Steve Huey’s Blog

I was just handed another Exec Summary and it is littered with “Buzz Words” that are supposed to make me swoon with investment fever.  In the first internet round it was “monetize eyeballs” or “our business model” or “whatever”.  Now the buzzwords are “Social Media” or “Web 2.0″, or “User generated content”.  Hey just tell me what you hope to build and how you’re going to do it. Don’t use buzz words and think you are selling me on something.

If your use of these buzz words really made me check my brain at the door and hold out my wallet – you should not want me as an owner in your company. 

The answer: A URL and password to a beta site containing your product or website.

Remember the five questions needed for investors to lay down big $$ in your company?

1. Who are you?
2. How much do you need and what will you spend it on?
3. How and when do I get my money back?
4. What do I have to believe to feel good about this investment?
5. Why should I believe you?

A beta version of the website that I can look at helps me believe and feel good about the investment.  No it is not always possible to open up a beta – in some cases a beta does not exist.  In some cases a beta is too buggy or the worry is that it is too buggy – so call it an alpha site whatever – just let me touch it and feel it – get an idea of where you are going.

It is one of the fastest ways for me to believe you.  If you have a web company or any company that has a product – send samples or a way to make your company tangible to prospective investors.  Try garnting them special access.  What about a private website that has additional information that only they can view?  Satisfying the fith question is usually the hardest one!

 I attended a meeting of the local Angel investor group that I am a part of here in Louisville.  They are a great bunch of people.  There was a ton of money in the room.  Three hopefuls entered to tell their story and get backing.  Only one of the three companies answered the magic five questions and not surprisingly it was the company that got the most buzz afterward.  So what are the “magic” five questions?  Well here you go:

1. Who are you? – What an investor wants to know is the management team’s background and do I as an investor believe that the team has integrity, knowledge, and experience.
2. How much money do you need and what will you spend it on? – This is vital this helps frame the risk of the investment. It also allows the investor to see your plans for their money. One group that presented had not worked through how they were going to spend the money they were hoping the raise. That begged the question so how do you know you need the money?
3. How and when do I (the investor) get my money back? - This is crucial. I am not giving you money, I am investing and I have to know what the expectation should be to get a return and when.
4. What do I have to believe to feel good about this investment? = What are the key assumptions that I must agree with in order for this to be a good investment.
5. Why should I believe that the management team can deliver on the key assumptions? – This is the absolute must answer question. If you the management team can convince me that your team can deliver on the key assumptions then I will invest.

These are the five simple questions that 90% of the companies pitching don’t answer.  If you want to look and sound sharp – answer these five questions and you will get your money.

We have a saying here in Louisville, where on the first Saturday in May the Kentucky Derby brings international attention to this small(er) town in the mid-west.  The Saying is, “Always bet on the jockey, don’t bet on the horse.” 

In Private equity investors do the same thing.  I have seen the best ideas, business models and technologies struggle to get funding when four 26 year old MBA students pitch them.  None of them has experience in the industry and none of them has depth of experience running something.  I have also seen medium ideas line up millions in an afternoon when industry veterans step up to the plate.  It is more than the desire from investment professionals wanting to bet on a sure thing – seldom are there such things.

What is it that makes the industry veterans so bankable?  It is deep experience.  Rich industry experience and I can tell you the deeper the better.  I just watched two friends pitch their company to a bunch of private equity’s pros this past week.  Seldom if ever were the vets stumped by a question and they provided key insights that only their rich experience could provide.  For part of their new business to work they were relying not on guesses as to what it took but actual experience concerning media traffic, industry relationships, and their ability to hire some of the industry’s top talent.  It helped that their idea was great but that did not seal the deal nearly as well as their experience.

So what should you do if you are four 26 year old MBAs with an insight into an industry and a new business model or technology?  You should go recruit an industry veteran to help you.  Help you test your hypothesis – help shore up you industry specific knowledge, and help you raise the money your new venture needs.

It is not just here in Louisville where they favor the jockey over the horse!  Find a veteran and you will hear – “And they’re off.”

Tips for equity planning: 

1.       Funding Takes Time: Raising money takes longer than you think so plan accordingly.  The last thing you want is to be in a position where to keep the doors open you have to take money at a bad valuation or from investors that you don’t want.  Professionals will smell desperation and drive funding terms that will include things like; preferred equity, full ratchet, liquidation multiple, ughh.  How do I know – I have done it.  I crammed a poor valuation down the throat of a too eager founder.  It was not pleasant and I learned a lesson on that one as well – that it is not worth it as an investor to have a damaged founder.  So please allow more time to raise money – everyone will be happier.

2.       Get a Few Dollars More: Raise 50% to 100% more than you think you will need to get to the next key milestone.  This keeps you safe from #1 and also allows for cushion should everything not go as planned.  Things happen, the market turns, people get sick, big clients don’t say yes, contracts get hung up in legal…  I could go on but why.  My pappy once told me when he got washed out during the real estate crisis in the seventies, “always arrange funding when you don’t need it because when you do people will be less willing to lend you the money.”

3.       Know Why You Need the Money: Know exactly what you will use the funds to buy.  Don’t raise more money than you need (usually not a problem).  An investor wants to know what you are going to do with the money, where will that take the company, how will the investor measure success (Company now has working beta, X number of customers, or Y page views), and that they are going to get their investment back.  The first three things on this list should be easy.

4.       Don’t Buy Stupid Stuff: As an example: I see plans all the time that include the premature buying of servers for growth that will happen someday.  (I got a clue for you – rent the server capacity from Amazon’s S3 service and save the money.  Actively look to bootstrap everything you can and don’t spend money on silly stuff that does not move the company to the next milestone.  (I have seen more waste in startups than most and my antenna raise every time I see big salaries for four “C” level execs in a start-up of six people or the new office furniture, or the A plus office space etc.)  Stay lean and it will actually help you sell the company (more on this later).

A Capital Plan is:

A Capital plan lays out how and when a start up will use equity financing to achieve its objectives.  It is important for the start up team to plan out the expenditure of equity (usually through the raising of money but not always) and should be accompanied by a set of milestones for where the founders want the company to be at the point that they spend equity to raise funds.  The two key parts to a capital plan are the Key Milestones and a Planned Capitalization Table.

Key Milestones:

Examples of key milestones investors may want to see are a beta of the product, proof that the business model works, key hires, distribution (web traffic), or other key success factors.  Whatever the key milestones are the funding should be tied to these events and not simply the running out of funds.  The biggest thing that I recommend to founders is a plan for funding tied to specific developmental milestones.  An Example is found here Key Milestones

 Planned Capitalization Table:

A Capitalization Table (Cap Table) is the document or table that communicates and tracks a company’s ownership.  The difference that I am suggesting in a Planned Version is incorporating your vision for how your Cap Table will change over time and during the maturing of your company.  In the beginning it will include founder’s equity only.  Over time it will likely change with Seed and early investors as well as stock or stock options granted for new team members and may also include warrants for key business partners (GE famously started collecting warrants from small tech companies as part of the price for doing business with them.)  An example is found here: Capital Table Plan

A Capital Plan that includes key milestones and a Planned Capital Table will help the management team think through their use of equity and help them raise financing.

Recently I have spoken with several angel investor groups. These groups add tremendous value in three basic forms.

1. Access to capital – usually seed capital from $100,000 to $2 or $3 million dollars. The angel groups are great sources for investment capital. They take the most risk in their investments and expect to make the highest returns. They usually do not negotiate the toughest terms (full rachets, preferred securities, etc.) but they do expect certain things. The most important is respect. These angel groups are full of people that have been very successful business people and they are a great resource for advice (we will get to that in a moment).
2. Access to next stage capital – usually if a company grows to the point that it needs large capital infusion or First Round Funding then these same angels will most likely be able to introduce you to Venture Capital Firms that have considerably more funds to invest. Venture Capital firms are the next step up in the tree but not always the best investor in early stage companies – even if they want to invest. (I will have a post coming up on VC firms.)
3. Advice and Guidance – this is the most important thing you should consider in seeking Angel Investment. Cash always flows for great businesses or business concepts. I know this sounds strange but cash is not hard to come by if you are experienced and have a good business concept. So if you are fortunate to be able to pick your investors look for the angels that can and are willing to help you. These people are some of the smartest business people and most successful around. It is rare that an Angel Investor is not astute and just some lucky “dude” who made a pile of cash from the dot com boom or inherited it. Usually these investors are flushed out after several “bad” deals.

If you are an Angel Investor – I have one tip for you. Be willing to invest more than just money. Great deals come along rarely so to get the best deals – to make the most money – to have the most fun – invest your time!