Category Archives: Invested Interests

Invested Interests

How would you break down the process of raising an angel round of investment in 5-10 steps?

1. Understand your business. It sounds obvious, but the majority of entrepreneurs who pitch me have obviously never thought through many of the major issues surrounding their companies.  You should know EVERYTHING about your business, product, customers and competition. You should know every metric regarding customer acquisition, conversion and retention. You should have a crystal clear understanding of your business model and your financials. And all of this should be at the tips of your fingers so you can instantly answer any questions you are asked about it.

2. Understand what investors are looking for, what they usually invest in, and why. There is a vast gulf between a ‘cool product’ and an ‘investable company’ and if you don’t understand the difference, you will be doomed before you start. There are many good books on this subject, and you owe it to yourself to read at least one of them before you begin talking to angels. A good beginning would be Bill Payne’s The Definitive Guide to Raising Money from Angels, available as a free download from http://gust.com/definitiveguide.

3.  ONLY after you’ve completed #1 and #2 will you then be ready for capital to be applied to your venture. And that capital is going to come from…YOU. That’s right, you should not even consider trying to raise money from anyone else until you have reached deep into your own pocket. This is the case for two reasons: first, because the bare fact is that investors simply do not fund ideas. The expectation is that in an era of increasing technology and decreasing costs, you will be bringing them an operating company with at least some traction. Looked at from their perspective, given two teams equal in entrepreneur, market, business model and potential, why should they invest in one that exists on paper, when the other has reduced its risk and improved its viability by actually getting started?  The second reason is that investors want to know that YOU believe in your own startup…and the best way for you to demonstrate that is to show that you have personally put your own money where your mouth is. Keep in mind that any cash you put in will remain in the company as Founders’ Equity, and will only come back to you on a successful exit in which your investors make money.

[3a. Although it is not required per se, and therefore is not being given its own discrete step here, in the real world most startups at this point turn to friends and family for additional capital, in the form of equity or loans, to help get the company to a stage at which it is legitimately investable by third parties. The important thing to note about this is that the money should either go into the company directly as a convertible note without a cap, or (depending on the personal relationships involved) as a personal loan to the entrepreneur, which he or she in turn invests as equity into the company, but will be responsible for repaying even if things don't work out.]

4. With #1 – #3 under your belt, you should start preparing the components you will use to support your pitch to outside investors. These range from outbound materials, such as pitch emails and funding applications, to presentations of your venture in different forms for different purposes, to detailed back-up information that you will be asked to supply during due diligence. A comprehensive list of things you might want is listed in the answer to What materials or software should I use to pitch a VC?, and these can all be neatly gathered into a confidential investor relations site, such as you can create with Gust.com.

5. Now, and only now, are you prepared to start fundraising. This phase is a combination of (to mix several metaphors) WMDs and sniper fire.  Start by letting absolutely everyone know that you’ve got a great startup looking for early investors. And I mean *everyone*. I have been led to deals by my barber, my interns, my cousin and my high school classmates. If you hide your light under a bushel, investors simply will not come looking for you proactively. At the other end, do your homework to really understand which investors would be the most productive for you to approach. Some only invest in their home city, others only invest $5,000, still others only invest in biotech, for example. Blindly sending your business plan to every single angel and VC in the world will have zero effect, and simply clogs the system while annoying everyone.

6. Seriously consider applying for funding from your local business angel investment group. There are many hundreds of these across the country and around the world, and virtually all of them accept applications over the transom. If you are invited to come in, even for a preliminary screening, you will have the opportunity to present your business to experienced investors. This will given you both pitching experience and usually solid feedback on your plan. And if you do get funded, the group can be extremely helpful in getting other investors to join in with additional funds.

7. Another avenue that is increasingly a good idea is to consider applying to one of the new breed of accelerators. While yCombinator and TechStars are the two best known, there dozens of others, local, national and international, many specializing in specific areas (including fashion, food, finance, gaming, etc.) Accelerators typically provide several months of intensive mentoring, at the end of which they host a Demo Day to introducing all their graduating companies to a large number of local angel investors.

8. Your goal in all this is to try to find a lead investor. This person will be critical in rounding up other investors, drafting a term sheet, and generally getting the deal done. He or she will be your primary champion, and often mentor. Doing a deal with a lead investor is 3 to 5 times easier than trying to pull everything together by yourself. Among other things, your lead can vouch for you with other investors in their circle, or who follow them on online financing platforms, which can be a good way to finish up a round (via “social proof”) once your leads are in place.

9. Before you start negotiating a term sheet with any potential investor, make sure that you GET A LAWYER, specifically, a lawyer with experience directly in the early stage financing world. This will NOT be your family lawyer, or the one who helped you beat that traffic ticket. There are excellent venture lawyers in every major city, with enough to form a flash mob in places like California, New York and Texas. For more background on this key step, see the answers to “What should one look for in a startup lawyer?”

10. Finally, from the minute you begin engaging with an investor, it is critical to COMMUNICATE early and often. Keep them up to date while circling your round, thank them as soon as it closes, and provide ALL your angels with either quarterly (at a minimum) or monthly (ideal) reports on how the company is doing.  In my experience there is a astounding correlation between frequent, thorough communication and successful follow-on funding.

*original post can be found on Quora @ : http://www.quora.com/David-S-Rose/answers *

Invested Interests

4 Startup Tenets for Extreme Focus on Customers

Image via Facebook

New product startups rightfully begin with a heads-down focus on creating the ultimate product – whether it’s a new technology, a new look and ease of use, or a new low-cost delivery approach. Most then add customer service at the rollout, but very few really understand what it means to be truly customer centric, and even fewer really achieve it.

Customer centricity is far more than providing excellent customer service, although that’s a step in the right direction. Customer centricity is a strategy to fundamentally align a company’s products and services with the wants and needs of its most valuable customers, with the aim of more profits for the long term. Read more

Invested Interests

What is the ratio of equity received for sweat equity vs. cash investment in a new venture?

There is no specific ratio between “sweat equity” and cash in a venture, and that’s actually not a good way to think about the issue. The bottom line is that cash is cash is cash, and everything else is “not cash”. The reason is that cash is fungible, which means it can be interchanged for everything else, from programming skills to vacations on the Riviera. Other things, such as your particular time and effort, are not.

A better way to think about this is to separate two aspects of the “sweat” that one puts into a new venture. These are critically different, and have very different economic attributes attached to them.

The first is the entrepreneurial value of the founder(s) in a new venture. This is what happens when someone starts an enterprise and creates something of value. So if you start a company, and then raise a round of angel investment at, say, a $2,000,000 valuation, the entrepreneurial value of the time and effort it took you to get to that point is…$2,000,000. The point is that the value created has absolutely nothing to do with a quantified effort that it took to get there. You might have created that value by slaving 18 hours a day, seven days a week for five years (in which case the value of the sweat equity is $8.70 per hour), or you might have created that value by having a brilliant concept, execution plan and team that you pulled together in two weeks of leisurely work (in which case the value of the sweat equity is $25,000 per hour).

The second component is the replacement cost of the specific skills and effort that are involved in the particular work. So if the same specific tasks could have been achieved by paying a programmer (or marketer or part-time CFO), say $2,000 on a short term contract, then that is exactly what the replacement cost value of the work would be.

In practice, once a company has been funded and a valuation established, “sweat equity” contributed after that point is usually compensated based on only the replacement cost number, either 1:1 (that is, the nominal salary, what you would have been paid if the cash had been on hand) is simply accrued, or some other ratio (say, 25% or 50% extra), in recognition of the fact that you’re willing to take the risk that it will never be paid if things don’t work out.

*original post can be found on Quora @ : http://www.quora.com/David-S-Rose/answers *

Invested Interests

Startup Map & Trends Analysis – November 2012

For November 2012 we are noticing an interesting trend of product ready companies declining, while concept stage companies are rising. This trend is mostly led by a decrease in product ready internet web service companies in the US, Canada, Spain and the United Kingdom, and with an increase in concept stage companies in Spain, India, Brazil and the United States.

The top four US states with the highest concentration of new startups are still California, New York, Florida and Texas. However, during the last three months the fifth and sixth places have been a battleground between Pennsylvania, Georgia, and Washington. For November, Pennsylvania takes fifth place and Georgia claims sixth.

Although the concentration of startups by country remains fairly steady throughout the last three months, we have several notable changes to our top 25 countries. Portugal and Chile both came up four spots, rising to 13th and 14th on the list. Kenya had one of the largest increases, and jumped 13 spots to 22nd for the month of November.

Invested Interests

10 Action Items to Keep Angel Investors Hovering

ABC Shark Tank Angels via Elite Daily

Every new startup I know dreams of being funded early by one of the 318,000 active Angel investors in the USA alone. But many entrepreneurs don’t realize that Angels are also extremely discerning in the projects that they will invest in, rejecting approximately 97% of the proposals submitted to them, according to the California Investment Network.

Most of these investors are members of Angel groups that have a rigorous filtering and screening process, to select the top 3% and most fundable proposals. What is this daunting process, and what can you do to optimize your chances of surviving it? Over the past 10 years, I have had the opportunity to see how the process works, several times from the startup side, and more recently from the Angel perspective (as a member of an Angel group screening committee). Read more

Invested Interests

Building a Startup is Navigating an Obstacle Course

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It would be no fun if starting a business was simply plotting a straight line between your idea and success, with no challenges along the way. Zigging and zagging amongst the obstacles is the fun part of being an entrepreneur, and it’s what sets you apart from the average worker who knows exactly what he or she has to do every day to get paid. Relish it, or if it scares you, don’t try it.

That doesn’t mean that starting a business should be a random walk into the unknown. There are certain foundational elements that every entrepreneur must build on to succeed, as well as some critical tools we all need. I found these tried-and-true principles summarized very well in a recent book “The Zigzag Principle” by serial entrepreneur Rich Christiansen: Read more

Invested Interests

Users Guide to Startup Advisors

What’s an advisor to a startup deal? Technically, advisor is one of those bucket terms that means anything and everything, depending on context. Those names and faces and backgrounds that turn up in pitches and business plans might be deep and important relationships, somebody with options or equity who is going to be helping for the long term; or meaningless fluff, somebody who agreed once to have his or her name appear, but really does nothing. 

When advisors come up in a pitch, I immediately ask how advisors are compensated and what they really do.  

And here’s how I feel about the answers I get:

  • Free advisors are likely to be as valuable as free advice. Yes there are exceptions to that rule, like family and long-time business relationships, but most of the time no compensation means no thought, no effort, no real contribution. Everybody’s busy. I see way too many deals bragging about advisors who are just lending their name to the business plan, as a favor to a former student or friend of a friend. I don’t believe they’re going to make calls, dig into details to offer real advice, or get dirty. And it hurts the credibility of founders when they show off names that don’t really mean anything. 
  • Advisors with small equity shares are good, and advisors with options are as good or even better. These are people who probably will return calls, and make calls, and pitch in to help. 
  • Advisors with options or equity should be long-term people who will stay with the company from startup to exit. Equity is forever. Options can become equity. Nobody should ever be on the capital table for what they did once in the past.  Everybody’s busy, but options motivate people to help. 
  • I dislike professionals as advisors. Attorneys and accountants, for example, are better as professional friends than as advisors with equity or options. Their business model values fees, not equity. So the advisee companies get the last quarter hour of the last day. And having a vendor own shares means fewer shares for the investors and management team. When a web designer is the advisor I wonder what that means down the road as the startup grows. Free web design forever? Why is the web designer not a regular team member. Why are they holding back? 
  • Advisors can have too much equity. There’s no exact rule but when an advisor who isn’t really working with the company regularly ought not to have even a whole percentage point of equity. 

Advice is easy to get. Help, contributions, real discussions, digging into the details, making calls, returning calls, opening doors, and getting things done, that can be really valuable. 

And on both sides, investor and startup, we need to figure out what advisor really means. 

Tim Berry , Founder, Palo Alto Software
December 6th, 2012 2