When you launched your firm with equity capital, you sold shares
to the original investors at a set price, issued the common stock
certificates, the money transferred into the company account, and
off you went spending the funds on the items disclosed previously
in your business plan. Life was good. People were hired, equipment
was purchased, leases were signed, contracts were executed, and
handshake agreements finally had cash to back them up.
Waiting for revenue to come in to your firm, at a level
sufficient to cover your regular monthly operating expenses, can be
frustrating in the early going. The bills are still there every
week, but the sales dollars are still inconsistent (or in the case
of many new launches, nonexistent). You know your venture is
ready to turn the corner and close on a few solid revenue deals,
but you're not quite ready to dig too deeply into the
company's line of credit until there is a clear path to
reliable cash flow coming into the firm.
Raising another round of equity capital is probably not all that
exciting of a project at this point, but it often turns out to be a
necessary endeavor given the open-ended nature of nailing down when
regular sales will start to happen. Your initial funding deal is
your "A" round, often called the seed round or the
"launch capital." Too often, entrepreneurs believe there
is some kind of shame in asking for money in a subsequent round of
funding, because they're afraid that it appears they didn't
do a very good job budgeting the initial capital raised. But
that's simply not the case.
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Many things in running a business turn out to be more expensive
than originally planned for. Salaries and benefits are often higher
than the figures quoted when the budget was constructed. And sales
don't always come strolling into the company's
"in-box" at the pace projected in the business plan.
Raising additional capital through a "B" round is a very
normal process in venture development. But there are good
ways to go about it, and awkward ways to try and make it
happen.
Let's start with the favorable scenarios. Pitching your
venture to investors in a "B" round can be a very
positive experience for the entrepreneur and the capital providers.
If you have a solid track record of benchmarks achieved; personnel
successfully recruited, hired and trained; partnerships put in
place; and customers in the sales pipeline, then the venture is
right on track with its targets. It simply might be that these
haven't happened in the exact same time frame originally
envisioned.
If you have a tight paper trail summarizing your strategies
employed, board meetings, contracts in place, employees and
projects completed and still in process, investors will generally
view that next round of funding as a favorable time to get into the
firm, because so many items that were once all outstanding and
pending are now finished and in place. The risk of investing in a
"B" can actually be viewed as lower than the
"A" round, if the entrepreneur does a great job of
documenting the forward progress of the organization.
But if the investors have little to go on in the way of tangible
evidence that you've done a great job in moving the venture
forward, asking for another round of cash could easily be
interpreted as giving money to someone who doesn't have a solid
plan for success. When you come asking for equity capital without a
clear demonstration that you're competent to lead this
enterprise, investors' confidence in you is greatly diminished.
But when you come asking for a second round (or later a third
round, "C") and investors see that you're well on
your way to making this business a solid reality in the market, and
it's just a matter of timing on some very promising deals, they
will be much more receptive to your pitch.
And remember, your "A" round investors probably have a
preemptive right in their stock agreement to maintain their
relative percentage equity stake in the firm when the company
issues subsequent shares, so you'll need to approach them first
to see if they have interest in backing you with some more cash. If
you have your company's house in order, "A" round
investors often have a strong interest in being capital providers
for the following rounds, and why not--they know you and your work.
And be aware that some of them may want to "pass" on
their preemptive right (for various reasons not involving you), and
that's OK. But be sure they don't opt out of the next round
because of their lack of confidence in your ability to run a tight
ship.
David Newton is a professor of entrepreneurial finance and
head of the entrepreneurship program, which he founded in 1990, at
Westmont College in Santa Barbara, California. The author of four
books on both entrepreneurship and finance investments, David was
formerly a contributing editor on growth capital for Industry
Week Growing Companies magazine and has contributed to such
publications as Entrepreneur, Your Money,
Success, Red Herring, Business Week, Inc.
and Solutions. He's also consulted to nearly 100
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.