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MicroVCs are Changing the Landscape of Venture Capital

Rockies Venture ClubAs the cost of starting a tech company has gone down, VCs have moved upstream, funding bigger and bigger deals while angels and angel groups have taken up the sub-five million funding space. Meanwhile, accelerators and platforms have also taken a place with funds to jump start companies going through their programs.  MicroVCs are venture capital firms with assets under management of less than $100,000,000.  That sounds like a pretty big fund to angel investors, but in the big picture venture capital world, these truly are micro venture capital funds.

MicroVCs have taken on a huge role in filling the gap between seed and angel funding and big scale unicorn-track venture funding.  If you think about basic fund structure, a $100 million fund will invest about half of committed capital, or $50 million into its first round investments.  The fund will want to diversify to twenty or more investments, so you might see an average of $2 million for a first round.  Then they’ll have the remaining $50 million to continue investing in the top winners from the portfolio.  $2 million is a great amount for a post-angel round, but is far less than the $10 million that an average VC deal is doing today.

The MicroVC area is more understandable if we look at what kind of entities fill this space. There are sub $25 million funds, also known as NanoVC Funds which operate very differently than $100 million funds.  Then there are the accelerators which are actually MicroVCs.  Also, more and more angel groups are creating funds (Like the Rockies Venture Fund) and are moving upstream a bit to do larger deals.  Finally, angel groups are syndicating actively, so they can move into larger and larger deals.  Some examples of the power of angel groups leveraging their investments by working in syndicates include Richard Sudek’s work at Tech Coast Angels who syndicated a $10 million raise via syndication and similarly Rockies Venture Club Participated in a Series F syndicate for PharmaJet locally.  These are not deals that we would typically expect to see angels playing in.  This means that angels, when working together can start filling the space occupied by the MicroVCs.  Rather than competing, we’re seeing angels investing alongside MicroVCs at an increasing pace.

There are other considerations, however.  MicroVCs will typically hold back half of their fund for follow-ons, while angels are less predictable and many still use a “one and done” approach to their investments.  Even with MicroVC follow-on investment of up to $10 million, this is still not enough to propel some companies to the scale they’re shooting for, so they’ll still need to engage with traditional VC once they get big enough.

Angel investors should help startups to figure out their financial strategies so that they can work on building relationships with the right kinds of investors from the beginning so that they don’t paint themselves into a financial corner by working with the wrong investors.  Similarly, startups need to understand the goals of any type of VC so that they don’t waste their time barking up the wrong tree.

 

To learn more about the evolving role of MicroVCs, consider attending the RVC Colorado Capital Conference.  It’s coming up November 6-7th in Denver, CO.  Visit www.coloradocapitalconference.org for more information on speakers and presenters.  This event is on of Colorado’s largest angel and vc investment conferences of the year and there are great networking opportunities.   We hope that  the audience will come away with an idea about how all these types of capital are evolving and the different strategies that companies can take in choosing who they want to pursue for their capital needs.

Peter Adams

Managing Director, Rockies Venture Fund I, LP
Executive Director, Rockies Venture Club, Inc.
 Buy Venture Capital For Dummies on Amazon

 

Creating an Angel Investor Certification Test

Many professional organizations have a certification test of competency that members must pass to demonstrate their knowledge and ability to perform at a high level.  Doctors, Lawyers, CPA’s and other professions must also take continuing education credits as well.

The criterion for being an angel investor, however, has nothing to do with knowledge and does nothing to provide the knowledge that an accredited investor needs to know to both make good investments and to exercise prudence with regard to their portfolio strategy.  Accredited investors qualify to be angels simply by wealth (having assets in excess of $1 million) or income, (having annual income of $200K per year or more, or $300K for married couples)

The SEC has proposed recently that a knowledge based criterion for accredited investors be added.  This would allow people with expertise to participate in angel investments.  The proposal, however, suggested that existing certifications such as a FINRA Series 7 might be a good benchmark.  Having passed the Series 7 test myself, I can assure anyone that the knowledge one acquires to pass that test, though it is significant, has nothing to do with what someone needs to know to be an angel investor.   Angel and venture capital investing has its own set of language and guidelines that have very little overlap with what a Series 7 certificate holder would have.  If the goal of accreditation is to protect the investors from themselves, then providing a certification that tested knowledge that was relevant to the asset class would be most useful.

A good certification test for angel investors would include several parts.  Here’s an overview of what it might look like.

  • Portfolio strategy. The presumed reason for the accredited investor guidelines is that people of high wealth have excess money to lose and can withstand a complete loss.  Just having money to lose isn’t really a great way to build a portfolio strategy.  Smart investors will allocate approximately ten percent or less of their investable portfolio into the angel investing asset class.  Within that ten percent, they will be invested in a minimum of ten deals and preferably twenty or more.  That means that a marginally accredited investor with a $1 million in investable assets will create an angel investing portfolio of about $100,000 which will be in at least ten $10,000 deals or even twenty $5,000 deals.  Someone with a $5 million investable portfolio will put $500,000 to work in angel deals, perhaps with twenty deals at $25,000 each.  Some angels really spread out their risk with fifty or more deals and it’s generally agreed that the more deals you can get into the better.  Finally, angels should understand the difference between making a “one and done” investment in a company vs. follow-on investments and how they can benefit a portfolio.
  • Exit strategies. Angel investors have only one way to get their money back and that’s through an exit. Anyone investing in this asset class should have a sophisticated knowledge of how exits work, how to analyze the market for exit potential, what typical exit multiples are and what the typical exit amounts are for startups in any particular industry.  An angel who doesn’t understand exits will not likely do well as an investor and may end up investing in a lot of great ideas that never see a liquidity event.
  • There are some who say that “valuation doesn’t matter”.  These are the VC hacks who think they can make up for any valuation by investing only in “unicorns” ( private companies that reach a valuation of $1 billion or more).  That’s a great theory until you realize that only one in several thousand deals results in a unicorn deal and most that exit at all will exit for under $50 million.  For these, understanding valuation and putting together a fair deal is critical.  A smart angel should have a valuation toolbox under their belt with several different valuation methods available to them.
  • Due Diligence. Smart angels know that the more diligence you do, the better your chances for investment success.  Just having lunch with a startup CEO and getting excited about their passion and commitment is not a good way to do diligence.  Investors should thoroughly investigate the market, the team, the product, IP and legal landscape, valuation, comparable transactions, financial projections, competition, exit potential, key documents and agreements and much more.
  • Term Sheets. Investing requires good knowledge of the terms used in negotiating the deal.  These terms are far from obvious and many that sound similar can result in a difference of millions of dollars when the company exits.  g. “preferred liquidation preference” or “participating preferred”.   I’ve seen angels who have caused serious problems for themselves and the companies they invest in by creating situations that make follow-on investment by VCs all but impossible.
  • Securities and Tax Law: Angels should be familiar with the various points of securities law to understand the registration exemptions that offerings are using, and to know the boundaries of proper securities offering processes. They should understand the difference between Regulation D 506B and 506C registrations, the proper filing of Form D, numbers of investors allowed, and verification of accredited investor status.  They should also understand tax law as it applies to angel investment including Section 1202, 1244, and 1045 as well as state breaks for economic development and federal breaks for research and development.
  • Proformas and financial analysis. Like it or not, there’s a lot of finance knowledge required to be a good angel investor.  Being able to look at a proforma and understand if it’s believable, or just a “hockey stick” graph someone put together to make it look good.  A proforma is a treasure trove of information about the company, its strategy and how it expects to operate.  Even though it’s never going to be right, the way that the information is presented gives the investor a window into how the CEO and team thinks.  Finance risk is significant for most companies and understanding how many future raises will be required, how big they will be and what the cumulative dilution to both founders and investors will look like is critical to assessing the potential for the deal.
  • Market Analysis. Understanding the trends in a market, competition, actual pain points and return on investment for customers is one of the most important parts of understanding the viability of a deal.  These require sensitivity to the particulars of specific industries and are not easy.  Many startup founders are technical wizards and they may have some insight into the needs of their markets, but many have no idea about how to create a go-to-market strategy, assess which channels are appropriate for their market, or how to allocate scarce resources to create the lowest Cost of Acquiring a Customer relative to the highest Lifetime Customer Value.  Many startups are blind to their competition and claim that they “have no competition.”  This should cause any investor to run from a deal.  Creating “virality” is an art that is lost on many tech or healthcare founders and angels should be able to assess the viability of the market strategy.
  • Post Investment Management and Serving on Boards. The work of the angel investor is just beginning after the check clears.  Managing the investment after the check requires expertise to help ensure alignment and to guide the CEO towards the best exit opportunities.  Serving on boards carries fiduciary responsibilities.

Unlike the questions for the FINRA Series 7 exam, most of the knowledge required for angel investing certification centers more around principles, definitions and best practices rather than distinct points of law.  Only about 10% of the angel certification test is about specific regulations and point of law, yet the knowledge the test represents is what angel investors should know.  This ratio represents the ratio of technical to legal know-how in other professional exams and would represent a step-up in the professionalism of angel investing.

The SEC has set income and asset limits to the definition of accredited investors with good intention.  Unfortunately, simply having wealth does not make one qualified to make good investments and there are plenty of stories of wealthy people making imprudent investments that resulted in disaster.  Better to allow a criterion based on knowledge, so that investors understand how to balance risk and opportunities through diversified investments and well accepted principles of successful angel investing.  We hope the SEC will consider this certification as a means to becoming accredited, and open up angel investing to a broader audience while accelerating American economic development through greater investment in our job creating startups.

 

Peter Adams

Managing Director, Rockies Venture Fund I, LP
Executive Director, Rockies Venture Club, Inc.
 Buy Venture Capital For Dummies on Amazon

Ten Reasons Why Not to Use Convertible Debt

It seems like a majority of pre-Series A deals are done with convertible debt these days and I’d like to point out a few reasons why this is a bad thing for entrepreneurs and investors alike.

Just to get definitions out of the way, we’re talking about the decision to raise funding for startups by either equity investment in stock of a company, or in a convertible debt instrument.  Equity is pretty straightforward – invest money, get stock.  Convertible notes, on the other hand are not widely known to those outside of startup investing.  Convertible debt works like regular debt in that there’s a promissory note and an interest rate.  The interest is rarely paid in cash for convertible notes though, and it’s usually rolled into equity when the note converts into equity.  There are usually a few “triggers” for h

RVC Convertible debt vs. equity

aving the note convert to equity, but the most prominent one is that there is a “qualified financing round” which is usually around $1 million.  The idea is that the professional investors at that stage know how to value the business and set the terms. The first early investors who invest will convert at the terms set by the VCs, but usually with a 20% discount in price to compensate for investing earlier.  Convertible notes today also have a “valuation cap” which is equal to what the equity valuation would have been if the deal had been a stock transaction in the first place.  So, when the qualified round causes the note to convert, it converts at the lower of the 20% discount or the valuation cap.

Ten Reasons to Avoid Convertible Debt

Reason 1:  Convertible Notes do not qualify for Section 1202 QSBS Tax Breaks<a href="http://www.freepik.com/free-photos-vectors/business">Business vector created by Dooder - Freepik.com</a>

Angel investors get a 100% capital gains tax break if they invest in equity in early stage companies that meet certain criteria such as being a C Corp., being under five years old, under five million in revenue and they hold the 

 

 

 

investment for five years.  Convertible notes don’t qualify for this tax break, so if all things were equal, the investor makes 20% LESS on convertible note deals since they have to pay capital gains tax on the investment, whereas investors who invest in equity do not have to pay any tax at all.

Reason 2: Equity is cheaper than convertible debt

You may have heard that it’s cheaper, faster and easier to do a convertible note, but the fact is that convertible notes are going to end up costing the company approximately 25% MORE than an equity deal.  The reason for this is that when the note converts, then it converts into EQUITY.  That means that the company pays twice for the legal: once to do the note and another time to do the equity.  So if a convertible note cost $2500 in legal fees and the equity deal cost $10,000, then the convertible note all-in is going to cost the company $12,500.  Why not just do it right in the first place and put all that money to work for the company?

Reason 3) 80% of Angel Investors Prefer Equity

If you’re selling something to a customer, wouldn’t you want to sell them what they want and not some more expensive and inferior product?  The American Angel Survey shows that investors prefer equity and I suspect that if the remaining 20% of angels read this blog, they’d prefer equity too.

Reason 4) You can lose your company if you default on a convertible note

When you take out the note you’re confident that you’ll have a qualifying follow-on round within 18 months, but many times it takes longer and the note comes due and payable and you’ve already spent the money and can’t raise any more.  You’re in default and investors can take your company from you.  Most investors don’t want to do that, but why go through the heartburn and stress of facing the potential loss?

Reason 5) Investors have to pay tax on interest they earned but never got

As interest accrues on convertible notes, interest is due.  Investors need to pay tax on those notes, even though they didn’t actually get the interest in cash.  So, if someone invests $100,000 in an 8% convertible note, they have to pay $2640 in cash to the IRS on that income.  Nobody likes paying taxes on money they never got and also, BTW, there is no tax due for equity investments.

Reason 6)  You have to come up with a valuation for convertible notes just like equity.

Many people think that using convertible notes lets them “kick the valuation can down the road.”  Nothing could be farther from the truth.  Every convertible note has a provision called the “valuation cap.”    The formula for calculating the valuation cap is as follows:

Valuation Cap = Equity Valuation

This means that when someone invests in a convertible note, they should never have to pay more than what the company is worth today.  If the valuation cap were higher than equity valuation, that would mean that note investors would have to pay more than the value of the company.  Just because it may convert at a higher valuation some time in the future does not mitigate the risks that the early stage investor has today.  In fact, the only way that the higher valuation comes about in the future is that the angel investor puts in the capital early, when risk is highest, so it doesn’t make sense that they should pay more than what the company is worth.

Many companies get confused about this.  One company told us that the valuation would be $5 million, but it would be $7 million valuation cap “because it’s going to convert at $12 million some day.”   It’s crazy to think that somehow using a convertible note makes a company worth $2 million more than one that uses equity. This kind of thinking makes no sense and hurts the startup community.

Putting valuations on early stage companies is something that is done every day and there’s no magic to it.  Seed Funds and Angel Groups have well established valuation methodologies that work well on pre-revenue companies.

Reason 8) Entrepreneurs get diluted with convertible notes

Entrepreneurs should be cautious about the cumulative dilution that paying interest which will be rolled into equity will create.  The longer the note goes on, the more startups will be diluted with the interest that they have to pay in the form of equity.  It would be better to preserve that equity for future growth.  Founders who chose equity over convertible debt don’t have to worry about interest accumulating and diluting their shares.

Reason 9) Equity creates better alignment between investors and founders

When convertible debt is used, there is a misalignment between investors and entrepreneurs.  Founders want to use high valuation caps or worse, no valuation caps, and prolong the amount of time before conversion, so that investors get the short end of the stick.  Some founders openly state that they want to use convertible debt to preserve their equity.  Those are founders that every investor should avoid – not because they want to build a strategy that preserves equity, but that they want to create unfair terms that preserve equity at the expense of investors.

Reason 10) Equity deals have all the terms defined

With a convertible debt deal, the conversion price is negotiated, but all the other terms which are extremely important to the relationship between the founders and investors are left open.  This represents a risk to investors and also leaves many matters unsettled.  One example is that there are usually terms about board representation which are not found in convertible notes.  Investors in early stage companies can offer much more to companies than just a check if they can serve on boards and help move the company along.  While there’s nothing to say that companies with convertible notes can’t have boards, in fact many don’t and that’s bad for both investors and entrepreneurs.

Last Words:

With all that being said against convertible notes, they can still be useful for the FFF rounds with friends and family who don’t know how to value a deal and who are investing primarily to support the entrepreneur.  Convertible notes can be better than some of the amateurish deals that get put together for early family investors who are often non-accredited that can make follow-on investments difficult or even impossible for the company, thus limiting its chances for success.

Visit www.rockiesventureclub.org to learn more.

 

Peter Adams

Managing Director, Rockies Venture Fund I, LP
Executive Director, Rockies Venture Club, Inc.
 Buy Venture Capital For Dummies on Amazon

 

Rockies Venture Club

Your Startup Just Cashed its First VC or Angel Check – Now What?

Rockies Venture Club Post-Funding Strategies

After the first angel or VC funding round closes and the checks are cashed, most startups go through a transformation, like from a caterpillar to a butterfly, that makes them fundamentally different than a pre-funding company.  CEOs who fail to realize the changes that need to happen will end up facing challenges they did not expect.

Here are a few changes that need to take place after funding:

  1. Create a budget.

    No – not your proforma with all the optimistic sales projections – this should be a budget with numbers you can commit to.  Many companies feel like having a million dollars in the bank is an unlimited blank check to buy fancy new furniture or hire a dozen new employees. But all those things drain cash faster than you think and having a written plan for minimizing your burn rate and maximizing the runway to your next raise (or hitting break-even) is going to be an important part of your success.  Running out of cash before you hit the milestones needed for the next raise is a death sentence for your startup.

  2. Update the Professionals that Serve Your Business.

    If you’ve had your Aunt Bertha doing your books, it’s probably time to upgrade to a CPA who can provide you with the advice you need to keep from making mistakes.  A CPA is going to be important once you need audits as well.  Your legal team should now include several different legal specialties including securities, Patent and IP, and general business and contracts.  You probably got your legal house cleaned up in order to get funding and now is the time to get the right people on board to keep it that way.  Bankers, insurance, and other advisors are all going to be able to scale with you as you grow.

  3. Communicate with Investors.  

    Investors notice when you stop calling them after the check has cleared.  This is a bad thing for founders – especially those who are going to need to raise another round.  Future investors will contact first round investors during diligence and a good relationship is important – even more so if you hope to have follow-on rounds from your first funders.  Monthly reports including good and bad news, financials and metrics updates are a minimum.  It’s better to stay on top of the investor relationship and by communicating frequently, investors are more on-board with what’s happening.  Use a platform like Reportedly.co that allows you to see who has opened your messages and also allows investors to comment and offer help when needed.

  4. Balance Growth and Resources.

    You’ve been pitching your $100 million top line you expect in five years, but now it’s time to match your resources to your growth targets.  Grow too slowly and you’ll never raise another round (so you’d better hit break-even) and grow too fast and you’ll run out of cash before you hit the benchmarks for Series A and then game-over.  Perfect balance is what you need for venture success.

  5. Update your Exit Strategy (Goals and Contacts)  

    During your pitch everyone wanted to acquire you, but now it’s time to start executing on your Exit Strategy.  You should include the update in every board meeting and monthly update.  Start making contacts with those companies for whom you create value early on.  If they don’t know who you are, you’re not going to get the multiple offers you need for that 5X multiple you were lusting after.

  6. Metrics.

     Ok, you think you’re growing too fast to waste time on shit like metrics.  Fine – go ahead and be mediocre.  The best companies are crystal clear on what success looks like, how to measure it and what their goals are.  Without metrics, your team is mis-aligned, your investors are in the dark, and really – you haven’t got a clue about where you’re going.  You don’t have time not to do this.

  7. Strategic Plan

    It’s not set in stone, but without a roadmap you’re bound to get nowhere fast.  Companies without at least a lightweight two pager plan find themselves going through expensive pivots left and right to try to figure out what they could have done in the first place with a good planning process.  BTW, statistics say that after three pivots you’re out.

  8. Change from Tech Culture to Sales Culture.  

    So far, success has looked like getting your MVP launched.  You are three founders and a dog coding away in a basement somewhere, but now you need to change gears and become a sales and marketing company with a tech foundation.  Too many companies can’t get out of their tech roots and they keep on coding, but never figure out how to sell.  Break out of your comfort zone and start selling.

  9. Speed up.

     You’re on the clock now and capital is the most powerful accelerator out there.  You’ve got to code fast, sell fast, grow fast.  Companies that think they can continue on their old pace don’t get venture capital.  It’s a race against the clock with ROI multiples of 10X in five years, 25X in seven, there’s no time to waste and the slow starters won’t ever get to Series A.

  10. Investors are your partners.

     Now that the deal has closed, and all the negotiations are done, it’s time to tap into your investor base for help, connections and advice.  Keep them in the loop and engage them – they’re worth a lot more than just capital.

 

Good Luck

Post funding transformation is hard and unnatural for most founders.  Pay attention to your successful peers and remember that getting rounds of funding are not what this is all about – work towards creating a great, meaningful company with huge value for your exit partners!

 

 


Peter Adams is the Managing Director of the Rockies Venture Fund, Executive Director of Rockies Venture Club and Co-Author of Venture Capital for Dummies, John Wiley & Sons, August 2013.  Available at Amazon.com, Barnes and Noble and your local bookstore.

Marketing Dilemma: Time and Capital is Key

The marketing dilemma in todays start-up world can be defined by the need for capital to increase marketing, but also the need for marketing to gain capital. Read more

When does the clock start at a VC Pitch Event?

Too many startups stress about how to get their whole story into a five minute pitch and they don’t think enough about how to cheat time a bit to get the most out of the five minutes (or two, sevenPitch Timer, ten, twelve, fifteen or whatever you’re given). This is the first to two blogs on the topic of how to cheat time — the first has to do do with the first slide and the second has to do with the last slide.

Ask yourself this – “When does the clock start at a pitch event?”

The answer is that it usually starts the moment you begin speaking. So you’re in control of when the clock starts. Now – what happens before you speak? The answer is that usually you are introduced by the MC or moderator and the first slide of your deck is queued up on the screen as you’re approaching the stage.

Here’s where many companies have a lost opportunity. Their first slide has mostly useless information that is already known to the audience. Why have a slide that has your company name, the date, the name of the event, the city, etc? Why not make sure, since your slide will be up on the screen for up to sixty seconds before you start talking, that the slide is doing a lot of work for you.

Your opening slide can:

Tell the audience about what market you’re in.
What is your product/service.
What is your primary value proposition?
And more!

At the very least, you should compose a tag line below your company name that is a tweet or less (140 characters) that describes your company, industry, and key differentiators.

If you do this, you’ll have the audience queued up and ready to hear a pitch for what you do.

I call this process “building a box”. When you do this, you’re developing a conceptual framework into which everything you say can be placed in context. People who don’t build a box early on in their pitch leave us guessing and ultimately uninterested in the pitch.  This is the way the human brain works – we have a hard time processing information that is out of context – yet inexplicably, over half of VC pitches leave out the context until we’re half way through the pitch or more!

Don’t keep the audience guessing until half of the way through your pitch about what you do.

If the audience doesn’t get what you do within the first thirty seconds of your pitch – you’re dead.

Why not use that first slide to make sure that the audience knows what you do BEFORE YOU EVEN START SPEAKING?

How to Cheat Time on Your VC Pitch – Part 1: The Last Slide

Too many startups stress about how to get their whole story into a five minute pitchVC Pitch Last Slide and they don’t think enough about how to cheat time to get more out of their pitch.

You can cheat just a bit to get the most out of the five minutes (or two, seven, ten, twelve, fifteen or whatever you’re given). This is the first to two blogs on the topic of how to cheat time — the first has to do do with the first slide and the second has to do with the last slide.

Ask yourself this – how long is the last slide up on the screen?

The answer is that in a five minute pitch event, the last slide is usually up for five minutes of Q&A. If this slide is up for five minutes, why do so many people waste this opportunity by having the slide say “Thank You” and their email. Most pitch events provide your email to all attendees, and it’s great that you’re polite with the “thank you”, but it would be much better if you could effectively use that time and that slide to reinforce the key points of your pitch.

A good last slide will reiterate the highlights of your pitch.

You can have the team, product, market, traction, the deal, or whatever you like. I have seen slides broken up into as many as six sections with key elements reinforced in each. Since this slide is up for so long, the twenty five word limit for slides in a pitch event is waived! Go ahead and toot your horn.

The kiss of death for a pitch is when nobody has any questions for the presenter. This means that either people didn’t understand your pitch, or that they understood it well and had absolutely no interest. The last slide will help clarify key points, but most importantly, it will provide key points that people can ask questions about. Sometimes people are shy to ask a question and sound dumb if they didn’t understand something. Sometimes in a big pitch event, people may even get confused and ask a question that doesn’t even pertain to your company, but might have been from one or two pitches prior. Having your key points up on the screen gib vets them the confidence to ask questions.

Of course – the other great solution to silence during Q&A is to have Back Pocket Slides that you can draw on to effectively extend your pitch if nobody asks any questions!

Why Venture Capital may not be a Silver Bullet for Startup Funding.

alternatives to venture captialVenture capital is a great solution to many startups’ finance problems, but it’s often not the best solution and, even when it is the best solution, it often works best as a part of a suite of financial solutions rather than a silver bullet that solves everything in one move.

Venture capital, including angel investment, is the most expensive type of capital out there. So why would so many people be intent on going for the most expensive option when others exist?  A typical VC is looking for a return of 60% or greater on their investment – compounded annually.  That means that at three years they want 4X. At five years it’s 10X. At seven years it’s 25X and at 10 years it’s a whopping 100X return on investment.  All of these are 60% compounding returns.

Venture capitalists need big returns to help offset their big risks.  About half of their investments might result in a complete loss of invested capital, so they need to have investments capable of being home runs in order to pay for all the losers.

There are different ways to create a capital strategy for startups who want to both grow fast, but minimize dilution and reduce the cost of capital.  Rather than using just one very expensive type of capital for their startup, they may use a suite of different sources that are appropriate to the phase of development.

Early Stage – Before VC

Early stage companies have many sources of capital available to them, even if they don’t know it.

SBIR (Small Business Innovation Research), Advanced Industries Proof of Concept and many other federal and state grants are available for early research and proof of concept.  Often these are expensive research projects whose risk is much greater than can be justified even for venture capital.  Startups that use these sources of funds can increase their value and decrease their technical risk without any dilution to the founders.

Another source of early stage funding comes from specialty service providers.  Attorneys and CPAs will often defer compensation or work out an equity deal in exchange for early work.  You might be able to get your patent filed for zero out of pocket costs using this kind of deal.

In Revenue

Companies that are in revenue have lots of new non-VC sources of funding available.  Consider accounts receivable finance to cover your rapidly growing need of cash to carry AR through thirty to ninety days before it gets paid.  Some lenders will even lend on purchase orders so you can get the capital you need to buy the components you need to build your product.

If your product is a SaaS (Software as a Service) platform, then your cost of goods is going to be people, not product.  Consider using Equity Compensation for all or part of your payment to your developers.  There are both individuals and development companies who will swap a portion of their compensation for equity.  You’ll need to have a good handle on your valuation, but why not give equity directly to your developers rather than give it to VCs who give you cash which you then turn around and give to developers?

So, there are many more types of finance options available to you than can be described here.  The main point to remember is that you are not required to use just one mode of funding.  Look at all of the available sources and design a suite of solutions that provides the best solution to your situation.

To learn more about how to use creative funding along with venture capital, or instead of it, consider attending the RVC’s Colorado Capital Conference November 15-16, 2016.  If you’re not in Denver on those days, you can register to participate in the conference via live-feed.

More information and registration at www.coloradocapitalconference.org

Colorado Capital Conference

 

 

 

Peter Adams

 

Peter is Executive Director of the Rockies Venture Club, Managing Director of the Rockies Venture Fund and teaches in the Colorado StaVenture Capital for Dummieste University MBA Program.  Peter is co-author of Venture Capital for Dummies, (John Wiley & Sons 2013) Available at Amazon, Barnes and Noble and your local book store.

 

 

 

Startups without an Exit Strategy are not committed to their company.

fire_exit-svgI heard it again this week.  The lame startup who answered that they didn’t have an exit strategy because they just wanted to create value for their customer.  I’ve heard this so many times by CEOs who think they’re being noble by focusing on their passion and commitment to the company and not to an exit – but what I hear is that they are NOT truly committed to their business.

  CEOs who don’t have an exit plan are limiting the potential for their business.

The fundamental lie of exit denial is in the belief that creating value for the customer is the same as creating value for the business.  Think about it – if you do something really well and create value for a customer, and you’re passionate about carrying out that mission to the greatest extent possible, then wouldn’t it be a good idea to identify larger companies who shared your values and could carry out the mission to even greater extents with their additional resources, capital, sales channels and expertise? Creating value for the acquirer means creating value for the customer as well – it’s rare that anyone wants to acquire a company with no customers.

But no – you’re just creating value for the customer, and then if you do that, acquisition offers will come along….eventually.  Yes, offers will come along, but they may not be from companies that share your values.  They may be from companies that want to shut you down.  They may be from companies that want to exploit your product or customers.  Just passively waiting for a suitor to come along is a cheap cop-out for lazy CEOs who believe that uncertainty means that you have to wait for whatever the world brings you.

Companies who are truly passionate about their mission are working to develop two value propositions simultaneously – the value proposition for their “first customer” who buys their product and the value proposition for the “second customer” who buys the company. Wayne Gretzky Exit Strategy

CEOs who think about the second customer are the ones who get me excited because they exhibit deep knowledge of their industry.  Like Wayne Gretzky, the hockey player who famously said “I don’t go to where the puck is, I go to where the puck is going,” these CEOs have identified a trend and they build value for companies in their industry who will be needing their innovation within a three to five year window.

To be sure, there is uncertainty.  You can’t just pick the acquirer, date and amount of acquisition.  This does not mean, however, that you can’t research comparable transactions and identify the key players and their behaviors.  You can create relationships with the companies who will be needing your technology so that when their board identifies a need for your product/service, they know that you are a key player in the industry that would be a good acquisition target and can reach out with an offer.

Identifying multiple bidders for your exit strategy not only allows you to select 6699678_sthe bidder who most closely matches your values and goals for the company, but also allows you to demand top dollar for the acquisition.

No, it’s not all about the money, but if you put your head in the sand and just wait for suitors, you will likely end up with a lower price for your acquisition and more importantly you may fail to truly carry out the mission of your company to its fullest potential.

Create a detailed exit strategy and show everyone your passion for the mission of your company.

“And we have NO competition”

Please, do not ever say these words to an investor. You are essentially telling them to run. It is heard over and over, but it is never true. Maybe no one is doing the exact same thing, but someone is doing something similar and needs to be acknowledged. Read more