Archive for category Structure
The reason behind Microseed Accelerators
Yesterday, I wrote about James St. Jean’s January article about New Venture Capital Models. He also wrote a part 2, addressing why these new business models are cropping up. Go read his article.
In summary, he said that it was first started by Paul Graham in 2005. Graham was new to the investing scene, a creative thinker and not tainted by the old ways. Sound familiar? This is how most entrepreneurs start when they break off from a large company. Unwilling to say “because that is how we always do it” entrepreneurs are willing to take a look at new ways that may offer advantages. Graham did this to investing.
Furthermore, it seems that NOW is almost a “perfect storm” for investing in small startups. You have products becoming cheaper to build and launch, a shift in traditional venture capital funds to larger investments leaving a vacancy for small investors, and the role of the internet in providing services (and products) to niche markets in a profitable manner. This leaves an opportunity for these microseed accelerators to fill.
The conclusion that St. Jean draws is since smaller capital is at risk the penalty for failure is a lot lower and so this fosters more creative and risky ideas. I agree that this is probably the governing reason for the idea of investing in smaller amounts but not that this is the reason behind providing the extra support.
My supposition is that certain people see a value in a skunkworks: A small team of dedicated developers focused on one goal with little or no distractions of a large bureaucracy but with the support and the skills that a major corporation provides. These certain people came from large companies and business schools where these skills and situations were studied and fine tuned. Realizing they could duplicate this in a skunkworks scenario it is just a matter of finding funding and the right entrepreneurs to make this work.
What makes the right entrepreneurs is THE discussion for this blog. Ultimately, it will not be just skills and experience, but also the entrepreneurs’ willingness to learn and grow into the role of a successful company.
Shark Tank or License Tank?
Which is a better deal for your business?
Offer 1: $35,000, the investor owns 100% of your business, and you get a 2% royalty.
Or
Offer 2: $50,000, the investor owns 51% of your business.
It depends on your belief on whether you will be successful or not with your own business or you should do a licensing deal. Offer 1 was a licensing deal.
Last night I watched about five minutes of an ABC show called Shark Tank. A regular group of investors review pitches from entrepreneurs and they offer a deal right there. Whether or not they consummate a deal depends on negotiations later but the deal offers are in good faith.
The owner of turbobasters.com was pitching her business. You can visit the web site to see it. She was given the two offers. She chose offer #1 because the investor had the network to get her product sold. 2% of something was better to her than 49% of nothing.
I stopped watching. Instead, I started doing my own little due diligence on the internet, visiting her website, texasstartups.com, and the show website.
A few things came up:
1. She does not have a working prototype. All she has are some drawings and a good idea. No business plan, or marketing plan. However, she may have mentioned that on the show.
2. The show does not do any business due diligence; only background checks.
3. Evidently other inventors get on there and instead get an offer to license their product.
As one poster put it succinctly on the texasstartupblog.com: some of these people have no business running a business…they are much better off licensing their product. In this case, the lady took the right deal between the two, if it really was a license.
As for my thoughts on the show; I have not watched enough of it. I do wan to point out one idea: This is on TV so it is supposed to be entertainment and there is a big difference between that and what investors do make sure they make a solid deal.
Quick note:
Offer 2 valued the business at $98,000. Offer 1 said the business was worthless and it was just the idea that was valuable. Big difference.
Sources of Funding
The following is a general list of sources of funding.
Funding in this case is defined as increased cash (the working capital) in your company.
The list follows the following three groups: sell more product, borrow money, or sell pieces of itself. That list is too vague, so in the effort of making a it bit more real, I constructed the below.
1. Yourself – put your own money in.
2. Personal credit cards – very high rate of interest, but easy to get cash.
3. Loan on personal collateral item – second mortgage, pawn a car/boat/jewelry. Very risky and you could lose your goods.
4. Line of credit from bank – typically has fees whether it is used or not, reduced if you carry a large balance and have a good relationship with them.
5. Sell products – (increase cash flow) you sell products and reinvest the profit back into your own company.
6. Sell off business – sell part of your business or the contracts
7. Factoring – advance against receivables
8. Advance Against Royalties/Against Contracts
9. Accept Credit Cards – accepting credit cards on average increases a business by 35%!
10. Merchant Cash Advance – a loan against future income not realized by a contract
11. Friends and Family – get them to put their own money in. It can be a gift, loan, or stock purchase.
12. Loan from bank – includes collateral loans, SBA-backed loans.
13. Grant – government or private sponsor to either do research, or provide funds to a need category
14. Private Placement Memorandum using a reg d wholesaler – selling securities in your company via a person who represents your company to financial advisers (they sell the securities) who in turn find investors
15. Angel investor – private investor who uses their own money
16. venture capital investor – private/public investor who uses third party money
Items 1 to 3 do not require you do convince anyone of the viability of your company or products. You only have to spend your own money, or have a valuable item you are willing to collateralize.
Item 4 is typically not a problem if you have decent financials. It becomes more of a problem if you want to negotiate out of your fees or lower your interest rate, but you do not have to convince someone that hard about
Item 5 now gets into the area of convincing others to buy your product. This is the most basic but does involve improving your budget management and taking less money for personal gain.
Item 6 is actually a lot more common in certain industries. You have steady customers in one arena, but while steady they probably will not grow. Why not sell off the future business and get that cash up front? This can be easy or difficult depending on the industry and mix of customers.
Items 7,8 and 10 typically are only used when the business is doing well and needs to increase their working capital. You do not have to work that hard to convince someone to do this but just have the right type of business and financials. Item 10 sometimes requires to you to already accept credit cards but in other cases you may be able to get cash against contracts.
Item 9 sounds simple but its hard for a new business to get credit cards. If they do then it will be more costly, and most likely require a personal guarantee.
Item 11 now gets into the realm of convincing others to bet on the future with you, without collateral. This is the focus of this blog. The first step is get friends and family who already know you and ideally, believe in you.
Item 12 is difficult. Banks will not loan to start-ups but they will loan against someones financials (because they personally guarantee the loan).
Item 13 is getting a grant from the government or some private entity. Takes time, money, and the ability to know the right people. This actually may take longer than any other category.
Item 14, 15, and 16 now getting into the realm of selling securities in your company to strangers. While Item 11 was selling a security (maybe) it was to someone that knows you. Each of these requires work.
Items 12-16 definitely require a business plan.
As you can see, there are at least 16 different ways you can raise money for your business to expand. I tried to put it in the rank of easiest to hardest, but there would be a lot of argument on that.
Checking if the Investor is For Real
Entrepreneurs generally assume that when a potential investor talks to them, that the investor has the money available. This is not always true.
Recently a client spent six months working with one buyer group on a multi-million dollar deal only to find out at the last minute that they could not write him a check. Instead they wanted him to finance them over a long period of time.
Part of the deal was that he would continue to be available to help the company. In the seller’s eyes, he was essentially going to be paid the same amount of money he is making now and after a period of time he would no longer own his own company.
The seller was expecting to have a large check in his pocket which he could use to fund his next project. Now, he could not do that and would be making the same money as before but lose control of his company. Why would he do that? Obviously I am simplifying the situation but essentially the seller said no. Quite frankly, the seller never asked early on what kind of terms they were seeking at the top level view. This means, are they investors willing to write a check, or needing outside financing (that they could get with their financials), wanting self-financing by the current owner, or a combination.
Any one of these structures is okay.
The seller should have asked three simple questions:
1. What deals have you done before?
2. How were those deals structured?
3. How do you think you would structure this deal?
Most likely he would have gotten no answers, and that would be indication that these “buyers” were not able to buy.
There is nothing wrong with asking potential investors about their capabilities. It just needs to be done in a diplomatic professional manner.
A win may not just be about money… other types of wins
Taking a break from talking about the executive summary…
I want to take a moment to think about this. Yesterday, I wrote that “it is about the win”, and I was relating it to how much money you are making.
Have you ever thought about other forms of wins, other than just making a lot of money? Are you saving something in the environment? Are you helping out your fellow inhabitant of Planet Earth?
There is nothing wrong with focusing your big win on something other than money. In many cases, this will actually help you get the attention of the investors. However, and unfortunately, investors have to answer to someone (if not just to themselves and their families), so they need to make money.
If your big win is saving a rare fish and you want investors; then figure out how you can make a big win for both: the fish and the investor.
Most likely, someone else will, and they will get the investment instead of you.
Asking for additional money – use a reserve
I met a film maker on a flight this week and we talked about his project proposal. He is funding his film himself but also seeking angel investors. The total amount he is seeking is $125,000 and he plans to market it via some traditional channels in the film industry.
Independent films are marketed primarily by the distributors and require little dollars from the film makers. Typically, the budget only covers making the film and a few expenses related to getting it into distribution. However, some filmmakers do include a marketing budget as they plan on taking the film to festivals. This film-maker plans on applying for many film festivals and hopes to get into a few. Some festivals may fly him there, but overall there will be some expenses.
The question is whether he should include the travel dollars in the budget. This may be logically sound but he pointed out that an additional $25,000 was an increase of about 20%. Would the investors shy away? Is there enough difference between $125,000 and $150,000 that would cause investors to say no at the higher amount? His point was that for the targeted investors this was a big difference.
He may be right. For some of his target investors $125,000 may be a stretch; they may use fund raisers. A additional $25,000 could crater the idea. However, I think it’s a matter of how you pitch it.
The other problem is that most investors expect to see marketing expenses. They know that without marketing then there are little chances of getting their money back and make a profit.
One idea is to propose a budget that is $150,000 but that $25,000 of that is targeted for a marketing reserve with specific points on where it might be used. If that money is NOT used, then it would be immediately paid back to the investors. In reality you could pitch it as $125,000 plus a reserve of $25,000 that would be only be used for X and paid back in a year if it is not used.
In conclusion, my recommendation is that you do need to include a marketing budget (or a contingency budget), but it could be presented as a reserve. This reserve is not used unless needed. It can be paid back immediately and not count towards shares (%ownership) but that really depends on what is negotiated.