Venture Financing - Reality versus Rumors with Dick BrownI’m very pleased that we receive mail from our TNNW readers. Many of these are people seeking funding and they ask incisive questions. I generally respond to them within a day or two. For this month’s column, I selected those topics that I feel might be of the greatest interest to most of our entrepreneurs and combined them for privacy of the writers.
If you have questions, comments or suggestions, send them along. (Click on the link at the end of this article, or contact me at American World (dick@amerwld.com). You’ll get an answer.
1. Angels and Valuations
"We're meeting with an Angel Group later this week. Things have gone very well so far and I think they may decide to invest. I know the total size of all their checks is often tied to a 'valuation.' What is this and how do I get one?' PS: We’re a start-up."You’ll be pleased to know that with a little effort, you can fight the angels to a draw on this issue.
Most financial people agree that a true valuation can only be established for a publicly-traded company that is also profitable. The openly-traded stock price represents the “worth” that independents are willing to pay. From this base, accountants can count assets and liabilities and establish a widely-acceptable valuation.
Since your company is new you have no sales and no profits so there is no outsider’s evaluation to work with. Your angels are shrewd enough to just pick the amount of money you want and adjust for the percent of the company you’re willing to sell. They say to you, “Entrepreneur, you want $150,000 for 25% of your stock, so you must think the company’s worth $600,000. Well, we just don’t believe this and we think the valuation is closer to $300,000 and we want 50% of the company for $150,000."
What they’re using has absolutely no basis in fact and is just numbers they’re pulling off the wall. Your comeback is to peg your valuation to a “real number,” or, at least one that’s in the pro forma of your Business Plan (BP.)
You say, pointing to the projections in the BP, "As early as Year 2, we project sales of at least $6,000,000 and with a minimum profit of 10%. Using the industry standard of 10 times profits, these numbers alone in only year 2 justifies my valuation – not to mention that our sales are projected to be $27, 000,000 in year 5 with a conservative profit of $3.915,000. (14.5%)"
The truth is that both sides are “blowin’ smoke,” but with printed numbers on a printed page in a great Business Plan, you should win (or at least break even) and/or gain the final advantage.
2. A Great Question
One of the entrepreneurs that asked the question about the angel meetings was also honest enough to add:“I’m trying as hard as I’m able to get this venture off the ground so we can all be successful. I’m very aware that most of the 'money people' I approach are older, more experienced and wiser than me. I get intimidated. What do I do?"
Find an equally experienced “gunfighter” and recruit him to your side. Maybe you bring him on as a director, coach or mentor. Fully brief him on what you want to accomplish and bring him to every such investor meeting. If he’s any good, just the fact that he’s sitting on your side of the table gives you some edge and maybe counter-balances the situation.
Characteristics:
• Has started his own companies (>1);
• Had at least one winner and one loser;
• Knows the “venture money” game;
• Isn’t afraid of anybody;
• And, is at least 50 years old.
• Be sure to set a fair compensation.
Don’t know anybody? Next best candidate: All angel groups have “sponsors” whose ads are in every angel publication. Pick one of these and recruit a “Partner,” not a junior attorney.
3. Business Plans
"I’m the manager of a software group for a hi-tech company in Silicon Valley. Several months ago, I had an idea for a software add-on with an incredible potential market. I have a demo-version that I have shown to very close friends and all were blown away and said the same thing: 'This will end up being on every computer there is.' I’ve done a rough budget and figure it’ll take about $425,000 to achieve this. I thought about writing a Business Plan but all my Silicon Valley friends say these are passé and not even serious investors read them any more. What’s your view?"Great timing… I have a friend who hates business plans also. He thinks planning is overrated and just a crutch. Let me tell you about his latest venture. He lives in Pawleys Island, South Carolina, not too far away from me. This September will be the 25th running of the Hurricane Hugo Rally from here to Market Street in San Francisco. Being a special year, the sponsors have arranged for the police to forgive any traffic tickets between here and there for five days. For safety reasons, travel is forbidden on any freeways or Interstates. The winners will have the shortest times in four different categories.
He's a great driver and has his eye on a rebuilt Cobra he can get for only $125,000. GPS systems are forbidden, but he's allowed on-board maps. However, he has such skill and a wonderful sense of direction that he doesn't ever need maps and doesn't plan to bring any. Also, the Cobra doesn’t have any spare parts available, but part of the real adventure here is that he needs to bring everything with him, onboard, including fuel, and then his “system” is sealed. He doesn't have much extra space.
That reminds me, I wonder if he's checked to see where he can store enough fuel.
Yes, four people died last year. The police said they were totally unprepared for such an event.
Since you two already seem “sympatico,” he said that he's going to offer you a 50% share for $75,000, and you’ll also drive the route with him. The first prize in his class is $200,000 that he’ll split with you. Please let me know this week as he has others that are interested.
Want to go along as an “investor”?
Now who would you want to invest in: my friend the race car driver with no planning, or any other driver who has planned for every contingency?
4. A VC Meeting
"I have an appointment for a meeting with a local VC next week. This will be the first time I have ever done anything like this and all I know is what I’ve seen on Shark Tank. Can you give me some tips on what to expect and how to behave?"Congratulations! You can assume they have some level of interest since VCs are very busy and waste as little time as possible. The first meeting is usually to feel out you and your people to determine if you are serious, rational and competent. Questions are usually “casual-personal,” trying to judge you. (Important: VCs are members of “The Club,” and if any of your people (or their relatives) are tied-in or related to power-structure holders, make sure the VCs know this.)
Most VCs have fancy offices. They have expensive tastes and they also like to impress visitors – not just entrepreneurs, but also those Limited Partners that invest in them. Fortuitously, the décor is totally unlike Shark Tank in every way. The two times I’ve managed to sit through part of this program, I could never stop thinking that this is farther from the “real-world” than any “documentary” style show I’ve ever seen. The basic set design reminds me of old Tyrone Power or Charlton Heston flicks where they appeared shackled at Inquisition before black-robed judges. The slightest deviation from normal meant burning at the stake.
And, unlike the TV show, VCs won’t invite their competitors nor are there any bidding sequences such as those for vintage Porsches.
Dress code varies widely. The best strategy is to ask. They will have three or four of their staff members also attend. It’s not unusual for one of these to be the designated VC-bastard/contrarian who’ll challenge you and your staff to see how you handle it and how easily he can make you “lose your cool” (if this happens it’s usually fatal).
You should have at least three people. A nice combination of talents is CEO/Financial, Technical/Manufacturing and Marketing/Sales. Practice two or three times before the meeting until you all say the same thing most of the time. Establish a “secret signal” to be used by the CEO which means “stop, smile, sit down and shut up.”
A “Deal Killer” Caution: squabbling in front of the VCs loses. You bring presentation materials and decide beforehand which of your group will present what part. Give copies to everyone.
My new book has an extended section on behavior at such meetings, including typical questions potential investors tend to ask. (See my web site: www.amerwld.com.)
This is a preliminary meeting. Make it through and you’ll be asked back for more details. Bomb and it’s the end of the line. The general rule is “don’t do anything stupid.”
If you have questions, comments or suggestions, send them along. (Click on the link at the end of this article, “Comment/Rate/Share” … or contact Dick at American World, dick@amerwld.com.) You’ll get an answer.
For more information, please visit Dick's TNNWC Bio.
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