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budget can be used in paying up-front fees associated with documentation
development, accounting and legal counsel, printing of marketing materials,
and providing a budget for a range of investor development expenses. Then
budget an additional 5 to 10 percent to cover the back-end fees. Investment
banking fees for a professional placement agent, finders fees for a financial
intermediary, and other residual legal and offering fees can all add up. As any
seasoned capital development professional knows, it costs money to raise
money. It is “pound foolish” to operate on a tattered shoestring when a small
investment can help you achieve your capitalization goal.

Anticipate Due Diligence
Anticipation is a wonderful thing. It works wonders in all aspects of life. In
tennis, for instance, being able to anticipate where your opponent™s shot will
land enables you to get in position to control the game. But tennis is not the
only activity in which anticipation works to your advantage. You can in-
crease the efficiency in the financing process by, for example, anticipating
due diligence that puts you in a position to accomplish your goal faster. Due
diligence is the analysis you can be sure will be conducted by the investors
and their advisers in order to determine your venture™s strengths, weak-
nesses, future profitability, competitive position, and identifiable and possi-
ble risks.
Typically, the investor and/or agents such as attorneys, accountants, or
private investigators perform due diligence in these cases. These are typically
sophisticated and experienced businesspeople who will evaluate not only the
venture but also you and your business and personal background.
Entrepreneurs can expect due diligence to take two weeks to six months!
Due diligence is no more than the caution any prudent person would exer-
cise with their own money. Sophisticated investors recognize that nothing
takes the place of a full-venture audit, an in-depth assessment of the founder
and entrepreneurs, and close scrutiny of the deal elements themselves to
judge the viability of a prospective early-stage investment; moreover, the in-
vestor will require numerous face-to-face meetings with the entrepreneur,
thorough review of the business plan and strategy, and interviews with cus-
tomers, suppliers, and competitors; and he may seek counsel from relevant
industry or technical experts.
The entrepreneur can expect”following the losses investors suffered as
a result of lax due diligence during the dot-com debacle”that investors will
investigate the principals, including comprehensive background and refer-
ence checks, as well as possibly conducting interviews with former superiors,
peers, subordinates, and business associates. To the entrepreneur, this due
diligence may seem elaborate, but we caution them to expect it and to be

prepared in advance of it. For more cautious and skeptical investors, noth-
ing will replace legal and financial audits, a keen assessment of market po-
tential, and the investors yearning to know potential risks in the venture and
realistic future profit and return potential. By nature, entrepreneurs are opti-
mistic and may understate risk factors, weaknesses in technology, and po-
tential delays in penetrating their market. Such an attitude not only is legally
suspect, but irresponsible, as the entrepreneur enters a much more critical in-
vestment climate.
An example of a due diligence case illustrates the point. A company was
offered at a $1.6 million acquisition price, then was subjected to due dili-
gence by one of ICR™s partners. The principals of the venture stated that
there was a net worth of approximately $1 million, plus off-balance-sheet as-
sets of $600,000. The CPA conducting the due diligence requested the com-
pany™s financial statements and tax returns. Subsequent analysis by the
accountant showed operating losses of more than $800,000 for the previous
18 months, fraudulently prepared tax returns, and a $400,000 tax liability.
Due diligence revealed the real value of the venture to be only $500,000.
The lesson for you is crucial: Know your own company thoroughly and
hire competent personal advisers to assist you in preparing for due diligence.
Due diligence typically is best approached with full disclosure by admit-
ting to yourself in advance those areas of the venture that reflect the
strengths but that also unmask weaknesses and expose risks. Only by this
procedure can you anticipate the questions that are sure to come and be able
to address them honestly. So prepare in advance of meetings with investors
all information necessary to support your answers. This becomes imperative,
because during due diligence nothing less than your credibility is at stake.
Too often, we have seen greed overtake the entrepreneur™s ethics, even
those with the best of intentions. Examples of ethical lapses were featured in
a 1999 article in Fortune Magazine:

– Companies investing in other companies that turn around and buy serv-
ices from the investor company to inflate their services.
– Companies recognizing revenues prematurely.
– Companies reporting barter transactions as revenues.
– Companies recording sales at full value, not the actual price paid when
using coupons or discounts.

Although it may be difficult to remain above the fray, especially when
others raising money seem to be awash in deceit, the ethical entrepreneur an-
ticipating today™s thorough due diligence will not lose his or her ability to say
As Exhibit 3.5 indicates, many factors go into investor due diligence, the
The Solution: A Strategy That Works

preinvestment research that will verify your proposal™s viability for receiving
financing. This preinvestment research will scrutinize the skills and back-
ground of your management team, check references, examine the appropri-
ate industry sector, interview customers and suppliers, assess product
realization, study the potential of growth in the market and potential com-
petitors, consult with technical advisers and other investors before investing,
establish a premoney valuation for the venture, explore financial projections
and other business attributes, and test the ability to match the deal with per-
sonal investment criteria.
Beware that preinvestment audit can involve questions about a number
of areas of concern to investors, including management, products or services,
industry, market, sales and distribution, competition, human resources, sup-
pliers, production, and R&D. In addition, financial projections will be ana-
lyzed, particularly if the case is made that management can reach the
objectives they have forecasted. Also scrutinized will be the company™s ex-
pected financial needs and capital requirements, valuation calculations, bal-
ance sheet, liabilities, shareholders™ equity, income statements, cash flow
analyses, use of proceeds, and all supporting financial assumptions underly-
ing projections. Lastly, investors might request a closer review of a range of
miscellaneous documents.
While we have focused on the entrepreneur anticipating and preparing
for due diligence by the investor, we advise entrepreneurs not to be shy in
conducting the same procedure on investors that investors conduct on them.
Be assertive in your due diligence of investors. Do not hesitate to inquire
about the investors™ investment objectives and their track record of invest-
ments with companies of similar size and within the same industry. Ask ques-
tions about other investments in the industry that could present a conflict of

EXHIBIT 3.5 Due Diligence, Preinvestment Research to Verify Proposal Viability

• Management team skills and background
• Reference check
• Industry sector research
• Customer/supplier interviews
• Product realization
• Market growth potential and competitors
• Consultation with others before investment
• Valuation
• Financial projections in investment proposal
• Other business attributes
• Fit/match with investor™s personal criteria

Source: International Capital Resources

interest. And clearly define what ongoing role the investor may want to play
in the venture.
In further conducting due diligence, you should obtain references of the
investors and follow up on what the paperwork reveals. Also be clear about
the financial terms of the investment before signing an agreement. Use pro-
fessional advisers whose experience in anticipating problems can keep a bad
situation from becoming worse. Use advisers who understand that you want
to do the deal. (Avoid deal breakers.)

Build Relationships with Prospective Investors
Angels do not invest in business plans; they invest in people. The relationship
between the angel and entrepreneur is the most significant factor in moving
forward the sale of the illiquid investment security. When the chemistry be-
tween dreamer and dream-maker merge, other factors, such as business
plans and private placement memoranda with risk-disclosure statements, be-
come secondary. The relationship is everything. Astute entrepreneurs will ap-
preciate that people are motivated to acquire relationships that improve their
self-image. Investors have different motivations for investing, just as they
have different motivations for declining the opportunity. Still, people invest
in people. This seems to be the sense of it: “I™m investing in you. If the asso-
ciation uplifts me, you have a better chance of gaining my contribution to the
venture.” By the same token, a transaction they think will lower their
self-perception will keep them on the sidelines.
So in raising capital, you need to move outside meetings and toward
building successful relationships with investors and their advisers; proceed
beyond the one-dimensional professional level. The gimme-your-money-and-
get-lost syndrome will no longer suffice”if, in fact, it ever has. You always
get the capitalist along with the capital. To cultivate a relationship with in-
vestors, you must add value through the relationship. Properly managed,
even investors who initially turn you down can end up providing feedback
on your offering as well as guidance on your development and presentation.
They can simultaneously provide you with a cost-effective way to cultivate
investor referral. Again, those who refuse early may well become investors at
a later, less risky stage of the venture™s development.
In raising capital, also get to know prospective investors who inquire
about your venture before you have contacted them. Last year, more than
$200 billion was donated to philanthropic causes, most of it by individuals,
a substantial portion of which was raised by professional fund-raisers.
As any successful fund-raiser will tell you, the key to getting a check is
matching the donor with the cause. You see, there is such a thing as a
$250,000 lunch!
The Solution: A Strategy That Works

To raise funds, gather information on prospective investors before any
contact so that you can determine whether a match exists between them and
your investment. Good research takes time, so if you cannot handle this
yourself, private investigators with access to online databases can be an in-
expensive and efficient resource for gathering and packaging the necessary
information preceding your meeting with prospective investors. Remember
this quote from John D. Rockefeller, one of the most generous philanthro-
pists in U.S. history: “The more you know about the person you are asking
for a gift, the better your chances of getting it.”
So just as you build a database of investors one name at a time, you build
funding one relationship at a time. Take the time to understand the person-
alities of these investor contacts; find out what they expect out of their rela-
tionship with you. Accelerate this process by getting comfortable with their
advisers. Take the time to understand their concerns: for example, the inter-
generational transfer of wealth. Learn about their favorite charities and pas-
times. Expand your relationship within the investor™s family. As we have
pointed out, spouses are increasingly involved in investment decision mak-
ing. You and your firm may even be able to speed the investment education
of the children of these middle-aged private investors, children who have
reached an age when investments may have begun to pique their interest.
Assembling profiles of possible investors becomes another way of build-
ing relationships. Three types of profiles exist: demographics, psychographics,
and”our choice”biographics. Demography categorizes information by
gender, race, age, geographic locale, and so on. Psychographics measures
such things as values and attitudes: “How do you feel about the job the
president is doing? Excellent? Good? Fair? Poor? No opinion?” Or “What™s
your opinion of the NRA? Favorable? Unfavorable? No opinion?” Psycho-
graphics aims at the individual™s thoughts and feelings, opinions often ex-
trapolated for a look at their broader implications.
The third type of profile originates from the new field of biographics. It
is based on the research techniques of case studies and content analyses that
assess the personal history and lifestyle of the individual. A biographical
profile gathers not only names and addresses”where people live can tell
you a great deal about them”but also professions, positions, memberships,
family histories, personal histories, financial positions, and investment
histories. In Chapter 5 we illustrate this kind of information in our pioneer-
ing new study of 60 investors from ICR™s network of angel investors. Our ad-
vice is simple: Stay close to the gold. Don™t just look at investors as deep
pockets; instead, cultivate a relationship with them; treat them as peers, if
not as mentors.
Remember too, if properly managed, even investors who turn you down
at first can provide invaluable feedback about your offering, guidance on of-

fering development, and valuation and pricing, while simultaneously pro-
viding you a cost-effective way to develop the venture and cultivate addi-
tional investor referrals. Commonly, investors who reject you at very early
stages become investors later, once the venture is more fully developed.

Line Up Precommitment
The entrepreneur can increase efficiency in finding investors by lining up a
commitment from them before spending time and money on preparing doc-
uments. Private placement investments involve two types of documents: (1)
the business plan and (2) the private placement investment memorandum
or risk disclosure document. Basically, the business plan proposes reasons
for investing, while the risk disclosure document suggests reasons against
Ironically, many entrepreneurs incur $10,000 to $25,000 in legal fees to
prepare a risk disclosure document”even before building interest in the
venture”which presents investors with reasons why they should not invest.
Before the dot-com bubble, a significant percentage of investors were will-
ing to invest without a complete business plan; that is not the case today. In
its newest study of 1,300 investors in its proprietary investor database, 95
percent of those who responded required a full business plan and financials
for review before seriously considering the deal. This important new find-
ing suggests a reduction in the difference in rigor associated with support-
ing documentation between informal, private investors and their
institutional counterparts in the venture capital community, which insists on
complete documentation. A better use of resources is to prepare a business
plan and stellar executive summary rather than prematurely expending
scarce resources on legal risk disclosure documentation too early in the
fund-raising process and before sensing the extent of private investor inter-
est in the deal.
At ICR we have found the investment opportunity profile (IOP) to be the
treasured tool in stimulating investor interest prior to doling out money on
documents. The IOP, an investor-oriented executive summary, supplies the
investor with enough information to decide whether to look at a complete
package of documents. After submitting an IOP to a number of prequalified
investors, the entrepreneur will feel confident about spending time and
money on more documentation.
In a published survey, The Capital Network made a dramatic finding
about investors in a network: Unsolicited plans rarely receive funding. The
IOP helps improve this low funding rate. An excellent summary tool, the
IOP was developed in close cooperation with investors in the ICR network


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