. 27
( 62 .)


Types of Private Investors

marketing plan, a sales plan, a manufacturing plan, a plan to bring in
capital in various stages, and a strategy to attract the kind of investor
who would be ideal at those stages.
Last, what are your plans to fill out the management team? In an
early-stage company, obviously the key person is the founder, the CEO.
Few early-stage companies can declare, “We have our whole manage-
ment team in place.” Obviously you don™t, and we investors understand
that. But I™m interested in your thoughts about how you™re going to fill
those important positions, such as a salesperson, in the early stage, and
what your plans are for bringing on those people in a logical progression.

Value-Added Investor #3
I try not to make investments that I don™t think the venture
community will be subsequently interested in.

As someone who has been making private venture investments now, I
guess, for the last seven or eight years, I believe that most investors are
not aware of the tremendous concentration of investments in just a few
areas. I was at a dinner with some people from professional venture cap-
ital firms”two of the larger Silicon Valley venture capital firms”who
admitted to me that in the last three years, more than 80 percent of their
investments had been made in the following areas: software, network-
ing, multimedia, and the last area was wireless. And so you can look at
presentations made today and 90 percent may fall out of those areas.
There may be one telecommunications-related activity and the bulk of
the investors will be in other perfectly reputable areas, but areas not very
accessible to the venture capitalists.
I™m not sure why the industry tends to concentrate like this. I think
it tends to want to put a consortium together and work in areas each
consortium can then become expert in. As far as my own investing phi-
losophy is concerned, I find it very difficult to fight these trends, so the
bulk of the investments I have been making in the last couple of years
tend to fall in those same areas. However, it™s the exception to the rule
that probably makes for the best opportunity, so I think all of us have to
be willing to look in other areas.
I make investments in the $50,000 to $250,000 range. I don™t make
them outside of the local Bay Area. I™ve had some bad experiences in try-
ing to fly to Boston or commute to Los Angeles to help make invest-
ments. I try not to make investments that I don™t think the venture
community will be subsequently interested in. And I don™t make invest-
ments outside of what would generally be called the high-tech area.

Formerly, I was a senior executive with a major computer hardware
manufacturer, so I™m involved mostly in that industry. Those are the
businesses I™m interested in. So I don™t want to invest in services, in med-
ical, or in distribution.

Value-Added Investor #4
I like to very quickly get an idea of the product, the market, the
competition. Then I go right into the people, because the people
are the ones that are going to make it happen.

In being asked what I look for in companies, I always respond that I™m
looking for the product and the market opportunity. And once I under-
stand that, it becomes 99 percent management. I™ve been through
enough companies to know that management is the key to making any
plan work.
I™ve had the experience of being part of a start-up company that
went public, and I™ve had the experience of working with a Fortune 100
company, of being responsible for billions of dollars in assets and thou-
sands of people. But the most fun has really been in helping to grow
young companies, which I™ve done all my life.
I™m very involved in these businesses and spend my time on the most
important problems or the biggest opportunities. I try to focus my time
on the things that make a difference for the company. I do debt and I do
equity deals with companies. The average investment that I™ve made has
ranged generally from $50,000 to $150,000 per company.
The industries I™ve been involved with have been diverse. What
drives me is the economic opportunity more than the industry, but I shy
away most definitely from anything exotic. I™m involved in due dili-
gence. I™ve invested in businesses related to the mountain bike industry,
the software that helps make the health care system more efficient, and
the coffee business. So I diversify and it™s a lot of fun. I am a generalist.
For me, the critical ticket for the laundry is the business plan. Ninety
percent of the deals that I look at have business plans and, frankly, the
flow, the funnel, has been real big over the years. I™ve gotten to the point
where if I just get the executive summary I™m a happy camper. And if it™s
of interest, I™ll talk with the company.
The companies are located in the Bay Area. I like to get there if they
need me. Then I look for a return on investment, which, obviously,
ranges. Also, there has to be a variety of exit strategies. One recent exit
was the acquisition of the company. Acquisitions are very nice.
Gross margins, I have found, are pretty important; the bigger the
Types of Private Investors

margins, the more attractive it is”for a simple reason. There are posi-
tives and negatives to large gross margins, but I have found, generally,
that with the bigger gross margins, there™s more forgiveness for problems
that a young company has. In fact, it has saved a few of them.
The projected numbers that you have in your business plans defi-
nitely are important, but they™re not as important to me as the assump-
tions that underlie them. I will spend time carefully going through those
assumptions, trying to comprehend the depth of understanding and the
degree to which the company has grasped all the components of its busi-
ness. I have rarely found projected numbers actually occurring, so I™ll
spend the time on the assumptions.
When I get a business plan, I™ll first take a look at the executive sum-
mary. I hope it™s not more than a couple of pages. Then I go right to the
resumes. In other words, I like to very quickly get an idea of the product,
the market, the competition”all the basic things you put in an executive
summary. Then I go right into the people, because the people make it
happen. If they pass muster, I™ll spend the time going through the plan.
Value-added investors, I think, are really important. I will tell you
this: I™ve dealt with an awful lot of companies; the most successful ones
have had value-added investors who have brought more than money
to the table and they™ve helped grow the business in ways that money
alone can™t.
Also, companies need to do their homework in understanding the
market dynamics and understanding distribution. Obviously a business
plan deals with the marketing issues, the competition, the distribution,
the pricing, the market needs, how to sell, and strategy. But when I sit
down with the people in the company, I have found, unfortunately too
often, that they do not have the necessary depth of understanding of
those issues. If a company doesn™t understand its market and understand
how to access the market, it™s going to face serious problems.
A lot of people running these companies are technically oriented;
they have a great idea of the product and its applications. But the issues
are broader than that. A common issue I see occurring with companies
centers on a naughty F-word: focus, focus, focus. The problem is the
lack of it. It™s easy in the early stages of the business to pursue opportu-
nities as they arrive, and multiple opportunities typically do arise. But it™s
the highly disciplined businesses that succeed.
In experiences I™ve had with a few companies I™ve invested in, I
learned a particular lesson. It really saved me; it saved a certain part of
my anatomy located just below my waist. There was a lead private in-
vestor, a major investor who had invested close to $1 million in the com-
pany. I felt secure because I knew that he had deep pockets; he had a

vested interest in, and a history with, the company, so I knew if problems
arose”and they did; they always do”he would keep that company
afloat. The lesson is this: Among your private investors, getting one in
particular who can bring added value along with a significant amount of
money can mean the difference. I think if you have a compatibility and
you know your investor, you™re going to bring something to the com-
pany that™s of real value.

Our second type of investor is the deep-pocket investor.


Deep-Pocket Investor #1
Even if you give up a significant chunk of your company to get the
right management in place, you™ll be way ahead for having done it.

In my career I™ve been an accountant, a lawyer, a consultant, a CFO of
high-technology start-up companies, and most recently I™m president of
a software company. I have been an active individual investor, and over
the past 15 years have done 15 investments, roughly one a year, although
it™s more a matter of accumulating enough money to make the next in-
vestment than it is an ability to accommodate them. The rate of invest-
ment seems closely related to my earnings from other things. These 15
investments ranged in amount from $10,000 to $90,000. The average is
about $50,000 to $100,000 (Exhibit 7.3).
My experience as an entrepreneur puts me squarely in the middle of
individual investors. And when you put up private placement out there
and you™re looking for 10 to 35 people on a regulation D offering, that™s
the kind of folks you™re going to get. Of my 15 investments, five have
been winners, four outright losers””losers” as in all my money is gone”
and five have either not had their outcome determined or have more or
less broken even. Of the 15, nine have been in start-up or early-stage
companies; three have been in venture capital funds”in which my money
was pooled with other people™s and then professional management hired
us out of the funds”and three have been in real estate.
I have divided my primary investment criteria between those that
are absolutely essential and those that are merely essential. It™s like say-
ing in a business plan that you want to have an analysis of the mar-
ket and a description of the people and a financial forecast and a de-
scription of the assumptions. I want good grammar and correct spelling.
Types of Private Investors

EXHIBIT 7.3 Deep-Pocket Investor

• Built and sold company
• Corporate not technical background
• Emphasis on deal structure to mitigate risk
• Invests only in what he or she knows
• Prefer that investor(s) hold control, e.g., outside board
• People and plan equally important
• Can be lead or independent investor; can search for opportunities, makes inde-
pendent decision to invest, suggests investments to others, welcomes leads from
respected colleagues, but always relies on own judgment, and investigation in de-
ciding to invest
• Geographic preference
• Fun is a factor
• Targeted ROI of 50%/year
• Some involvement to make a contribution
• Open to both debt and equity
• $50,000“$100,000 per investment, 1“3 investments per year

Source: International Capital Resources

If it doesn™t have all that stuff, I™m disappointed, though I may still make
the investment.
At the top of my list of criteria is a high ROI”at least 50 percent a
year”50 percent a year after all of my discounting of time slippage, risk
assessment, and everything else. Only in an early-stage deal are those
kinds of returns usually offered, which is what drives me to early-stage
companies. Sometimes”and I™ve made this kind of investment a couple
of times”you can do a short-term debt instrument that has that rate of
return. It happens when somebody has an existing business, an oppor-
tunity that requires capital, an opportunity that has the level of risk no
bank wants to back. By having something that combines debt and
maybe some warrants, or some other equity component as a sweetener,
you can get the same 50 percent return and have a short liquidity time”
certainly an added attraction.
My second criterion demands exceptional management, especially a
solid CEO. Over time I have found that even if the rest of the manage-
ment team is good, it™s really only the CEO that people invest in. And
having been a CFO”a somewhat humbling experience”has helped
me crystallize the need for a top-notch performer in that position.
Generally, an investment becomes a gamble on that individual and, as an
investor with some experience, I™ve decided that, after ROI, there™s
hardly a more significant consideration in my deciding to invest or not

invest. Obviously, if that person changes, the risk of your investment
changes a lot, so how committed the management is and how commit-
ted the funding sources are become critical. If it™s a start-up company, I
cannot fund the whole thing out of my own pocket.
One of the common themes among my investment losers is not find-
ing enough financing to take the venture all the way. It wasn™t because
the idea was all bad. (At least, no one but the people who turned down
the investment would say so.) There need to be people with deeper pock-
ets than mine as part of the deal structure, a structure in which my in-
terests are aligned with theirs, so that they don™t get a big return if I don™t
get a big return.
In addition, I prefer that investors as a group have control, certainly
control if downside contingency occurs. If the management or founders
as a group have control and want to keep control, they™d better have
been in business a while and have had some revenue and perhaps even
made a profit. If there is a 50-50 split”which is often the case in the
early-stage deals between capitalists and workers”I think the capitalists
need to have a way of gaining control if milestones are not met.
An essential criterion focuses on local connections. First, all my in-
vestments are in the Bay Area; the exception occurs where there is a
strong local connection and the company is actually operating some-
where else or considering relocating to that area.
Another criterion of mine in deciding whether to invest is whether
the opportunity is available for input to management, typically a board
seat. Because of the skill sets I have, I usually can count on people asking
for my help to set up accounting systems, or hire lawyers, or write their
business plans, or evaluate the deals for them. Thoroughness of the busi-
ness plan is very meaningful. I run across entrepreneurs”or would-be
entrepreneurs”who actually hire other people to write their business
plan for them. It™s one thing to hire somebody who can do an Excel
spreadsheet better than you can, but I have never seen a CEO able to run
a company successfully who couldn™t describe in writing what the plan
was for that company”and do so in a fairly articulate manner.
So I think it is essential for you to write the plan demonstrating an
understanding of the market, a careful forecast of the future expressed
in numbers, complete with the assumptions for a forecast. Frequently a
business plan has page after page of month number 10 as well as month
number 24. However, what I™m more interested in is three or four pages
of careful assumptions carefully described, plus prepaid expenses based


. 27
( 62 .)