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Monday, October 25, 2010

VENTURE FINANCE – REALITY VS. RUMOR: Failing the Investor Tests!

Venture Finance - Reality vs. Rumor with Dick Brown

We’ve talked a lot about various kinds of investors and generally what they seek to make a positive investment decision. Having paid attention to these details, often entrepreneurs properly target their investor group, submit Executive Summaries (ES) and Business Plans (BP) and get nowhere. Sometimes they receive a form letter saying “no interest” or worse, no answer at all.

Investors will rarely tell you why they won’t invest … and, if they do it’s probably not the true cause. The following are some common, “deal killers”. Avoid them!

1. No Management Experience
You’re a VC. There’s a business plan before you that looks very interesting. It requires a commitment of $5 million by your partnership. The oldest of the principals is 22. None of the team has any real management or business experience. What would you do?
Solution:I’d tell the principals to add some really tough, experienced people to their team and then come back.

2. The Projections Are Wildly Optimistic
x A Real World Example: A long time ago, a small company that employed me as a VP decided to back a lone, individual entrepreneur. In this era retail stores began to demand computer technology in their checkout stands. Key to using this new technology was the design and acceptance of one, standard UPC (Universal Product Code.) The final choice was to be made by both a committee of major stores and the US government.

Our “one man show” had invented a superior coding and scanner scheme. His tag was round. Although IBM actively supported the competitive, rectangular algorithm and laser technology, our man had made it to the finals.

We decided we needed more muscle on our side to win. I set up an appointment with a senior VP at Digital and we all met to discuss a potential joint venture. The meeting was going very well and Digital began to see the value in teaming with our inventor and us. I began to think we might really be able to pull this off and “hit a home run.”

Unfortunately, at a pause in the conversations, our lone entrepreneur (who lacked an office and had no funding over a $100) turned to the Digital VP and boasted:
I am going to crush NCR.”
The eyebrow of our Digital VP fluttered slightly. He paused, then rather quickly, yet gracefully, ended the meeting and basically said: “Don’t call us. We’ll call you.”

IBM won the competition.

I have seen overblown business plans that had the same flaw. They project millions of dollars of sales in the first year, quickly followed by billions in the next year. The real world just doesn’t work this way.
Solution: Be very conservative in your sales forecasts. The wise dictum is: “Under Promise. Over Deliver.”

3. Overvaluing the Deal
Every print media from the San Jose Mercury to Time magazine tickles the dreams of their readers with tales of easy VC financing, instant success and boundless wealth. It’s not at all surprising that adventurers overvalue their deals and “I’ve got an idea that’s worth $50 million” becomes the cry of the budding entrepreneur. Unfortunately some of them actually believe this and never get funding since the price they want defies any reason.

In the real world, ideas aren’t worth anything!

(to make the idea a profitable reality) is everything!

Further, your company and venture is arguably worth exactly what you can substantiate in your pro formas (financial projections: P&L, Balance Sheet and Cash Flow, etc.)

4. Don't Look, Act or Talk Like a Businessperson?
You may live in Silicon Valley, not shave or take baths and wear jeans and sneakers to work. You may know exactly what “TCP/IP” means, but you have no idea of the derivation of the term “ROI.” If you’re plan to raise money, you better “dress upward” and also learn the language of finance.

Don’t use Warren Beatty as your role model. In the 60’s movie, Shampoo, he plays a hairdresser that needs to borrow funds to expand his salon and makes an appointment with a banker. He enters the bank with long, flowing hair, a shirt open to his navel, love beads and flared jeans. Early in the conversation with the staid banker he says: “Man, if you’ve got the bread, I’ve got the heads.”

He didn’t get the loan.

5. Looking For Development Money Over a Protracted Period
Hey! I’ve got a helluva idea. I think that I know how to learn new secrets of levitation and invent a spectacular, new propulsion system. I have five of my technical colleagues from work that are willing to join me as my team. We want to form a venture and try to learn whether or not we’re able to solve this very complicated problem.

In our business plan, we project that this investigation will take at least five years, but we just need $8.7 million in financing. If the project works, at the end of four years we’ll begin to investigate the kinds of products we might be able to sell.

I want you to be an investor.

Two questions:
1. How big a check would you, personally, be willing to write for this venture?
2. Why should a VC or angel view this deal differently than you?

6. No Financial Commitment by Principals
If you and the members of your entrepreneurial team aren’t willing to invest money in the deal, why should outsiders? As “investor-types” like to say: “How much skin have they got in the game?”
Solution: If you really have a good venture, you and your team should be willing to risk your own money before asking outsiders to do the same. If you say your venture can make 25 times the investors money, why isn’t your team writing checks?
Investments of substantial time (without pay) count as well.

7. Naive Entrepreneurs Selling "Gee Whiz" Technology
A handful of brilliant scientists or engineers discover a brand new technology and have managed to design a workable prototype. The team believes their “new baby” beats the pants off any/all competition. They just know that VC’s and potential investors will be tearing down their door and shoving million dollar checks at them. Also, they are positively convinced that the entire world will immediately, and instantly, embrace their superior technology and they will all become “overnight millionaires.”

Neither thing ever happens. Why?

None of the team has ever tried to turn an idea into a product ... and then, a product into a company. None of them has any sales, marketing, management or financial background in the real world. Basically, they have “a technology looking for a market.” For the potential investor, what they have is an insatiable sinkhole for huge sums of capital. No mature investor wants to play in this game.
Solution: Add some senior managers to the team before proceeding. Your BP then shows a way to turn the technology into products with outrageous profits … and, with minimal risk.

8. The Lonely Soul
It doesn’t happen very often, but occasionally there’s a business plan submitted by a single individual. Regardless of the amount being sought, there must be a management team to raise money and actually implement the company. Regardless of the merit of the idea, “one-man-shows” don’t get funded. For one thing, if the lonely soul walks in front of a truck, both the founder and all the investors are dead.

9. Don't Understand Investor Mentality
If you don’t understand that people invest only to make money, you’ve not been paying attention. You’re wasting your time reading these columns and I’ve failed to make this most important point clear to you.

10. Poor Sales Skills
Yes, folks. Raising money is a sales game. You and the key members of you team must already have sharp sales skills to sell potential investors ... or, you better learn them very quickly.

Next month we’ll look at operational blunders that drive investors crazy and result in them hiding their checkbooks.

For more information, please visit Dick's TNNWC Bio.

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