Andrew D. Clapp

 

How do you measure perfection? That’s easy, in the realm of raising capital: it is when capital is raised in a timely manner, on attractive terms and at a high valuation. Like most things in life, perfection is rarely achieved, and most young and successful companies experienced their own rocky beginning and had to deal with the challenge of raising capital.

To make this process just a bit easier, we recommend that a firm prepare an Executive Summary for use with prospective investors prior to providing them with a complete business plan. This is our recommendation, based on many years of advising companies seeking to raise capital, and more recently, as managers of the Arctaris Income Fund, LP and Brook Venture Fund, LP.

The investor we refer to in this memo is an institutional investor, typically a venture capital firm, or a sophisticated Angel investor or Angel Investment Group, or even a corporate investor.

Before you can prepare an Executive Summary you need a business plan from which the Executive Summary will be extracted. The Executive Summary may take a few hours to draft, provided that your business plan is in order. We strongly advise you to prepare your business plan for the purpose of managing and operating the business rather than for the benefit of investors. It should focus on substance rather than form, and need not be pretty. The executive summary on the other hand, should be well articulated and be viewed as the fundraising document.

Armed with an Executive Summary (Part I), we offer Tips and Suggestions for Fundraising (Part II).

 

Part I: The Perfect Executive Summary

Here are our suggestions for preparing what we believe is the Perfect Executive Summary:

1. THE EYE-CATCHING INTRO

The first paragraph of an Executive Summary should be compelling and capture the reader’s attention. Take your best shot. Play your strongest card by stressing that single feature of your business that is its most eye-catching and distinctive characteristic. Don’t rely solely on what you think is your strongest feature; ask others to tell you what they think. Here are some examples:

The replacement of textbooks with a whole new learning paradigm begins this fall at more than 30 colleges and universities with the first time, classroom use of EduSmith’s internet-based electronic textbooks. The cost of electronic vs. printed text is low, the enhanced learning features are high, many of which are much more difficult to obtain, and the target market is well defined. LitmusWorks was profitable in its first year, earning $65,000 on sales of $650,000 last year, and will generate profits on sales projected at $4 million this year and $9 million next year.

When our salespeople call on restaurants that are using one of the 2-3 national brands, they try ours, and 6 out of 10 restaurants switch and begin ordering our product through their distributor. The reason? Taste and appearance, never price. We now have 30% of the New England market and are expanding down the East coast. Does the consumer like our product? We have more than 1,000 emails and letters on file received from consumers over the brief life of the company.

Both of the above businesses successfully raised the funding they were seeking.

2. BUSINESS DEFINITION

Your second paragraph or section should define your business, leading off with a clear statement of what your product or service is, and for whom it is targeted.

Jamesco manufacturers 1/2 to 2” stainless steel check valves for the petrochemical industry.

You should then expand on the products or services and the variations so that the reader has a full appreciation of the company’s breadth of product line.

iMakeNews (now renamed IMN) is a powerful and easy-to-use content management system and Web site authoring tool that enables businesses and organizations of all types to work together via the Web to publish interactive on-line newsletters.

This should be short. Any paragraph containing excess words, as most plans and executive summaries are guilty of, dilutes instead of enhances the impact you are seeking.

You should also talk about products you plan to develop. All too often a firm seeking capital will describe the market, the industry, the competition, etc., leaving a reader to guess what the business does until they are well into the document. Do this clearly, indicating What the company does, for Whom.

3. THE OFFERING – HOW MUCH ARE YOU SEEKING?

Right up front indicate how much capital you are seeking, and to what use the proceeds will be put to. This quickly allows the reader to assess the financial parameters of the investment and this puts into context what follows. Most plans avoid discussing what funding they are seeking until the end, if at all, which frustrates the professional or institutional investor. Often they will scan the document looking for that number, and aren’t engaged in the flow of your pitch. You want to keep them reading every paragraph and not feel frustrated. Their needs differ from yours – you want to tell how wonderful the business is, whereas the investor wants to know how much you’re seeking, and who else thinks highly of you . . . more on that will follow.

You might wish to indicate a range of value you place on the company, so the reader is aware of what equity interest they may receive for the proposed investment. Most firms are reluctant to do this, as they are afraid of putting too low a value on the Company, or conversely, too high a value, thus discouraging potential investors. That is why we recommend a range, albeit a rather wide range, with some discussion of the basis for such a valuation. Of course it is subject to negotiation, and circumstances may change, such as receipt of an important order that might necessarily increase the valuation prior to your reaching an understanding with an investor.

One startup firm we met with placed a valuation of $200 million on his firm. The industry was municipal waste treatment systems, and nothing short of a miracle would warrant such a valuation. We wasted a day visiting the company and vowed, never again! Ironically, two years later, they have approached us again, ostensibly with a far more reasonable valuation. They lost two valuables years, and could have been much further along by now.

If you’ve ever received a catalog that precedes an auction of fine art or antiques, there is usually an estimate given for the expected bid or range of bids. They are often lower than what the final bid comes in at . . . which stimulates the bidder’s interest in either attending the auction or submitting a bid. The key is to get the firm interested in participating in the process, and not discouraging interest too early with an excessive valuation.

Some firms prepare an Offering Document or registration statement that is quite formal in appearance, having been prepared by an attorney. It describes the company as well as states the price per share, number of shares offered, the terms, risk factors, etc. of an offering. More often than not, this turns off an institutional or professional investor, because it says that the offering has been prepared from the Company’s perspective, not the investor’s. It also implies that the offering is intended for individual (retail) not institutional investors. Most serious investors will pass when they receive an offering that is so rigidly outlined.

4. MANAGEMENT

Management is the single most important part of an Executive Summary in the eyes of most investors. Yet most firms put the section describing management towards the end of the document or executive summary. You can always attach detailed biographies at the end in an appendix.

You should look for an imaginative way of describing your management early in the document or executive summary, fore example:

The four key managers of the firm, while only having worked together for 2 years at Xylo Corp., have worked together in prior firms. They have built a close working relationships that has previously been tested under the strain of managing and growing a previous business within a large company. One of the board members of this new company was previously the President’s reporting executive at a prior company, so that relationship is also well developed. The two founders attended M.I.T. together where they developed the concept. Following graduation they launched Ronex and subsequently brought in a 62 year old CEO who also is a graduate of M.I.T. and was even a member of the same fraternity! Thus, despite the age differences, there is a bond and a commonality that allows the young, technical talent to permit it to be guided by the more mature and experienced business leader. Your management team should have balance and consisting of a visionary who is the driving force; an experienced operations person; a technologist where appropriate; and a sales/marketing executive with a track record. Also absolutely essential is someone who has administrative and financial management experience.

Having a fulltime CFO is premature for an early stage company, but when millions of dollars are to be placed in the hands of an entrepreneurial company, the question will arise as to who will manage the funds, maintain the books, and be accountable for the use of proceeds. A part time CFO might be a far more economical answer, engaging one for the first 2-3 years, and then considering hiring a full time CFO.

If you have a key vacancy in your management team, try to fill it before you seek financing. If you cannot afford to fill the void prior to funding, try to identify someone who has agreed to accept the position subject to funding, and ask if he/she is willing to meet with the investors beforehand.

5. BOARD OF DIRECTORS (OR ADVISORS)

You are judged substantially by the company you keep! Or attract. Very young companies may find potential directors reluctant to take a board seat because of the potential liability they would bear, however they should be willing to accept a position on an advisory board, with the understanding that if the company achieves certain goals and milestones, then they might be offered a board seat. Realistically, a young company that has yet to prove itself cannot attract strong leaders that it would like to bring onto its board in 2-3 years, so it is better not to offer anyone a board seat until you’ve seen them in action while serving on your advisory board.

Attracting ‘star’ board members can be overdone however, and it did not influence us to invest:

We saw a business plan for a rather mundane company that had a stellar board of directors that included the Dean of the business school at MIT among others. We happen to meet with the MIT Dean on another matter, and he confided that his school had used the company to provide certain services, and he felt okay about accepting a board seat, in part because there were some other prominent board members.

As you build your board, seek people with diverse backgrounds so that you have one strong sales orientated executive, one strong financial executive, and one strong operating executive . . . perhaps VP’s of their own companies as you may not be able to attract CEO level executives.

One mistake often made is to load a board with investors. All to often a company outgrows this early board but is stuck with it. The CEO is usually reluctant to replace board members with people having greater experience within larger organizations, and this can hold a company back. That is yet another reason to start with an advisory board and then build a board of directors over time.

Often an early investor will insist that they be given a board seat. While they might have invested $250,000, which was very important to the company at a time, their presence could dampen the interest of a venture fund that is considering a $2.5 or $5 million investment.

One company we invested in had 6 board members, 4 of which were from venture capital firms, plus one angel investor, and the CEO. The meetings focused excessively on financial performance and issues and not enough on sales and business development. The company witnessed a better funded company with a competent board of directors soar past them and win the race.

6. FINANCIAL PERFORMANCE

Too many executive summaries place the historical and projected financial performance at the very end, whereas most investors want to know what the expectations are for the company in terms of how large will the firm become, and how soon will it be profitable. We recommend using a summary table that shows one or two years of historical performance where it exists, and five years of projected performance, and only 3 key variables such as revenue, gross profit and EBIT or net profit, as shown below:

 

2012 2013 2014F 2015F 2016F 2017F 2018F
Revenue
Gross Profit
EBITDA

 

A brief explanation should accompany the table, describing those events that are the cause of a projected spike in revenue or change in profitability or poor previous performance.

Here, as anywhere in the Executive Summary, you should take advantage of the opportunity to relate an anecdote that breaks up the monotony of most business plans:

Early in 1997 the Company wanted to raise equity but its board vetoed the idea until the Company proved that it could operate profitably, something unheard of in the Internet industry. During the 3rd and 4th quarters, the Company managed to achieve profitability in 4 of the 6 months, satisfying its board’s mandate. Thus the Company is confident with its ability to attain the profit projection.

How soon should your Company show a profit? That depends on your type of company and the industry you are operating in. If yours is an exceptional venture, i.e. within the top 1 or 2 % of companies that venture capitalists look at, then you might show losses for more than 2 or 3 years. Biotech companies typically show losses for many years. However many investors like to see profitability within a year or two.

If your projection shows losses for more than a year or two, you should analyze your numbers to see what would happen if you stopped growing and ceased the heavy investment and expenses associated with growing the company past year two. You will probably find that your firm would start generating a profit in the year that expenses were greatly reduced. That is very revealing and should be shared with the prospective investor! It demonstrates that at a defined point, the business is capable of being profitable, and yet may choose to grow rapidly, hence justifying the investment.

Forecasting sales and profitability is both an art and a science, and it is not done well by many firms. Excel makes it easy to do but also can lead to a mechanical and not particularly realistic picture. How often have we seen revenue rise in a geometric fashion, with gross profits remaining high, and expenses declining as a percent of revenue, yielding unimaginably high and ever increasing profits. What about the impact of competition? What about larger firms that, once they discover your firm, invest resources you never imagined they had into competing with you and probably winning?

We’ve all read about ‘NEST’, the smart thermostat company that communicates with your smart phone or computer via the internet . . . which Google paid a substantial price for . . . well, Honeywell is entering the market with their very competitive and attractive smart thermostat.

When a large competitor decides to deploy resources into what you thought was a protected segment of the market, it can do so with impunity and with frightening results. Your plan should candidly recognize this risk and discuss how you would postpone that event, and how you might not be terminally harmed. Your forecast should realistically show the impact of competition.

Recessions do happen with almost predictable regularity. However nearly every forecast we’ve seen from companies raising capital never shows that a recession will ever occur. If you want to impress an investor, build a recession into your forecast, showing a decline in sales, gross margins and EBITDA.

7. FINANCIAL MODELING

Today a financial model consisting of a simple income statement is unacceptable. Cash management is essential from the onset and an investor needs to see evidence that the company has built a fully integrated financial model before investing. This should be a fully integrated income statement, balance sheet and cash flow statement, extending out 3-5 years. It should be dynamic, that is, if certain variables are changed, the effect flows through the entire model so that it does not have to be rebuilt each time the assumptions are changed. Very early stage companies may not need a fully integrated model but all companies will eventually require one, not just to evaluate the investment proposal, but to manage and plan for the company’s cash needs going forward.

Cash planning is very important – It may sound hard to believe, but companies have gone out of business because they were too successful and could not meet the working capital needs of the business. A good financial model that is developed to raise capital can be adapted to forecast the cash needs of the business going forward, and enable it to see when it will need to raise the next round of funding.

Who should do the financial modeling? Later stage companies should have a CFO or competent controller able to model. Early stage companies may not have such a financial executive and may want to hire someone to do this. Accounting firms offer this service but expect to pay $15,000 or more, and it may take 2-3 months before it is fully functioning. There are a handful of capable consultants that specialize in doing this, quickly and competently, for $5,000-7,000. If you can possibly contract it out to a consultant, do so, because they know how to incorporate the bells and whistles that go well beyond what you thought you knew about Excel, and it will look more professional and not contain the circular references and other errors that you could spend hours trying to resolve. We use a consultant and can recommend him. He is fast, reasonably priced, and creates models that can be used for fundraising and then used to forecast the cash needs of the business on an ongoing basis.

A venture investor will typically build their own financial model for the company or they may use yours and vary the assumptions.   For starters they will ratchet down your sales forecast to a level they believe achievable. This Forecast may drive their own valuation model from which they will calculate how much of a return they expect to receive if they make a certain investment.

8. MARKET

By now you should have the reader’s attention, and he/she is steeled to the task of reading the rest of the Executive Summary or requesting a copy of the full business plan. Now you should describe the addressable market that you serve, segmenting it so that it is sufficiently narrowed to the market you serve. As you describe the size and growth rate of the market you serve, you should reference the source for each number or each statistic you present for credibility. Too often we receive plans or summaries that dramatically size the industry or market well beyond the company’s ability to service, and does so without any reference to sources for where the numbers came from.

You should forecast the market size and growth rates for each segment in which you compete, not the entire industry. Be focused because investors will query you deeply on your target market.

Here’s where companies fail most often . . . characterizing the competition. You identify the competitors are within your market segment as well as those firms that might logically enter the market in the future. The remark, “We really don’t have any competition,” shows naiveté. Every business has competition and a statement like that will lead to a rejection.

Then characterize the competitors in substantial detail, because this demonstrates that you respect your competitors, understand their strengths and weaknesses, hence their competitive advantage.

Create a competitor matrix listing each competitor along the top, and the characteristics that describe each along the left side. You should start with the basics: sales, estimated profitability, estimated market share, location, whether venture backed, independent or corporate-owned or publicly, plus many other characteristics such as technology, customer focus, relative cost versus the completion, unique features or attributes, etc.

Try to use outside data to support this competitor matrix. Opinions or guesses will not stand up to scrutiny, and here is an area in which investors will drill down. If you can’t fill in a cell in the matrix, put N.A. or Cannot Determine or Unavailable. Conversely, if you are preparing this analysis solely from your own experience in the marketplace, with no 3rd party independent validation, your rankings or comparisons will be viewed with reservation unless you qualify it with a strong statement as to your knowledge of the industry.

Most investors do their own market due diligence, and if their findings differ materially with your conclusions, questions will be raised concerning your lack of knowledge within your market, and further due diligence may be suspended. State clearly what you know, and why, and also what you do not know.

The possibility of a large firm entering the market at some point in the future might cause you to hesitate about mentioning that possibility. For example, Google is often mentioned as a likely entry into many businesses, and that can give investors pause. On the other hand, an investor may see such a firm as a strategic partner, investor or perhaps an acquirer for the company. Also a large competitor could add credibility to what your firm is or proposes to do, and might accelerate acceptance of your product or service.

Finally, you should briefly describe your firm’s competitive advantage, if any. This might be because of your location, technology, patents, cost advantage, etc.

9. SALES & CUSTOMERS

If you are currently generating revenue, list your key customers and their purchase history and volume, and the outlook for future orders. There is no greater test of the credibility of a business than the existence of paying customers who, by their purchases, validate the business concept. Given the large number of pre-revenue companies seeking financing, if you have revenue, mention this up at the front of the executive summary to set yourself apart.

Perhaps the largest mistake companies make is forecasting sales, and second, forecasting profits. We see plans in which companies show sales growing by 4X in the year after funding, 3X the following year, then 2X, 1.5X, etc. First, it takes time to hire people needed to scale up. Sales people are in great demand, and take time to recruit, train, and weed out those who can’t contribute. How could a company possibly build sales that quickly, unless it is one of those rare consumer products that fly off the shelves.

Persuading new customers to buy from you, particularly if they are being asked to switch from an existing provider, is difficult. Switching costs or other factors may deter a customer from moving his business to you. This is why investing in pre-revenue companies is so risky. Even beta tests may not sufficiently confirm the marketability of a product or service.

One venture investor we know, prior to investing, actually accompanies sales personnel on sales calls to gain an appreciation for the difficulty of closing a sale.

We recommend that a company develop a detailed sales plan in a document separate from this Executive Summary. This could be a 5-10 page document, prepared by the sales executive responsible for delivering revenue. Achieving the sales goals should be a sizable portion of the sales executive’s compensation. In a well-run company, we’ve heard CEO’s express pride in the fact that the sales VP earns more than they do. Sales personnel are motivated by current dollars more than equity, so put together a generous program that rewards sales performance.

10. TECHNOLOGY

For companies in which technology is a key component of the story, describe it in your plan and how you plan to remain current or ahead of the rest of the industry. However be sensitive to the fact that a confidentiality agreement may not have been executed by the reader of your Executive Summary.  Venture capitalists may be reluctant to sign a confidentiality agreement unless it is their own. They are unlikely to divulge what they learn from you as it could affect their reputation within the financial community. Individual investors are less careful and need to be cautioned as well as required to sign a confidentiality agreement. Corporate investors may resist signing one, but ultimately may agree to sign yours if you sign theirs. Be careful what you reveal to a corporate investor as they can afford to mount a defense and can outlast you long after you’ve exhausted your funds in litigation.

Patents are a good thing, but they are very costly to defend or pursue patent infringement.

A medical device company had patented devices however a substantially larger and well-funded company did not hesitate to offer products on the market that were a clone of the company’s products. The cost to litigate was well beyond the company’s means. Ultimately the larger company saw additional value in the rest of the company’s business and acquired the company for a respectable sum.

Another company possessed a technology, which it licensed out to 23 firms and was receiving royalties. However another 50 firms freely employed the technology and ignored requests to obtain a license and pay royalties. The Company had already spent more than $3 million to take 10 of those firms to court and require them to license the technology, but they were facing a long and costly battle, which, if they lost, would result in the other licensees cancelling their royalty agreements. IP Litigation is very costly.

If technology is a critical part of your company’s appeal, you might wish to place your description of the technology nearer the beginning of the Executive Summary. Keep in mind that most readers are not technically inclined, and too detailed an explanation may imply: that the business is being run by techies and not business people, hence it is a risky investment lacking in good managers/marketers; or the business lacks revenue or other indicators of success, which is why the company emphasizes technology rather than revenue accomplishments.

Ideally, the business will have some proprietary technology, but in its plan the company stresses its marketing and sales prowess, and its ability to advance the technology beyond its current state.

11. CLOSING PARAGRAPH

Why do so many Executive Summaries or business plans on a flat note? So often they do because the writer has run out of steam, or simply is not highly skilled at composing narratives. Think about it: none of your sales letters to prospective customers end on a flat note, nor would an written appeal to anyone that you are seeking any favorable decision from. Yet most executive summaries do just this, and end without having made a compelling closing statement and ‘asking for the order’. The Executive Summary should summarize the essence of the opportunity, and invite action such as a meeting, a conference call, or a request for additional information.

 

 

Part II: Tips and Suggestions for Fundraising

Here are a number of tips and suggestions, some of which you may not find elsewhere which can help you in your fundraising efforts.

Appearance

The Executive Summary should be attractively presented, with the occasional and consistent application of bolding and italicized type, indenting, etc. but not too many type fonts. If you are unskilled at this, the tendency is to overdo it; therefore when you prepare your executive summary, do so in an attractive but understated manner. Have others look at it solely from an appearance point of view and give you their opinion.

What Writing Style Should you Employ

The writing style of your Executive Summary as well as your business plan is very important. Avoid the excessive use of adjectives or superlatives, something most executives preparing business plans are guilty of. The reader of such a plan soon becomes numb and begins to subconsciously discount what is being said. Build credibility through frankness and a simple choice of words, presented in a direct, somewhat factual style. There is plenty of time to ‘sell’ in your cover email, over the phone, and in person. Use the active tense and minimize using the passive voice.

Try to stress facts to build credibility, and again, minimize the use of adjectives or superlatives.

Target Your Recipients

Don’t broadcast your Executive Summary by sending it to a large number of venture capital investors. That will lead to overexposure. Rather, do your research on firms and select those you believe might have an interest based on their stated criteria, past investments, etc. Be sure that you are targeting firms that are investing in companies at your stage of development that match their investing stage.

A prominent venture capitalist, Fred Wilson, believes that a company should raise money in a stair step fashion, beginning with a seed round:

I feel very strongly that seeds should not be as large as they are these days and they should not be used to fund anything other than building product and finding product market fit.

It is possible to raise a large seed that, in theory, could fund all of that, plus a lot more. And all entrepreneurs are encouraged and interested in taking as much capital as they can given the dilution that they can stomach.

But I’m old school. I think of building a startup and funding it as walking up a flight of stairs. My partner Albert prefers the videogame (leveling up) analogy. Both work. I will stick with stairs.

The first step you need to climb is building a product, getting it into the market, and finding product market fit. I think that’s what seed financing should be used for.

The second step you need to climb is to hire a small team that can help you operate and grow the business you have now birthed by virtue of finding product market fit. That is what Series A money is for.

The third step you need to climb is to scale that team and ramp revenues and take the market. That is what Series B money is for.

That is a very simple view of the world. Very few companies will walk up the stairs easily and hit each one perfectly. Shit happens. And we all know that and can deal with that.

But I will tell you that the companies that have performed best in all the portfolios I’ve been involved with over the years have climbed those stairs more or less like that.

I don’t think its a good idea to jump over the first three steps and land on the fourth even if you have the legs (and funds) to do that. It is risky. If you don’t land it right, you can slip and fall. And its hard to get up if you do

The fourth step you need to climb is to get to profitability so that your cash flow after all expenses can sustain and grow the business. That is what Series C is for.

The fifth step is generating liquidity for you, your team, and your investors. That is what the IPO or the Secondary is for.[1]

The following is a guide that we use to distinguish the stage at which investors and venture capital funds invest:

SEED STAGE (pre-revenue); Funding sought: $50,000-250,000; Sources: Management, families, friends, former co-workers, individuals (angel) investors; Examples: Some angel investor groups – see Angel Capital Association for more than 150 Angel groups nationally (http://www.angelcapitalassociation.org/).

EARLY STAGE (or series A round): Funding sought: $250,000-1,000,000; Sources: angel investors, angel investor groups, early stage venture funds; Examples: Northbridge, Walnut, Common Angels, and a few corporations that do corporate investing.

EARLY EXPANSION OR FIRST STAGE (or Series B round): Funding sought: $1,000,000-5 million, the so-called ‘Funding Gap’ between Angel investors and Institutional Investors. Sources: Early stage or smaller venture funds and some Small Business Investment Companies (SBIC’s – see http://www.sba.gov/content/sbic-directory); Examples: many Venture Capital funds (see www.thefunded.com), some corporate investors.

SECOND STAGE or Series C round): Funding sought: $5-10,000,000; Sources: many Venture Capital Funds, SBIC’s, some corporate investors.

THIRD STAGE (Series D or pre-IPO round . . . or perhaps the IPO or a secondary): Funding sought: $10,000,000 and up; Sources: large, later stage Venture Capital Funds, Private Equity Funds, Corporate investors. Or possibly an IPO led by a FINRA registered broker dealer. These funds are used to accelerate a firm’s growth or prepare it for acquisition or an IPO.

Quite often the investors in the earlier stages participate in the later stages to preserve their equity stake as well as their role and influence, but recognize that the lead investor in a later round brings certain skills, so they usually play a lesser role thereafter.

Screen for Venture Capital firms by searching the web. Venture firms want to be found so they will appear on various lists, often searchable. As noted above, the SBA has a list of 300+ licensed Small Business Investment Companies that can be accessed via the web, and The Funded has hundreds listed as well information about each firm and its partners.   Other regional groups such as the New England Venture Capital Association may make available their membership lists available.

Targeting the appropriate venture capital firm requires effort and each venture capital firm’s investment criteria are listed on their websites. These typically include

* Stage of Company

* Industry or technology

* Investment amount

* Geographical preference

* Revenue and/or loss/profit

There are well over 1,000 venture, sub-debt and private equity firms that provide various types of funding. Each is looking for the ‘right’ investment with good management, a particular technology, industry or industries, etc. and these are described in fair detail on their website.

There are some automated databases that can be searched, such as Capital IQ, which is available on a subscription basis. However some libraries and many business schools are subscribers to Capital IQ, and may be able to assist you.

After the initial sort, which should yield between 30-100 firms, you will need to review each firm’s website again and:

* Look for those partners that are knowledgeable about your technology or industry;

* Look for personal details that you can relate to, such as a common school, degree, hometown, hobby or sport, kids in the same school, or anything that might enable you to connect on another level when you finally do make contact;

* Look for the firm’s law firm or accounting firm if it is shown;

* Look for ‘industry partners’ who are former executives within an industry that are charged with looking for companies within their field, which might be your field.

Now prioritize the firms in order of ‘fit’ or suitability, from best to least. You may be tempted to contact the top 3 firms first, but instead, plan to start at the bottom of the list, with those least likely to fund you. You don’t want to approach your best funding sources first because you need to develop your pitch, refine your approach, obtain feedback, revise your plan, revise your presentation, etc. By the time you reach out to your top prospects, you want to be at your peak, not at the early stages. A poor initial contact or presentation is very tough get past. Plan on getting only one shot, and make it your best.

One more step is necessary before you attempt to reach out to them.

Get An Introduction

Venture capitalists are difficult to connect with. They travel a great deal, seem to be in meetings 95% of the time, and as such are known for not returning phone calls from people they don’t know. Sending an unsolicited email with an attached Executive Summary or Business Plan might at best get handed off to an analyst or associate. More often it is ignored.

How do you get their attention? By getting introduced by someone that knows them and may have done business with them in the past. This would include, in order of best to least effective introducer:

* A fellow Venture Capitalist

* A Lawyer

* A Consultant they’ve worked with or one that is in a field they invest in

* An Accountant known to them

* An Investment Banker known to them

* A fellow club member

* A neighbor

If none of the above works for you, then get creative!

You’re going to need a securities attorney sooner or later, so find out the 5 best securities attorneys in the city where you do business or where the largest number of venture firms on your target list are active. Make an appointment to meet with each attorney, ostensibly on the basis of interviewing them to represent your firm. In the course of the conversation, ask what venture firms they’ve interacted with to see if any are on your target list. You might even show them the list of firms you’re targeting. If they think that your business has merit, and that you would be a good client for their firm, they may offer to introduce you to those firms that they know, as a gesture of good will to win your business.

When an attorney emails or calls with a candidate for funding, the venture capitalist listens and responds, because deal flow is the lifeblood of their business, and they almost always follow up with an introduction from a referring source.

Whether or Not to Use an Investment Banker

The debate is whether or not you should engage an intermediary and pay a retainer and a placement fee on funds invested. It depends on many factors including:

* Do you have the ability and the time to pursue funding while running and building your company? If you are in a race to get to market, you might be well served to offload the fundraising effort, which some CEO’s will tell you is like having another job because it is so time consuming.

*   Do you have the network of funding sources, or referral sources that could introduce you?

* Do you have the time to write the business plan, executive summary, or do the financial modeling?

* Are you willing to delegate and to be ‘managed’ or do you resent having someone else manage so important a process?

* Do you have sufficient funds to pay a $5-15,000/month retainer?

* Do you have the time and ability to manage multiple discussions with potential funding sources?

* Do you know enough about the types of securities used, what goes into a term sheet, and the backbone to negotiate?

Your securities attorney can do some of this for you, particularly when you need to evaluate a term sheet or negotiate. But an investment banker is motivated to close the deal or he doesn’t receive the bulk of his fee. In defense of investment bankers, raising capital is not easy. If you choose an investment banker that does it solely on a placement fee that occurs at the time the investment is made, you will not be attracting someone who has experience and knows how to get the job done. There are no guarantees as fundraising is done on a ‘best efforts’ basis. A good investment banker will tell you early on if the effort is unlikely to yield the funding you are seeking.

If you do decide to use an investment banker, evaluate his experience, his ability to negotiate and close, and then be sure to manage them! Frequent and regular updates should be insisted upon.

Expect to pay a placement fee in addition to the retainer, of 5-8% of the funds raised, possibly accompanied by a small number of warrants for having placed the financing.

Some investment bankers limit their work to high tech while others are generalists and are known for their ability to get the job done.

Some firms are actually Merchant Bankers which may invest money from their firm or from a fund they manage in addition to funds they raise from their investors or from venture capital firms. Most institutional investors are receptive to companies that are represented by an investment banker, especially those they know, but they can be more frank and honest with an investment banker.

One of the major complaints companies have about venture capitalists is that the process seems to take forever, and they never know where they quite stand. An investment banker will stay on top of the process and call the venture capitalist to ascertain the status of the deal.

If you are some distance from Boston, New York, Chicago, or Silicon Valley, which is where probably 60% of the Venture Capital firms are located, an investment banker in those cities may be more important to your success in raising capital.

The Goal: Set up a Meeting

Whatever means you pursue to establish contact with the investor or venture capital firm, you should be working towards the goal of meeting with them face to face. That is very difficult to accomplish because of their busy schedules and the number of unread business plans that clutter their email inbox. As such, you may have to resort to all kinds of methods to entice them into reviewing your plan as well as meeting with you.

First, let’s assume that you have properly narrowed the list of investors and/or venture firms you are approaching through screening and selection. Hopefully you’re been introduced by someone known to the venture capitalist. If not, you must go through the front door and expect to leave lots of voicemails before an analyst or associate follows up on behalf of the Partner.

Don’t be discouraged if they ask that the meeting be rescheduled once or twice due to conflicts that come up. But don’t let them hang up without at least trying to pin down another date/time. Getting that first meeting will require your marketing charm. Sometimes the comment that might work is something like, I plan to be in town for a meeting on Thursday from 1:00-2:00, and would like to come by either before or after that meeting to spend 20 minutes with you, to put a face together with the plan you are reviewing.

You may think you’ve chosen the right person in the venture firm to become the sponsor of your deal. If you’ve chosen the wrong person and he or she is not be senior enough, or perhaps too senior and no longer very active with selecting and overseeing investments . . . or perhaps doesn’t possess the industry or technical background, or is too overcommitted to spend time on it, etc., your effort may not lead to a meeting. Your goal is to find the most suitable individual and establish a relationship with them so that ultimately they will lobby on your behalf within their organization. If the first person you contact within a firm doesn’t seem to connect with you, either through demonstrated apathy or a personality difference, it’s not easy to switch, and it may be out of your hands, but you should try anyway. Perhaps another partner at the meeting showed greater interest. Keep their names and business cards straight to you can reach out to that individual on some pretense. This is important because if you haven’t connected with the right person or someone on a personal level, it is unlikely that they will carry you to the finish line, and their firm will not fund your company.

A few years ago we met with a firm that had come to us through a referral source, and we visited them. I was left uninspired and I told my partner who accompanied me that I thought we should pass, and I thought that this would be the end of it. However my partner said that he liked the business and we shifted the responsibility for sponsoring the firm to him. We subsequently funded the Company. Among the partners, we truly have different tastes. But we’ve come to understand each other’s preferences and now are able to suggest to one another where they might be better suited to work with a particular company.

Some companies get attention simply because of the persistence of the entrepreneur. Each time you speak with the partner, introduce something about your company that will interest them as well as educate them about your company, and keep notes on your conversations.  Each call should show progress such as, “We just signed up XYZ Corporation and they will begin with our service next month!” Don’t simply call them to find out if they received the plan, or if they have any questions. You should offer to meet with them at their offices, not yours, unless they offer to come visit you. The average investor or venture capitalist is terribly busy, and can more efficiently work when a company schedules their first meeting at their office, not the company’s office. You might prefer to have them come see your product, your plant, your working model, etc., but the benefit of that is outweighed by the greater likelihood of scheduling a meeting much sooner, and the possibility that the person you are speaking with will invite one or more of his/her colleagues to join the meeting, thus increasing the likelihood that interest will develop. So, plan to create an effective demonstration that can be done at their office.

Strategic Corporate Investors

A couple of decades ago many large corporations such as IBM, Olivetti and others invested millions into young companies, and in the case of IBM, billions, leaving them with a minority stake in companies they thought possessed technology or a product. After a few years IBM asked a national accounting firm to value these investments into which they had invested billions, and the firm came up with a total of a couple of hundred million dollars. So ended that phase of IBM’s venture investment program. However like most things in life, corporate investing goes in cycles, and IBM and many other companies are back in the investing game, although they are targeting larger, later stage companies with revenue in excess of $10 million/year.

Corporate investors are willing to consider investments in new ideas and technologies, investing from a few hundred thousand dollars on up into the millions. However corporations are not well equipped to evaluate and oversee venture investments and typically consume inordinate amounts of a young company’s precious time during the review process leading up to a decision. Yet they can be the most appealing of investors when you can land them! They can leverage your business into markets it would otherwise take years to penetrate, share technology with you, and might be more willing to invest at a higher valuation than venture investors. But CFO’s of such companies usually dislike having to book an equity investment on their balance sheet and can be counted on to vote no. But the greatest risk is that they will meet with you time and time, as they take you through their committee process, pump you dry as they seek to understand your business and your technology (so be sure you have executed confidentiality agreements), and call repeatedly for meetings, at their office . . . and nearly always decide not to invest. Beware! But sometimes they DO invest, so it is worth considering.

Here are some examples of Corporate Investors.

Recently a startup firm in the Worcester area that was at the pre-revenue stage was in discussions with Intel regarding a $1 million investment. Intel was very interested in their process, and ultimately made a $1 million investment. However a couple of years later when the firm required additional capital, Intel declined to make any further investment. Most venture capital firms, on the other hand, almost always reserve an amount equal to their initial investment for follow on investing.

Another firm had developed a pump technology that was revolutionary and caught the attention of the country’s largest pump manufacturer. Instead of an investment they acquired the company, agreeing to an initial payment of $3 million, plus a payment based partly on performance in 5 years, and again in 10 years. Within a year management at the large company had changed, and the relationship between the two companies turned chilly. Four years later management of the smaller company bought back the stock under very attractive terms.

A firm that we were in discussions with was raising $3 million for their vending machine software and data collection system that had sales approaching $1.5 million, received an offer to sell their company outright for $15 million, plus incentives on future performance. The offer was sufficiently attractive for them to take the money and end what might be years of capital raising cycles, but also end the dream of building a substantial enterprise under independent ownership. They accepted the offer and the CEO moved on.

A talented team of software engineers proposed their storage software solution to an $80 million/year distributor of storage solutions as an investment. Their entire presentation consisted of a whiteboard presentation, accompanied by nothing in writing! They were offered a $1 million investment, plus lots of market guidance, which enabled them to reach the beta stage a year later, and another round of financing by an outside investment group. The first round required them to give up 40%, which might have been less if they had prepared a good business plan and executive summary.

A strong strategic investor could greatly add to the appeal of the investment in the eyes of venture capital investors that might be considering an investment, creating a little competition. But ideally, they both might invest. A strategic investor may ultimately be the exit strategy for the firm by buying it. However it is like sleeping with elephants, never knowing when they may roll over and make demands far out of proportion to their ownership interest:

One corporate investor invested $3 million in a young medical instrument firm but then imposed onerous requirements that necessitated a complete redesign of their instrument before they would distribute it, and further required that they hire quality control engineers, etc. This delayed introduction of the Company’s instrument by more than 2 years, and the delay consumed all of the invested capital. The firm finally introduced the instrument into the market, but by then the corporate investor had tired of the adventure and literally walked away from their investment. For the next few years the Company struggled, going through additional fundraising, management turmoil, etc. While the temptation to accept capital, expertise, marketing and distribution resources of a large in-place sales organization is great, there can be a downside.

On the other hand, if these issues are discussed openly with a prospective strategic investor, and a written understanding and go-forth plan is agreed upon, then there is the possibility that the company could accelerate its growth. Just remember, they make decisions by committee, and your contact there will use ‘the committee’ or higher decision makers as an excuse of why it’s taking so long, or why you need to make your 7th trip to Pittsburgh to meet with them and discuss such and such.

Do not lose sight of the fact that a corporate investor more often than not has the intent of acquiring your company, or at a minimum, accessing your technology and knowhow for its own purposes. They are not charitable in their motives. As noted, they can be fickle, and with a change of leadership, you could find your firm all of a sudden being out of favor.

Having a venture capital firm as an investor could be a counterbalance to a strategic investor and vice-versa. Both bring different insight, experience and resources to a company, so in an ideal world, a company should raise capital from both and have each represented on your board of directors. While this section has been rather harsh on strategic investors, there are instances where it has worked out and a company was able to grow much faster than it would have without the assistance of the larger company.

Your Lawyer is Not Your Friend

That’s right. You may already have an attorney who probably is your friend, but he probably is not a securities attorney. A securities lawyer is an expert who spends the majority of his time on ‘deals’, mostly securities related, and you should use no other type of attorney for this purpose, least of all your general practitioner who does contracts, advises on business and board matters, etc.

This particular lawyer is not your friend. He or she is a specialist, brought in for one purpose, to assist you in closing on a financing that is in the best interest of your company and its shareholders. A securities attorney costs more per hour but works very efficiently.

We dealt with an NYC attorney representing a company we were investing in and watched in dismay, as he took twice as long to close on a financing and cost his client three times as much as a competent securities attorney would typically charge.

We have reached the point where we will not issue a term sheet to a company unless they have already engaged a competent securities lawyer. Our firm and most venture firms view good legal counsel on the company’s side as facilitating the process through good representation of the company’s interests. They know what’s fair, and will serve the company well.

A few years ago a company was anxiously calling us wondering when we could close on the agreed upon financing, and finally I called the CEO and said, “We’re ready to close this Friday.” He sighed, and said, “We can’t. The State has just told us that we are prohibited from raising any more money because our local attorney screwed up on the filings.” I suggested that he and his lead angel investor go meet with the regulator, and ‘beg’ . . . beg forgiveness for the errors, and ask what amends they might possibly make so they would not have to lay off 30 employees and possibly go out of business (and thus throw 30 applicants for unemployment claims on the state). “Is there something we can do?” the CEO asked, respectfully? The state securities regulator said, “Oh sure, it’s quite simple. You need to pay a $10,000 fine now, and then you need to have every one of the 88 investors in your firm sign a form saying that they waive their right to rescind their investment.” If the investors had refused, the investors could insist that the Company return their investment . . . which had long since been spent. Five days later the CEO called and said that he had in hand all the signed forms from all the investors, and was now ready to close. He also said that he had engaged a capable securities lawyer who was known to us.

Unfortunately this story has been repeated many times in this industry. Using a qualified and experienced securities attorney can avoid such errors.

So, Isn’t it All About Valuation?

You’ve heard this already. Give up the least number of shares for the largest dollar investment, right?

It’s not that easy. Investors want to make money and have done it many times with other firms long before your company came to their attention. They also know that companies get into trouble. Therefore they prefer serial entrepreneurs who have built and sold companies before, which you probably have not done this before. In fact there are many things you’ve not done before which they and their firm know how to do. They represent a resource, and you want to structure a deal in which your interests are aligned with theirs. That is easily said, but remember those words, because when yours and their interests are not aligned, you may not see it but your securities attorney will and he will caution you accordingly.

The partner you work with at the venture firm is likely to have the greatest influence over you and your company’s success. You need to feel confidant that you can work with him or her, and that they are someone you can trust. There will be challenging times during which you may have to rely on trust. If you have any doubts about the firm, or the partner, or the terms of the investment, back off. Discuss your apprehension with your securities attorney because he probably knows the investor and their reputation. And consider recontacting the #2 venture firm on your list, who you also liked.

So, we would weight deal terms (i.e. valuation, etc.) at 50% of the decision, and allocate the rest to how you and your attorney feel about the venture firm, the partner or individuals you’ll be working with, their experience and network of contacts, and your gut feeling about the financing, because it is about the journey and not just the destination (valuation).

Finally, your payday is about 4-5 years away, perhaps longer. A good relationship with a good partner can tip the angle of the growth curve such that a small difference in the first year or two can have a significant impact on the exit value of the Company. So much so that the lower valuation at the time of investment has much less effect that the slope of the curve that the venture firm was able to affect.

The Term Sheet

If you’ve survived the meetings and myriad of questions, you might expect that a venture fund will issue a term sheet, and if you are very fortunate, you might receive term sheets from multiple firms.

These often have an expiration date of a week or 10 days, so you want to begin educating yourself on term sheets well in advance of when you may receive them. Your lawyer or investment banker should be able to provide you with copies of term sheets and be able to walk you through them. There are many terms that will be unfamiliar such as ‘participating preferred stock’, ‘full ratchet clause’, etc. A term sheet may run between 6-12 pages, however it might be preceded by a Letter of Intent (LOI) which summarizes the key terms.

An LOI moves both sides closer on the basic terms, however there are many terms not included in an LOI that should be discussed and agreed upon before committing your company. Therefore once you are in general agreement with the LOI, ask for a detailed term sheet before having your attorney begin billing significant time. Also, many firms require a deposit that is applied to the due diligence and legal expenses, ranging from $10,000 to $50,000. Under the terms of the Term Sheet, you are responsible for the Venture Fund’s expenses incurred in conducting their review as well as their legal expenses, travel, accounting due diligence, etc.

A term sheet also should detail all of the business and financial terms of the investment, leaving little for the attorneys on both sides to negotiate, which can be very expensive. Good attorneys are very busy, and you need to keep after yours to keep moving things along. The time from a signed term sheet to a closing could be in as little as 30 days, but more likely is 60 days, or longer if there is intellectual property to be evaluated, or if the company’s financial or corporate records are not in order. During the week before a planned closing, things will slow to a crawl as the attorneys zero in on things, so again, you need to push to get to a closing. At the beginning of the process, get everyone to agree to a timetable, and tell them that you will be relentless about ensuring that everyone stays on schedule.   If you are using an investment banker, he can assume that role.

Persistence is essential

Institutional investors are criticized for how difficult it is to get them to provide you with an answer. Very few firms respond in a timely manner and many are so overloaded with funding requests that an analyst responds, or they are forced to use form letter responses, or they simply don’t respond at all, leaving you waiting for an answer. Some simply do not want to say ‘no, and almost all will avoid going into any detail as to why they are saying no.

Finally, and here is the real secret of getting funded. We mentioned it above, but it bears repeating: be persistent while somehow avoiding appearing annoying.

Always end the conversation with some action item such as a meeting, not simply, “Well, I look forward to hearing from you . . .” because the investor is really looking forward to getting off the phone and back to what he/she was reading or talking about with others prior to your call. So, you should try to lever their desire to get off the phone into scheduling a brief meeting with you, when you’ll have their undivided attention.

Some people have good interpersonal skills, and their persistence is cloaked in a style that is pleasant and intriguing. Others, perhaps with more worthy ventures, don’t communicate as well, and need to develop their telephone pitch. Practice on a colleague or an advisor or your attorney or accountant, who you have a close enough relationship so that they will give you good feedback. They receive enough annoying calls to know which ones to accept, and can help you.

And one last point you should think about. The aggressiveness that you exhibit, and the manner in which you go about raising capital, may be seen by the venture investor as a proxy for how aggressive you are in driving sales and the rest of your business!

Your persistence will win you either their respect or their coolness, depending on how you do it, and how receptive they are to your calls and their interest in your venture. So what if you irritate a few people; the benefit far outweighs the risk. So what if you embarrass yourself or having to grovel a bit! Thousands of others have had to do it before you. Asking for capital is like asking for help, and that is something that is not part of the male genetic makeup. Women do it far better, but have hurdles of their own to overcome. Our advice: risk it and be persistent, just short of annoying or being perceived as a pest.

The ‘Two Minute – Two Paragraph Rule’

Venture Capitalists are born with adult onset ADD (attention deficit disorder). This manifests itself at just about every opportunity you have to pitch, whether in person or in your document. This is untreatable, however you can manage the effect that the disease has on your need for funding by following the two-paragraph/two minute rule.

Your executive summary should attempt to capture or engage the reader in the first two paragraphs. Therefore you should not waste this valuable opportunity by dryly describing the company, its organization, etc. in the beginning. Enough has been said about the creative writing side of presenting your company out of which you should be able to craft two strong, compelling paragraphs.

When you do finally arrange an audience with the VC, your presentation should follow an equally compelling course in which your goal is to engage the individual or group during your first two minutes of presentation (following the chit-chat). If you plan to use PowerPoint, do so after you have presented orally without slides, your two-minute ‘grabber’. Those first few minutes that you are speaking are your greatest opportunity to connect with these captains of capitalism, whether through humility, enthusiasm, or whatever. Do so without notes, and without slides, extemporaneously. Speak slowly, look them in the eye, going from face to face, and ‘move them’.

The PowerPoint Presentation

PowerPoint has the inadvertent effect of anesthetizing an audience and should be used as a supplement to a discussion and not become the centerpiece. It should be attractively prepared, not overdone with fancy PowerPoint features, and it should be fairly brief, perhaps 12-15 slides requiring no more than 15-25 minutes to deliver. Watch for cues such as members of the audience pulling out their smartphones or laptops, or slipping from the room ostensibly to answer a call on their cellphone, only to reappear just as you are wrapping up. If you can, deliver your presentation by alternately turning the projector on and off so you can break up the flow.

One of the most powerful presentation tools you can use is ‘the story’. You should interweave 2-3 stories or anecdotes into your presentation. People remember stories long after they’ve forgotten key points. People simply love stories. Listening to stories has primitive roots and we all cue in to listen to them. Use them to make your points.

Remember, Venture capitalists are investing in people first, and they prefer to look into your eyes, rather than stare vacantly at a PowerPoint presentation, so use it sparingly.

 

 

 

 

 

For additional information, or if you have questions or comments, which this article may have provoked, contact: Andrew (Andy) Clapp 617-535-9928, ext. 701 andy@arctaris.com

Copyright © 2001 – 2014 Andrew Clapp

[1] Fred Wilson, from his blog: What Seed Financing Is For, http://avc.com/2014/06/what-seed-financing-is-for/

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