There are many varieties of entrepreneurs: those who become a franchisee, those who start a professional service firm, those who open a retail outlet, and on and on. However, my world revolves around those I label the company-formation entrepreneurs; they have a BIG idea and want to create a thriving company around it – most of the time to sell it for a bundle of cash.
To reach this objective they almost always need outside funding, and the amount can be well into seven or even eight figures. So my company-formation entrepreneurs have to understand the ‘art of the ask’. Although it has progressed from the “Buddy can you spare a dime?” quote of the Great Depression, you’re still asking for cash. Of course our Depression area person was asking for charity and returning nothing, while our entrepreneur is playing Solomon and ‘slicing up his child’ (i.e. giving away equity in his company) in return for a projected bundle of cash for all the owners!
Unless you’ve been through it before, the ‘rules of the game’ can be daunting and may cause you to use up a chunk of your life and a lot of your money only to end up with nothing! So it’s important to understand the nine rules of positioning your endeavor to get funding.
1. Are you a successful jockey?
While somewhat of a cliché, it is not inaccurate to say, “Investors don’t bet on the horse, they bet on the jockey.” It is widely believed (and fairly true) that a previously successful entrepreneur can make a marginal company a winner, while an inexperienced entrepreneur can cause a ‘no-brainer’ opportunity to fail. If the entrepreneur was previously successful, AND has experience within the company’s target industry – you’ve got yourself a home run!
If you’re falling a little short on these criteria, then you need to fill a top executive position with a seasoned entrepreneur, OR a rain maker type from within your target industry. This is not necessarily a deal killer, though, if you don’t measure up, it does create another hurdle.
2. Do you have a want or a need?
Now here is the absolute deal killer. If the product you are offering is a ‘want’ (aka nice to have), your chances of obtaining funding are greatly diminished, if not non-existent. Needs, though, are products critical to enhancing business profitability, and for which companies will happily pay.
Here’s an analogy – I need to eat to live, and I want to eat filet mignon. I can, however, exist very well on meat loaf, or even cereal. Since my money has to be spread over a lot of things, I’ll probably eat more meat loaf than filet mignon; satisfying my need, but mostly ignoring my want.
This is not to say that filling a ‘want’ isn’t a good thing, BUT it entails a much harder and longer sales cycle, and your company may never be able to progress far enough to justify investor funding.
3. Are you prepared to take a leap of faith?
Remember the scene in Indiana Jones and the Last Crusade where he has to step into space – take a leap of faith? Well, you have to be prepared to do the same with your life and finances. You have to develop your company to a point where you have created a product that actually does something and is being used by someone.
Investors normally will not fund what they label development (or technical) risk, meaning money to create something usable. While they don’t expect you to have a fully featured product, they want to see you had the fortitude to find a way to create an initial version of your grand idea. Whether you drain your savings, mortgage your home, max out your credit cards and/or convince your friends & family to believe in you with funding, you must get to this point before approaching an investor.
4. Can your team go all the way?
This relates back to my first point about the jockey, but you also need to have a competent, and hopefully, experienced management team. Investors don’t expect your team to be fully fleshed out, although you DO get bonus points if it is. However, they will look for people with entrepreneurial success, industry experience and appropriate skills. For example, if your endeavor involves an understanding of Fortune 100 finance, you better have a top-flight CFO on the team.
One position that always stands out is your sales executive. Having a top salesperson with deep industry experience will help investors open up their checkbook, because they know the most critical position is the sales executive. Rainmakers are worth their weight in diamonds, since they are very rare!
5. Who is your guinea pig?
Do you have one, or even better two, large companies ready to use your product? Further, can you get them to pay something, anything, to use it? If you go in front of an investor and say, “We are generating revenue from Amazon and Walmart using our product,” the investor will be impressed, no matter how much is coming in. Their thinking is that a major company paying to use your product validates a NEED for it (refer to Point #2).
6. Do you know where you are going?
Have you prepared a comprehensive business plan? This is usually one of the last things the prospective investor will study, BUT they won’t do the deal unless they can see you have adequately planned for building the product, going to market, growing the company and responding to contingencies. It is a lot of work, but worth it. Not necessarily just for impressing investors, but, more importantly, for you to understand what it’s going to take to achieve success.
7. How much money do you REALLY need?
You want to correctly project your funding needs; not too much and not too little. Call this the Goldilocks equation. Investors know this is an inexact process, and that most entrepreneurs tend to underestimate how much funding will be required. All the investors I know automatically assume the company will require more money than is originally projected.
One thing to absolutely avoid is suggesting you will only need a single investment round. This almost never occurs and is a ‘red flag’ to investors that you don’t know what you are doing. Even if you believe you can make it with one round, it’s best to project at least two rounds of funding. Doing so gives you credibility with investors.
8. Can you play well with others?
When others invest in your company you give up equity, AND take on partners. They probably won’t be active on a day-to-day basis within the company, but will sit on the Board, and require more attention than you may anticipate. You have to be effective in a power sharing environment, because, as soon as there are other owners, you can’t be a dictator any longer. Investors always judge whether you are someone they can work with as part of their due diligence. I know of many cases where investors walked away from deals for this reason alone.
9. Where’s the exit?
Investors fund your company because they expect to make a very good return and realize it within five years. There are two ways to satisfy this investor objective; either the company is acquired by another company, or you have an IPO. In either case you are selling off most, if not all, of your company. So you have to plan an Exit Strategy – who will buy us, when will it happen and how much will we make.
You must understand that investors usually don’t share your passion for the product. They are looking at two basic points – how much money will I make, and when will I get it? Further, investors are looking for a minimum 10x return – if they invest a million dollars they expect to take out at least ten million dollars (and hopefully more) within about five years (or less).
If your opportunity meets (or comes close to) the criteria of these nine points, you have something investors will consider. With the hundreds of potential deals flowing through any VC firm, they are extremely judicious about which ones get into the ‘under consideration’ status. Realistically, it’s well under 10% of everything that comes in front of them.
If you make it to this point, congratulations; you made the cut! Now you’ve got the audition, which starts the next phase of our entrepreneurial courting process.
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