Updated October 17, 2011Doc Sheldon
(Part one of a series)
Those of us that are, or have been, in business for ourselves are all too aware that cashflow is almost always an issue. Whether your hobby business brings you $20-$30K per year, or your corporation measures its revenues in the millions, the successful management of your cashflow is critical to your survival and success.
If growth is a serious part of your business plan, the criticality of cashflow can be even more pronounced.
If your business is doing well, and you recognize greater opportunities to be realized by scaling your operation, then funding (or the lack thereof) can often be the limiting factor. A need for more or better equipment, larger or more experienced staff or simply larger operational expenditures can cause you to reflect on the possibility of gaining additional funding.
Similarly, if you just had a fantastic idea for a new venture, but need some operating capital in order to launch it, you may find yourself in the same position.
In either case, this may mean looking at a bank loan, selling assets or seeking investors, depending upon the nature of your business, your personal situation and the economy. A new start-up will normally find it difficult to get the bank interested, however. Banks prefer solid collateral – typically with greater value than the amount to be borrowed. Don’t expect to find a visionary behind the loan officer’s desk at your local branch.
If you have significant assets, then asset liquidation to fund your new idea is certainly a possibility, but frankly, not many budding entrepreneurs find themselves all that asset-laden.
Investors, then, become the next option to consider. That’s where this article will go… presenting a few of the common options, and some of the major considerations of those options, from the viewpoint of both the entrepreneur and the financing entity.
The new start-up.
You suddenly have an amazing idea for a new product, that you’re certain will take the market by storm. You’ve done some preliminary investigation and found no competitive product, and have polled a small quantity of potential consumers to see if they would accept the concept. You’ve worked out how to source components and the assembly of a prototype, but now find yourself with nearly empty pockets.
You approach a circle of family and close friends, and manage to raise $20,000 that should allow you to develop a working prototype and perform some better market research. This, along with your own money that you already spent, is referred to as seed money or seed funding.
Next, with your prototype in hand and a PowerPoint presentation on your laptop, you start meeting with angel investors, in hopes of gaining sufficient funding to start production and sales efforts.
If you’ve never been through the process before, you really need to do some research, in order to put your best foot forward. If you don’t blow their socks off during your initial presentation, don’t expect a second meeting.
The Entrepreneur – King of his Castle
I think that one of the most prevalent reasons for people deciding to start their own business is their desire to make their own decisions. They’re often tired of taking direction from others; perhaps they’ve had the misfortune of working for someone that they felt challenged Darwin’s survival-of-the-fittest theory. Or maybe they think they’re much smarter than others in their niche. Most often though, I suspect they are just independent souls, that prefer to build something for them, rather than for someone else.
An independent spirit is an important part of what makes the entrepreneur tick, I think. Without that, most would probably continue to hunker down in a cubicle-farm, happy or not, until overtaken by either retirement or hardened arteries.
After a short while, of course, most of us realize that we have simply traded one boss for many – our customers. That requires some “attitude adjustment” for some, and they’ll hopefully adapt quickly.
If we’re new to the entrepreneurial world, we may also be rudely awakened by cashflow issues. Looking at the month-end report balance sheet is one thing… finishing in the black is what’s important, right? But what if our accounts payable all come due on the 10th, but receivables don’t start hitting until the 20th? On paper, the cash may be up to the demand, but on the calendar, it may not be in the right place at the right time.
My first business went under because I failed to adequately manage my cashflow. By the time I realized what my problem really was, I was in trouble with my suppliers, who first put me on credit hold, then COD, which essentially shut me down. That was a bitter pill to swallow, for two reasons: (a) the business was growing rapidly and well in the black; (b) it was entirely my own fault.
Before things got to that point, I sought some funding from a local friend. Not a lot – just $50K to provide me about two weeks of float. He looked at my books and turned me down, saying I didn’t need more money… I needed more smarts. He freely offered me a good batch of advice on how to manage my cash to overcome the problem, though.
Unfortunately, I didn’t listen to his advice. Fortunately for him, he didn’t invest. At least my failure only affected me.
At the time, I was almost relieved that he declined my invitation. Id already had one partner, and had bought him out to escape the constant battles. So I wasn’t anxious to jump into bed with someone else that might be constantly trying to dictate what should be done and how.
The truth is, I wasn’t mature enough to enter into such a relationship yet. I needed to get burned a few times and learn not to reach out and touch every hot stove I found, before I could put the business before my ego.
That was my problem… I was in love with the idea of being in charge of something. At any cost.
If you’re taking on investors or partners, that is one of the first traits you need to get rid of! If you can’t put the business ahead of your ego, don’t expect much of a future.
The Investor- The Other King of the Castle
Contrary to what some people may think, angel investors usually aren’t millionaires that are just greedy for more money. Set aside for the moment that there are many reasons a person might be willing to invest in others’ ideas. Let’s just focus on a few realities for a moment.
Suppose a person has a million dollars in cash, and puts it in the bank. If they’re single, not prone to extravagances and are willing to live a very simple life, they might be able to live on the interest it’ll bring them. But if they’re married, enjoy a few low-end luxuries now and then and live in the Bay Area, then they’re going to have to invest a lot more wisely than that. Even twice what an interest bearing savings account will bring them won’t put a dent in their needs.
There are many different types of investment vehicles, of course. Depending upon what each investor personally feels comfortable with, risk-wise, the return can vary greatly. The typical angel investor isn’t interested in a 10% return. For that matter, 50% isn’t likely to get their attention, either, unless it’s over a very short period. 500% is more in the range of the scale that will get his attention, and even that is probably at the lower end of the scale. 1,000% will almost assuredly get at least a serious glance, though.
As we all know, greater returns come from greater risks, but of course, there’s a flip side to that coin. So it’s understandable that angels need to be very thorough in their research, have a good grasp of marketability and business practices and hopefully, nerves of steel.
Understand, they’re not just betting their money on the viability of your offering and the market’s collective willingness to buy that product or service, they’re also betting on your ability to deliver it. For their willingness to accept that sort of risk, it’s understandable that they may want to be actively involved in the management of the company.
The level of involvement will vary from one angel to another, obviously, but it’s a safe bet that you won’t often see one with a hands-off approach to investing. There may be some out there… but I’ve yet to hear of one. At the very least, I think most are going to want to be in the loop.
Most experienced angels are very aware of the difficulty some entrepreneurs have with letting go, and will be tactful and supportive in their methods. If the entrepreneur is equally aware and supportive of the investor’s position, the relationship can be off to a good start.
Like newlyweds, they’re not going to agree on everything. They may even have a spat or two. But if they both stay focused on the business, rather than egos (more often the entrepreneur’s issue than the angel’s), things will generally work out.
I knew one angel investor that had just entered into a deal with a pair of entrepreneurs for the fourth time. The first three ventures had ended in total failure, and everyone had lost everything. I asked him why in the world he was getting back on that same horse after getting thrown three times.
He said that horse had spirit, and that was worth more than looks or speed. He got along great with them, they heeded his advice and used their heads. And they kept fighting, even when it was obvious that they’d lost. He just knew that eventually, they’d win a race.
And the fourth venture was a raging success, bringing him over 20 times what he’d invested in those partners from day one.
I don’t imagine that happens every day. But it did demonstrate to me that the relationship and the character of the entrepreneur(s) were big pieces of the venture puzzle for him.
Like a new writer submitting his first novel, the entrepreneur actively seeking angel investment should be prepared for rejection. If the venture lacks any of these, serious consideration isn’t likely:
- Demonstrated technical expertise in your niche;
- Demonstrated business acumen, particularly in start-ups;
- Personal recommendation;
- Viable, marketable product/service with double-digit growth potential.
Since many first efforts are likely to lack one or more of those, initial rejection is a real probability. That may seem disheartening, but you’re only defeated when you stop fighting. Take whatever feedback you can get and use it to polish your project – and keep trying.
To give you a little more insight, here are a few comments to specific questions from both the entrepreneur’s point of view and that of an angel investor:
What do you think are some of the most important factors to consider when deciding whether to bootstrap or seek seed money for a start-up?
Steve Gerencser, entrepreneur:
For me there is only one question when it comes to deciding between bootstrapping and seeking outside funding. Can I get to market, with a quality product, before anyone else without help? If the answer is yes, then you do not need to share your company, your goals, or your potential profits with anyone else. However, if someone may see your idea and run with it, or you are entering a niche late in the game with a better idea, then being able to hire staff to help you reach your goal faster makes sense and you should seek help.
In our case we can bootstrap our way in to the new business because the old business we will be competing with is so entrenched in their ways that we could take several years to get there and still be quite successful. However, if we can get the funding that we think we need earlier in the process, we can move much more quickly than we currently are.
Rand Fishkin, entrepreneur:
This is a topic that’s been written about endlessly in the entrepreneurial world, and I suspect many/most of those authors have far more experience than I do. I’ll say that for SEOmoz, in 2007, we decided to raise our $1.1mil investment round because we wanted to build a product that required a far more substantial amount of money than what we could generate in profit over the next 2-3 years, and we wanted to be first to market.
When looking at a potential investment, what are some of the key factors you pay the most attention to in your evaluation process?
Nova Spivack, angel investor:
I look for extremely talented technical co-founders, and ideally a business lead with strong relevant sales and marketing experience in the appropriate domain. It is also very important that the product is awesome – even if it is only a concept. I have to be really blown away – I see a lot of ideas that are quite mediocre and only rarely does something come along that truly excites me. I’m only interested in really major breakthrough ideas that have the potential to disrupt or at least significantly evolve industries and markets.
Do you research the investment team as deeply as they investigate you and your management team?
Steve Gerencser, entrepreneur:
If you don’t, you are crazy. This is business and while you may be friendly with your investors, their goal is to do as well as they can for their fund and their investors. You should approach any deal the same way.
Always hire a good lawyer who is familiar with venture capital investments. Do not rely on your college buddy that happens to be a divorce lawyer. You also want to avoid lawyers that want a percentage of the deal rather than to be paid for their hours.
Rand Fishkin, entrepreneur:
Despite doing lots of diligence, I’d have to say no. Investors are cagey and they don’t like you digging into their records, their finances, their win/loss record, all the deals they’ve looked at but haven’t funded. It’s not a fair equation or relationship, but investors have money and businesses need it, so they tend to hold the upper hand.
What are three immediate deal-breakers for you?
Nova Spivack, angel investor:
- Lack of a strong technical co-founder. Without that I’m not interested.
- Not a defensible idea. If it’s easy to copy I’m not interested.
- Boring. If I can’t imagine being excited every day when I think about the product, I’m out. There are a lot of great businesses that happen to be truly boring as well. I’m not interested in those, even though they are great businesses.
The entrepreneur and the angel investor, working together, can overcome many obstacles. Certainly, the funding is an important piece of the puzzle, but the mentor aspect shouldn’t be discounted. Most angels have invested many times, in many different types of projects; their experience can be invaluable to the entrepreneur. Trust, cooperation and comprehension from both will maximize the benefits of the partnership and make success a more likely outcome.