1. Welcome to The Capital MatchPointTM “ Where Business Meets Capital.”
Our eBook, How to Raise Money for Your Business: 75 Years of Raising
Capital: How we did it and what you need to know, contains easy to read
vignettes of information on a wide range of topics in a conversational format
taken from years of trial and error and now we’ll share these experiences with
you!
As the principals of NuQuest, Inc., and owners and developers of The Capital
MatchPointTM web portal, we have over 75 years of experience in entrepreneurship,
corporate finance and I’ve personally started a public company from scratch and exited at a
multiple of profitably. We’ve been principals of Wall Street brokerage firms, have
demonstrable investment banking backgrounds, we’ve come up through the ranks of
Fortune 500 companies and are serial entrepreneurs in our own right raising millions of
dollars from the private and public sectors.
We welcome you to use this eBook for its intended purposes…you’ll find a video section to
almost every topic. Click on the links and take the video tutorial with the NuQuest, Inc. / The
Capital MatchPoint’sTM principals presenting in layman’s terms with a big touch of
professional advice on the topics you need to be a success.
Is your company further down the road, more mature and looking to raise further rounds of
financing? Do you find that running your company and having to locate capital and position
it to do so is a three headed monster? We can help…our AVSTM Consulting Platform
may be the answer. Our winning Assessment, Valuation and Structure consulting model
will help you get “investor ready” for the Capital MatchPointTM investment corps.
Let us share our vast experience with you in what I’m sure you’ll find to be a compelling,
insightful and above all, useful tool in your search to make your company the best it can be,
how to position it for funding and above all, how to locate it!
Regards,
R.K. (Ken) Honeyman
President, CEO
NuQuest Inc.
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2. How to Raise Money for Your Business:
75 Years of Raising Capital- How we did it and
what you need to know…
By
R. K. (Ken) Honeyman
Dave Dambro
&
Mark N. Bass
© 2009 by NuQuest, Inc. and The Capital Matchpoint™. All rights reserved.
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3. TABLE OF CONTENTS
PART I The Basics of Capital Formation ......................................................... 4
1. Need Capital To Start Your Business? ................................................................ 4
2. True Cost of Raising Money…Are You Really Ready for This? ............ 5
3. Stages of Financing........................................................................................... 6
4. 50 of the Worst Business Mistakes You Can Make .................................. 8
5. Raising Capital: Prepare a Cogent Business Plan ........................................... 12
6. Elements of A Good Business Plan For Capital Funding ................................ 13
7. The Most Valuable Secrets to Raising Capital…Use These! ................ 14
8. Top Eight Tips On Raising Angel Financing Today ............................. 18
9. Raising Capital – Create a Business Plan: Another 10 Point Process! ......... 20
10. The 3-Minute Review: What Are Investors Looking For?................................. 21
11. How do I Raise Capital in this Economy?.......................................................... 23
12. Should I Seek the Assistance of Professionals when Raising Capital?......... 24
13. Which is Best: Debt or Equity Funding? ........................................................... 25
14. When Seeking Capital, How Much Money Should Be Raised? ....................... 26
PART II Practical Advice…Putting it All Together ......................................... 28
15. What Not to Tell the Investors When Seeking Capital Funding ....................... 28
16. What TO Tell the Investor When Seeking Funding ........................................... 29
17. Investors Perception of Your Team When Seeking Capital Funding .............. 31
18. Know the Investor When Seeking Capital Funding .......................................... 33
19. Negotiations with Investors when Seeking Capital Funding ........................... 34
20. What Does It Mean If Turned Down When Seeking Capital Funding? ............ 36
PART III The Financials: Make or Break Time................................................... 37
21. Business Plans and Pro-Forma Financial Statements .......................... 37
22. Complete Set of Financial Statements ....................................................... 39
23. Debt Financing vs. Equity Financing…Which is Best for Us? ............ 40
24. Income Statement and Investor’s Interpretation ..................................... 41
25. Cost Categories – Cost of Goods Sold (COGS) and Overhead ........... 42
26. Gross Margin ..................................................................................................... 43
27. Balance Sheet and Investors Interpretation ............................................. 44
28. Statement of Cash Flow and Investors Interpretation ........................... 45
29. EBITDA – What does it mean? Why is it important? ............................. 47
30. Burn Rate ........................................................................................................... 48
31. Ratio Analysis of Financial Information..................................................... 49
32. Price to Earnings Ratio .................................................................................. 50
33. Return on Investment ..................................................................................... 51
34. Valuation and Pricing...................................................................................... 52
35. Investor Considerations When Valuing Your Company........................ 53
36. Considerations When Negotiating with Investors .................................. 55
37. Financial Statements That Will Stand up to Investor Scrutiny ............ 56
38. Term Sheets ...................................................................................................... 58
Summary .................................................................................................................... 59
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4. PART I The Basics of Capital Formation
1. Need Capital To Start Your Business?
The investors at the Capital MatchPoint want to see a number of things,
but the thing that they want to see the most is the business plan. Your
business plan creates so many opportunities for you, not only as a funding
source, but as a road map for your own success.
So, you started a new business. I say congratulations to that, but you have
to create a written business plan which is actually the next logical step in
that process. Smart entrepreneurs plan, not because accountants and
financial people tell them to, but because they understand it increases their
chances for success.
There are successful people out there who have flown by the seat of their
pants, and they probably succeeded despite a lack of a written business
plan. But how much better would they have been if they would of had one
that really made a lot of good sense?
I tell the entrepreneurs that come to our site, look, business plans are used
for two main reasons. You can plan for the future, create a road map, or
establish your business credentials so you can get funding for yourself and
use that as a really good tool to hand off to an investor when they want to
see what you're all about.
The guts of your business plan are so important. So, if you're just starting
out in business, your written business plan can help organize every
thought. It can put everything into context. A well-established business, on
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5. the other hand, trying to grow can use the business plan as a modeling
tool to examine various options before committing to any particular one.
Your business plan should be treated as the most important document
you’ll ever produce, you’ll need it and so will investors…
2. True Cost of Raising Money…Are You Really Ready for
This?
One expense that entrepreneurs almost always overlook is the cost of
raising money. Most feel it will only cost their time and that of their key
managers. Granted, it will cost at least this amount and then some, make
that a lot.
Consider the following…..
Do you know how to write a good business plan? Most entrepreneurs
know that they need a business plan but lack the time or skill-set or both to
write one that is thoughtful and complete. Generally speaking, a good
business plan takes at least a month to write from scratch, longer if your
business is larger or more complex. Having this work done will cost from
$5,000 to upwards of $30,000 depending on the amount of work involved.
Advisors – are you a one man or woman show? Or, does you
management collectively have the competencies necessary to raise capital
and formulate the tactics necessary for your business plans success. If
not, you may want to consider retaining advisors. The successful
entrepreneur is on who recognizes their own strengths and weaknesses
and surrounds themselves with people whose strengths and weaknesses
are complimentary.
Advisors will generally want to paid in cash for a short term introductory
period. That way, they have something in exchange for their time if the
relationship doesn’t work out. Going forward, you can most likely work-out
a cash and stock compensation plan. At any rate, you should plan on
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6. spending $7,500 - $10,000 for advisors over a three month period
depending on how many you hire and the demands your company puts on
their time.
Marketing your business – Think of the countless color copies of your
business plan that you will be mailing to potential investors. Also, consider
how much it will cost you in travel to present to investor groups and the
fees associated with presenting at investor forums. For a six to twelve
month process you should count on $15,000 on the low expense, short
time frame end and up as time goes on an expenses go up.
Legal and accounting fees – Unless you’re an attorney and your partner is
a CPA these fees are unavoidable. You’ll spend money organizing your
company and setting up the correct legal and financial structure. And, if
you have intellectual property to protect you’ll want to do that up front in
way of patents, trademarks or copyrights before going forward. It’s hard to
say how much you will spend because it is so dependent upon individual
situations. But, you should plan on spending at least $5,000 or
substantially more if there is intellectual property to protect.
All in all, for a process taking six months to a year you should anticipate
spending upwards of $30,000 on the low end.
3. Stages of Financing
We have the opportunity to meet a lot of entrepreneurs at different funding
stages in their life cycle. One thing that I’ve found is that it is important that
you communicate to investors which stage you’re in and, if possible, how
many rounds of funding you anticipate before exit. You can bet the
investor will form their own opinions, but it is important that you, as an
entrepreneur, give this serious consideration and show the investor that
you have done so. It will go a long way in establishing credibility. Let’s
talk briefly about the different stages of financing.
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7. Think of investment needs as a time line with milestones highlighted at
different points, much like you would see in a history book. The first stage
of funding, called seed funding is at or very near the beginning of the time
line. This is when money is spent on activities such as technical
development, market research or in securing intellectual property rights.
Basically, it is money spent evaluating potential viability and preparing for
the commencement of operations. Many times this money comes from the
entrepreneur’s own personal savings or from investments from family or
close friends. Institutional investors such as venture capital firms or angel
investors usually see this stage of development as too risky.
The next stage of investment comes when the company needs money to
get operations off the ground. This is known as start-up financing. The
start-up financing stage is usually characterized by the business’ first
revenues that fall short of supporting positive cash flow, hence the need for
a capital infusion to fund operations until revenues are sufficient to sustain
operations on their own. Sometimes start-up financing is dubbed series A
financing, referring to the first outside capital brought into the company.
Once the business is on firm footing, there will come a time when more
money is needed to support continue growth. This money may be used for
things such as refining marketing efforts, hiring additional management
and staff or new product launches. This round of financing is called
second round or series B financing. Sometimes companies have a seed
round of funding followed by series A and series B rounds of funding then
proceed to a sale or public offering.
The last stage of financing with the general purpose of preparing the
company for a profitable sale of IPO is called mezzanine financing.
Mezzanine financing is generally some combination of debt and equity
than can lower a company’s overall cost of capital.
Funding stages can take on many different forms depending on the
business and market in which it participates. At some point when cash
flow is positive companies may elect to take on a revolving line of credit
backed by working capital, to support operations or some companies may
choose to move on to subsequent rounds of series C and D financing
before exit.
Whatever your funding strategy, remember that each stage will require a
valuation of your company and that too much funding will lead to dilution of
the founder’s stake.
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8. 3. 50 of the Worst Business Mistakes You Can Make
While starting a business can be advantageous and quite prosperous for a
great number of people, there are a variety of business mistakes that new
entrepreneurs can make. Some of these common business mistakes are
repairable, while others are truly detrimental to the health of a company
and can spell certain death. Here are the top 50 most common business
mistakes, divided into five primary categories as they apply to business.
A. Planning Errors
1. No Sound Business Idea: Without a sound idea, how will you
develop your business plan? Without a plan, how will you develop
a successful business idea?
2. No Business Plan: Your business plan is the core of your
business. Without a solid business plan, there is no way that you
will ever be able to turn your business into a successful operation.
3. No Market Research: Market research will determine the viability
for your product or brand. If you don’t know your market do you
really know your business?
4. Poor Timing: There is a right time to start a new business, and a
wrong time. If you roll out your business when the market is not
ready for it, you may fail before you ever even get off the ground.
5. Poor Location: Location is everything for many businesses.
Choosing your location is one of the most important decisions that
you make when planning a business.
6. Poor Choice of Suppliers: The quality of the products and
supplies that you offer is vital to the success of your business.
7. Underestimating the Competition: Every business and every
concept has competition. If you do not recognize it, you are
missing something important. Identify your competition before you
launch your business.
8. Choosing the Wrong Type of Business: Sole proprietorship,
partnership, LLC? Choosing the right business form is vital.
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9. 9. Failing to Seek Advice: It is important that you turn to successful
people for advice in the planning process of your business;
otherwise you will not be successful.
10. No Financial Preparedness: Simply put: If you’re not financially
ready to launch your business, prepare to crash and burn.
B. Personality Problems
1. Not Mentally Strong: A certain attitude is required of successful
entrepreneurs. Do you have what it takes to lead rather than to be
lead?
2. Inability to Analyze: Successful entrepreneurs need an analytical
spirit. Can you be analytical and even a little bit critical in order to
guarantee business success?
3. Inability to Self Critique: As a business owner, you need to be
willing to self critique. A business owner who is not critical of his or
her self is an unsuccessful one.
4. Lack of Desire: You have to be passionate about your industry,
niche or business in order to succeed. Do you lack desire for your
business? Then you are destined to fail.
5. Low Motivation: Just like desire, motivation is critical for business
success. If you are lacking motivation, perhaps you are in the
wrong business. Get motivated or get another job.
6. Over Confidence in Expansion: While expanding may be a
necessary part of business, if you become over confident in your
ability to expand, your business will surely flop.
7. Making Rash Assumptions: If you walk into your business
making assumptions, you will have trouble acting on real
information.
8. Failing to Take Responsibility: When you are an entrepreneur,
you have to accept responsibility for failures in your business; you
cannot simply shirk them off onto someone else’s shoulders.
9. Procrastination: If you procrastinate, or are lazy, or otherwise
simply cannot get things done, you are NOT suited for
entrepreneurship.
10. Overzealousness: Your business will not go from 0 to 60 on day
one. You need to be prepared for a slow battle, and shoot for “slow
and steady” business growth.
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10. C. Financial Mistakes
1. Not Having Enough Savings: Finances are obviously a large part
of owning and operating a business. If you are not prepared
financially, you will sink.
2. Poor Credit Rating: You will run across situations where loans
and other assistance is required, but if your credit is destroyed,
your business too will fall apart.
3. Overspending: Overspending without any thinking or researching
can have a serious negative impact on your financials.
4. Poor Budgeting: Budgeting is a vital part of running a business
smoothly, so make sure yours is good! Poor budgeting will prevent
you from getting a handle on your finances.
5. Unrealistic Targets: If your financial targets are unrealistically
high and you continue not to meet them, your business will never
succeed.
6. No Organization: When it comes to financials, organizing is
absolutely vital. Keep yourself organized and keep your financials
in order and you will succeed.
7. Dishonesty: To yourself or to your employees, dishonesty can
destroy the financial standing of a business.
8. Taxes: Pay your taxes as often as you can. Work out a basic plan,
stick to it and always be honest about your taxes if you want to
prosper.
9. Deductions: If you want to save money every year, do your
deductions right and get some money back each year.
10. Set Goals: Your business needs to have clear cut goals if you
want to climb from the red to the black.
D. Advertising Blunders
1. Misuse of PPC Ads: Using Pay Per Click, (PPC), correctly is an
art. Master PPC advertising or your business will initially languish
until you build organic traffic.
2. Poorly Performing Offline Ad Inventory: If your ads are
performing poorly, you are throwing good money after bad.
3. Poor Word of Mouth: Word of mouth is actually a powerful
marketing tool. What are you doing to spread the name of your
business?
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11. 4. Choosing the Wrong Advertising Medium: Advertising is
everything. Choose the right medium or your business may flop.
Hard.
5. Overspending in Advertising: Stick to a budget when you pay for
advertising. Do not go over your budget no matter what.
6. No Tracking: If you can’t track advertising progress, you’re doing
something really wrong.
7. Poor Branding: Is your brand memorable? If not, you’re doing
something terribly wrong.
8. Bad Name: Your name is half of your branding. Can your
customers remember your name?
9. No Business Cards: Carry business cards at all time and be
prepared to pass them out at all times.
10. Poor Business Cards: Forget cheap business cards. Buy nice,
legible and attractive cards.
E. Networking & Human Resources
1. Insularity: Detaching yourself from the people around you is an
excellent way to destroy your business.
2. Unwillingness to Talk & Share With Competitors: Networking is
a powerful part of business. If you fail to network effectively, you
will surely crash and burn.
3. Poor recruits: Pay close attention to who you recruit and hire.
Look for employees that will stay for the long term.
4. Badmouthing Competitors: You don’t have to like your
competitors, but you do have to cooperate with them.
5. No Benefits: Offering benefits to your staff is the best way to keep
them around. If you don’t offer any incentives, they will go on to
bigger and better things.
6. Staying Informed: Stay informed with what is current in your
industry, or your competitors may pass you by.
7. Keep Things Fair: Keep things fair with your competitors. Don’t
steal ideas or products. Respect one another even if you are
competing.
8. Cold Calling: Cold calling is not the answer to networking. Meet
your contacts in person first.
9. Getting too personal: Getting to know your networking contacts is
a great way to spread the good word, but getting too personal can
be a deal killer.
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12. 10. Drinking at social events: Just because there is alcohol where
you’re networking, that does not mean that you should drink! Stay
sober.
5. Raising Capital: Prepare a Cogent Business Plan
Now you know what NOT to do!! So you’ve answered those breathless
questions with a high degree of certainty and you’re ready for the next
step. Let’s go...what next?
A lot of people come in to the Capital Match Point offices with a game plan.
It's not so much a business plan. It's a game plan. Our investors want to
see your business plan.
You’ll have to create a business plan as your next logical step in this whole
evolution. Smart entrepreneurs plan not because their accountants tell
them or because their financial people say it's a must.
Sure, there are successful business owners out there who had no
business plan, and they stumbled along and certainly made some money
for themselves, and that's great. But I will tell you that 98% of people that
walk in our doors have to have a very cogent business plan. You have to
plan for your future. You need to create a road map for your success.
What do you really want to get out of your business plan? It may help
establish your business credentials for financing purposes.
So, if you're just starting out in business, the business plan is going to help you
organize every piece of the puzzle, and it's going to come together to make your
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13. business grow and be a success, hopefully. Your well-established business plan
is going to grow your business. If you're a larger company, it could take a
“business-as-usual” rut and turn it right around.
6. Elements of A Good Business Plan For Capital Funding
The phone rings at the Capital MatchPointTM, and inevitably, it's one of the
capital seekers, and one of the most frequently asked questions almost on
a daily business is about their business plan. There seems to be a lot of
anxiety... is it long enough? Is it good enough? Does it contain the
information that the investors want to see and does it really tell the story?
From my 30 years of experience and knowing what our investors want to
see, plan on spending between 80 to perhaps 200 hours on your business
plan. A word of caution: don't try to make it perfect. It will never happen.
So, don't try to make it so.
Let's condense this into the simplest terms. The basics: How long should
your plan be? What I like to see and what our investors like to see is
between 25 and 30 pages. No more and certainly no less. You have to
tell the story. And if you have to ask yourself who needs a business plan,
then don't plan on getting funding.
Types of plans: Mini-plans, working plans, financing plans, presentation
plans.
The contents? The Executive summary, business description, your market
strategies, your competitive analysis, how you're going to develop your
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14. business, operations, management, and of course, above all, the financial
components.
Above all, they have to be very specific and get to the point. I've seen
hundreds and hundreds of business plans over the years, and the ones
that grab me are the ones that tell the story quickly and succinctly.
Remember, its quality not quantity.
7. The Most Valuable Secrets to Raising Capital…Use These!
Should raising money in today’s economic climate be the equivalent of
“pulling teeth?” NO! We know. We’ve been on both sides of the fence,
as entrepreneurs raising money and as professional investors. We have
used our experience and built the Capital MatchPointTM to address this
daunting task and make it easy for the capital seeker and capital provider
to come together with common goals. That’s just the first, all important
step…to get you in front of the right investors who’ll look at your deal.
Here are 10 valuable secrets as you plunge headlong down the path
of raising capital that you MUST consider…
SECRET #:1 Who are you dealing with?
Every capital provider, be they an angel, venture capitalist, private equity
firm, or your favorite crazy, rich uncle, has their own set of investment
guidelines they follow when making investments. You should learn as
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15. much as you can about the people you will be asking to become a part of
your company. In today’s internet age everyone has a website. Visit the
on-line home to potential investors to learn about them and their
investment strategies. They will do the same to you. Typical rules include
geographic focus, investment stage preference, lead/follow-on investor,
minimum and maximum investment amount, industry focus and board
seat requirements. Make sure that the strategy of the firms you are
targeting match your funding needs. Use the Capital MatchPointTM to
automate this exercise.
SECRET #2: Get personal
If you’re cold calling, stop the insanity! It just doesn’t work. You’ll hear
the expression, “Deals thrown over the transom,” more than once. It
means someone just tosses their business plan over the door hoping
someone finds it, reads it, falls in love with it and funds it. We built the
Capital MatchPointTM to eliminate this practice by selecting quality
business opportunities and matching them with quality investors. Capital
providers are looking for good investments and tend to prioritize personal
introductions.
SECRET #3: Get to the point, will you?
You’ve secured your first meeting with the person with the money.
Hooray! Now, get right to the point. Time is money and if you’ve gotten
this far, don’t waste their time or yours. I’ve sat through countless
meetings with a capital seeker looking for money; they usually have a
great idea or concept, but can’t articulate it and loses me in minutia. Be
crisp. Be clear on what you do, who buys your products, how you make
money, and how you plan to grow. Keep presentations under 12 slides
and executive summaries under 2 pages.
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16. SECRET #4: Is your team the right team?
Does your founding team have the passion you do, or does cousin Eddie
think he can help because he has knows someone who knows someone?
If you don’t have people on board that have the unique combination of
experience, passion and who are smarter than you, it’s going to be a
tough grind. You don’t have to have a complete executive team, that’s
what the new money is for. Be flexible and be willing to listen and give up
some portion of the deal to the capital seekers…and don’t think they’re
interested in giving you a simple loan and you’ll pay them back when it
gets huge, that’s for rookies. One of my old mentors, the late, and very
great Hy Federman used to say, “Money is honey, use the company’s
paper as wampum for trade. Never be afraid to give up equity for cash.”
It’s true.
SECRET #5: I’m different…I really am!
If you don’t know who your competition is and why you’re better than they
are, at least after funding, then save the trip. Everyone has competitors.
Those that say they have no competitors are not believable. Directly
present yours and the measurable difference your product or service
offers. Identify them, don’t be afraid of them, and make your deal better
than theirs. After all they were there first and can be picked apart for
weaknesses.
SECRET #6: The ROI
What is your value proposition to the customer? How does your business
save time or money or both? What is the cost to the customer of not
using your product or service? Show the investor how darn valuable your
product or service is to the market you address.
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17. SECRET #7: The real market size may not be as big as you think
Who exactly are your customers and what is the real market you are
serving? Don’t be expansive. Be realistic. What is the exact size of the
addressable market of purchasers of your product or service? Don’t use
“fuzzy math”. If you tell the capital provider “if we capture 1 zillionth of
1% of the market we’ll make billions!” your credibility will be called into
question. The people with the money have resources necessary to
corroborate or refute your claims. After all they have the money for a
reason.
SECRET #8: Know your numbers!
How will your company spend the money and how does this all come
together to break even and make a profit? Explain the key business
drivers such as number of customers, sales per customer, cost per
customer etc. Show a bottom-up analysis of how many customers you
need to hit your numbers. Be prepared to discuss what you would do with
more money and how you could make it with less, which is usually what
the capital provider wants to know.
SECRET #9: Tell me how I exit
These days, the public exit strategy is dead, and I mean DEAD! Don’t
even go there. Assume the only way for your investors to realize a return
(what this is really all about) is an acquisition of this wonderful business
you are going to create. Provide tangible examples of recent and related
acquisitions by at least three different categories of potential acquirers
(suppliers, distributors, competitors). Be prepared to cite five companies
in each category to show that there are plenty of viable of exit options.
Oh, and don’t forget to tell the investor the time line to harvest his reward.
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18. SECRET #10: Valuations come last
Valuations for start ups and early stage deals are virtually worthless, so
don’t get too excited. If there is virtually no operating history and financial
data is spotty, be realistic. DO NOT use the words “it’s based on
conservative numbers”. Early stage valuations are subjective, so get
over it. Your first round of investors will probably own 30%-50% of the
business.
Keep these 10 points in mind when you set out to build your business plan,
build your company and seek the capital you need to forward it.
8. Top Eight Tips On Raising Angel Financing Today
Here are the eight things companies need to do in this altered financing
environment to survive and raise angel funding:
1. BOOTSTRAP Companies must pinch every dollar, when possible.
Get individual contributors to work for free, pay upon performance
and do everything you can that does not cost real money. Work from
home, barter, use stock, and look for services and/or consulting
revenue to help build the product.
2. HAVE A FOCUSED LAUNCH STRATEGY - This means ONLY
ONE market niche as the initial target. Startups need to be a small
fish in a small pond.
3. BE PREPARED TO DELIVER ANY SIZE PITCH – It amazes me
how many companies still can’t state what their company does in a
few clear sentences! If you cannot articulate your deal confidently
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19. 4. Cash Breakeven in 6-12 months maximum - Today it is required.
Tune your plan to get to cash breakeven in 6-12 months on no more
than $1 million!
5. A FINANCIAL BUFFER - I recommend a year's worth of personal
expenses in the bank.
6. CORPORATE PAPERWORK - You need to get your "corporate"
house in order with written agreements on ownership sharing. If
these are not clean you can scare off investors who want to take a
closer look.
7. NETWORK AND LEARN - Attend many entrepreneurial workshops
regularly. This helps you to learn how to run business models in your
head better and see how investors react to holes in plans etc.
8. GET A MENTOR - You cannot afford to learn by trial and error here.
Typically, you need someone available for at least two to four hours
every week to review all major decisions. This will be the best time
and money you will ever spend. An hour or two a month will save
you tens or even hundreds of thousands of dollars in errors, can
generate sales faster, and will get you to critical milestones months
earlier.
Doing all these things can increase your chances of building a successful
company and getting angel financing from one in a thousand to as high as
50%. There are few guarantees in life, but hang this list on the wall and
review it every month and I guarantee you will improve your chances
greatly.
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20. 9. Raising Capital – Create a Business Plan: Another 10 Point
Process!
You know you need to write a business plan, so let's talk about actually
writing it. Here are the guts of a great business plan. I've got ten points
here that I'd really like you to follow and pay close attention to. Yes,
another 10 pointer!
#1 Decide why you're writing the plan. Are you raising money?
Probably. Are you clarifying your future? Certainly. Launching a new
venture? Figure it out quickly.
#2 Get the big picture. Prepare an outline then visit The Capital Match
Point’s online resource library. There's over 750 sites dedicated to this
alone.
#3 Grab everything that's already handy. Consider marketing pieces,
press releases, anything that you think is important. Websites, notes that
you've accumulated over time are great fodder.
#4 Just start. Start typing thoughts, ideas, questions, words, and to-dos
in each section of your business plan and place your thoughts in the most
appropriate section.
#5 Prepare a rough draft. Take your brainstormed ideas and shape
them into a useable draft.
#6 Now it's research time. Compile information and research to support
your claims and assertions.
20

21. #7 Start thinking about your numbers. At this point, you can make
assumptions and develop a form of financial statement. If you start any
sooner your numbers will be fantasy.
#8 Write a final draft and finish the numbers. If one of our investors
sees an error, you lose credibility almost instantly. Double and triple your
writing for grammatical and spelling errors and certainly your financials,
please.
#9 Set a deadline. Set a deadline you can't ignore.
#10 Finally, polish your plan to perfection. Get critical comments from
readers. Not your husband, wife, business partner, significant other. Go to
the source. Lastly, prepare an executive summary that encapsulates the
highlights of your entire plan and places it up front.
Congratulations, you're now the proud owner of an excellent business plan
and ready to present it to the investment community.
10. The 3-Minute Review: What Are Investors Looking For?
Having sat on both sides of the desk as an investor over the past 25 years
and as a capital seeker as well, I could tell you, during that three-minute
review I talk about, there’s some eye catchers that are going to pop out at
you and really grab your attention and those are the deals that are going in
the to-do file. Here’s what generally pops out during that review.
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22. First of all, I think patents. If you see a patent, you generally know you got
something there that nobody else has. It’s worth taking a look at.
Trademarks are pretty good, too.
Additionally, we like to see capital invested personally, call it “skin in the
game.” We want to see management teams that have a personal stake in
the business and believe enough in it to put their own money behind it
before they come and ask the capital provider to add to that.
Management? This is a huge category for us. Executive summaries
reveal gems and big names and experience. Companies need pedigrees.
Milestones achieved. It’s good to look at a company and see, have they
made it to their stated goals so far? That’s a good indication of how
they’re going to handle the capital infusion you’re thinking about providing
for the investor.
The value of the idea, or the product, or the service in a monetized basis.
In other words, what’s the market for that idea, product, or service look
like? Is it a multi-billion dollar market or is it just niche? A couple million
here and there is a big difference.
Growing market demand versus shrinking market demand. This one’s
pretty obvious. Everybody wants to get in on the ground floor.
Revenue growth year over year…we always take a look back and see
what they did last year or the same quarter and look for the trend. You’ll
want to see that trend line steadily up. If you see it spiking up, it’s even
better.
Strategic partnerships are also very, very important. Who is this company
aligned with? Who is supporting the business model and enhancing it as
well?
22

23. Lastly, intellectual property which is a little esoteric, but nonetheless it can
be valuable. It can be booked as an asset, and it is something to take a
second look at.
These are the things that really catch the eye of the investor. If you’ve got
some of those things in your business plan, during the three-minute
review, they’ll pop out.
11. How do I Raise Capital in this Economy?
I’m frequently asked this question from our entrepreneurs, “How do I raise
capital given this economy?” There’s a lot of anxiety surrounding it, so I
think you want to be aware that it’s true. IPOs were down 85% through the
years 2007 and 2008. And now, in 2009, it appears that the well has dried
up completely. But don’t despair. There are options. Even though the
banks have pretty much cut back their lending, and investment bankers
are sitting on the sidelines, there will always be entrepreneurs. In fact,
there are more entrepreneurs created in times of economic crisis than
usual.
I'll give you a perfect example. Top-level executive loses his job. Has a
highly skilled position. Has some savings. He’s got a great idea, and he’s
always wanted to be in business for himself. There, you’ve got an
entrepreneur being born. On the other side of the coin, there’s always the
investors. There are professional investors that run just like any other
company, and they are in the business of providing capital.
23

24. The dis-connect is occurring in the deal flow. So, how do you access the
deal flow as an investor? As an entrepreneur or a capital seeker, how do
you get in front of the investor directly? If you don’t have a strategy, it’s
like shooting an elephant with a BB gun.
What you need to do is develop a strategy. You need to be able to
package and provide your deal criteria and capital requirements, convey
those to a targeted audience of capital providers, and one of the ways that
you can do that really efficiently now is through a capital network website.
The Capital Match Point is a perfect example.
One of the benefits in going that route is that you’ve got a captive audience
of investors that are professional investors. They are interested in your
industry, your stage of business where ever it might be: start-up, early
stage, later stage and they’ve got the capital level that you’re looking for.
12. Should I Seek the Assistance of Professionals when Raising
Capital?
I'm often asked, should I go it alone when it comes to funding, or should I
seek the assistance of a professional? I think the best way to answer that
is ask yourself a couple of questions. I've got four in particular that you
need to keep in mind.
First of all, do you have limited contacts? You're probably great at the
business that you are engaged in, but you do not want to call your friend
24

25. the lawyer, or your buddy the accountant, and see who they know who
raises money for your company.
Number two, you are probably strapped for time if you're running a
business, and let's face it, time is a precious resource, treat it like one.
Number three, you've got to ask yourself, do you have the experience? If
you haven't been down the road of funding a company before while
running it, you probably want to seek the advice of a pro.
Lastly, you want to keep in mind this one, raising capital is a two headed
monster. You've got to ask yourself the question, am I capable of running
this company effectively and efficiently while raising capital? I typically
recommend help... the right help. Get back to the business of running your
business!
13. Which is Best: Debt or Equity Funding?
I get this question a lot, which is right for our company, debt or equity?
There are two really distinct types of financing and you need to understand
the benefits and the implications of each.
Debt is an infusion of capital into your company. The expectation is that
there will be a periodic re-payment, in the form of principal plus interest.
The end result is the ROI for our investor, or the return on investment.
25

26. A good example of debt funding would be loans or bonds. There are some
pluses and minuses. The biggest one for debt is that you don’t have to
give up ownership. The down side is you must have sufficient and reliable
cash flows and collateral to back it. It is really not a good option for most
new companies.
Let’s take a look at equity. Equity is an infusion of capital in exchange for
stock representing ownership in the company. Common examples would
be: a common stock, a preferred stock, warrants, which are the right to buy
the stock at a future date at a given price. The positives here are you have
an infusion of cash and no debt service attached to it. The downside is
this really is a high price, or high cost of financing. You may ask the
question, well why is that? Equity investors take on a high degree of risk,
and their expectations are for a higher ROI.
14. When Seeking Capital, How Much Money Should Be Raised?
I think it's instructive to try and get in the investor's head and find out how
much an entrepreneur really needs to raise, and I want to talk about the
actual amount of capital that's considered being raised and what our
investors really look for.
First of all, the amount of money being raised is a pretty good indicator of
how much the entrepreneur thinks the company is really worth. The thing I
find most interesting is how the company arrived at that number. What our
funding sources want to know is where they're going to spend the money.
Can they do it for less? What would they do if they had more money?
26

27. Secondly, the question is, “How much money should be raised?” The right
amount of money to bring into a company is enough to reach sufficient
milestones, if they raise more money to a higher price at a future date. If
all goes well, the money invested will be used to drive all sorts of risks out
of the business. Will it be used to take the company to cash flow positive?
Will it be used to pay down debt? If they don't know exactly what they're
capital needs are or they raise too much money early on, they could be
selling off too much of the company for too little capital.
Third, if too little money is raised, the company may run out before the
business is proven enough sufficiently to raise additional capital. In other
words, raising too little money can be fatal.
Fourth, companies should leverage early stage venture money to drive up
the value of the company, so the next time the company fundraises they'll
be able to bring in larger amounts of money while suffering smaller
amounts of dilution, which is very important for management teams.
Unfortunately, the perfect amount of money to be raised is not always
obvious, and the question of why is the company raising the amount of
money it's raising is really important.
27

28. PART II Practical Advice…Putting it All Together
15. What Not to Tell the Investors When Seeking Capital Funding
When in front of a potential investor, the question is, how does an
entrepreneur establish credibility?
What the capital seekers say to our investors may make or break their
funding. I think the easiest way to understand of what to tell these people
is really what not to tell them. With over 30 years of hearing these phrases
or some semblance of them have driven me and capital providers to see
caution flags that instantly appear. Keep these phrases out of the
conversation!
Don't tell me our projections are conservative. Entrepreneur projections
are never conservative. If they were, they'd be zero. Or, "the market will
be $50-billion in 2010." The magnitude is just not logical in this economic
environment.
Here's another nugget we hear. "HugeCo is going to sign our purchase
order next week." This line is trying to show the capital provider there is
some attraction beneath their heel. Ultimately, nine times out of ten, the
purchase order won't be signed until the next week or the week after or the
next year if ever.
Employees. That's a favorite turn-off. "Key employees are set to join us
as soon as we get funded." Well, my question is, why would an executive
leave a $250,000 a year job to join a start up? That's not going to happen
in this economy.
28

29. Here's another one to close the door behind you quickly. "No one else is
doing what we're doing." Either there isn't a market or you're incapable of
finding your competition on the web. Or, "We have a proven management
team." Just because your bio says you have a proven team means
nothing to us. Surround yourself with reputable directors and advisors and
step aside when necessary.
"Patents make our product defensible." Mentioning patents should be
talked about one time in the presentation and that's it. Saying you have a
deed filed for patents for what you're doing is enough. Filing back up
patents is a defense of a hole through your presentation.
And the best of the best is, "Hurry, because several other funding sources
are interested." Creating a sense of scarcity is simply stupid. There are
very few people who actually have multiple firms chasing them in this
economic climate.
16. What TO Tell the Investor When Seeking Funding
You know what not to tell the investor…so let’s talk about what you tell
them to get that much closer to the “holy grail” of a solid funding. At the
Capital Match PointTM, we've distilled our best advice in what we call the
winning pitch. There are ten components to this, and I'll go through each
one of them.
29

30. #1 Target the pitch. The Capital MatchPointTM actually takes the guess
work out of that equation because the person who has interest is the
person who talks to the capital seeker.
#2 This is simple: be on time. Or better yet, be early. Capital sources
usually have a hard stop. They only have so much time for anybody.
#3 Don't overwhelm the money provider. The goal at the first meeting
is not to get all the money at the first time. Don't try to cram six or seven
meetings into one meeting. Pique their curiosity but don't abuse their
attention span.
#4 Know your audience. Try and find out in advance who is going to be
at the meeting and spend some time learning about them at their site and
find out who's actually going to be in that room when you're there.
#5 Get to the point fast, and I mean really fast. Funding sources sit
through presentation after presentation. That's their livelihood. So, it's
easy for them to lose interest if a presentation doesn't get to that point
quickly. Here's a little bit secret sauce. To get their attention, answer this:
what problem is my company solving? Tell them up front. They'll listen.
Trust me, they'll listen.
#6 Use analogies. Use bold ideas to present new concepts. Draw an
analogy from an unrelated product. For instance: Facebook for the Rich.
podcasting for cell phones, or eBay meets CNN.
#7 Power Points. Over kill or under fill? How many slides to get the
message out? My answer is the baker's dozen. Five minutes per slide
makes the case. By the way, don't read it to them. They can read it for
themselves. Tell them your story.
#8 Know what you don't know and admit it. This is very critical. Our
investors don't expect entrepreneurs to know everything. Be upfront about
30

31. it if you make a mistake. If you don't know the answer, do three things.
One, admit it. Two, make a note of that question and after the meeting,
follow up, find out, and get back to that person. Do not, and I repeat, do
not fake it with an evasive, oblique, or indirect attempt at an answer. Our
investors want to know that they can trust the entrepreneur.
#9 Competition. Know who they are and what not to tell the capital
provider. What not to tell them. Don't ever say the dreaded words, "We
have no competition." That's a death warrant. Capital providers know that
it's rare for any company to have no competition whatsoever. They'll know
that you haven't done enough homework on your deal, and the company is
going to be sort of lacking, and it's probably not worth backing either.
#10 Control the meeting. Don't spend too much time on a particular
point or line of questioning. Politely but firmly move on, follow up, and set
a meeting to satisfy their concerns.
17. Investors Perception of Your Management Team When Seeking
Capital Funding
We've been talking about entrepreneurs so far and what their needs and
realities are, and what I'd like to do is talk a little bit about the other side:
investors and what their perception is, particularly when it relates to
management teams, and how important is the management team? That's
a great question, and if you think investors only invest in great deals and
leave everything else on the sidelines, well, think again.
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32. The management team is probably one of the most important components
of the deal. The team is going to figure very prominently in any investor’s
decision to fund the company especially if the track record is thin. The
history of the management team may be the only solid, understandable
piece of information available to the potential investor.
Businesses must be able to succeed in the face of a lot of different
challenges and rapidly changing conditions. Experience gives the
potential investor comfort that the management team can spot issues and
challenges and are flexible and skilled enough to deal with those as things
develop.
Integrity and commitment are also a part of that. Investors want to see a
high level of work ethic on the part of management and certainly to see
that they have enough skin in the game.
Charisma in a management team is great, but too much can get in the
way. Our investors want key players to have egos that are big enough to
get the job done but not so big that the individual can't be a team player
and can't accept advice, and this is a real sticky point with a lot of smaller
companies. If our investors suspect that management is too arrogant or
egocentric to accept advice, the prospects of the investment being made
are going to be very minimal.
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33. 18. Know the Investor When Seeking Capital Funding
So, the investor has just dragged you through the due diligence knothole.
What about the veracity of the investment team? When a company needs
our investors, we want them to be ready. You might say, "For what?" Do
your homework on them just as they do homework on you.
Due diligence really is a two way street. If you only think it's a one way
street when you talk to a capital provider, I'd like you to examine how you
can evaluate the funding source themselves. At the same time your
business plan is under a microscope, you should be assessing the
prospective funding source's strengths and weaknesses. Consider the
following questions:
 How well does the firm know your industry?
 How often does it work with companies that are in a development
stage similar to yours?
 What assistance can the investor bring to you in terms of
management expertise, industry contacts, or support services?
 What's the reputation of the firm in the investment community? I
 If the firm is going to serve as the lead investor, then how effective
will they be in helping to attract additional co-investors?
 Has the firm asked for any special reward or compensation for
serving as a lead investor?
 What effect this will have on the willingness of other co-investors to
participate?
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34.  Will this firm be able to participate in later rounds of financing if the
company continues to grow and needs additional capital?
To answer these questions, you speak with the owners and managers of
other companies in the investor's portfolio. Determine their level of
support, conflict, communication. Be sure you talk to both successful and
unsuccessful portfolio companies.
Remember, this is not a “me against the world” scenario. You deserve to
know who you're getting involved with too.
19. Negotiations with Investors when Seeking Capital Funding
So, you found an investor that is willing to hear what your company can do
and how it will make everyone rich beyond their wildest dreams.
Let's talk about actually structuring and negotiating the deal. The fun really
is just starting. Now comes the negotiating and the harrowing process of
really doing the deal and making everyone happy. The need to strike a
balance between investment and investment acceptance is critical. Keep
a few things in mind as we go down this path. The company's concerns
and the investor's concerns that really need to be pointed out here.
As far as the company is concerned there's going to be loss of
management control, dilution of personal stock, repurchase of personal
stock in the event of employment termination. How about adequate
financing? Security interests being taken, key assets of the company.
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35. What of future capital requirements and dilution of the founder's
ownership? And intangible and tangible indirect benefits of our investor's
participation, such as access to key industry contacts and future rounds of
capital?
Our investors' main concerns…let's talk about some of theirs. Their level
of risk. projected levels on return of investment. Liquidity. Protection of
the firm's ability to participate in future rounds of funding. Influence and
control over management strategy and decision making. Registration
rights in the event of a public offering and rights to first refusal to provide
future financing. For both parties, how about retention of key members of
the management team? A resolution of conflicts, financial strength of the
company post investment, and certainly tax ramifications of the proposed
investment.
Negotiations have to have ample time to be studied. Legal advice is first
and foremost, and I beg you to get great quality securities attorney's
working for you. Don't be foolish and try to negotiate this alone. Legal
fees are meant to be spent here where it counts for the future of the
company.
These considerations can be overwhelming and you may think the deal will
never get closed…it will, so be prepared to answer these and have a very
good understanding of the terminology and the motivations as you
progress.
35

36. 20. What Does It Mean If You Are Turned Down When Seeking
Capital Funding?
When a capital source really says no, what does that mean? Let's learn
something from this. I tell the entrepreneur, you've had a number of face
to face meetings with funding sources, and they turned the deal down, and
that's tough. Let's debrief a little bit about what's happened and what they
probably told you.
Let me give you an insider’s look and decipher what they've said to the
entrepreneur when he gets turned down. Hey, we've all been turned down
by financing before, and I think it's instructive to know, but more valuable
as a learning tool when these standard push backs occur. They're telling
you something, so let's be prepared. I think it's time to read the lines
between the standard phrases they get back to you on.
They say, "I liked your company, but my partners didn't." In other words,
no. if this person truly believed in the project, he'd vouch for you and get
this thing going.
If they say, "If you get funding or a lead investor, we'll follow." And what
that really means is, once your first round of financing is completed by
someone else, we'd be happy to give you more, but let someone else take
the risk.
They say, "Show us some more traction, and we'll invest." What that really
means is, “I don't want to say no, because you may land a large customer
in the interim. But right now, I just don't believe in it.”
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37. They say, "We'd love to co-invest with other VC's or other angels." What it
really means is, if your deal was worthy of a VC, they'd want it all for
themselves.
When they say, "We love early stage investing." What that probably
means is a VC's dream is to put one to two million dollars in a pre-money
company and winding up owning 33% of the next Google. VC's aren't that
risky. They only want to invest in proven teams with proven technology in
a proven market.
So, there you have it. We've heard it all before. These are typical
responses when they say no. So, be prepared to hear any of these and
take it with a grain of salt.
There's always an investor to fund any deal. We just don't want a capital
seeker to shut down after the first one or two turn downs. We can help re-
purpose the deal and adjust it and turn that "no" into a "yes."
PART III The Financials: Make or Break Time
21. Business Plans and Pro-Forma Financial Statements
Let’s start off this vital part of any capital formation strategy and talk about
the building block of your company, its telltale value and how well the
company is doing…by its financials.
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38. Entrepreneurs seeking funding and preparing business plans frequently
ask me to explain the concept of pro forma financial statements. It’s a very
important concept and is a critical part of any business plan.
Pro-forma financial statements put your vision for your company into
language private investors to understand: dollars and cents. Pro-forma, in
this context, is another word for forward looking. Therefore, pro-forma
financials state the financial results that your business plan is expected to
generate. This includes a complete set of financial statements which are a
balance sheet, income statement and statement of cash flow, and looks
out three to five years.
Generally speaking, the first year, when assumptions are more clearly
defined, financials are expressed on a monthly basis and the remaining
years on a quarterly basis.
Making assumptions about your business and market place is perhaps the
most important part of assembling pro-forma financials. Investors
generally give more credibility to “bottoms up” assumptions as opposed to
“tops down”. An example of a “tops down” assumption is estimating a
market size at say $200 million and assuming that your company will get
5% market share for annual sales of $10 million. A more credible “bottoms
up” approach would be to assume that you will initially hire five sales
people who will each realistically call on two clients per day, close 30%
and make annual sales, on average, of $2 million for a total of $10 million
in annual revenue.
Macroeconomic assumptions are also a very important element in
assembling pro forma financial statements. When seeking funding the
entrepreneur must demonstrate a firm grasp of how the larger economic
environment will impact their business. For instance, is your business
sensitive to changes in energy prices? If so, then what are your
assumptions about the coming months and years? Will your business be
impacted by changes in the housing market? If so, then what do you think
about the near to intermediate term housing market?
When analyzing your business plan investors will realize that your pro-
forma financial statements are based on assumptions and will discount
accordingly. However, it is important to show potential investors that you
have given careful consideration to the real forces that drive your business.
The confidence you inspire will go a long way in establishing credibility.
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39. 22. Complete Set of Financial Statements
Let’s talk briefly about financial statements in general. Financial
statements express your company in the language investors speak, dollars
and cents. A complete set of financial statements consists of three
individual statements necessary to give an investor a comprehensive
picture of your company from a financial perspective. Specifically these
statements are a Balance Sheet, Income Statement and Statement of
Cash Flow.
The Balance Sheet is a snapshot of your company’s financial position at a
given point in time. It is expressed in terms of assets such as cash,
receivables and physical items owned by the company, liabilities, or money
owed by the company against those assets and stockholder’s equity which
represents the initial investment by owners and any past profits that have
been retained in the business.
The Income Statement measures the success of your company’s operation
over a period of time by comparing revenue, money generated from the
sale of goods or services, with the expenses associated with providing
those goods and services. The difference between the two is called net
income, earnings or profit. The ability to consistently generate profit is the
ultimate indicator of your company’s viability.
The Statement of Cash Flow describes the changes in the cash your
company has on hand over a given period of time. It is simply a
comparison of actual disbursements and actual receipts. This is of
particular interest to investors, especially in start-up and early stage
companies, as they wish to see if companies have sufficient receipts of
cash to support continued operation and plans for growth.
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40. Financial statements can be compiled on a historical basis to give a view
of your companies past performance or on a pro-forma, or forward looking
basis, to give a financial picture of where you want to take your company.
Investors are generally interested in seeing both. Prepare to speak the
investor’s language, if you’re not strong in this part of your game, bring in
the professional and don’t try to go it alone.
23. Debt Financing vs. Equity Financing…Which is Best for
Us?
A common question is, “What type of capital structure is best for my
company?” The answer to that question is individually dependent upon
your company, its stage of development and its needs. In the broadest
sense there a two types of financing, debt financing and equity financing.
Let’s take just a minute to consider the broad implications of both.
Debt financing is the infusion of capital by an investor in exchange for an
agreement or repayment and interest over a specified period of time. Debt
is usually backed by collateral and subject to other restrictions the investor
may impose to secure their position. Common examples of debt capital
are loans and the issuance of bonds. Debt may be an attractive means of
securing capital for your company because you are not required to give up
equity in exchange for the infusion.
However, carrying debt on your balance sheet requires that you have
sufficient cash flow to make periodic interest payments, projected
resources to pay off principal at the time of maturity and collateral
necessary for securitization. Debt financing is many times not an option
for early stage companies because of lack of positive cash flow. An
exception could be debt put in place alongside owner’s cash for the
purchase price of hard assets, such as plant equipment or real estate,
that’s liquidation price would be sufficient to cover the amount of the loan
Equity financing is the infusion of capital by an investor in exchange for
stock in the company. Equity issued to investors in exchange for cash can
40

41. take many forms such as common stock, preferred stock or warrants.
Common equity investments are those made by venture capital funds,
angel funds and hedge funds. Whatever the agreement structure, equity
investors expect a return in the form of dividends and appreciated stock
value at the time of a company sale or public offering.
Equity financing may be attractive because it allows for an infusion of
capital into your company without the immediate cash obligations
associated with debt service. Additionally, bringing in equity investors
means that you’re bringing in new owners and possibly new board
members which may a change in the corporate culture. Many times these
new owners are experienced businesspeople in their own right and can
offer management valuable insight and perspective as your company
grows and changes.
While equity financing does not make significant demands on cash flow,
except when dividends are paid, it can come at a high price. Equity
investors take on a lot of risk when investing in your company at an early
state but generally reap handsome returns on their investment at the time
of company sale or public offerings.
24. Income Statement and Investor’s Interpretation
Let’s take a minute to talk about your company’s income statement. The income
statement, by determining profit, measures the success of your company’s
operation over a given period of time. Plainly put, the ability to consistently
generate profits is the ultimate indicator of your company’s viability.
The income statement is divided into two sections, revenue, the money
generated from the sale of goods and services, and expenses, the money it costs
you to generate those goods and services. The dollar difference between these
two sections is called net income, earnings or profit.
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42. Revenue and expenses are generally divided into sub-categories so that
investors can more easily understand how businesses generate revenue and
incur expenses. For example, if your company generates revenue by selling
products and providing services it is a good idea to show an investor how much
revenue comes from each source.
Likewise, expenses are generally incurred in two ways, those directly associated
with providing goods or services such as raw materials or labor, generally
referred to as direct costs, and those associated with supporting operations such
as rent and management salaries, typically referred to as indirect costs. The
sum of all direct costs is referred to as cost of goods sold, sometimes called
COGS for short. The sum of all indirect costs is typically referred to as overhead.
An investor will want to see your income statement broken down into the
appropriate revenue and cost categories so that they can determine your gross
margin, revenue less cost of goods sold, and understand how much of that is
required to support overhead before delivering a return in the form of profit.
25. Cost Categories – Cost of Goods Sold (COGS) and
Overhead
Let’s take a few minutes to discuss two major cost categories from the
perspective of an income statement, cost of goods sold, sometimes called
COGS, and overhead. When an investor is reviewing your historical and
pro-forma income statements they will want to understand which costs are
necessary to provide the product or service you sell and which cost
support your business from an administrative standpoint.
Cost of goods sold, many times called COGS for short, is the sum of all
costs directly associated with the product or service your company
provides. This could be items such as raw materials and labor for a
manufacturer, the cost of inventory for a retailer or cost of delivering web
based services for a technology company. Cost of goods sold is
important to an investor because subtracting this number from revenue
allows them to determine how much raw value, if you will, your product
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43. creates (called gross margin) and how much your company can afford to
spend on overhead and still generate an acceptable return.
Overhead, sometimes called indirect costs, is the sum of all costs of doing
business not directly associated with providing the goods and services
your company sells. This could range from accounting costs to legal costs
to insurance to rent to salaries for management. It is important for an
investor to understand overhead so that they can determine how much
cost can be curtailed in times of slumping sales or falling prices without
compromising the base function of delivering goods and services.
A detailed understanding of cost is important for investor and manager
alike so that your business can perform most efficiently and maximize
return by continually eliminating excesses.
26. Gross Margin
Gross margin is actually a very important financial metric derived from the
income statement. Conceptually, gross margin is the amount of money
your company would make if it only incurred costs directly associated with
making and selling the product in absence of the cost of all overhead, such
as rent, insurance, professional fees and management salaries that are
required to support your business.
Gross margin is calculated by taking revenue and subtracting those costs
directly associated with making and selling the product, cumulatively
known as cost of goods sold. The resulting number, gross margin, is the
amount of money your company has left over to cover overhead and
generate a return for private investors. This is important to investors
because it helps them to ascertain your company’s ability to continue to
generate a return in the event that sales are less than expected or
overhead costs are higher than expected.
Therefore, the answer is yes, you should clearly highlight gross margin in
the financial portion of your business plan. This will show a sophisticated
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44. venture capitalist, angel or other investor that you have a detailed
understanding of your company’s cost behavior.
27. Balance Sheet and Investors Interpretation
One question that frequently arises among entrepreneurs when seeking
capital for their business is “how will investors interpret the financial
statements that I provide in my business plan?” It’s a good question and
something every entrepreneur should understand when dealing with
investors, whether they be angels, venture capital, hedge funds private
investors or any other source of funds. Let’s talk briefly about the balance
sheet.
The balance sheet is a snapshot, if you will, of your company’s financial
position at a given point in time. It is expressed in terms of assets such as
cash, receivables and physical items owned by the company, liabilities, or
money owed by the company against those assets and stockholder’s
equity which represents the initial investment by owners and any past
profits that have been retained in the business.
The balance sheet is aptly named because the assets of must equal the
sum total of liabilities and stockholders’ equity. Said another way, a
company’s assets less its liabilities is the stockholder’s equity in the
company. Obviously, this is a very important indicator a company’s overall
value to an investor.
An investor that is considering funding your company will look to the
balance sheet to get an indication of your company’s financial strength.
The investor will look at assets to see what your company owns. Large
amounts of cash and marketable securities, sometimes called liquid assets
or current assets, are attractive as they give a positive indication of the
ability to meet near term obligations. Other assets such as intellectual
property and brand names could also be attractive because the potential to
monetize those assets is sometimes substantially more than the value
reflected on the balance sheet. Large amounts of goodwill, or the amount
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45. you may have paid for your company above its book value, relative to total
assets could be a red flag due to its intangibility and illiquid nature.
A view of your company’s liabilities gives an investor a picture of leverage,
the amount of debt your company is carrying relative to your company’s
net worth. In other words, if the company were forced to liquidate could it
pay all of its bills and have something left over for them? A close
examination of your company’s liabilities will also give the investor an
indication of how much cash will be required to meet near term obligations
and, by comparing to assets, your company’s ability to meet those
obligations.
In addition to telling a potential investor how much equity the owners have
in your company the stockholder’s equity section of your balance sheet will
also give an investor insight as to how much money has already been
injected into your company, the number of outstanding shares in your
company’s stock and your company’s use of earnings. The line entitled
additional paid in capital and shares outstanding lines plainly tell an
investor how much capital has been put into your company and how much
stock you had to issue in return for this capital. The retained earnings line
will tell an investor how much of past earnings you have retained in the
company. A historical analysis of the retained earnings account will also
give an investor hints regarding dividends.
28. Statement of Cash Flow and Investors Interpretation
The statement of cash flow describes the changes in the cash your
company has on hand over a given period of time. It is simply a
comparison of actual disbursements and actual receipts. This is of
particular interest to investors, especially in start-up and early stage
companies, as they wish to see if companies have sufficient receipts of
cash to support continued operation and plans for growth.
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46. The statement of cash flow has three sub-sections, cash generated or
consumed by operating activities, cash generated or consumed by
investing activities and cash generated or consumed by financing
activities. The operating activities portion of the statement of cash flows
converts net income from an accrual basis of accounting to a cash basis.
For example, depreciation and amortization are recognized as expenses
on the income statement but they do not require cash payments.
Therefore, these charges are added back to net income for the purposes
of calculating cash flow.
If your company makes sales to customers on credit you recognize this as
revenue on the income statement. However, you do not recognize that
sale on the statement of cash flows until the payment is actually received.
Likewise, when you purchase materials from vendors on credit you do not
recognize that purchase on the statement of cash flows until you pay the
bill.
The investing activities portion of the reports the disbursement or receipts
of cash for purchasing or selling long term investments and property and
equipment. The financing portion of the statement of cash flow reports
money received in exchange for stock in your company, money spent in
re-purchasing stock in your company and money disbursed in the form of
dividends.
While the income statement is the measure of your company’s operational
success and the ultimate arbiter of viability, it can sometimes be
misleading, depending on accounting policies and the timing of certain
activities. The statement of cash flow leaves less room for gray areas by
summarizing the flow, in and out, of something that is easy to understand,
cold hard cash. It gives a very clear picture of your company’s ability to
meet obligations and sustain operations. That’s why investors depend so
heavily on the statement of cash flow as a companion to the income
statement.
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47. 29. EBITDA – What does it mean? Why is it important?
I can’t tell you the number of times I’ve been asked “what is EBITDA?”
The next question is almost invariably “why is it so important?” When
talking with potential investors, entrepreneurs quickly become familiar with
the term, even if they’ve never heard it before.
EBITDA is actually an acronym for Earnings Before Interest, Taxes,
Depreciation and Amortization. Among investors, it is the measure of
choice of a company’s ability to generate earnings. Why, you may ask?
Are interest, taxes, depreciation and amortization not legitimate expenses?
Indeed, they are legitimate expenses. And, before you say it, yes interest
and taxes are uses of cash. However, interest, taxes, depreciation and
amortization are structural expenses, not operational expenses.
When an angel fund or venture capital fund, or any investor for that matter,
is considering a large infusion of capital into your company they are
assuming that there will be structural changes that will impact items such
as the tax structure and debt profile. Therefore, an investor is more
interested in your company from the standpoint of its ability to generate
earnings from operations. This, in turn, allows an investor to make an
“apples-to-apples” comparison of companies in which they are considering
for investment. EBITDA is also a widely used measure by investors when
valuing companies. Many times a company’s valuation is a multiple of its
EBITDA
.
EBITDA is also a good internal metric for companies when evaluating the
performance of operational personnel because it expresses company
performance within the limits of these employees’ control. Although it may
be tempting, it is important, however, not to use EBITDA as a short-cut to
measuring operational cash flow. Remember, it still an income statement
and, as a result, subject to the interpretation of accounting rules and
policies.
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48. 30. Burn Rate
A frequent topic: “What is my burn rate?” Investors frequently talk about
potential target companies in terms of their burn rate. When funding start-
up companies, investors try and determine the potential target’s burn rate.
Burn rate is the rate at which a company will use its capital to finance
operations before generating positive cash flow. It is usually expressed on
a monthly or quarterly basis and is a measure of how fast a company will
use up its cash.
For example, a company with a burn rate of $1 million per month will
exhaust $12 million in capital in one year, obviously. Burn rate is
synonymous with negative cash flow. This is of importance to investors
because it helps them to determine if a company will sufficiently capitalized
with their investment and how long their investment allows the company to
operate before becoming cash flow positive. If an investor feels that their
capital infusion is not enough to sustain operations for a long enough
period, they will naturally assume that your company will require more
financing in the future.
When burn rate is more than anticipated or sales are less than anticipated,
companies usually respond by reducing burn rate, which generally means
cutting expenses associated with overhead. Accordingly, investors will
look at your company from the standpoint of being able to reduce burn rate
in the event that actual performance does not meet expectations. For
early stage companies cash is king.
Managing cash is one of the most important duties of an entrepreneur.
Cash required for growing sales usually precede the receipts of cash from
those sales. The lack of cash diverts management attention away from
running the business and can disrupt operations as bills become more
difficult to pay. Therefore, the sophisticated investor will take a very close
look at a company’s burn rate, the underlying assumptions and the ability
to reduce burn in the event of sluggish sales.
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49. 31. Ratio Analysis of Financial Information
Entrepreneurs seeking capital from investors frequently find that the
financial projections they provide are broken down and analyzed using
ratios. Every investor has their own idea of what is important and what
ratios best reflect that aspect of performance. Many times the task of
keeping up with these and understanding them proves tedious and time
consuming for an entrepreneur that has a business to run. I advise
entrepreneurs faced with sorting out this type of information to think of
ratios in five broad categories.
First of all there is profitability ratios. This category includes ratios such as
return on equity, return on assets, earnings per share, return on sales and,
In short these ratios express net income in terms of a percentage when
divided by a chosen return criteria.
Next there are solvency ratios. These help an investor determine the
ability of your company to meet near term financial obligations. The most
popular solvency ratio is called the quick ratio which is the sum total of
your cash, marketable securities and accounts receivable (from your
balance sheet) divided by current liabilities (also from your balance sheet
and typically defined as obligations due within 30 days).
Activity ratios give investors a sense as to how fast assets turnover within
your company. This also gives important insight into cash flow. For
example, receivables turnover (credit sales divided by average accounts
receivable) calculates the rate at which receivables are collected. A higher
number indicates that you are collecting receivables more quickly and are
hence bringing cash into the company more frequently. Likewise inventory
turnover (COGS divided by average inventory) give an investor a sense of
how efficiently inventory is being managed. A high inventory turnover
means that product is being sold much sooner after hitting the warehouse
and hence turning into cash more quickly than a product that lags in
inventory before being sold.
Capitalization ratios such as financial leverage (Return on Investment –
Return on Assets) and debt to equity gives investor a sense of importance
of debt and equity in your company’s capital structure.
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50. Market ratios are very important to investors as they will ultimately play a
part in the value an investor places on your company and the amount of
stock they will require in exchange for investment. Two very important
market ratios that companies seeking capital should understand are price
to earnings and return on investment
32. Price to Earnings Ratio
Price to earnings is the ratio of it a company’s stock price to its after tax
earnings per share of stock outstanding for the most recently reported
twelve months. For example, if Company A’s stock price is $20, its
earnings for the most recently reported twelve month period is $2 million
and there are one million shares of stock outstanding then Company A’s
price to earnings ratio is 10, $20 divided by $2 earnings per share.
Price to earnings ratio of publicly traded companies in similar industries as
yours is important to investors because it will give the investment a sense
of what your company will be worth when sales and earnings are at a
sufficient level for exit via sale or public offering. Once the investor is
comfortable with this, he or she can consider how long they believe it will
take your company to achieve sales and earnings necessary to support a
profitable sale or public offering, compare against their required return on
investment and arrive at a number of shares in your company that they will
require in exchange for funding.
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51. 33. Return on Investment
Do you know what is most likely of chief concern for any investor when
looking to fund a company? It’s their return on investment, also called ROI
for short.
ROI is the return an investor receives on the money that they invest in a
company. It is expressed as a compound annual rate in terms of a
percentage. By knowing what ROI they require for a particular investment
the investor can then take a company’s business plan and financials, make
projections about a company’s growth and profitability and future valuation
to determine how much stock they will need in a company in order to
achieve their ROI objective.
Different investors have different requirements. But according to Clint
Richardson, in his book entitled Growth Company Guide 4.0, that in times
of an economy supporting prime interest rates of 10% or lower investors
generally require greater than 35% ROI for seed or start-up investment,
20-50% for first or second stage and 15-30% for third stage and
mezzanine investment. The amount of time an investor feels it will take to
exit via sale or public offering will also factor into how much stock they will
require in exchange for investment.
For example, an investor who gets three times their investment in three
years will realize an ROI of approximately 44% while the same multiple in
five years will reduce ROI to 25%. So, the investor in this case will require
significantly less stock in exchange for capital if he or she feels an exit can
be achieved in three years as opposed to five.
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52. 34. Valuation and Pricing
A question that I always ask an entrepreneur is, “What do you think your
company is worth?” The answer usually comes back very vague or maybe
just simply, “I don’t know.”
When seeking capital funding it’s very important to have a fact based,
analytical sense of what your company is worth. After all, if you’re seeking
equity financing you will be giving up a negotiated portion of your company
in exchange for cash.
Admittedly, valuation is almost just as much art as science and everyone
has their own way of doing it. Also, it’s very dependent on assumptions
and how realistic you or an investor believes those assumptions to be. It is
also important to remember that an investor is going to be most interested
in the value of your company at the time of exit via sale or public offering.
You should conduct your analysis similarly.
There are several methods of valuing your company. Among them are
price to earnings, discounted cash flow, price to sales. When determining
the value of your company I recommend that you take all three methods
and see if the results are convergent. If they are and the assumptions you
made are reasonable and defendable you’re probably on the right track.
Let’s talk briefly about the methods we mentioned.
Price to earnings (P/E) is a ratio of the value of a company’s stock to its
after tax earnings. For instance, if a company’s stock sells for $20 per
share and its earnings for the most recent year is $2 per share then the
price to earnings ratio 10. In order to value your company using this
method you will need to gather market data about the price to earnings
ratios of publicly traded companies in your industry and make some
assumptions about stock market performance at the time of your planned
exit.
Price to sales is very similar to price to earnings except that it expresses
the value of a company’s stock relative to its sales revenue. Let’s say that
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53. our company whose stock price is $20 per share had sales in its most
recent year of $20 per share. Its price to sales ratio is one. Like price to
earnings, this method will require gathering market data about the price to
sales ratios of publicly traded companies in your industry and make some
assumptions about stock market performance at the time of your planned
exit.
The discounted cash flow approach is different to price to earnings and
price to sales in that it does not estimate company value by comparison
with publicly traded companies. This method measures the cash flows at
various points in the future and discounts them to the present and then
sums them to arrive at a valuation.
35. Investor Considerations When Valuing Your Company
The question that is probably at the top of the list for every entrepreneur
seeking funding is this: “How much of my company will I have to give up to
get my desired level of funding?” The unfortunate answer is, “It depends.”
Investors consider many different factors and each investor knows what is
important to them and what is not. That said there are some general
questions that investors ask themselves when considering funding. Some
examples are:
 How attainable are the goals set forth in the company’s business
plan? Sophisticated investors are sophisticated analysts. If they
think there are items in your business plan that are unrealistic, they
will normalize them to something they’re more comfortable with.
 When will the company be able to go public or secure a buyer at an
attractive price? The longer an investor has to wait for exit, or
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54.  What will the appetite be like for IPOs when the company is ready to
go public? A bullish stock market will support IPOs at higher price
to earnings ratios thereby raising the value of your company and
reducing the amount of equity an investor will require in return for
their funding.
 Will the company need more money before exit?
 How much does key management have invested in the company? If
management has a significant amount of their own money in the
company the investor will assume that management is committed to
success.
 How much of the initial investment will we get back if the company
fails?
 How will my investment be structured? I f an investor puts all of their
money into stock as opposed to a less risky instrument, then the
price of investment will go up.
Once investors answer questions such as these, they will then begin to
make adjustments to your business plan and consider their risk
accordingly. It’s all about managing their risk and you need to be realistic
in the actual value of your company to attract the real investors to fund
your deal before they’ll get excited enough to move.
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55. 36. Considerations When Negotiating with Investors
If you’re an entrepreneur seeking funding for your company and you’ve
gotten to the point of receiving a funding proposal from an investor,
congratulations. Now that you’ve got it you may be asking yourself, “How
do I analyze the proposal and negotiate?”
The most powerful negotiating tool is other investment proposals. Outside
of this there are other valid points for discussion that may lower the price of
investment (the amount of stock you give up for a given amount of
investment money). They generally center around and investors’
assumption versus your assumptions. You may want to consider:
 The return on investment the investor expects – Is this realistic and
in line with rate generally accepted in your industry
 What is the investor’s valuation of your company at the time of exit?
How does this compare with your valuation? It’s safe to assume that
your valuation will be higher. But is it higher by a few percentage
points or a factor of ten?
 What did the investor use as a price to earnings ratio? Did the
investor choose the low end in a down market? Does the investor
believe that the market will be down at the time of exit?
 When did the investor assume the company will be acquired or go
public? Are these in lines with your expectations? Again, the
investors assumption will be more conservative than yours but is it
overly conservative?
 Get a feel for the investor’s perception of downside risk and why
they feel this way. Is there something of which you are aware but
the investor is not that may reduce this risk?
Obviously, to ask these questions and engage the investor in a reasonable
and thoughtful dialog management must have conducted their own
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56. thorough analysis up front and have defendable arguments of their own.
Doing this will produce a more compelling offering and just may attract
multiple investment proposals and give your company the most powerful
negotiating tool of all, another offer.
37. Financial Statements That Will Stand up to Investor
Scrutiny
Past experience in helping entrepreneurs prepare financial statements for
business plans has taught me that one of the most important factors in
getting an investor’s attention is the perceived credibility of your financials.
To make sure you pass this “litmus test” consider the following when
compiling your financial information for the fund raising process.
1. Have a complete set of financials – This includes the balance sheet,
income statement and statement of cash flow. The composite view
of these three statements will give an investor important insight into
your company. A missing piece will leave some gaping holes and
call matters into question that might otherwise not be an issue.
2. Look forward three years – The first year, when assumptions are
more clear, should be expressed monthly. Years two and three
should be expressed quarterly.
3. Include historical financials – Try and go back at least one year.
This may be a stretch for a very early stage company but the effort
should be made to get credible information as far back as you can.
This will allow the investor to make a fluid transition from your
company’s past performance to that you expect. This also a good
check for you before submitting your financials to investors. Ask
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57. 4. Make sure your financials and your business plan “hang together”.
For example, if your business plan shows moderate sales growth
and calls for the addition of labor but your financials show
exponentially increasing revenue and no increases in cost the
investor will immediately raise a red flag.
5. Dot your i’s and cross your t’s. – Remember, Investors look at a lot
of business plans and have very little time to allocate to any
individual plan. That’s why it is important that the little things are
buttoned up. For instance, assets must equal the sum of liabilities
and stockholder’s equity on your balance sheet, the income
statement must be categorized correctly with a clear differentiation
between cost of goods sold and overhead and the cash balances on
the statement of cash flow must match those reported on the
balance sheet. If an investor detects errors such as these they will,
at very best, assume a lack of attention to detail and probably move
on to the next plan.
Compiling financials that will stand up to investor scrutiny is no easy task.
It requires a lot of thought and attention but it’s worth the time an effort.
Remember, your financials put your vision for your business into the
language investors understand, dollars and cents.
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