Ready, Set...

Be prepared when seeking capital - or you'll never get off the starting block.
Magazine Contributor
8 min read

This story appears in the February 1998 issue of Business Start-Ups magazine. Subscribe »

Q: How do I go about raising capital?

A: is like painting a room. A lot of the work is in the preparation. But if prepped right, the job goes rather quickly and easily.

When raising capital, entrepreneurs often skip the preparation stage and move right into dialing for dollars. This is fatal to the capital formation process because investors, particularly those who make equity investments in risky, early-stage businesses, are temperamental. The slightest deviation from convention, or even a missed telephone call, can spell the difference between success and failure.

Here are steps to take before you even think of calling on investors:

1. Write a plan. Guess what? Most investors will report they never even read them--but they still want to see that you've done the work. It's through writing a business plan that you gain the ability to present your deal and answer questions with the kind of conviction that gets investors to reach for their checkbooks.

Once you've put the plan together, write a two-page executive summary. You'll need it when investors ask you to send them "a quick write-up."

2. Have an accountant prepare historical financial statements. You can't talk about the future without accounting for the past. Internally generated statements are OK, but investors want the comfort of knowing an independent expert has verified the information. In addition, if you're taking less salary than you think you deserve, historical financial statements are the best way to document the company's accrued liability to you.

3. Line up references. An investor may want to talk to your suppliers, customers, potential partners or your team of professionals, among others. When an investor asks for permission to contact references, promptly answer with names and numbers; don't leave him or her waiting for a week.

4. Figure out your sizzle. Investors will ask what you do. Give them a memorable answer that they can repeat to other investors. The founders of Xyplex Networks, a Littleton, Massachusetts, company with a difficult name and an even more difficult-to-understand technology, said to investors "We are the company that turbocharges your DEC computer."

5. Get warm-body introductions. You must decide what kind of investors are right for you. But once you've made this decision and isolated your prospects, get personal introductions to as many as possible. Cold calling is the most difficult way to go.

Q: Is it worth my time to call when I'm looking for money?

A: You should look for venture capital but probably not from professional firms. Incidentally, this is another reason raising money is so hard: Entrepreneurs tend to look in the wrong places. Institutional venture capital is wonderful stuff, but it is an extremely limited source of financing that is appropriate for just a small number of companies. Here's a diagnostic test:

  • Are you a technology company? Most professional venture capital firms invest in technology. Why? Breakthroughs in products or services create opportunities to dominate a market. Look how Ed Land and his camera created--then dominated--the instant photography market with new technology.
  • Do you need $500,000 or more? Few venture capitalists look at deals for less. Why? With many venture partnerships looking to invest $100 million or more, they want to do 20 $5 million deals rather than 200 $500,000 deals.
  • Will you go public or be acquired? If not, there is no payday for the venture capitalist, hence no interest.
  • Can you reach $50 million in sales in five years? Of course, every venture investor is different. But taking into account the numbers on margins, valuations, time horizons and the required rate of return, only companies of this size make sense for professional venture capitalists. Venture investors know this and tend to shy away from companies that may be star performers but are too small to make a difference to the investor's portfolio.

Before you rule out venture capital, keep in mind one critical distinction. The words "venture capital" are generic in nature, referring to equity invested in young, risky companies. Institutional venture capital is out of reach for perhaps 99.8 percent of businesses. But venture capital from individuals (angel investors) is appropriate for almost every early-stage business. (For more on angel investors, see "Raising Money," January.)

Q: Should I hire a financing consultant to help me find money?

A: It can be a good idea. If you've never raised capital before and don't understand the issues, hiring a consultant might be wise. The advantage a consultant offers can be likened to the value an brings to the table. With intimate knowledge of several carriers, an agent can often do a better job finding you insurance than you could on your own. But just as a bad insurance agent will probably get you bad insurance, a bad financing consultant will likely get you undesirable financing. So here's what to do:

  • Structure fees carefully. Contingency arrangements may save fees, but several things can go wrong. First, if prolonged effort is required, consultants may run out of steam. Second, if they don't run out of steam, they might push a certain transaction, not because it's in the best interest of their client, but because it's the fastest route to the closing table and their back-end fee. Third, and this may sound odd, entrepreneurs tend not to take the advice of professionals whom they are not paying. This can cause the consultant to become prematurely discouraged and often leads to the collapse of the relationship.

The ideal fee structure is a modest monthly retainer with a success fee, usually a percentage of the capital raised--or, more often for smaller deals, an equity stake in the company on the back end.

In the case of a public offering, investment bankers sometimes refuse to pay intermediaries because it reduces the amount of compensation they can earn from a deal, according to National Association of Securities Dealers regulations. Likewise, in some private transactions, investors prefer to not pay off a financial intermediary.

Experienced consultants know this, and shop their deals to sources of capital that protect their fees. But it doesn't always work out; consultants often end up working with investors they've never met before. Situations can get sticky, with the entrepreneur actually mediating between the would-be investor and their own consultants.

You can avoid many of the problems of equity compensation by having consultants buy their equity cheaply before the search for capital begins. Of course, if the consultants don't produce, you may have unwanted, and sometimes cantankerous, minority shareholders. The whole process is structurally imperfect, and as a result, plain old fees are sometimes the best way to go.

  • Make sure there is a 60-day out-clause in your contract. If you aren't put in contact with investors within this time frame, your deal is probably withering.
  • Check references. It's amazing how many entrepreneurs hire consultants without looking into their past. To do this, speak to the principals of three firms the consultant has worked for. Did they add value? Did they do what they said they would? Did they act professionally? Most importantly, did they raise the money needed?

The absence of codified professional standards when it comes to raising capital probably accounts for the voluminous number of financing consultants. In truth, just about anybody can hang out a shingle. While there are plenty of qualified financing consultants, the first rule for hiring consultants is buyer beware.

Q: Should I consider an (IPO)?

A: The likelihood of taking your company public is even smaller than the likelihood of securing institutional venture capital. In 1996, 874 companies went public. A big number, yes, but not when you consider that there are some 600,000 new business incorporations each year.

Happily, there are several alternatives to an IPO that are far more appropriate for emerging growth companies. These include direct public offerings, reverse mergers and exempt public offerings.

  • With direct public offerings, a company sells shares directly to shareholders. These are best for companies with a large, loyal customer base.
  • Reverse mergers occur when a private company is acquired by a dormant public company and, in the process, becomes publicly held. The reasoning goes that as a public company, its options for securing financing increase dramatically.
  • Exempt offerings are exempt from state and federal securities laws. This is important because it is the existence of securities regulations which makes conventional IPOs so difficult. The federal government and almost every state have exemptions for public offerings of $1 million or less. They're worth looking into because by utilizing them, companies can gain direct access to individual investors. (Read "Raising Money" in April for more on exempt offerings.)

David R. Evanson, a writer and consultant, is a principal of Financial Communications Associates in Ardmore, Pennsylvania. Art Beroff, a principal of Beroff Associates in Howard Beach, New York, helps companies raise capital and go public.


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