. Deal-makers,
on the other hand, understand how to offer short-term economic incentives
made all the stronger by appealing to psychological needs.
like to learn how to put together B2B deals? If you answered, yes, get a copy
of How Deal-makers Raise Capital.
There's no information on this new book on raising money on Amazon yet, but even if it's only half as good as his other business classic, it will be a worthwhile addition to any entrepreneur's library.
Free Mini-Course in Creative Financing for Startup Entrepreneurs
Are you an Entrepreneurial Champ or Chump? Find out.
Champs are the ones who understand how entrepreneurial finance works. Chumps are those who sit around hoping that some kind stranger will give them money after reading their business plan. When it doesn't happen, they complain about investors being "too stupid." You can increase your chances of being successful in attracting capital down the road if you learn how savvy entrepreneurs are always moving their companies forward.
Let's look at the typical stages in
a successful company's financings. We'll start with the last and finish with the
first. Although there are rare exceptions to this sequence, in most cases it
looks like this:
-The IPO This is the big pay-off at the end of
years of hard work. It means liquid stock selling at, hopefully, a high P/E
multiple. (The second best alternative is to be acquired by a large company such
as a member of the Fortune 1000.)
-Venture Capital C-Round The IPO
is now in sight and the C-round is used to "fatten the pig" as much as possible
in addition to preparing the company for it. Often this preparation includes
replacing management with C-level officers who are known to and respected by
Wall Street. -Venture Capital B-Round Wall Street is starting to
take notice of the company. Therefore, the VCs want to maximize its forward
-Venture Capital A-Round VCs step in when the business
looks like it has potential for an IPO or acquisition a few years down the road.
-Angel Round Angels come in with money when you have started
selling. They jump aboard because you now have tangible proof of concept. You're
finally walking your talk. It's no longer all just hot air coming from the
founder. Be honest, talk is cheap.
-Seed Round At this stage you
have no more than an idea. You are going to build the next Facebook or Google or
Apple...only it will take a year or two of work before there is something that
can be sold. Or maybe it's a dull little business which excites only you?
So, who comes in at this stage if you should be lucky enough to attract
any money? The answer is the "3Fs", otherwise known as Family, Friends, and
Fools. Yes, this means your parents and rich frat buddies from your days at
Harvard or Yale. What's that? Your family is not wealthy and you didn't attend
an Ivy League college? In that case, you are going to have to finance your seed
stage the most common way: with a day job.
Welcome to Planet Earth.
That's how 99% of startups get through the seed stage.
I am providing
this information because so many people post online requests for funding to cover
2 to 3 years of coding or R&D. Then when they are ignored, they get angry.
If you are realistic about what types of scenarios attract investors,
you won't get angry. Instead you will work to create an opportunity that will be
attractive to investors at every stage.
If you think that you are going
to attract money to cover your living expenses and provide a bit of fun money
while you code or do R&D for 2 or 3 years, you are in for nothing but
Forbes has a very interesting articled dated January 12th, 2009 titled Venture Capital's Coming Collapse. Sounds as if reality has finally caught up with the VCs too and not a moment too soon.
Here are a few key excerpts:
The swashbuckling risk takers in venture capital have been laying giant eggs for a decade. Could this finally be Sand Hill Road's day of reckoning?
The venture capital industry is staring at the most vicious shakeout in
its history. Returns are pathetic for most funds, the public offering
pipeline on which venture depends for its exit strategy is clamped
shut, and with the shares of many big publicly traded tech companies
swooning, those firms are less likely to buy up promising upstarts.
Heroes of capitalism they’re not. It has been 11 years since the
venture industry has returned more cash than it has plowed into
investments, according to the National Venture Capital Association. The
industry is now managing $257 billion, up from $64 billion in 1997.
It would be helpful if there were some way of knowing in advance
which firms are going to be the good guys. Apart from those in the very
top tier, which consistently outperform, it’s difficult to know.
That’s always been the case in venture. But since equity markets
cratered earlier this year, many big investors are scrutinizing all
their holdings more closely. Illiquid investments like venture-backed
startups don’t look so hot. VCs “have been living off fumes for a long
time now,” says one prominent Silicon Valley investor. “If you have any
money, the last thing you’re going to do is put it into an asset class
that hasn’t generated a return for ten years.”
Until recently VCs have been able to keep the cash coming despite
dismal performance because of the long-shot nature of their business:
Investors know that one Google or YouTube could make them millions even
if most other bets bomb.
The venture industry promotes that spin. Christopher Douvos is a
manager in Palo Alto, Calif. with the Investment Fund for Foundations,
an $8 billion investment pool headquartered in West Conshohocken, Pa.
He sees the sales pitch of venture capital as “lottery slogans with an
Ivy League veneer.” Instead of saying, “Hey, you never know” or “You’ve
got to be in it to win it,” the industry talks about “asymmetric
outcomes” and “optionality,” he says.
Just ten short years ago everyone and his uncle was a venture capitalist or at least claimed to be. People who by virtue of little more than pure luck had cashed in big after their employer had IPOed would regularly announce the opening of their very own VC firms. By 1999 half of the Microsoft staff were venture capitalists. Then it all crashed in early 2000. This is now the final nail in the coffin for the industry. Only the very best will survive.
In about 50% of instances where an early stage company actually succeeds in raising venture capital, the founder CEO is fired within the first year and kisses most of his or her equity good-bye. Even the Wall Street Journal pointed this out in a article by Barnaby Federer from 09/30/02:
"If you ask a VC what value they add, and you get them after a few drinks, they'll say, 'We replace the CEO' ", he said. And that, he indicated, does not vary with the economic climate.
It usually occurs in this manner. The venture capitalist invites the founder
out for a friendly lunch. During the meal the venture capitalist brings up a
new person who would benefit the company greatly through his connections or
industry experience. The venture capitalist explains that although this person
is not available to serve on the management team, he could probably find the
time to serve as a director. Yes, it would mean making the board larger than
originally agreed to by everyone but this guy is a “star”. The founder
wishing to please his venture capitalist reluctantly agrees to the change in board size.
The new face turns out to be the extra vote the venture
capitalist needed to make wholesale management changes. Within a week the board
has fired the founding team and replaced them with friends of the venture
capitalist. Oftentimes the new board member assumes the CEO role.
Yes, this scenario happens often and has little to do with
the founding team’s performance. Venture
capitalists just prefer their friends at the helm.
Bottom Line: If you had the clout at the beginning to negotiate a board of directors balanced between management and venture capitalist, don't be a wimp and give it away for nothing. To do so only reinforces the venture capitalist's belief that he was right about replacing you.
The best tactic to employ when faced with this offer is tell the venture capitalist that you 1) can't recommend someone for a board seat until you are satisfied that they can make an actual contribution, and 2) that since the board is working well it would be preferable to compensate this person--once they have made a tangible contribution--with consulting fees instead of a board position.
Finally, if you sense a strong negative reaction from the venture capitalist you can be assured that there's trouble brewing in River City and it's spelled with a capital "T". He will always have a Plan B for pink-slipping you and it won't be pleasant. Call your lawyer immediately, and I mean your lawyer not the company's.
You're about to experience your own personal "Night of the Long Knives".
Everyone knows that when you're dealing face-to-face with clients or customers, you should try to look and act like them. The same rule applies to dealing with suppliers. So it behooves you to use the same tactic when pitching your startup to venture capitalists.
The undersized suit is the latest rage amongst the Silicon Valley venture capital crowd. The unidentified gent in the photo apparently works for a white shoe venture capital firm.
My advice to venture capital seekers is to hang out at Buck's of Woodside with a copy or two of your business plan while wearing a suit that you ran through the wash/dry cycle at least five times.
To be honest, my BS detector goes off immediately whenever anyone introduces him or herself as a venture capital "finder" or "broker." These words are normally "tells" that you are dealing with a con who is going to ask you for an upfront fee. While there are rare instances of a middleman assisting in a financing, I have never come across anyone who could deliver the goods more than once. What I have seen over the years are people, who through luck more than anything else, happened to be in the right place at the right time when a financing went through. They then attempted to establish themselves as finders by greatly exaggerating the role that they had played.
So my questions are:
1. Do you know of any venture or angel capital finder / middleman / broker who has put together two or more financings?
2. Do they charge upfront fees?
Every week I receive emails from desperate entrepreneurs wanting to know if they should hand over advance fees to these people. There's even a west coast angel group that charges $2000 just for the privilege of doing a dog & pony show to its alleged members.
While capital from
personal loans might be available it's not always the best beginning to a