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How much money should I raise from an Early-Stage Investor?

An assortment of United States coins, including quarters, dimes, nickels and pennies. (Photo credit: Wikipedia)

Raising money for your startup is never fun. It takes time, distracts you from developing your product, is fraught with emotional ups & downs, and doesn’t have a guaranteed outcome. Frankly, many founders would rather go jump into an icy lake than take another fund raising meeting where they aren’t sure what they should say to ‘convince’ an already hesitant investor to open their purse strings and invest in their company.

So, back to the main question… how much money should I raise?

The flippantly short version of the answer is, “as much as you can”… but in some cases, more isn’t necessarily better. Although you should raise as much money as your company needs to achieve major proof-points/milestones, overfunding a company can also have its drawbacks.

Let me explain this last point before going further on the ‘how much money should I raise’ question:

Many founders are obsessed about raising as much money as possible all at once because well, if you do raise a big war chest, then that’s one less problem you need to worry about. However, with a large amount of money come several potential problems:

1) With more money usually come more investment terms and more due diligence. It is probably a fair statement to say that the more money involved, the more control provisions an investor will want as well as more diligence to make sure that their money isn’t going to be misused.

2) A high implied post-money valuation. In order to accommodate a large round, investors need to adjust your valuation accordingly. For example, if your business is objectively worth 1 million, but you are raising 2m, unless the investor plans on owning 66% of the company after investment, they need to adjust the valuation upward (I’ll abstain from giving ranges for now). Having an artificially higher valuation prematurely can put a lot of strain on a startup if things don’t go well and then later need to raise money again, as it increases the likelihood of a subsequent round being a down-round (when you take a negative hit to your valuation) or rather, other new investors passing on the deal in the future because it is ‘too expensive’.

3) A propensity to misuse ‘easy money’. You could argue this point from a psychological point of view if you wanted, but suffice it to say, I know many VCs that believe that over-funding a company leads to financial laxity, lack of focus, and overspending by the management team. Perhaps it is lingering fear over the hey-days of the late 90′s were parties were rife, and everyone got an Aeron chair, but the general fear with overfunding a company is that it will be tempted to expand faster than it can absorb employees into the culture, integrate new systems, or expand real-estate needs without substantially disrupting the efficient operations of the company.

4) A last one, which is hard to really quantify and happens only to very few startups, is the media’s reaction (positive or negative) to how much money you’ve raised relative to what you have. Think about this story, although very rare, it’s what the effect of what too much can cause.

Ok, got it, overfunding can be bad… too much money can be a bad thing, but if you said I should raise as much as I can, where do I start and what is the ‘magic’ number to ask for then?

Alright, let’s look at this question from a different point of view, as I mentioned in my previous post on how an investor evaluates your financial plan, an investor (depending on their areas of focus) may not necessarily know what the exact figures your business will need to grow to its next major milestone, but rather, the investor will rely on your ability to communicate this on your financial plan for the investor to then make a decision on whether your accurately understand your cash needs or not. Tied to this cash need is an implied understanding of your company’s milestones.

Let’s define what a milestone is before proceeding:

A milestone is a quantifiable achievement, be it in terms of product development, team expansion, or market adoption of your company’s value proposition.

Your financial plan will likely be a series of chronologically organized milestones. For example:

Month 6 – Hire UX guy to optimize app
Month 8 – Launch mobile app
Month 10 – Start charging on the mobile app
Month 11 – Hit 10,000 users
Month 12 – Launch partnership with key distributor
Month 18- Hire CMO

These are all milestones. Some more important than others, and frankly an investor will likely want to talk to you about the importance of each one of them to get a feeling for which ones are the key ones to focus on to determine if your business is going to ‘take off’.

The reason for this is simple, the best time to go fund raising, is RIGHT BEFORE or SHORTLY AFTER the successful completion of a key or series of key milestones. For example, right before a key milestone, you can woo new investors with the promise of how successful you will be at the completion of the milestone and basically you convince them that if they don’t get into your company by investing now, that they won’t have a chance after you’ve achieved the milestone because many others will also be interested and the competition will be stiff (remember, investors don’t want to lose out on potentially hot deals). Shortly after achieving a key milestone is also a good time to try and convince investors because you’ve effectively accomplished a major thing (like launching a product), which de-risks the investment for them, but they can still get in the company before it ‘takes off’. Frankly, the worst time to go fundraising is when your last major milestone has grown stale and the next one is too far away to be de-risked. So, this is why it is key to know your milestones, and when they are happening.

Parallel to this milestone timeline is the ‘cash timeline’. As in, how much money, in aggregate, you will have spent to get there. So using my examples from above:

Month 6 – 60K
Month 8 – 80K
Month 10 – 100K
Month 11 – 110K
Month 12 – 120K
Month 18 – 240K

Ignore whether this is a realistic example for your business for the time being, but I’ve assumed a 10K cash burn on this example up to the end of year 1, and then starting in Year 2, I’ve assumed 20K monthly cash burn. If you don’t know what your monthly cash burn is, you’re in trouble. Monthly Cash Burn is a KEY figure to know before meeting any investor.

As you can see, an investor could choose any of the milestones above to focus on for your cash needs. The idea is simple, fund your company through the achievement of major milestone(s) (to reduce investment risk and to see if your company has any traction before putting more money in) and then go fund-raising for more money, hopefully on a strong note, where you will have met your timelines and expected outcome (be it market traction, or successful completion of your product, or hiring of the appropriate person).

For example, an Angel investor (someone that usually invests from their own money) typically can’t invest millions, so their investments tend to be less than 300K. However, they’ll want to make sure your business is going somewhere before putting all their money in, so it’s likely they’ll want to come in early to give you enough cash to achieve something plus a little extra to help you fund-raise after, but also to see how you achieve the milestone before putting in more. So, perhaps this Angel may opt for funding you through month 10 with your requirement of 100K plus a few more for fund-raising. This would get you through your product’s launch and give you a couple of months to see how it goes in terms of market traction (all the time you will be speaking to new potential investors) so that you can have something strong to talk about for fundraising purposes.

Alternatively, an institutional investor (one that invests other people’s money as well as their own), say a VC fund, may see that your company has some real potential in what it is trying to do, sees that you have a plan that requires 100K to launch before you start trying to monetize, but with their experience of seeing your kind of business having to do a few pivots before getting the launch product 100% right, think that perhaps the best quantity to give you based on your calculations is about 500K for about a year to a year and a half. This should also give you some breathing room to work on achieving your various milestones rather than having to focus on having to be constantly in fund-raising mode.

So now you are probably asking yourself, how is it that some investors have different perceptions of how much money I need and wish to give me? Effectively, how much money does an investor ACTUALLY think I need vis-a-vis what I ask for?

Your exact calculations may have said that you needed 100K to launch your product, but an experienced investor may have seen various companies like yours and seen that there are usually mistakes done along the way that consume cash without quantifiable progress towards the agreed milestone (you may have learned something, but you may be delayed in your launch because of some screw up). Because of this, investors some times include ‘buffers’ into the number they offer you in a deal. This buffer could come from the various sensitivity analysis the investor did, such as, what if the company is delayed in launching their product by two months, or what if the company can’t find that key employee, or what if the company can’t start charging for their product for an extra few months, or what if the product needs a pivot, or what if people aren’t willing to pay what the company expected? All these things will affect the cash flow of the company and because of them, the investor may assume some or all will occur, leading to the company needing more money than was planned by the founder. Effectively, your 100K in a perfect execution timeline, may actually be 250K after some minor delays and mistakes, and with the extra cash the investor in my example above gave you, you now may have enough cash to go fund-raise without having to panic about having to get cash in ‘yesterday’ or be constantly in fund-raising mode.

Keep in mind that this larger amount an investor may be willing to give you will also affect your valuation range, too much and it ‘inflates’ the valuation range your company sits in (as per my point number 2 in the intro), so an investor won’t give you ‘excessive’ buffer so that it forces the company to be ‘overpriced’ for them and for the company’s future. Inversely, hopefully you can also see where an investor may deem a company to be ‘underfunded’ if it doesn’t have enough money to get to where it can achieve a meaningful milestone(s) upon which to go fundraising with a strong foot forward for future investors to be attracted.

In conclusion, raise as much as you can but understanding your monthly cash burn and map out your company’s important timelines and the cash you will realistically require to achieve them. Then have an engaging conversation with your potential investors as to how much they think you need based on their experience. As a rule of thumb, try and raise enough money so that you have time to go fund raising after you’ve accomplished your next key milestone(s). In a future post I’ll discuss how much time you should set aside for fundraising, but to make the rule-of-thumb complete, add AT LEAST 6 months to the amount of money you need for your next milestone to include time to go fundraising.

Hope this helps

Update 1:

A friend of mine emailed in and mentioned that perhaps there was a difference in how investors from different geographies look at this issue of how much they want to invest in a company up front, and yes… I would agree with that statement, but the point of my post is merely to provide the reader with a ‘framework’ by which to approach the question of how much to raise, not so much to answer the multiple varied ways that investors might look at the amount required and subsequent fundraise amount. For example, some investors may choose to just want to back the team and thus will just give them an amount that they think startups typically get for the stage the company is in, and others will give an amount of money merely to exclude the investor competition from winning the deal from them!

However, I believe the framework I’ve mentioned in this post can help a founder assess how much money they may need for a period of upcoming time no matter the risk averseness (or not) of the investors they meet with. Whereas a bolder investor may not really focus on minor milestones, but rather just focus on a larger one such as ‘grow the network’ and for that the amounts invested is done with far less due diligence and far more quickly, a more risk averse investor will probably be more specific about what you plan on accomplishing with his money.

In the end, the most important thing, is to be keenly aware of your cash needs on a month by month basis, so that if the question comes up, you know how much you plan on spending and by when. You should also focus on raising enough money in your timeline so that you also have time to accomplish your key milestone(s) before going fundraising again, and lastly you should include enough buffer in your last fund raise to help you through your next fundraising period post-milestone. If you meet an investor that wants to invest a lot quickly, great, if you meet with various investors that are more risk-averse, at least you won’t get caught not understanding your execution plan. If you want another rule of thumb, many Early-Stage VCs will look at the next 12month to 18month worth of cash needs + a buffer to estimate the cash needs of a company. Add to that 6 months of additional cash burn and you have a rough starting point for a ‘headline figure’ from which to start discussions.

Hope this helps clarify the question further..

Related articles

• How does an early-stage investor review your financial plan? (thedrawingboard.me)
• [Excerpt] Fundraising: From $1,000 To $1,000,000 (techcrunch.com)
• How does an early-stage investor value a startup? (thedrawingboard.me)
• The Right Time To Raise Money At A Startup (kellblog.com)
• Angel investor Ron Conway to portfolio: Cut expenses now (news.cnet.com)
• Do You Really Need an Outside Investor? (inc.com)
• We Raised Too Much Money (battlehardened.wordpress.com)
• How much money should I raise from an Early-Stage Investor? (thedrawingboard.me)
• Do you have what VCs are looking for? (marsdd.com)
• Should Companies Retain “Strategic” Cash? (blogs.hbr.org)

How does an early-stage investor review your financial plan?

You are about to go meet an investor… you’ve read on the web and heard differing views from people on whether you need a financial plan… some say you don’t, it’s a waste of time as its all made up numbers anyway… others say, you absolutely need a financial plan… so you walk into an investor meeting full of anxiety as to whether not having something is going to reflect poorly on you or if what you’ve created (if you did create something) will be crap in the investors eyes… so what to do?

The financial plan, for most tech-focused early-stage founders, is probably one of the most dreaded bits of the investment pack to send your prospective early-stage investors. The variety of opinions online don’t help either as they just confuse the matter…

• Do I need one or do I not need one?
• If I build one, how do I know it is ‘right’?
• If I build one, surely the investor will know that my numbers are all “fake” and just slash them all in half?

Let’s face it, as much as we’d like to think we can predict the future with all sorts of fancy extrapolations on growth rates… but we can’t… Considering that most people create financial projections based on assumptions of what needs to happen for an upcoming month’s worth of operating events to happen and then project from there for x number of months or years, you effectively create a series of increasingly improbable chronological events with the last event (month) in the series being effectively a function of the compounded set of decreasing probabilities, all of which are asymptotically approaching zero percent in their likelihood of happening “according to the plan”.

What’s my point? Well, that your financial plan isn’t worth much from an accuracy perspective.
So what then? If my numbers are crap, why bother with whole financials nonsense?

It is in its forensic analysis of your thinking behind the model, however, where an early-stage investor really gets a feel for how you think and how you want to direct your company in the near future. Next, it is in how your cash will be used efficiently to accomplish the mutually agreed goals.

Before we continue further, I want to clarify that I’m not going to discuss how it is that you should format your financials, or explain basic accounting principles, or how financial statements work. There are plenty of resources online that can help you with that. Rather I want to explore how an early-stage investor (well, at least myself) forensically reviews the financial plan of an early stage startup (vs. a later-stage startups where there is a historical performance record already there and with multiple years of budgets and actual figures).

So what do I mean by conducting a forensic analysis of company’s financials?

Well, I certainly don’t mean it in the sense of reviewing the financials of the startup from a post-mortem basis, but rather reviewing them with the same level of scrutiny on ‘reasons’ why things may have occurred or may occur as one sees on TV shows like CSI. Effectively, I’m looking for what are the cause & effects of each of the numbers and what are the key assumptions behind them, with emphasis on the word “assumptions”. The verbal discussion with the entrepreneur’s financials will focus entirely on their assumptions and the reasoning behind them.

When an investor is discussing numbers (which may be entirely wrong from a future-perspective) with an entrepreneur, if the entrepreneur shows a solid understanding on why the numbers are there, having a clear view of the market dynamics in which their company operates, with realistic customer acquisition assumptions, realistic hiring plans, effective use of marketing budgets, appropriate expenses for a growing company, it can have a HUGE impact on establishing the necessary credibility of competence an entrepreneur needs to inspire confidence in the investor. The opposite, seeing a financial plan with current month revenues/expenses projected five years into the future assuming linear or exponential growth in all aspects of the organization and then stated with a confidence of ‘this is what we realistically expect to happen’ can be both demoralizing for an investor if not outright humorous.

Let me share with you a little secret: With a few exceptions, you will always know your industry and its numbers better than any investor will. However, an experienced investor will ask you the right questions to ascertain whether or not you know your industry well enough to increase the probability of your own company’s success. As such, really do your homework… by homework I mean, don’t just go out and build a product and hope there will be customers. If you take the Lean Methodology approach, for example, as soon as you have customer validation, make an effort to understand the market dynamics of that customer… how many of them are there? What is their concentration? How do you reach them? Are they locked in with a competitor with some sort of monthly or annual contract? Do they buy in a cyclical pattern? Do they prefer to buy online or only from salespeople? Do they need help with setting up your product or can they use it as is? What are they generally willing to pay for other similar services? How is the market growing? Mind you that in some circumstances the ability to ‘charge’ money of your customers may not be deemed the real potential for revenues at first (think Twitter 3 years ago), but again it is how you articulate the future value that matters.

If you take all those questions and research them, what you will find are key components of what will make up the assumptions on your future revenues (or value creation objective). Perhaps your customers are only willing to buy your product during the holiday season, so you will have a hard time with cash coming into your company during the off-season. Financials that didn’t take that into consideration would look to an investor as somewhat unrealistic, not in the numbers, but in the market dynamics of your product. Take other assumptions for example, if you can only reach your customers via another party (perhaps a distributor?)… As in you aren’t directly selling to your end customer, how does that affect the time until you get cash, and the amount of customers you get all at once (or lose all at once)? How long are your customers likely to stay within your service (churn)?

Again, all of these examples are about doing your homework on how your company will operate within its industry and how it will acquire customers. The better you can explain the reasons why a number in your financial model is based on a realistic set of assumptions, the better off you will be. But look at it another way… while you are doing this exercise, you will realize whether there is actually a business that can make money (or other method of value creation) or not. For example, if you do the analysis and find that in the sector you are exploring people aren’t willing to pay and that many other competitors are giving the product away for free, and that there aren’t many opportunities to inject ‘advertising’ as a supplementary source of revenue, you may have just saved yourself a serious amount of wasted energy!

Which brings us to the next part of the homework: the understanding of your company’s expenses. If you have found a market where your product is actually capable of generating some sort of value (note again that I’m not necessarily focusing on “revenues” because there are many ways investors define what “value creation” is, whether it be a growing user base or actual sales) the next part is how do you spend your money to match that customer growth. When do you hire new sales people (and how many sales people do you need relative to a customer sale?),  when do you bring new servers online, spend on marketing, spend on new offices, laptops, etc..  Obviously the types and amounts of expenses vary from company to company, but what matters here is how they map to what you are trying to do and whether that mapping is realistic (what is your customer acquisition cost?). For example, if you have a marketing charge of $500 one month, is it realistic to expect that next month your customer sign ups will increase by 500%? Well, as I said before about the “little dirty secret”… I have no flippin’ idea, but I will expect you to tell me how the $500 will equal 500% in customer growth and I will basically evaluate the credibility of your answer. If you answer, I will buy $500 worth of flyers and pass them out, you can rest assured that I will not believe your 500% figure, but if your team’s background has a track record of low-cost viral marketing campaigns, and your answer is basically a version of that… well guess what, I might just find it plausible. I may be exaggerating the bit about having ‘no flippin idea’ as most investors will have seen enough of what works and doesn’t work to call BS, but again, if you can walk an investor credibly through your assumptions, it will do wonders for the confidence you create.

Lastly and most importantly, is the review of how the expenses map to the revenues as far as cash flow is concerned. The lifeline of a company is how much cash it has before it either dies or needs to go fund-raising again. As such, investors not only want to know how much a company needs in terms of cash to execute its vision (perhaps the subject for an upcoming post), but also on how that cash is being used. If there is a huge mismatch here or there isn’t enough time for you to reach your company’s next point of tangible progress (a validation point), this may be a point worth discussing. Much is joked about how an investor will take your revenues and cut them in half, actually an investor may outright eliminate your revenues from the overall sensitivity analysis he is doing to get a feel for how much cash your company would burn on a monthly basis at time x in your plan (you should know your current monthly burn number by heart, by the way). This is because if your company has to do a pivot or something else goes wrong, this will not only accelerate the cash drain relative to your plan, but also have an effect on when the company needs to go fund-raising again and an investor needs to take all of that into consideration as part of the investment analysis.

In summary, do your homework before you build your financial model, but definitively go through the exercise of building one. It will be hugely helpful in helping you identify how your business may need to grow in order to adapt to the sector in which it operates and how you may need to spend money in order to achieve your goals. Most importantly however, by being prepared with a thorough understanding of why everything is there within your model, the less anxious you will be when meeting potential investors… and remember, you may not know all the answers, such as how much money will it cost you to acquire a new customer, but even if you at least start with a reasonable assumption, confess that you aren’t sure about it, and then play around with a range to see if things work, that is also helpful to the investor for them to get a feel for how you can evaluate uncertain circumstances and adapt accordingly.

Related articles

• Get Your Financials Investor-Ready (openforum.com)
• Most Investors Bite Only at Specific Startup Stages (startupprofessionals.com)
• Putting the Romance in Due Diligence (inc.com)

Additional Notes on Early-Stage Startup Valuation

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In my recent post on how an early-stage investor values a startup, I talk about how market comparables were the closest guide to how early-stage investors value a startup vs. any other methodology. However, I feel like I left one question unaddressed. Namely, why are there valuation discrepancies for comparable companies across the world (more specifically at investment stage rather than exit stage)?

The answer has to do with liquidity of deals, the localized risks for investors, and the supply of investors.

As I mentioned in my last post, there are various factors that can come into how an investor values a startup, but using market comparables from deals done in the USA doesn’t always incorporate all the risks that are prevalent in the specific geography where the company and investor in question operates. Furthermore, the availability of capital in any geography will also affect how an investor gauges his own risk/reward ratio when pricing deals.

I’m going to talk about this point abstractly and without incorporating the argument of the global nature of internet-based businesses (they do have some localization risk still, but less so). So, for example, startup exits for investors in certain developing economies will happen less often than say, in Silicon Valley. This has to do not only with the number of companies coming out of the country, but the universe of potential buyers for these companies in that geography.

This affects that risk an investor takes, as he is less likely to get that 10x that I mentioned in my previous post. Therefore an investor seeks a ‘discount’ to take on a deal in order to have a portfolio of deals where there is the possibility that one will be able to exit in spite of whatever market conditions exist locally. Add to that the fact that the investor may be one of very few investors, and therefore can command this discount more forcefully than if more competition existed (once enough investors exist, market pricing becomes more stable and in parity with other larger markets).

Think of it this way… If you’ve been on tourist holidays to resorts abroad, you’ll have noticed that things that are generally cheap(er) back home are notably more expensive at the resort store. This higher cost is due not only because of the transport cost to the resort, but also the cost of holding them there in inventory without knowing if anyone traveling to the resort will buy them. If the seller doesn’t include a higher premium on these items, he will not break even considering the high scrap-age risk he must take on inventory not-bought, and if there aren’t any other stores around, the store doesn’t have to compete on price either, but can continue to seek profit under the circumstances.

So, the point of this post is only to highlight why in certain parts of the world financing can be more difficult to get, but also why it can be priced differently than equivalent deals elsewhere.

Related articles

• How does an early-stage investor value a startup? (thedrawingboard.me)
• Putting a Value on Your Startup (forbes.com)
• Why Fewer Companies Are Successfully Raising Series A Rounds (eladgil.com)
• An Inside Look at how a VC Evaluates Startups Pt. II (thomvest.com)

How does an early-stage investor value a startup?

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One of the most frequently asked questions at any startup event or investor panel, is “how do investors value a startup?”. The unfortunate answer to the question is: it depends.
Startup valuation, as frustrating as this may be for anyone looking for a definitive answer, is, in fact, a relative science, and not an exact one.

For those of you that want to cut to the summary of this post (which is somewhat self-evident when you read it) here it is:

The biggest determinant of your startup’s value are the market forces of the industry & sector in which it plays, which include the balance (or imbalance) between demand and supply of money, the recency and size of recent exits, the willingness for an investor to pay a premium to get into a deal, and the level of desperation of the entrepreneur looking for money.

Whilst this statement may capture the bulk of how most early stage startups are valued, I appreciate that it lacks the specificity the reader would like to hear, and thus I will try and explore the details of valuation methods in the remainder of my post with the hopes of shedding some light on how you can try and value your startup.

As any newly minted MBA will tell you, there are many valuation tools & methods out there. They range in purpose for anything from the smallest of firms, all the way to large public companies, and they vary in the amount of assumptions you need to make about a company’s future relative to its past performance in order to get a ‘meaningful’ value for the company. For example, older and public companies are ‘easier’ to value, because there is historical data about them to ‘extrapolate’ their performance into the future. So knowing which ones are the best to use and for what circumstances (and their pitfalls) is just as important as knowing how to use them in the first place.

Some of the valuation methods you may have have heard about include (links temporarily down due to Wikipedia’s position on SOPA and PIPA):

• The DCF (Discounted Cash Flow)
• The First Chicago method
• Market & Transaction Comparables
• Asset-Based Valuations such as the Book Value or the Liquidation value

While going into the details of how these methods work is outside of the scope of my post, I’ve added some links that hopefully explain what they are. Rather, let’s start tackling the issue of valuation by investigating what an investor is looking for when valuing a company, and then see which methods provide the best proxy for current value when they make their choices.

A startup company’s value, as I mentioned earlier, is largely dictated by the market forces in the industry in which it operates. Specifically, the current value is dictated by the market forces in play TODAY and TODAY’S perception of what the future will bring.

Effectively this means, on the downside, that if your company is operating in a space where the market for your industry is depressed and the outlook for the future isn’t any good either (regardless of what you are doing), then clearly what an investor is willing to pay for the company’s equity is going to be substantially reduced in spite of whatever successes the company is currently having (or will have) UNLESS the investor is either privy to information about a potential market shift in the future, or is just willing to take the risk that the company will be able to shift the market. I will explore the latter point on what can influence you attaining a better (or worse) valuation in greater detail later. Obviously if your company is in a hot market, the inverse will be the case.

Therefore, when an early stage investor is trying to determine whether to make an investment in a company (and as a result what the appropriate valuation should be), what he basically does is gauge what the likely exit size will be for a company of your type and within the industry in which it plays, and then judges how much equity his fund should have in the company to reach his return on investment goal, relative to the amount of money he put into the company throughout the company’s lifetime.

This may sound quite hard to do, when you don’t know how long it will take the company to exit, how many rounds of cash it will need, and how much equity the founders will let you have in order to meet your goals. However, through the variety of deals that investors hear about and see in seed, series A and onwards, they have a mental picture of what constitutes and ‘average’ size round, and ‘average’ price, and the ‘average’ amount of money your company will do relative to other in the space in which it plays. Effectively, VCs, in addition to having a pulse of what is going on in the market, have financial models which, like any other financial analyst trying to predict the future within the context of a portfolio, have margins of error but also assumptions of what will likely happen to any company they are considering for investment. Based on these assumptions, investors will decide how much equity they effectively need now, knowing that they may have to invest along the way (if they can) so that when your company reaches its point of most likely going to an exit, they will hit their return on investment goal. If they can’t make the numbers work for an investment either relative to what a founder is asking for, or relative to what the markets are telling them via their assumptions, then an investor will either pass, or wait around to see what happens (if they can).

So, the next logical question is, how does an investor size the ‘likely’ maximum value (at exit) of my company in order to do their calculations?

Well, there are several methods, but mainly “instinctual” ones and quantitative ones. The instinctual ones are used more in the early-stage type of deals and as the maturity of the company grows, along with its financial information, quantitative methods are increasingly used. Instinctual ones are not entirely devoid of quantitative analysis, however, it is just that this “method” of valuation is driven mostly by an investor’s sector experience about what the average type of deal is priced at both at entry (when they invest) and at exit. The quantitative methods are not that different, but incorporate more figures (some from the valuation methods outlined) to extrapolate a series of potential exit scenarios for your company. For these types of calculations, the market and transaction comparables method is the favored approach. As I mentioned, it isn’t the intent of this post to show how to do these, but, in summary, comparables tell an investor how other companies in the market are being valued on some basis (be it as a multiple of Revenues or EBITDA, for example, but can be other things like user base, etc) which in turn can be applied to your company as a proxy for your value today. If you want to see what a professionally prepared comps table looks like (totally unrelated sector, but same idea), go here.

Going back to the valuation toolset for one moment… most of the tools on the list I’ve mentioned include a market influence factor , meaning they have a part of the calculation that is determined by how the market(s) are doing, be it the market/industry your company operates in, or the larger S&P 500 stock index (as a proxy of a large pool of companies). This makes it hard, for example to use tools (such as the DCF) that try and use the past performance of a startup (particularly when there is hardly a track record that is highly reliable as an indicator of future performance) as a means by which to extrapolate future performance. This is why comparables, particularly transaction comparables are favored for early stage startups as they are better indicators of what the market is willing to pay for the startups ‘most like’ the one an investor is considering.

But by knowing (within some degree of instinctual or calculated certainty) what the likely exit value of my company will be in the future, how does an investor then decide what my value should be now?

Again, knowing what the exit price will be, or having an idea of what it will be, means that an investor can calculate what their returns will be on any valuation relative to the amount of money they put in, or alternatively what their percentage will be in an exit (money they put in, divided by the post-money valuation of your company = their percentage).  Before we proceed, just a quick glossary:

Pre-Money = the value of your company now
Post-Money = the value of your company after the investor put the money in
Cash on Cash Multiple = the multiple of money returned to an investor on exit divided by the amount they put in throughout the lifetime of the company

So, if an investor knows how much % they own after they put their money in, and they can guess the exit value of your company, they can divide the latter from the former and get a cash-on-cash multiple of what their investment will give them (some investors use IRR values as well of course, but most investors tend to think in terms of cash-on-cash returns because of the nature of how VC funds work). Assume a 10x multiple for cash-on-cash returns is what every investor wants from an early stage venture deal, but of course reality is more complex as different levels of risk (investors are happy with lower returns on lower risk and later stage deals, for example) will have different returns on expectations, but let’s use 10x as an example however, because it is easy, and because I have ten fingers. However, this is still incomplete, because investors know that it is a rare case where they put money in and there is no requirement for a follow-on investment. As such, investors need to incorporate assumptions about how much more money your company will require, and thus how much dilution they will (as well as you) take provided they do (or don’t ) follow their money up to a point (not every investor can follow-on in every round until the very end, as many times they reach a maximum amount of money invested in one company as is allowed by the structure of their fund).

Now, armed with assumptions about the value of your company at exit, how much money it may require along the way, and what the founding team (and their current investors) may be willing to accept in terms of dilution, they will determine a ‘range’ of acceptable valuations that will allow them, to some extent, to meet their returns expectations (or not, in which case they will pass on the investment for ‘economics’ reasons). This method is what I call the ‘top-down’ approach…

Naturally, if there is a ‘top-down’, there must be a ‘bottom-up’ approach, which although is based on the ‘top-down’ assumptions, basically just takes the average entry valuation for companies of a certain type and stage an investor typically sees and values a company relative to that entry average. The reason why I say this is based on the ‘top-down’ is because that entry average used by the bottom-up approach, if you back-track the calculations, is based on a figure that will likely give investors a meaningful return on an exit for the industry in question. Additionally, you wouldn’t, for example, use the bottom-up average from one industry for another as the results would end up being different. This bottom-up approach could yield an investor saying the following to you when offering you a termsheet:

“a company of your stage will probably require x millions to grow for the next 18 months, and therefore based on your current stage, you are worth (money to be raised divided by % ownership the investor wants – money to be raised) the following pre-money”.

One topic that I’m also skipping as part of this discussion, largely because it is a post of its own, is “how much money should I raise?”. I will only say that you will likely have a discussion with your potential investor on this amount when you discuss your business plan or financial model, and if you both agree on it, it will be part of the determinant of your valuation. Clearly a business where an investor agrees that 10m is needed and is willing to put it down right now, is one that has been de-risked to some point and thus will have a valuation that reflects that.

So being that we’ve now established how much the market and industry in which you company plays in can dictate the ultimate value of your company, lets look at what other factors can contribute to an investor asking for a discount in value or an investor being willing to pay a premium over the average entry price for your company’s stage and sector. In summary:

An investor is willing to pay more for your company if:

• It is in a hot sector:investors that come late into a sector may also be willing to pay more as one sees in public stock markets of later entrants into a hot stock.
• If your management team is shit hot: serial entrepreneurs can command a better valuation (read my post of what an investor looks for in a management team). A good team gives investors faith that you can execute.
• You have a functioning product (more for early stage companies)
• You have traction: nothing shows value like customers telling the investor you have value.

An investor is less likely to pay a premium over the average for your company (or may even pass on the investment) if:

• It is in a sector that has shown poor performance.
• It is in a sector that is highly commoditized, with little margins to be made.
• It is in a sector that has a large set of competitors and with little differentiation between them (picking a winner is hard in this case).
• Your management team has no track record and/or may be missing key people for you to execute the plan (and you have no one lined up). Take a look at my post on ‘do I need a technical founder?‘.
• Your product is not working and/or you have no customer validation.
• You are going to shortly run out of cash

In conclusion, market forces right now greatly affect the value of your company. These market forces are both what similar deals are being priced at (bottom-up) and the amounts of recent exits (top-down) which can affect the value of a company in your specific sector. The best thing you can do to arm yourself with a feeling of what values are in the market before you speak to an investor is by speaking to other startups like yours (effectively making your own mental comparables table) that have raised money and see if they’ll share with you what they were valued and how much they raised when they were at your stage. Also, read the tech news as sometimes they’ll print information which can help you back track into the values. However, all is not lost. As I mentioned, there are factors you can influence to increase the value of your startup, and nothing increases your company’s value more than showing an investor that people out there want your product and are even willing to pay for it.

Hope this helped! Feel free to ask questions in the comments.

UPDATE: I wrote some additional notes on early-stage startup valuation because I felt I didn’t quite cover all parts in the above summary. You can ready those by clicking here.

Other Pieces on the subject

http://www.quora.com/How-do-VC-firms-value-a-start-up
http://www.quora.com/Internet-Startups/How-do-investors-value-a-consumer-internet-start-up
http://www.entrepreneur.com/article/72384

Related articles

• 10 Ways to Size Your Company’s Value for Funding (startupprofessionals.com)
• Why Fewer Companies Are Successfully Raising Series A Rounds (eladgil.com)
• 4 Quick Factors in Startup Valuations (davidcummings.org)
• Fred Wilson Explains Why Most New Angel Investors Are About To Get A Seriously Rude Awakening (businessinsider.com)
• Putting a Value on Your Startup (forbes.com)
• 5 Funding Lessons From A Second-Time Founder (forbes.com)
• Factoring Liquidity Preferences in Startup Valuation (davidcummings.org)
• Is there a valuation bubble in Brazil? (thenextweb.com)
• Entrepreneur seeking an investment? Here’s a survival guide (sgentrepreneurs.com)
• Is the money drying up for startups, or not? (poll) (venturebeat.com)

How does an investor evaluate a startup’s team?

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A startup’s management team is its lifeblood… no amount of awesome ideas will ever overcome a fundamentally flawed management team. In the early stages of any startup, it is all about the people.

But what makes up a good team? How do you know if you have a good team, if you are a good team member, and if an investor will perceive you the way you perceive yourself?

Perhaps it is best to then approach this question from a different point of view…

A startup is fraught with challenges from day one. These include commercial, HR, and technical hurdles of all sorts, to name a few. These generally require a certain attitude and personality attributes from the founders for the startup to have a chance at surviving.

These personality attributes include a combination of confidence, stubbornness, individuality and a sense of self without arrogance, curiosity, humility, energy, maturity, and an eagerness to learn. I have found that founders that share many of these characteristics tend to fare better over the long run than those that do not share these.

While the above are just personality attributes of a likely ‘good’ founder, the equation is in fact far more complex. In addition to the above, I also believe you need to include the following variables as well when doing an analysis:

1)    The technical or commercial competency (depending on their focus) of the founding team. This can either mean the founder(s) have the relevant experience from either having done a startup before (or the relevant role) or they have developed the appropriate skills necessary to execute on the stated vision of the company.

2)    The ability to resolve conflicts quickly and constructively within a team. As most teams will likely hit road blocks when they can least afford them, an ability to either insert humor at the right time, or to divide a problem into parts, or know when to take a break, can all be really important skills to demonstrate the longer term likelihood of a team staying together and working well in spite of the inevitable conflicts that will arise. Although I have heard of some investors doing an artificial ‘stress test’ during investment reviews, it isn’t standard practice for you can usually tell just from spending time with a team, when a team may have potential internal personality issues.

3)    Intuitively know when to persevere and when to quit (on anything). Some people just quit too early, others keep on going too long beyond the point when a strategy is the right one to use. Although harder to evaluate when meeting a founder or their team, this is an important attribute to have internally so as to use an investors time and money most optimally.

4)    The team understands the assumptions and metrics about the market they wish to operate in, or have at least an understanding on how to research this information (the Lean ‘Build Measure Learn’ loop is a good example of a framework that is applied). An airplane pilot can fly an airplane through the dark and through really bad weather because he understand where he was, where he is going, and what he needs to be keeping an eye on the dashboard during the flight. Every great team I’ve ever met always understood the dynamics of their market well enough, knew what they needed to find out as part of what their startup was attempting to do, and knew how to measure it so as to know if they were going down the right ‘flight path’.

5)    The team or founder can articulate their thoughts and plans. Communication both internally and externally is the most important thing to get right within an organization. It makes absolutely no sense if you have an awesome coder who can put out some amazing things if they are wrong because he didn’t get specificity from management or didn’t understand what he was supposed to be working on. Also, it is pointless if the founders of a company are awesome at building product, but then are entirely unable to communicate their vision to the outside world to both interest others to join their business and also to raise more capital.

6)    Although defined as ‘working together to achieve a common goal’, I believe you could argue that collaboration can be summarized as a combination of both conflict resolution skills and communication skills. A team’s ability to collaborate both internally (with team members) and externally (with biz partners, investors, and the media), I believe, greatly increases the chances that they will succeed.

7)   The geographical spread of a team is also something to be considered. This has mostly to do with the dynamics of working as a team. Yes, Skype has done marvels to revolutionize the way we communicate, but for the necessary ‘collision’ of ideas (borrowing from Steven Johnson’s book on Where Good Ideas Come From) to occur repeatedly, close physical proximity is an asset for any new team.

8) The equity spread between founders. Although generally speaking most founding teams have an equal equity spread (50/50, 33/33/33, etc) an investor will take note if there is an equity imbalance that makes for a key hire or co-founder to feel unmotivated.

So, when I meet a startup’s management team… aside from looking at the attributes I’ve listed above, I generally ask myself three questions:

1. Does this team have the necessary experience it takes to deliver what they have set out to do? (Teams with technical founders are of particular interest to me).
2. Does this team have the insight to identify their own weaknesses and hire good people to complement them?
3. Can this team constructively deal with all the challenges that are and will occur during the life-cycle of a company?

Once I feel like I’ve been able to answer these questions while also keeping an eye out for the attributes I’ve listed above, then I feel comfortable in appending the arguably overly-simplified statement of “they have a good team” when speaking about a startup.

So, some parting thoughts and advice for anyone evaluating their own team in the context of forming a new startup or raising money:

1. Get a co-founder that complements your skills
2. Understand what skills you lack as a team and hire them
3. Research the hell out of your market & understand your customers
4. var stated_vision = (think_big) *  2; -> multiply your vision by two.
5. Rehearse your pitch A LOT
6. Don’t be arrogant, but also add some spice and humor to your presentation

Appendix A:

John W. Mullins, PhD, Associate Professor of Management Practice, Marketing and Entrepreneurship at London Business School has kindly offered for download chapter 7 of his book titled The New Business Road Test.

Appendix B:

In my experience, the more subjective a subject matter is, the better off you are by getting more opinions to ‘triangulate’ around a ‘right answer’. To that end, I asked some friends of mine what their thoughts were around this topic. I have included their thoughts below:

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In my view, I look for three things:

(i) Leadership: a CEO who can articulate a vision that excites and imbues a sense of mission in his team is very important. This is often evidenced by the calibre of team he is able to recruit around him [when he has nothing else to offer].

(ii) Self Awareness:
a) Breadth: businesses need ‘flour to balance the yeast’. The great teams have a balanced breadth of expertise and experience, not just one hero.
b) Evolution: as a business grows, so the team must evolve. A willingness to embrace this change is critical.

(iii) Openness: We look for teams who are willing to consult and collaborate. We are not good passengers and we wish to work closely with and assist teams wherever possible.

Alliott Cole (@alliott)- Octopus Ventures

—————————

 ”I look for founding teams with a balance of skills in the following three areas:

1) design / ux,
2) marketing / distribution and
3) tech.

However the skills are distributed amongst the founders, they need to be present. I don’t worry too much about traditonal management skills, other than the founder who is the CEO showing a desire to learn them.”

Sitar Teli (@sitar) – Doughty Hanson Technology Ventures

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“When we look at very early start ups, there is not much to judge, but the story and how it is told. The delivery of the story is as important as its content. The founder(s) have to be credible. One of the issues is that technical founders are proud of their technical competence and tend to overdo it on tech and lose the perspective of the other side of the table, that is thinking “are these guys going to make me money?”  That is the bottom line, but it is not a question you can ask directly. The first attempt to answer comes out of the observation of the team during the first hour of meeting (it then needs more time to confirm it, but if the first impression is negative, there is the end of the journey). Are they passionate? Competent? Ambitious? Do they come across as honest and dedicated? Is this “a project”, or is this the thing they will be doing 22 hours a day for the next years? how is the team dynamic? Do they complement each other or are their duplication of the same guy. Is there a decision making process, or is it one guy that decides. Do they argue against each other (bi no-no during the pitch) or they have built a good delivery of the pitch so that it shows maturity and collaboration. “

Ivan Farneti (@ivanfarneti) – Doughty Hanson Technology Ventures

—————————-

1) Balance: product, technology, market/commercial.
2) A Leader [in the team].
3) Good mutual respect for one another.

Robin Klein (@robinklein) – Index Seed

—————————-

“Eden likes to invest in a team.  That is NOT one founder who has hired a group of employees but still holds all the equity him/herself.  To us, a team is a group of like-minded people who have come together to pursue a common vision.  They are all ‘at risk’ in the opportunity and so are looking for significant wealth creation.  They regard each other as ‘peers’ in the business and have comparable equity stakes.’

 They have to be smart.  And persistent.  One good sign is where the team worked together before, it didn’t work out but here they are again on the next gig.  Let’s call it ‘stickability’.

 ’It’s easy to build a team once you have raised money.  We often hear that ‘the team will come once the money is in’.  This is not what we are looking for – we are looking for a team that has been built on a common vision through the tough times of starting a company.  Where the founders have got behind the opportunity, as a team, before the cash came in.’”

Ben Tompkins (@b_tompkins) – Eden Ventures

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 ”Metrics, knowing your numbers cold, measuring everything. I’m all over that stuff. Seriously. Don’t know what’s going right or wrong if you’re not measuring it.”

Sean Seton-Rogers (@setonrog) – Profounders Capital

—————————

“There are lots of “obvious” qualities which a founder/management team should have – they must know their market, they must me smart, they must be extremely dedicated etc. This has been said a million times already of course, but that doesn’t mean it’s wrong.

To pick one quality which is particularly important from our point of view, the founders need to be able to build a kick-ass product which solves a real problem. As early-stages investors we can and love to help in many areas like sales, marketing, hiring, financing etc., but the ability to create a great product with a clear product/market fit is something we believe needs to be in the founder team DNA.”

 Christoph Janz (@chrija) – Point Nine Capital

—————————

 ”I look for teams that innovate vs optimize.”

Jason Ball (@jasonball) – Qualcomm ventures

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Related articles

• With Great Startups It’s All About The Execution (startupprofessionals.com)
• There Are Alternatives When Your Startup Falters (startupprofessionals.com)
• 8 Key Questions to Break Thru Entrepreneur Hype (startupprofessionals.com)
• How to Build a Stellar Team at a High-Potential Startup | Entrepreneur.com (bjconquest.com)
• A Deeper Look At Blackbox’s Data On Startup Failure And Its Top Cause: Premature Scaling [Infographic] (techcrunch.com)
• Marty Zwilling: You Built a Great Startup, But Can You Scale It? (huffingtonpost.com)
• Adult Supervision (startupcfo.ca)

The Importance of Good Legal Counsel

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Going into any new legal agreement is scary. On the one hand, you’ve seen enough movies to know that legal documents can have all sorts of loopholes and/or subtleties that feed your paranoia about walking into a trap at some point in the future, but on the other hand, you know you need to get them done in order to move on with any deal.

Legal docs are just part of business life.

The thing is, though, that it doesn’t have to be something that is so scary that you need to be extremely paranoid about. This is particularly the case when you’ve been able to bring on a good legal firm on board. Good legal counsel can basically help you understand all the tools in the legal toolbox. What the tools are for, how they are used, when they are appropriate, and what they are protecting against, etc.

Now, when I mean good legal counsel, I don’t mean your cousin’s best friend who is a lawyer and can do it on the cheap or a favor. That is probably the single worst thing you can do in terms of starting off on the right foot with your investors, you’ll waste their time and yours. If you can’t find good legal counsel where you live or nearby, then go outside of your area or move your business (and the good thing is you may not have to do it physically either). One sure sign of a startup ecosystem being mature is the availability of top tier legal firms in the area. If you need to move the legal state of your company to get access to these… do so, you won’t regret it. If you don’t know where to start, cold-call a startup you admire and ask around.

A good anecdote always helps in illustrating the point…

A few years ago, I was working with company that had reached out to a local lawyer, but not one that specialized in venture law. After having provided the company with standard industry docs, a long, almost two week period followed where I didn’t hear back from either the company or their counsel. Then, once I did receive the documentation, it was red-lined so much that it took another week just to come up with the response. As you can imagine, every single conversation we had was tough and grueling, and the entrepreneurs, grew increasingly paranoid that we were trying to get the better of them, but it was mostly due to the lawyers providing poor advice on items that we standard across the industry. This carried on for a few weeks with volleys going back and forth and various stalemates being reached at different points. In the end, we did reach an agreement, but it was after much work and much education. The situation was salvaged in the end, but it didn’t have to start off like it had. And, as you can imagine, the legal fees were over budget.

In summary, good Legal Counsel does the following:

1) Validates your company. The best Firms will be selective of whom they work with. Their time is valuable as is their reputation. Working with a top tier firm definitively says something about your company.
2) Saves you money. Yes, it sounds counter intuitive, but whilst you may pay higher in terms of fees, you’ll spend less on legal fees in the long run with the reduced issues that you’ll have during a negotiation as well as with any future issues that are the result of poor legal advice.
3) Saves you time. As mentioned in #2 above, the time an experienced lawyer takes going through documents they’ve seen time and time again is a huge savings over a lawyer who is getting acquainted with the docs on your time and money. Additionally, that time could be better spent on helping you think of what realistic scenarios you are trying to protect yourself against rather than making mountains out of molehill standard terms.
4) Helps you consider the future. As your company will go through many permutations throughout its life, a good and experienced lawyer will not only be able to help you with your current situation, but also in preparing you for situations to come, be they setting up your company in a specific way, to how you should try and negotiate with potential investors.
5) Good counsel knows the industry players. By the very nature of being a top tier legal firm, they will have worked and will know the top tier investors first hand. The firm will know what the investors tend to offer in their deals, what to expect as being standard in their terms, and what might be out of the norm.

After considering the above, however, you do have to manage your counsel. In the end, you are responsible for every item on your documents, and only you care as much about your document as well.. you do. So as much as great legal counsel can help you on not making mistakes, don’t slack off during the process. Stay engaged, you’ll learn a lot.

Do I need a technical founder in my team to get started?

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[Update] If you have a great startup idea, or want to try and hack on problems that industry players have, think about going to http://www.seedhack.com to present it.

This is a quick answer to a frequently asked question.

So you’ve come up with a good idea… you feel like you can get a lot of it going on your own, or perhaps you have another founder in your team, but both of you are not technically inclined, so key parts will need to be outsourced.

Do you need to bring in a technical founder early in the business’s life? Yes!
Do you need a technical founder to get your business idea off the ground if you don’t have one? No!

There are many people out there with great ideas that solve real world problems, but they just don’t know any good technical people. You might be one of them. That shouldn’t prevent you from getting started thinking and doing, but you will hopefully be doing an interesting enough project that you’ll quickly be able to attract top technical talent to join you. What you don’t want to do, is get a company off the ground completely based on outsourced tech help, and never really bring the tech in-house, thus being entirely at the mercy of an external shop for your core technology.

There are clear advantages to having a technical person/founder on board including:

1) A technical founder, unless they are not committed, will continue to work on beer and pizza long after cash becomes a limited resource. An outsourced development shop will probably not show the same level of commitment.
2) A technical founder will help you in creating a product/service that is architected for your specific needs and not based on (possibly) some recycled code.
3) A technical founder will be able to react to tech emergencies far faster than an outsourced shop.
4) A technical founder will help you beta test and a/b test business ideas far faster and more efficiently.
5) A great technical founder will also attract other great technical people into your team. Birds of a feather flock together, and at some point, when you have to bring the technology in-house, you’ll appreciate this.

However, even if you don’t have a technical founder, all is not lost. Viability and execution of your business idea is the most important thing to start. If you need to outsource to kick things off, do yourself and your business a favor by learning how your website/service/product works and perhaps how to modify it on the fly and in the most basic of ways. Otherwise you will always be at the mercy of your outsourcing team. If you don’t know HTML/CSS start there… it will serve you well.

Other articles on the matter:

http://cemagnifique.com/2011/04/15/why-ceos-withouta-technical-background-need-a-strong-cto/
http://www.adamwaaramaa.com/building-a-site/you-need-a-technical-co-founder/
http://rosskimbarovsky.com/2009/10/do-you-need-a-technical-co-founder/
http://www.explainbusiness.com/questions/201/do-i-need-a-technical-co-founder

Related articles

• Getting Started as a Non-Technical Founder (startupdigest.com)
• The Seed Stage Dandelion Effect (techcrunch.com)
• Do you need a technical co-founder? (jeffreytalajic.com)
• How to evaluate a non-technical co-founder (hirelite.com)
• A note about the “Business Guy seeking Technical Co-Founder” (bigthink.com)
• How to find a technical co-founder (jeffreytalajic.com)
• Why you can(‘t) recruit a technical co-founder (launchbit.com)
• VC CONFESSION: I Have Doubts Once I Think Of Women Founders Getting Married, Having Kids, And Being Distracted From Work (businessinsider.com)
• How Much Equity a Technical Cofounder Should Get (nahurst.com)
• How To Work Better with Your Co-Founder (readwriteweb.com)

Do I need to write a business plan?

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Let’s face it, most investors don’t have time to read anything more than the executive summary of anything that is sent to them.. So, should you even bother writing a business plan? What should one look like? And what may it say about you?

In short, yes, but depending on the stage of your business (early early vs years of operation and profits). A business plan will help you in crafting your business as well as provide those investors that do take an interest with further ‘meat’ to evaluate your company after meeting you.

From Guy Kawasaki‘s ‘Art of the Start‘ to Business Plans for Dummies there are plenty of books out there on what constitutes a good business plan… but what is the point of a business plan in the first place? Shouldn’t you just ‘get on’ with doing your business and worry about that business stuff later?

Well, in some cases yes you can get away with not doing one, but generally, I believe, the answer is no… A company’s business plan, no matter how short it is (10 slides), has been useful for me as an investor the many times I’ve had to evaluate an opportunity.

Remember, a business plan is about helping you organize your thoughts and then being able to convey them clearly to someone else, not about meeting some magical quota of pages with graphs and charts (although depending on the complexity of your proposition, this may be necessary).

Generally speaking I have found a company’s plan has allowed me to determine:

1) The company’s communication style and ability to articulate what they (their product or service) do, clearly and succinctly. Does the company rely too much on buzz words and/or comparisons to get the point across, or is it clear in articulating its objectives and vision? Is the plan well written (grammar)? Do I walk away from reading it being able to describe the opportunity in simple terms to others?

2) The company’s ability to research their market size, competitors, and key industry players, distribution channels, etc. If a company has not adequately researched the size of their market, this can be a real deal-killer. One time I had a company come and speak with me about what they were doing. Whilst originally really excited about the potential of what their product could do, upon further probing during our meeting, they concluded that the market size was only  few million in sales world wide, for the whole industry. As you can imagine, realizing the size of your market size during an investor meeting is probably not the best way to make an impression. The identification of key competitors is also an important detail to include and can actually play to your favor if you can clearly articulate how you differentiate from them. In the case of some companies, where distribution channels and key partnerships are important, identifying these and discussing them is important in providing potential investors with confidence that your team understand the challenges inherent in its industry.

3) The company’s ability to analyze their cash needs and expectations for growth. Nothing is more scary than a company whose ambitions are huge, but whose idea of cash management is not in line. You don’t need a CFO, but you do need to have thought out what key costs grow with your ambitious growth and when are the crucial cash-points are for your company. Generally speaking, I don’t have financial discussions with companies until subsequent meetings, but you can guess that in meetings with companies where I walk away learning something new about how the finances work for their specific industry are the ones where I feel most comfortable that they’ve thought things through.

4) The completeness and experience of the company’s team. Although I’ll discuss what I look for in a management team in a later blog post, suffice it to say that if you have a great team, highlight their accomplishments. If you know you need to hire someone to round out the team, it’s OK to put that down as a future hire.. at least it’ll make the investor know that you know there is a weak-point in the team that you plan on solving as soon as the investment comes in.

So, would a company be able to articulate all of these points during a face to face meeting? Perhaps, but it’s more than just communicating the story to me as an investor, but rather, writing a business plan is also so that the founders can justify all the components of a business plan to themselves. During the writing of the business plan, you may find that the business model changes or even the industry focus changes to avoid some risks that were identified early on.

Now, a couple of tips… the first one being, don’t put a valuation in your business plan. Investors may ask you this in person, but you are likely to get your hopeful valuation wrong on paper and come across as either too big or too small for the investor instead of just forcing the investor to focus on what the company could be. Generally speaking, every time I’ve seen an expected valuation in a company’s business plan, it has been out of line with the market. The second tip is that a cap table can be a handy thing to include in your business plan (but perhaps you won’t have space to include it in a presentation). This is useful mostly for subsequent discussions, but can greatly help the investor do calculations on potential returns.

Another big bonus to having a business plan is that many times investors (VCs in particular) have a structure whereby the person evaluating the deal has to defend the deal to his or her partners in a team meeting. For this process, they usually do a lot of research on the company’s industry, but your business plan provides them with a good head start, pictures, etc for them to include in their own research, saving them (and you) a lot of time in getting the deal done.

In conclusion, one of the best things you and your team members can do, is co-draft a business plan, no matter how simple, that you feel can represent your company without requiring your physical presence to get the value of your opportunity across. It should, at the bare minimum (even if slides or doc), include (not necessarily in this order either):

1) An overview of who you are and what you’ve done (basically, why you and your team can make this happen..)

2) A succinct explanation of what your product/service does, screenshots if possible.. run it past a non-techie friend and see if they can explain it back to you

3) A market overview section, the market size of your opportunity, key players, competitors, partnerships, target market, etc.

4) Your financials (at the very least, your expectations of cash usage), if preceding a physical meeting, a cap table would be useful. If your business is about growth first, then clearly show your potential investors how much money you will need to grow it to where it hits the tipping point.

Hope this helps!

Related articles

• The Difference Between a Business Plan and Planning (blogs.constantcontact.com)
• April 18, 2011 Business Plan: A roadmap to you, Necessary for Loans (learnedatscore.wordpress.com)
• Tips for writing a business plan (premierlinedirect.co.uk)

The UK Startup Visa – Driving future economic growth

Image via Wikipedia

I’m extremely excited with the good work the UK government is achieving in approving the new Startup Visa program.

In summary, three types of visa applicants will benefit from this new program:

“Investors who invest £5 million will be allowed to settle here after 3 years, and those investing £10 million or more will be allowed to settle after 2 years. This compares with the current minimum 5-year requirement.”

and,

Entrepreneurs who create “10 jobs or turn over £5 million in a 3-year period.” Additionally, “the standard investment threshold for an entrepreneur to qualify for a Tier 1 visa will remain at £200,000, but the government will allow high-potential businesses to come to the UK with £50,000 in funding from a reputable organisation. And entrepreneurs will be allowed to enter the UK with their business partners as long as they have access to joint funds. Additionally, a new type of visitor visa will be created for prospective entrepreneurs. They will be allowed to enter the UK so that they can secure funding and make arrangements for starting their business before they transfer to a full Tier 1 (Entrepreneur) visa while they are here.”

and lastly,

An Exceptional Talent visa (limited to 1000). “This innovative new route for exceptionally talented migrants will be limited to 1,000 visas per year. It is for those who have already been recognised or have the potential to be recognised as leaders in the fields of science, arts and humanities.” The limit to 1,000 of these is the only downer in the new reforms… hopefully this will change with time as the process to evaluate credible candidates is streamlined (currently this is set for review after 12 months).

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