How to Avoid Fundraising Woes (Hopefully!)

“The hurrier I go; the behinder I get” – quote by Lewis Carroll

I talk to so many startups that struggle with fundraising that at times it is really heartbreaking.  Well-intentioned and motivated entrepreneurs seem to get their dreams crushed by turn-downs and wasted meetings. While I have been advising startups for more years than I care to remember, I promise to find financing.  So, a quick story on that point.
It was a number of years ago and I was working with a company that had pioneered some really groundbreaking voice recognition technology.  They were making the rounds with investors and having a bad time of it. They approached me and I thought it fortunate that I knew an investor who understood this space.  We worked on refining their approach and they had their meeting.  They were told at the end of the meeting that both their team and technology were really top-notch, but the investor already had a voice recognition investment and wanted to diversify.  Once I heard this, I decided I did not have enough time in the day to get inside the mind of all the investors out there and thus, my no promises on funding pledge.
So what are the three things I find are major contributors to fundraising woes:

The first is clearly the lack of a sustainable business model.  Your solution must address a real problem (see my blog “Are You Selling Aspirin or Vitamins?) and be elegant in its simplicity.  Making it too complex to use is a no–no as is the model which will rely on advertising (eyeballs) to generate revenue.  If it takes three slides to describe your model or it requires too many revenue streams, it will not work with many investors who have come to appreciate the fine art of simplicity.  For you older folks, this in my opinion is why Excel endured and VisiCalc did not.

Next, approach the right investors.  For established companies seeking to expand, there are various sources of funds, from cash-flow lines of credit to asset-based loans to private equity and subordinated debt.  Financing 101 says match the financing need with the proper source.  It is the same for emerging growth companies.  Seed money is not venture money – getting a VC to get interested in your pre-revenue startup is an impossible mountain to climb.  Focus your efforts to match your stage of development with your financing source.

Finally, make sure your market is big enough.  I just reviewed a pitch deck for a “commission type” model.  All the market size data was based on gross sales which really exaggerated the market opportunity as certain sales in that space did not involve a commission.  If a CPA like me realizes that point, so will an investor.  Stay relevant and make sure there really is a big enough market.

So, if you want to avoid running around in circles as you undertake your rounds with investors, please keep these ideas in mind.  It may not result in success but at least it may keep you from spinning your wheels.  Good luck.

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What Do You Know About Your Financing?

Barf: “I’m a mog: half man, half dog.  I’m my own best friend! “– quote from Mel Brooks Spaceballs :The Movie

I continue to experience some confusion by owners as to the nature of their financing agreements.  When I ask what form of financing they have, I get responses which remind me of this line by Barf.  I realize it can be complex and bankers, lawyers and even accountants seem to revel in throwing around terms like springing liens, clean up period and covenants and I am sure for most owners, this just serves to make their hair hurt. They wonder if their advisors and bankers are talking about some strange animal, their son’s bedroom (which never has a cleanup – period) or the Old Testament.  So, let’s spend a few minutes describing three basic types of financing. By design, I am leaving out equity and more complex instruments like commercial paper, subordinated notes and convertible debt in an attempt to keep the suicide rate down. Let’s stick to basic loans from financing (legitimate) sources.

The first is a cash flow loan sometimes called an unsecured loan. The banker or financing source looks to historical and projected cash flows and determines the amount they will lend, the period of the agreement and how and when they will get paid back. This is true borrowing off the cash flow of the business and usually has the most favorable rate. While personal guarantees are less prevalent now, they come and go based upon the overall economy.  These loans also usually have covenants – financial benchmarks you will need to meet to prove you are still worthy of this type of loan.  This loan is the most common instrument for providing working capital to a profitable business.

Next is a secured loan.  It is modeled similar to a cash flow loan but you may not be as credit worthy so the financial institution will take a security interest in (put a lien on) your assets – principally receivables, inventory and fixed assets. Many of the concepts under cash flow loans apply here and the rate is usually a bit higher.

Finally, there are asset based loans or ABL’s.  This type of loan is for those struggling a bit where the financing source wants to monitor the overall level of debt.  It is also a secured loan as the security interest is present but it is more formulaic – the company prepares a periodic borrowing base certificate containing eligible assets and negotiates a formula – usually a certain percent on receivables and inventory with exclusions for aging, concentration and foreign accounts.  The result is the amount of borrowings the financial institution will allow.  As you can tell, it is a bit more complex but it does force a discipline which keeps your borrowings within a range your assets can support.  This type of financing can be costly as it limits overall availability and there are a number of fees (in addition to a higher interest rate) to cover.  I would not suggest getting into this type of arrangement without some internal or external qualified financial personnel.  Dealing with an ABL can be a bit overwhelming.

While every loan does not fall directly into one of these categories the vast majority do, so as an owner, an awareness of the basics should make you more knowledgeable as to your alternatives and also provide you (based upon the type of loan you obtain) with a view as to how the outside financing world perceives your business.

I Am Ready to Sell My Business – Now What Should I Do?

Quote: from High Anxiety by Mel Brooks (my favorite)

Brophy: I got it, I got it, I got it [thump]

Brophy: I ain’t got it.
Sometimes, when I talk to entrepreneurs about their “plan” to sell their business, I begin to think of this scene from High Anxiety.  They start with some high-level thoughts as to how they will complete the sale only to drop the ball when you ask the first question about execution.  Most soon realize, like everything else in the world, this is a process.  In fact, we have been through it so many times that we have a registered mark for it called TransactReady®.  The purpose of this blog is not to take you through the entire process, but to focus on some preliminary thoughts to help you get started.

One major assumption we will make is that there is no one to leave the business to (so, a succession plan is not an option) and you have decided to sell (if not, see my blog “Am I Ready to Sell My Business?”) So, here are some focus points for the entrepreneur:

  1. Know what your business is worth – Get a solid understanding of what the business is worth.  Next to seller’s remorse, an unrealistic expectation as to value is a second major reason why a sale of a business fails.  Use brokers and other professionals to help you gauge what you should expect.  It is rare that someone comes along and offers a price substantially above what the professionals think is fair.
  1. Do a SWOT analysis  – Do a thorough assessment of your strengths, weaknesses, opportunities and threats.  Big checks for your company are usually accompanied by significant due diligence, so it is best to know where you stand (warts and all) before a potential purchaser does.
  1. Make sure you will realize enough from the deal to meet your needs – Engage a professional to assess those needs.  While you may think you know what it takes to maintain your current lifestyle, an objective view by an accountant or a financial adviser can be eye opening when it comes to making sure that your financial objectives will be met.
  1. Understand how you want your business to look after the deal. – We often hear an entrepreneur say they want to sell all (or a good part) of their business, get a good price and stay in control.  Our standard response to this is “you probably can stop looking; you are not ready to sell.”  However, that is not to say that you may not have options depending on your strong preferences.  If you want to keep your management intact, you probably want to consider a sale to a financial sponsor, including management or funding a sale yourself.  If maximizing sales proceeds is your preference, then sale to a strategic buyer may be the best route.
  1. Think long and hard before doing this yourself. – Unless you have been through this process before, doing it yourself is not for the faint of heart.  You probably would not sell your home or building without a professional broker, so why choose that route for perhaps the transaction of your lifetime?

There are plenty of very qualified professionals to help you through this process. You can still control it but trust me, you do not want to do it on your own. Get the right help and you will not be sorry.

Five Steps to Raising Funds

“Step 1: We find the worst play ever written.  Step 2: I raise a million bucks.  Lots of little old ladies out there.  Step 3: You go back to work on the books; one for the government and one for us.  Step 4: We open on Broadway and before you can say Step Five…  Step 5: We close on Broadway, take our million, and fly to Rio.”

Paraphrase of dialogue from The Producers by Mel Brooks

Okay, so you don’t exactly subscribe to Max Bialystock’s approach to raising funds.  Most of you do not start out counting on failure to succeed.  But, based upon some of the approaches I have seen, it may be helpful to compare and contrast what you are proposing versus what Max is doing; perhaps there is a hidden lesson there.

Everyone looking for financing wants the five steps to follow to achieve success.  I wish I had them, but this is one of the hardest things to do in business and, in 40 years, I have not found the secret formula.  However, I can offer five points to consider but they will all take some time and hard work.  (If it was easy, the success rate would be so much higher.)

  1. Prepare a pitch deck that is based on a true business model.  If you need help, you can refer to our website.  The good news is it will tell you exactly what should be in the deck; the bad news is you need to provide the content.
  2. Invest some of your money. Investors are not interested in helping someone with no “skin in the game.” They want to know that you are serious and have something to lose if you do not succeed. Fear is a great motivator.
  3. Get friends and family to invest. If the people who know you can’t be convinced, how are you supposed to win over strangers? They don’t need to mortgage their homes; they just need to demonstrate commitment.
  4. Communicate and refine your plan. Talk to advisors, friends and your network. See what they like and don’t like about your plan. And don’t force the issue; don’t let them feel bad if they are not thrilled and would like to tell you so. Make the feedback process easy and use what they say to consider modifications.
  5. Target your investors. Understand what they want and how you match up. If you are pre revenue and looking for seed money, friends and family and angels are the place to go, not venture capital funds. Use your network to get to the right people. A few good targeted meetings are much better than dozens of ones that end “don’t call us; we’ll call you.”

So, nothing magical here and no guarantees.  But, like everything else that is worth pursuing, it is a process.  Don’t let it control you.

Business Divorce – It Ain’t Pretty

“My dad doesn’t live with us anymore.  He lives in New York and drives a taxi.  My mom hopes he’s going to die real soon.” – Dialogue from the movie Kindergarten Cop

At this point in my career, I have lost track of the number of clients that have suffered through an ugly separation of ownership.  Fortunately, from my perspective, the statistics do not seem to mirror the rising number of family divorces, but that doesn’t mean that they are any less emotional, costly or time consuming.  In fact, my good friends at a regional law firm have a practice called Business Divorce.  If you can build a practice around it, I guess it is pretty prevalent.  So, as I work through another round of business separations, I thought it might be helpful to point out a few ways to avoid this situation:

The first is the obvious (at least to me) – choose a partner or partners wisely.  Just as in real life, don’t just look at what each brings to the table, but how compatible you are.  Every business will go through cycles – those ups and downs that make business life both interesting and frightening.  You need to take some time to understand how you will ride the waves together.

Next, there is ownership and there is voting power and the two should be considered separately.  For example, when looking at a funding source, granting an ownership interest versus a voting interest is not the same.  I experienced an individual who helped a company find a bank and earned a 30% ownership in the business.  While the economic pain was hard to deal with (the principal owner never forgave himself for that decision), the individual had no real knowledge of the business and more time was wasted by management explaining every move it made. The lack of focus on external matters was in my opinion one of the reasons the business failed.

I am sorry but 50/50 or equal voting deals are not one of my favorites.  I can rattle off half a dozen failures with this structure. Perhaps the worst was the father who owned 100% of a business and left it to two of his two siblings equally when he passed. They had equal voting and economic ownership.  One really knew the business (and worked it) while the other considered it to be more of a hobby. Their constant infighting eventually resulted in the sale of the business long before it achieved its real value.  You can share the economics without sharing voting rights – it is not that hard.  I also find it hard to argue with the concept that somebody has to be in charge.

Finally, follow the old adage – do not get into a deal without knowing how you will get out.  The interplay of owners at the onset of a venture is much more amenable than facing each other when parties decide it is time to “go in a different direction.”  Early on in the relationship is the time to focus on this issue.

So, follow some simple rules and you and your Partners will have a nice long run as colleagues and friends – not spending your latter years wishing the worst for each other.

Preparing Your Early Stage Company for an Exit

Are you ready? Lyrics from the song of the same name – by Pacific Gas & Electric (circa 1970)

So, I tend to blog about recurring items I see in our practice.  In this case, over the last few weeks, we have been approached by a couple of early stage companies entertaining Letters of Intent to be acquired.  While these are exciting opportunities to monetize those long hard hours, I can’t tell you how much I wish these entities had embraced the lyrics from this rock classic.  The absence of the most basic information has left their advisors “hogtied” and unable to help.  Of course, the owners wanted to be responsive to points raised by the potential purchasers, yet they and we were ill prepared to address even the most rudimentary of concepts because some standard housekeeping had not been done.  Now, trust me, I am not crying over the need to have pristine records available for due diligence.  I am talking about basic information that can seriously impact the economics of a deal.  Some examples will help to explain:

  1. No tax returns prepared for the last 2 – 3 years.  Forget the compliance issues.  Both of these companies appear to have significant losses which may allow us to structure a potential deal as an asset sale (which the buyer wants) with a similar tax impact as a stock sale (which the seller wants.)  But, we can’t even approach this without knowing about tax operating loss numbers and you need tax returns to figure that out.
  2. No assessment of state tax exposure.   What states are the sellers doing business in?  Is the product taxable?  What is the tax exposure?  These are all good questions that we and the potential buyer would like to know the answers to.
  3. No Delaware franchise tax filings for 3 – 4 years.  In layman’s terms, one of the seller’s first representations is that they have a corporation in good standing and these delinquent filings mean they do not.
  4. Equity nightmare.   Options and stock grants without support; unfulfilled promises to employees for ownership – are they valid claims and at what price?  Is there a potential tax to the employee and what is it?  Grants with no valuations – a tax and accounting nightmare.

So, what is the lesson boys and girls?  You do not need to have all your ducks in a row.  But, most of these items could have been addressed along the way.  It would have cost a little money, but both companies will pay now in terms of deal terms and one deal may not get there because of these issues.  For example, the DE franchise tax can be filed online in less than an hour and the tax is probably less than $700 per year.  Working with a CPA or financial advisor, you can at least identify issues and work through fees.  You do not need an audit each year.  We work with emerging companies on such matters all the time.

So, please, do not be penny wise and pound foolish.  Be prepared to say you are ready when that offer comes across your desk.

Business Models Are Not Business Plans

Ace Ventura: [to Lt. Einhorn] Whew… now I feel better.  ‘Course, that might not do any good; you see nobody’s missing a porpoise.  It’s a dolphin that’s been taken.  The common harbor porpoise has an abrupt snout, pointed teeth and a triangular thoracic fin.  While the bottlenose dolphin, or Tursiops truncatus, has an elongated beak, round cone shaped teeth and a serrated dorsal appendage.  But, I’m sure you already knew that.  – Ace Ventura – Pet Detective.

So, I had the opportunity to attend a Demo Day this week which was outstanding but I was struck by the conversation in our little group about what was needed to get funded.  All of the conversation (and advice) centered around the plan and the deck – how many pages; what colors to use; how much to disclose in the financials; how to convey what you were going to do.  There was an absence of discussion on what, I thought, was the far more important issue – the why.  I have previously blogged on the concept of why (another simple but powerful concept) and thought it worthwhile to expand on an article I wrote last year on the difference between a business model (the why) and a business plan (the how).  I was a bit concerned about revisiting this subject, so I invoked one of my favorites Ace Ventura (rrreeeeeaaaallllyyyy) to help me through it.

A business model defines the underlying need for your product or service in a market.  It defines the way your product or service solves a problem or alleviates a “pain” and is the premise you need to justify in establishing the true worth of your business.  A couple of examples may help clarify this point.

Zappos realized that, for years, people had been buying shoes in the same size and that buying and returning shoes was inefficient and time-consuming for you and me.  Thus their business model was to move the shoe store from the mall to our homes with a no-hassle return, thus alleviating the normal “pain ” of shopping for shoes.

LinkedIn observed that when a company was looking to hire someone, most used “job boards” like Monster and other resume collecting tools.  But, many companies realized that perhaps some of the best candidates were probably gainfully employed and there was no effective way to get to them.  Contributing to this was the fact that most who worked were concerned about “floating their resume” for fear superiors would find out and perhaps dismiss them, so their resume was not “in the market.” LinkedIn made placing your “resume” in public an acceptable practice via social media and accordingly, opened up the world of currently employed candidates to recruiters.  Obviously, LinkedIn can charge a premium for access to this information which solves the problem.

A business plan on the other hand, is more of a “how you are going to do it.” nIn addition to the business model, it covers the three elements required to succeed; people, time and money.  It indicates the people you have or who you will need, how long it will take until profitability can be achieved and the funds needed to get you there.  Though most concentrate on the Financial Model in the business plan (there are many packages around that can help with this), it is the business model that contains the key to success.

So, please make sure to focus on the why, because without it, the how is just another unfulfilled dream.