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the technology or product. Add to this gathering those other individuals,
such as manager-investors, who invested in the venture and took an opera-
tional management position. These are the people who form the backbone of
individual participatory investment.
Last, during the initial market growth stage of their development and fi-



n = 328 Manufacturing and service companies achieving $1 to $50M sales
1989“1994
$500,000
$450,000
$450,000
$400,000
Affinity for
$350,000
deal
$300,000
$250,000
$200,000
$210,000
$150,000
Affinity for
$150,000
$100,000
technology
Affinity for
$50,000 $75,000
or venture
you
$10,000
0
Seed stage Start-up Survival Initial market
growth
Mean time frame = 28 months

Exhibit 3.2 Correlation of Stage of Development with Private Capital Source
Source: International Capital Resources
44 THE CHALLENGE AND THE SOLUTIONS


nancing, these companies typically raised $450,000 to $500,000 from non-
related individuals and investors and groups with an affinity for the deal.
These likely were private placement investments or direct public offerings,
institutional venture capital investments, or bank loans and credit lines
arranged by the principals.
The chart in Exhibit 3.2 on the correlation of stage of development with
the private capital source provides a road map, complete with stopping-off
points along the way. You should avoid trying to tap family members and
friends at a stage of development requiring an amount they cannot con-
tribute, say $500,000. Likewise, why approach manager-investors for an
amount in this range when they typically invest only $100,000? The idea is
to gain a sense of the best source for capital at each stage of the development
of your venture. As you develop a capitalization strategy, keep in mind the
amounts of capital typically being raised at these pivotal points in a develop-
mental-stage company.


Focus on Management, Not Documents
Although development of the professionally prepared business plan and
presentation (see Appendix A) is important to funding, only implementation
of the ideas contained in the plan bear value. We emphasize the importance
of the Investment Opportunity Profile over the business plan as a marketing
tool during the initial stages of investor development and as a way to inspire,
as well as assess, investors™ interest in the venture. And while we affirm that
investors invest in people, not documents, this does not render business plans
and summaries unimportant. In the beginning, you want to focus on man-
agement, but eventually you will need documentation to enunciate your vi-
sion. Documents may not be crucial in the early going, but be assured their
time will come. Never minimize their importance.
But before preparing documents, you should create a number of com-
pany boards, particularly a board of directors or an advisory board. A re-
spected board of directors is one of the most important credentials that a
private company seeking funding can possess, and it is central to potential in-
vestors being able to distinguish the “pedigrees” from the “mutts.”
Getting the most from your board means selecting individuals who add
value, not merely serve in an honorary capacity. Look at the legal debacles
we read about daily in the business press. An entrepreneur™s best insurance
against future litigation lies in his or her careful selection and scrutiny of the
board of directors. Many entrepreneurs believe boards are just a check
against their Lone Ranger tendencies. Not so. Independent boards serve in
an important advisory capacity, providing help, counsel, and insight in car-
rying out your business plan. We will discuss later how the Sarbanes-Oxely
45
The Solution: A Strategy That Works


Act has established new standards for all business entities, whether public or
private companies.
So an independent board is important in attracting new investors, in-
vestors who must know these people will stay on if and when things get bad.
In this highly litigious age, as the entrepreneur adds more investors while the
company develops, he or she correspondingly becomes vulnerable to law-
suits. PricewaterhouseCoopers, in their Growing Your Business booklet,
suggests the following tips for getting the most from your compnay™s board
in the current environment: Establish an independent nominating committee
rather than have a CEO unilaterally identifying board members; ensure that
the board as a whole has the necessary skills and experience; exclude those
who are not independent, for example, those who happen to be close to the
CEO but who themselves lack the knowledge, judgment, skills, and experi-
ence; provide an in-depth industry orientation to all board members; foster
trust with your board by being open, and seek their counsel on major issues;
and, finally, create a safe environment for asking questions by using meetings
to communicate, not just to present facts.
Entrepreneurs should remember that poor decisions about investors and
board members “let in” to the transaction can make your deal less attractive
to needed investors, venture capital, or corporate lenders when you seek fu-
ture rounds.
Even if entrepreneurs need to provide director and officer insurance”
which on a $5 million round might cost $100,000”the availability of such
insurance and coverage can make attracting prospective board members eas-
ier, especially if they have concerns about financial vulnerability. Does such
director and officer insurance protect you? Yes, it does, but fraud and mis-
representation will preclude policy coverage. Still, carefully read a potential
policy and familiarize yourself with all its exclusions. Failure to do so could
lead to your paying twice the price for half the coverage.
If you have trouble developing a board of directors because of issues rel-
ative to the liability exposure of directors and officers, an advisory board is
an alternative that will allow you to bring people into the organization, pro-
vide counsel, and gain the benefit of the board relationship while lessening
their legal exposure.
Next, identify respected technical advisers and establish professional ad-
visory relationships; they are indispensable to a winning team. Assembling a
credible fund-raising team and establishing constructive and cooperative re-
lationships among its members should also be a high priority. The team will
include not only the entrepreneur, founders, managers, and board of direc-
tors, but also the attorney, accountant, CPA, advisory board members, tech-
nical advisers, investment bankers, and any financial intermediary or finder
assisting in introducing investor prospects for the transaction. Even more im-
46 THE CHALLENGE AND THE SOLUTIONS


portant”and this is reiterated by private investors”you must assemble a
credible management team instead of placing faith in the capability of docu-
ments alone to generate investor interest (Exhibit 3.3).
It™s also important to develop a complete set of references you can use
with your investors to prepare for the due diligence process. To clarify, some-
times you need technical advisory support. Technical advisers possess differ-
ent proficiencies. For example, some advisers can provide support in
developing the business plan, or in completing a competitive analysis for the
marketing section, or in assisting in obtaining patent protection.
Next, though perhaps less recognized as part of the team but in our ex-
perience absolutely critical, is your including any lead investors or investors
initially interested in the deal among your resources and reference list. This
kind of thinking helps you use all the resources available in building the most
effective team with which to move forward. Once you™ve exhausted your
own resources and that of family, friends, and referrals, consider a financial
intermediary or other resource to supplement your pool of investor
prospects. A competent financial intermediary will help you with your pri-
vate placement in a number of ways: provide introductions to qualified, ac-
credited investors interested in your type of deal, help you raise funds by
helping to place the security, provide knowledge about the private market,
share extensive private capital sources they can tap on your behalf, bring ex-
perience of the private placement process, guide the company to help you to
legally attract qualified investors, share their aptitude for fund-raising with
your team, and identify sources you may have missed or were unaware of as
appropriate for your deal.


Technical advisors
(e.g., business plan)
Resource for
investor
Attorney
introduction

ENTREPRENEUR,
MANAGEMENT TEAM,
References Lead investor
AND BOARD OF
DIRECTORS

Investment Accountant
banker
Advisory board
Exhibit 3.3 A Winning team for the Private Placement
Source: International Capital Resources
47
The Solution: A Strategy That Works


Finally, it will pay to remember that venture documents are like milk:
They spoil with time. An experienced entrepreneur carrying only a “B” plan
will always be financed over a novice with an “A” plan or product.
Remember what we have stressed about funding: Business plans do not get
funded; people get funded.

Budget for the Financing Program
Ironies abound in the money-raising game; for example, only companies that
“look like” they don™t need capital are successful at raising money from
high-net-worth investors. Another irony is that it takes money to raise
money. This means building a budget to raise money. While every exuberant
entrepreneur believes that skilled professionals will line up to work on com-
mission for the privilege of being associated with his or her venture, good
help willing to work “on the come” (i.e., on commission) is hard to find.
Worse, you™ll get what you pay for”nothing. We have often advised entre-
preneurs to start early, assign an individual to be solely responsible for and
focused on fund-raising, premarket the deal vigorously before beginning the
capital raising, and never stop fund-raising by making it part of your job de-
scription and daily task list.
Regardless of these suggestions, many entrepreneurs exhaust their re-
sources developing their product and spending money on attorneys and
consultants in pursuit of venture documents. But money needs to be set aside
to raise capital. Entrepreneurs commit a common error in using all their
money for product development and for documentation, leaving no money
to raise money.
Another risk unfolds here: Working on the come creates dependency on
the commission for remuneration. In many cases an intermediary will oper-
ate outside your direct control during fund-raising. The concern is that since
intermediaries work on commission, pressure will mount to persuade in-
vestors to close. The intermediaries may make inappropriate promises to in-
vestors, misrepresent the opportunity, or, in their exuberance, fail to disclose
risk. This last circumstance especially adds to the hazard of employing peo-
ple who work solely on commission.
In Exhibit 3.4 we outline expense items typically associated with raising
capital, which include a number of different expenses usually paid up front
as well as fees that follow the completion of the transaction.
Estimates indicate that $10 million is required to get 0.5 percent of the
mind of the U.S. market. Similarly, you will need financial resources to gain
consciousness of the affluent, high-risk investors™ market. So develop a
budget, detailing the anticipated up-front costs of raising money and a real-
istic schedule allowing 6 to 12 months to close the transaction. Remember to
48 THE CHALLENGE AND THE SOLUTIONS


Expense Items in Raising Capital (6%“25% of capital raised)
EXHIBIT 3.4

Up”Front Expenses Back ”End Fees
• Development of a financing strategy • Investment banking
• Business plan, financing proposal, • Finders™ fees
profiles
• Financial projections (accountant • Brokerage fees (e.g., sales commissions,
or CPA) underwriting fees, due diligence,
processing costs, red”tape fees)
• Legal security documents (disclosure • Legal fees
documents, terms sheet, investment • Offering fees
agreement, stock purchase agreement) ”State and federal
• Printing
• Capital search
”Profile
”Travel
”“Advertising”
”Presentation materials
”Telephone
”Seminars
”Postage
”Printing
”Other

Source: International Capital Resources


calculate these costs into your forecasts. Running out of money before rais-
ing capital or setting up unreasonable, overly optimistic funding schedules
will create an atmosphere of desperation that will accompany you like a
shadow in your discussions with investors and finally work against your fi-
nancing goal.
For the entrepreneur new to raising capital, costs can be shocking.
Although raising private capital is less expensive than going to the public
marketplace, costs still loom. However, no direct correlation exists between
money spent and money raised. In our experience, a “rule of thumb” for
total fees and expenses of fund-raising range from 10 to 25 percent of the
money raised. Some entrepreneurs may spend $100,000 to raise $1 million,
while others will need to spend $100,000 to raise $400,000.
To be sure of covering start-up costs, budget a minimum of 10 percent
of the amount to be raised in your capitalization program, figuring that dur-
ing the first few months costs will outstrip investment capital raised. This
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The Solution: A Strategy That Works

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