Q:
I'll be meeting with some investors soon to attempt to obtain
financing for my start-up. Should I expect to give up a great deal
of control of my company if they decide to fund me?
A: One
of the biggest questions involved in the deal-making process for
business financing is what the two sides have to give up to get a
deal finalized. The entrepreneur has concerns about ownership
positioning and relative control of the company's future
direction through a majority equity stake. But that same issue is
actually one of the biggest concerns for the investors who provide
the growth funds for the business. The funding partners also want
to be sure there's a tangible means of monitoring their
ownership stake in order to provide a measure of risk reduction
given the potential downsides to launching a new venture.
Owner-entrepreneurs must get out of the mind-set that capital
providers are going to "give" them money and then be
content to sit on the sidelines and watch the enterprise grow (or
crash and burn) from a distance. In the same way that the owners
want to get as much funding for as little ownership transferred as
possible, so, too, do the investors want to put in as little
capital as possible in exchange for as large a stake as they can
secure.
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The key to coming to agreement on a funding deal is to know
going in what a reasonable positioning is for both parties, and
then head in that direction with clear goals in mind. First, the
entrepreneur must have a very solid investment schedule in place.
This "use of proceeds" must delineate exactly how and
when funds raised will be allocated. For example, it's not
uncommon for a new client to tell me when we first meet that he
wants to raise $500,000. My next line of questioning is simple.
"OK, what are you going to do with that money, and at what
points in time will you need it?" So I would help prepare that
use of proceeds alongside a calendar, and it might look something
like this:
Month 1
$50,000: tenants'
improvements of facility
$25,000: office equipment
secured
$25,000: licensing agreement
contracted and signed
$200,000: working capital cash
flow management account opened
Month 2
$40,000: distributor deal
finalized and signed
Month 4
$20,000: first major trade
show
Month 6
$40,000: two additional trade
shows
Month 8
$50,000: second national
distributor deal finalized
Month 9
$50,000: Web site catalog
finished and launched online
Second, the owner must now present the proposed revenue stream
that will happen within the time-frame of the "use of
proceeds" investment schedule. In this same example, there
might be no sales in the first three months, with revenues starting
in month four (at the first trade show). Once the investors see the
entrepreneur has a tangible plan to generate sales, the risks to
the enterprise can now be noted, and the relative ownership stake
in the firm can be determined for the capital providers.
From the investors' positions, the prior numbers and
timeline are certainly helpful, but they are also not guarantees.
No one is going to fund your business from a distance. Investors
will want to have a material representation in how the company
strives toward meeting specific sales goals and managing costs.
This will come either through seats on the board, senior managerial
positions or the placement of a representative among the senior
managers. It's unreasonable to assume an angel investor or
capital fund will provide funds and then be comfortable stepping
away from daily operations and allowing the owners to run the
business without some means of systematic oversight.
The final issue is to determine what percentage of ownership the
$500,000 (from this same example) represents. There are numerous
methods that can be employed to calculate this, so I'll deal
with this in detail next month. But know this: Early-stage
investors are taking on a great deal of risk in funding a new
venture. If the entrepreneur maintains majority control for all
decisions and company directions, investors will insist on detailed
disclosure and regular oversight in order to monitor the firm's
progress and limit risk exposure where possible. So be prepared to
negotiate a deal that's fair not just for you and your firm,
but also for the ones putting up the money that makes everything
happen.
David Newton is professor of entrepreneurial finance at
Westmont College in Santa Barbara, California. He is the
contributing editor on growth capital for Industry Week Growing
Companies and a moderator on small-cap stocks for eRaider.com. His
books include Entrepreneurial Ethics(Kendall-Hunt)
and How To Be a Small-Cap Investor(McGraw-Hill), named November 1999 book-of-the-month by
Money magazine and a 1999 Top 10 book by Forbes. His latest book
is How To Be an Internet-Stock Investor
(McGraw-Hill). He has written or contributed to more than 80
articles for publications including Entrepreneur, Your
Money, Business Week and Solutions, and has been a
consultant to emerging, fast-growth entrepreneurial ventures since
1984.
The opinions expressed in this column are those
of the author, not of Entrepreneur.com. All answers are intended to
be general in nature, without regard to specific geographical areas
or circumstances, and should only be relied upon after consulting
an appropriate expert, such as an attorney or
accountant.