Professor Raiton’s Inside Perspectives: Entrepreneurship, Creativity, Innovation

Infusionsoft CEO Clate Mask talks about the challenges he faced while raising capital late last year in this episode of The Deal’s Behind the Money online video show.

Infusionsoft, which makes marketing software for small businesses, began raising its Series B last fall, just as venture capitalists were waking up to the realities of the recession.

Nevertheless, Infusionsoft succeeded not only in raising a $7.9 million round but also in attracting a new investor in VSpring Capital, which led the round. VSpring managing director Scott Petty has joined Infusionsoft’s board. (Both Infusionsoft and VSpring are based in Salt Lake City.) Existing investor Mohr Davidow Ventures also participated in the round, which closed in December. Watch the video below or download it at iTunes.

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From  Nesheim Online 

People come with the money. That person is the investor. He will sit on your board of directors and direct you. He is your new boss. You will have to live with him for half a decade. So pick wisely.

If you pick family-friends-fools money, you will have to live with less-than-the-best investor professional. That can slow you down when they ask so many naïve business questions. But it may give you freedom from a heavy handed boss (the occasional ego-centric angel or arrogant venture capitalist).

If you pick an angel, you will live with a person expecting to often meet with you, give you advice that is expected to be followed, and dig into your business in minute detail. That may interfere with your time to execute your business plan. But it may give you the executive experience in your industry that you are missing.

If you pick a venture capitalist, you will live with a tough minded professional who expects to be in charge (“The person with the gold sets the rules.”). That may pressure you into making strategic moves you think are not wise. But it may give you connections to large customers, strategic partners and to a lot of precious cash.

You manage each type of investor in different ways. Family-friends-fools are best managed with regular (every two weeks will do wonders) email communications about progress (be honest about the bad things) and a phone call to each, one-on-one, every month. One person will attend monthly board meetings (but others will occasionally request to observe at a meeting).

Angels are managed by embracing their eagerness to jump into the business and help. They have less time than they think they have (“Ops, time to go fishing for three weeks for black marlin off the outer banks of Australia”). So make appointments, perhaps for a weekly in-person morning of work. Hand-on work is expected of you and the angel. Take full advantage of the time offered. Assign work tasks to the angel, just as you would a vice president. Angels are experienced business people, from successes in the past as outstanding managers. They can be of significant assistance if you manage them proactively.

VCs are hard ball professionals. They expect you to meet monthly at board meetings and tell them everything important. You manage them best with frequent communications between board meetings. Emails are used to ask questions (copy everyone on the board, including observers). Use ad hoc telephone conference calls (including everyone, just like in a full board meeting) to address an important issue that has popped up and to make a decision (“We need to decide on how to respond to attacks at our customers in Asia by XYXCorp whose sales reps are telling lies about us going bankrupt.”). If you do not manage the VCs, they will manage you. Give them homework and hold them accountable for results (e.g. the introduction to the VP of business development at Amazon).

VCs are optimists, just like you, the entrepreneur. So they promise more than they can deliver. Serial entrepreneurs know that means CEOs must do the heavy lifting. VCs will do their best to provide a few introductions to strategic partners, customers and other VCs as requested. Experienced CEOs will not lean on VCs because they know you cannot win a race running with crutches.

If  you  respect that a person comes with the money, then you will not be disappointed. You can then plan to manage your new enterprise to get the most out of that person.

From  Nesheim Online

In High Tech Startup, I explained the process of the fourteen steps entrepreneurs go through from idea to IPO.  In The Power of Unfair Advantage I elaborated on what the venture capitalists look for in presentations of business plans. To get your money, there is a special process that you go through. It involves the creation of that plan and presenting it until you get financed.Here are the steps in the process:

1.       Idea: come up with your starting point, the idea you will begin with.

2.       Management: attract your core team (CEO, VP Marketing & Business Development, VP Engineering).

3.       Business Plan: document your forty page business plan, create your PowerPoint presentation and executive summary.

4.       Research Investors: investigate the various sources (angels, friends-family-fools, venture firms, employers and so on). Choose your targets (long list of about twenty; start list of about six).

5.       Get introductions: find friends, professionals who know you, people you have worked with to make introductions to the investors. Do not go in cold or send emails.

6.       Present to The Partner: He will become your champion.

7.       Present to The Other Partner: He will try to shoot you down.

8.       Present to All the Partners: This takes three to six hours.

9.       Get a term sheet: a list of the terms for investing, including the price per share.

10.    Negotiate the term sheet: takes about thirty days of lawyers going at each other.

11.    Due diligence: an associate (grunt 24×7) will dig into everything you said and send (tons more) over thirty days.

12.    Close on the deal: get the money into the bank. Until you have the cash in your account, you do not have a deal done.

Plan on taking about 9 months from idea to cash in the bank. Yes, I said 9 months. The first three steps take about 3 months. Steps 4-6 take another 3 months. Plus the last steps take the other 3 months. So be prepared to be living on your savings for a good part of one year.

From mark@startupcfo.ca (startupcfo)

Marc Dangeard wrote an interesting post yesterday on the cost of VC$ vs. debt. He gave a clear and extreme example of a company that gave up a lot of equity only to go on and achieve a significant increase in value. Marc’s illustration clearly shows the dilution in value to existing shareholders that could have been saved if they had raised that money in debt.

VC funding has been and always will be the most expensive form of funding in the market. Still, I’m not sure the comparison with debt works as you often cannot choose one over the other. Especially when it comes to financing startups. Why?

1.) Unprofitable and small companies cannot usually access debt. Certainly not in the same amounts as they can with equity.

2.) Investors get in for one simple reason - to get out at a profit. Low valuations going in compensate for the risk that an investor may not get out for a long time if ever. Given the exit environment these days, it is very uncertain how investors will get their money + a return back.

3.) Loss of IP: If you don’t repay your debt, in the most extreme circumstance you can lose your whole business. IP is the most important asset a startup has and any smart lender will demand it as security.

The argument for selling part of your company of course is that it’s better to own a smaller % of something big vs. 100% of nothing. Still, you should not use equity to fund all your capital needs. As you get more mature (and profitable) debt should take on an increasing role since it is cheaper.

The only meaningful debt available to growth companies early on is venture debt. You can read more about that here.

From Entrepreneur.com

Asheesh Advani offers three tips for raising cash with a second round in mind.

I received an education about money during the last recession. I was raising money for my startup by stringing together a series of small investments from angel investors, friends and relatives. It was a tough slog, but I eventually assembled a group of investors and a board of directors. Not long after, an investor offered to make a sizable investment. But the share price he offered was lower than that paid by previous investors. I only had three months of cash in the bank and was desperate to accept, but the board turned down the offer. Despite my protests, I was back to the drawing board with 90 days to find an investor willing to pay a higher price. I eventually did find one, but only after two more years of stringing together small investments at incrementally higher share prices from angels, friends and relatives.

My story isn’t unusual; entrepreneurs who have raised money through private investors know shareholders will fight to avoid dilution. The interests of founders, new investors and shareholders often diverge between the first and second round of financing, particularly during recessions. Here’s how to raise your first round of financing with your second round in mind.

1. Use convertible debt, not stock. This allows you to raise money without setting a price per share. You can set a discount or a bonus for early investors by enabling them to convert the debt to stock at favorable terms when a larger investor comes along. This protects and rewards your early investors and allows you more flexibility and control. Setting a share price for selling stock to early investors is arbitrary and could paint you into a corner. I recall times when I was embarrassed to even mention offers from new investors to my older investors.
2. Set a fair price or an appropriate discount. The price you offer to early investors says a lot about your character. You want a high price because you’re confident about your business; meanwhile, you want to keep the price low to avoid taking advantage of your relatives, friends and other private investors by setting them up for future dilution and acrimonious investor relations. Somewhere between these two extremes is the right answer. Similarly, when setting a price discount for convertible stock, you can set it too high to attract investor dollars. In that case, future investors will think you’ve been too generous.
3. Communicate regularly. When you’re raising money, it becomes second nature to brag about your business. However, don’t let this affect how you communicate with shareholders. Rather than sending them only good news, send them updates on a regular schedule–annually at least, although I recommend quarterly. Even if your startup isn’t generating any revenue yet, tell them what you’re doing to move it forward. Sharing news consistently builds trust. You’ll need that trust when it’s time to raise your next round.

From The Startup Lawyer by Ryan Roberts

Selecting the optimal structure when raising capital for your startup can be a challenging task. When clients ask me for my recommendation, I find myself recommending the convertible debt financing route more often than traditional equity financing (i.e., I’ll give you $100k for 20% of your company’s stock).

So what is convertible debt?

Convertible debt financing is basically an investor loan to your startup that has a future conversion-to-equity feature. That is, your startup’s investor gives your startup a loan like a bank would, but the outstanding balance of this loan will convert to shares in your corporation at a future date.

When does convertible debt convert to equity?

Convertible debt typically converts to equity the next time your startup raises capital (think venture capital or similar large investor). Technically, this large raise is called a “qualified financing” per the convertible debt agreements (note and note purchase agreement).

How does convertible debt convert to equity?

Convertible debt converts to equity based on the valuation your startup receives from the venture capital firm in the “qualified financing.” For example, if your venture capital investor ends up paying $1 per share for your startup’s preferred stock and you have $800,000 of convertible debt, the investor will receive 800,000 shares of preferred stock. The loan will then be cancelled. (Note: Convertible debt often converts to preferred stock at a discount than what the venture capital investor pays for the preferred shares.)

So why do I recommend convertible debt so much?

Simple: It delays the valuation discussion. I see many founders struggle with their investors over a valuation to do a straight up cash-for-shares equity investment. And this struggle can last for months and eat up development time.

From Lightspeed Venture Partners Blog

It is difficult for startup companies to raise venture capital at the best of times. A venture capitalist might get emailed 5-10 pitches from startups each day. Over the course of a year that adds up to 2,500-5,000 pitches. Of those pitches, that venture capitalist might fund one or two companies. Not great odds for a startup. Granted, some of the other startups may raise funding from other venture capital firms, but even so, it’s a chancy proposition.

Recently, startups have been facing an even more difficult environment for raising capital. There are three factors that are contributing to this. Some of these factors will change in the short term, but others will likely continue to be a factor for a while. From longest to shortest then:

Angel financing has dried up. Often, when a company is too early to raise institutional venture capital it will raise money from angel investors - wealthy individuals. According to the Center for Venture Research, $26B was invested by angels in 2007, a marked increase compared to $15.7B in 2002. The precipitous drop in stock markets and housing markets since the beginning of the year has made many angel investors nervous about making new investments in risky and illiquid startups. Many angel investors will likely sit on the sidelines until we see a rise in stock markets and in consumer confidence. While the companies who raise angel financing would not likely have raised from venture capital firms anyway, a slowing down of angel financing will mean that less companies are ready for institutional venture capital in the next few years.

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By Javier Rojas, Venture Beat blog  

Times being what they are, it’s encouraging to know that some of the world’s leading public companies got to where they are without taking any early venture capital funding. That’s right, Microsoft, Dell, Cisco, Oracle, eBay — they all “bootstrapped” it.

Others, like Siebel Systems, Checkpoint Software, Broadcom and dozens of others, have followed their examples to success. The early years may have been challenging for the new execs forced to turn down paychecks. But they kept the faith that focusing more on customers and real revenues than market sizing and early valuations would someday pay off.

There are many compelling reasons for young companies seeking venture capital to turn to bootstrapping, even when they have other options. Not only might it be a safer way to go today, but it’s also a smart way to build a business.

How it works

When you decide to bootstrap, you commit to fund primary development and growth through internal cash flow from real-life customers. You — the founder — and a limited number of early employees may forgo paychecks for quite some time to make this work. But to keep that strategy to a minimum, it’s common for bootstrapping companies to turn to consulting engagements, non-recurring engineering contracts, value-added reseller agreements and projected supplier contracts. In short, “moonlighting.” These funds go toward initial growth and expansion until the company can stand on its own two feet.

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From Get Venture by Mark Davis

I recently attended a networking event with Jeff Stewart, one of the founders of both Mimeo and Monitor110 (two of our portfolio companies). Over the course of the event, I heard Jeff offer some advice to a group of younger entrepreneurs. I found one of his points to be very compelling and thought I would share it here.

Jeff argued that trying to raise money from venture capitalists early in the life of the company is a great idea. While he thought securing capital was important, however, the money wasn’t the reason he encouraged the young entrepreneurs to engage in the VC fundraising process. The benefits he cited were as follows:

• Enhance the plan: By pitching to VCs and getting feedback, an entrepreneur receives valuable feedback that helps him refine his business model, marketing strategy and other aspects of his plan.
• Make connections: While VCs don’t make introductions for every entrepreneur that they meet, Jeff argued that the entrepreneurs would likely be connected to important customers, partners and future members of their teams through the investment community.
• Learn how to pitch the company: By pitching early in the life of the company and pitching often, entrepreneurs learn how to sell their companies. From his perspective, selling in this way is not only important in fundraising, but is also critical for making key hires, securing partnerships and literally selling the company when the right buyer comes knocking.

Don’t spend precious resources wooing early-stage investors. First build your business, then seek funding that can help you grow

By Monica Mehta, BusinessWeek 

It’s the ongoing irony of early-stage investing: Just when your little-engine-that-could startup desperately needs funding, sophisticated investors have no interest in parting with their money. Not for a startup, not right now. But once your company has traction, customers, and revenue, those same investors are all over it. The timing couldn’t be worse…or could it be perfect?

Entrepreneurs need money the most in the beginning, when there are staffs to be hired, products to be developed, and customers to be acquired. But early-stage investors, from angels to venture capitalists, are not in the business of funding product development. That class of investor vaporized several years back, along with the IPO dreams of picklesandshoelaces.com.

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