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FINDING STARTUP SEED CAPITAL: When, How Much, Who, Valuation (5 of 5)

This is part of a series focused on raising the first batch of cash to finance your cool idea. When should you get seed capital? How much should you raise? Who should you got to for the capital? How do you value your startup?

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What is the most important thing to remember when you raise your seed capital?

That is the most common question I get, so here is my suggestion:

Be prepared for a very painful test of your character.

• Most investors will turn you down. It is common to have zero investors interested even after you hang up the phone on number 20.
• You will feel insulted, put down, rejected. Part of this is how investors test how strong a person you are. And some investors are just plan nasty.
• Investors will let you down. Angels go on vacation without notice or start writing a book and ignore you. VCs will drop your nearly done deal because a better one arrived before they signed the check.
• It takes a long, long time to get a deal done. Plan on taking 6 to 9 months to raise your seed round. Sounds too long? Just ask serial entrepreneurs: that is typical.
• Competition is stiff. You have to compete for money against a lot more than direct competitors. Angels may be looking for a new jet. VCs are looking at Internet startups in different markets. Many things compete for the cash you need. All of them are talking to the same investors that you are.
• Prepare a support group for the long slog. Find friends and mentors who can talk to you frankly and frequently. They will help you when you get discouraged, off on the wrong trail and are becoming unrealistic.
• Know when to stop. Your idea may be too early or too late. Someone may have a better version of the same thing and be far ahead of you (but you did not learn that until an investor told you). Your idea may be awful. That's time to stop. Rethink the idea. Be realistic (ask your support group). Ending it can be the best thing you ever do.

BOTTOM LINE: Serial entrepreneurs know that raising a seed round is very challenging. It is what will test your character. How you go through the process will shape your character. It will be part of your soul. So treat the process of raising seed capital with high respect. Plan it, prepare for it, and conduct it so you emerge -- with or without seed capital -- with a stronger character, without damaging your ethics or personal reputation. If you have to stop, it's not the end of the world. Real entrepreneurs generate a new startup idea every day. So can you.

FINDING STARTUP SEED CAPITAL: When, How Much, Who, Valuation (4 of 5)

This is part of a series focused on raising the first batch of cash to finance your cool idea. When should you get seed capital? How much should you raise? Who should you got to for the capital? How do you value your startup?

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How should you value your startup when you raise your seed capital?

That is a question I am often asked by first-time entrepreneurs. Here is what I have found works:

• Work backwards. Estimate how valuable your startup will be at the time of IPO. Working backwards, put a smaller and smaller price on the startup for each prior year. Why? Because the IPO is your final goal, the time when everyone wins (by sharing in the value of the public company via shares purchased in prior years).
• Double the value every year. Next, modify your first estimate so the value each year is a double the prior year. This is getting close to the average achievement desired by professional venture capitalists.
• Forecast a set of five year financial statements. This will tell you (a) how much cash you will need and (b) how large the sales will be in Year 5 when you go IPO (Year 10 for life sciences).
• Adjust Your IPO Price. Modify your end goal valuation and then modify your prior years' valuations.
• Decide what percent to sell to the investors each year. Start by guessing the seed round will cost you 30% of your startup. Go on to the next year, sell more to the next round of investors until you get to IPO. Each year the new investors get a smaller and smaller percentage because the risk drops as you grow the company.
• Decide on the percent to sell to employees via stock options. Start with 20 percent.
• Pick the number of shares you own on Day One. Try using 5 million. Then sell shares to investors for each round of capital raised.
• Get real with your valuation by asking other CEOs of startups and your lawyer and CPA. They will help you further adjust your estimates of valuation. By the time you are finished you should have increased your confidence a great deal.
• Find recent venture deals to compare with. Find people in the know, do your research, ask people, read the blogs, find the web sites about deals done. This gives you support for the valuation you choose.
• Save time by using a good financial model that does the hard arithmetic for you. Take a look at QuickUp, it includes all you need to value your startup the way venture investors do.

BOTTOM LINE: This is one of the most difficult tasks you have to do. It is also one of the most important. You cannot correct errors made after a deal is done (sold too large a percentage for too little cash). Serial entrepreneurs and their advisors are worth a lot to you when this work is your first time valuing a startup. It is one of the skills that separate the beginners from the veterans.

FINDING STARTUP SEED CAPITAL: When, How Much, Who, Valuation (3 of 5)

This is part of a series focused on raising the first batch of cash to finance your cool idea. When should you get seed capital? How much should you raise? Who should you got to for the capital? How do you value your startup?

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From whom should you raise your seed capital?

That is a question I am often asked by first-time entrepreneurs. Here is what I have found works:

• Yourself. When you have an idea but nothing else: no business experience, no core management team, no working prototype, no written business plan, no financial forecast. You need cash in the bank (savings) plus a lot of credit cards. EXAMPLE: Dell
• Family, Friends and Fools. When you have parts of a business plan, at least one person who can manage a business, and are ready to make the following phone call:"Hi, Dad. I have good news and bad news. The good news? I've learned a lot during the last months. The bad news: I lost your life's savings." EXAMPLE: I've been there three times when three founders made that call.
• Angels. When you need more advice and time to determine how large your idea can become. Angels will work with you daily, get in your face, give you strongly worded advice, be generous with contacts, supply technical and business know-how, all aimed at getting your bplan into such a high quality state that it attracts the finest venture capital investors. EXAMPLE: Google.
• Your Employer. This is for when you buy an orphan from your employer in exchange for a small number of shares and a large loan. EXAMPLES: Conexant (ex Rockwell).
• Venture Capital. When you have a bplan large enough to go to IPO (initial public offering) within five years (ten years for life sciences). And when your total capital required is in the multiple millions. EXAMPLE: Baidu (DFJ ePlanet).
• Bootstrap. When you are disgusted with all of the above, are immune to self-flagellation and are confident of generating fat profits week after week after week. EXAMPLE: Nearly zero make it to IPO, most linger on as tiny private small enterprises. Rare example: Dell.

BOTTOM LINE: Think carefully before you go looking for money. It comes in a lot of forms. Each has a different cost and strings attached. Picking wisely will boost your competitive advantage, adding to its power, leading to its becoming an unfair advantage.
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Tomorrow I'll discuss Valuation of a seed round.

FINDING STARTUP SEED CAPITAL: When, How Much, Who, Valuation (2 of 5)

This is part of a series focused on raising the first batch of cash to finance your cool idea. When should you get seed capital? How much should you raise? Who should you got to for the capital? How do you value your startup?

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How much seed capital should you raise?

That is a question I am often asked by first-time entrepreneurs. Here is what I have found works:

• Raise enough to complete your first major milestone. That may be "Proof of Concept". Or "50,000 active users". or "Working Prototype." Be careful to have a reserve of cash because you are most likely going to need much longer than you hoped for to achieve the major milestone.
• Raise more than you think you need. The cash reserve is important. So is respecting the unknowns that can happen. Experienced investors will agree and will not object to surplus cash.
• Expect the percentage the seed investors get to be independent of the amount of cash you raise. That weird lesson is a reality. Serial entrepreneurs know that. So double your planned amount of cash raised and the related dilution will be tiny.
• Forecast your first 24 months of cash burn by month in Excel. Investors expect you to show headcounts, salaries, benefits, expenses, equipment, services for web site, lawyers and the bank. I recommend saving time by using a simple, inexpensive Excel model such as QuickUp.

BOTTOM LINE: Get enough cash to get you past the next big milestone. You can ask investors which milestone is important to them. Measure the cash you need with a detailed monthly forecast, it is work well worth the hard work needed to do it. That will be key to getting your seed round at a fair price.
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Tomorrow I'll talk about Who to get the seed money from.

PICK THE RIGHT CATEGORY or ERR AND GET CRUSHED BY THE GORILLA

I'm back from a week of fly fishing with my best friend in one of California's most beautiful wild places. It was a trip filled with renewed spirit, and the fish added lessons that were humbling. The sport is filled with rewards. I recommend you pick an activity that brings you such benefits and pursue it with vigor. It will reward your startup efforts.

This morning I read a helpful comment to my blog on gorillas of June 28, 2009 and will share with you an important lesson for startup founders: "You must be careful to pick the right category or your error will get you crushed by a gorilla.

Here is what Rodgrigo commented:

"John, as much as I agree to this advice in general, many start-ups became huge business by ignoring gorillas. Facebook was a startup when MySpace.com was the gorilla. Google was a startup when Yahoo! was the gorilla. Amazon.com also could have been crushed by Barnes&Noble. The truth is, technology industry is very dynamic and if you have a better technology, focus and the right team, you can compete too, although generally it's not recommended. That's the Innovator's Dilemma at work!"

Here is my reply to Rodrigo:

Rodrigo, you are close to understanding the secret.

MySpace focused on a new category "creating a personality" and became the gorilla of that category. Facebook saw a different opportunity in a new category lacking a gorilla, "social networking." Frendster was the pioneer and got the arrows in their back. Facebook was "first to get it right" and became the gorilla of 2-dimensional social networking (3DSN is starting in Asia).

Yahoo focused on the new category "portal" and became its gorilla. Google focused on the new category "search" and became its gorilla.

Amazon focused on the new category "books on-line". Barnes & Noble was gorilla of "chain bookstores" and failed miserably to enter the new space to compete with Amazon.

Note how a gorilla of a new category fails to become the automatic gorilla of a different new category, instead fails in a sea of red ink losses. Test your history on Microsoft. Then do Yahoo. And watch Google.

BOTTOM LINE: When studying startup history, be extra careful when picking your market categories. That will keep you from making fatal errors. It will reveal the light in the darkness.

You can study more about categories by searching my blog with the word category and look at some of the marketing blogs I've posted. Even more is contained in my book The Power of Unfair Advantage.

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Tomorrow I'l continue on the series FINDING STARTUP SEED CAPITAL.

FINDING STARTUP SEED CAPITAL: When, How Much, Who, Valuation (1 of 5)

This is part of a series focused on raising the first batch of cash to finance your cool idea. When should you get seed capital? How much should you raise? Who should you got to for the capital? How do you value your startup?
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When should you get your seed capital?

That is a question I am often asked by first-time entrepreneurs. Here is what I have found works:

• Get startup seed capital like you plan a vacation. Get your seed money after you have your idea converted to a written plan. Sure, it's fun to spontaneously rush off to "somewhere" on a vacation, but you'll find a lot of disappointment using that method (no hotels, bad season for that location, too much driving, an emotional letdown, too expensive, etc.). Startups done with spontaneous money raising are similar. Instead, I suggest you document your idea in at least a four page business plan before you think about getting seed capital. Serial entrepreneurs will also forecast 24 months of cash spending and three more years to complete the set of financial statements. The prepared founder gets the money. VCs in today's cautious startup money markets look for planned startups. It reduces their work load and the risk of the startup.
• Get start money like you would buy gas for your car to go on a vacation. You will get your gasoline close to home. You'll purchase the quality you think best for your vehicle. You'll shop for the best price, but not too long. Startups run by serial entrepreneurs do the same. They find investors in the area they live in (preferably an hour car ride away, or at least reachable to and from easily the same day via car). They decide on the quality of investor they want (wealthy friend, famous angel, rich farmer, world-class venture capitalist, local banker). They get investors competing for their round of financing, they do not settle for a single bidder. They aim to get the financing done within six months of effort. That method produces a quality seed financing.
• Pick a date as close as you can to launching your product or service. The closer you are to launching your first product, the less risk there is to your investors. That attracts more investors. That reduces the cost of the money charged by investors (percent of your company they will expect to own). This may not be what you want to hear. You may need cash to live on while preparing the first business plan. But you may have to prove the concept behind your idea is viable before investors will respond with interest. That is why budding entrepreneurs save enough to live one year without any income. To settle the when decision, I suggest you test your idea on one or two investors in an informal discussion. "I have an idea for a startup, I'd like to have your thoughts about how far I should advance it before raising my seed round." I've found quality investors do that very often. They like to see the newest ideas, meet fresh entrepreneurs, and be among the first to see a cool new idea.
• Have your core management team ready. This is the most powerful thing you can bring to an investor. A core team of qualified leaders who can work together well is a price sought after by seed investors of every kind. I cannot emphasis this enough to you. If two other managers are eager to join your startup, investors have less risk of things going wrong. Veterans of startups believe your choice of such talented people distinguishes you from the crowd. It greatly increases the value of your idea.

BOTTOM LINE: Think carefully about when to raise your seed round. You may find you have to do a lot more work on your idea before proceeding to find the cash. When you pick the best time to raise the precious capital, you will be well on your way to building an unfair competitive advantage.

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Next: "How much should you raise for your seed round?"

TIP OF THE WEEK: Work with the number 3 to prepare for more success

I like thinking about a startup using the number 3.

Give it a try. Apply the following to your new enterprise to see how you might improve your plan for success:

• 3 makes a core team. CEO plus VP Engineering plus VP Business Development add up to the core management team that talented startup employees are eagerly looking for. Investors are even more eager to find that threesome united, ready to launch a fresh business. If you are missing members of that threesome, get going immediately to fill the missing slots. It's nearly impossible these days to get quality investors and top talented employees working for startups that have incomplete core teams.
• 3 bowling pins make your target market. The first focused market profile is the one you must win big in. The next two will follow your win in the first. The follow-on market segments are also very focused. They are closely related cousins to the first market segment. One knocked down hits two more and that starts your momentum. Sales accellerate. Employee morale rises. Investors start knocking on your door with open checkbooks.
• 3 board members is a great number. Small boards of directors work best. They make quick decisions. There is time to get to know each other well. Small is efficient. Founder, CEO and investor. After you get your multi-millon dollar round, you can add one more investor (probably a venture capitalist) and an independent who can advise you and support you, who comes with some related market experience.

BOTTOM LINE: Try testing the number 3 on your plan for your startup. That can tell you a lot about how strong your competitive advantage is. The stronger it is, the more your competition will complain it is unfair.

STARTUP BUSINESS MODELS: How can one distinguish you from the competition?

Over the last three years, business models have risen in importance. Now they have become the core of the method for converting a good idea into a wining startup. In this series I'll explore what a business model is and how you can use it to win.
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How would you like to compete against 65,000 other products in the same store?

That's what is facing the herd of software developers eager to get rich quick selling applications that work on the Apple iPhone. Details can be found in "Seeking Fame in Apple's Sea of Apps" (Wall Street Journal, July 15, 2009).

That is not where you want to be. That sea is filled with ruthless sharks, branded giants and schools of blood thirsty piranhas.It is so congested that ethical limits are crossed by desperate competitors. Digital Chocolate abbreviated the word each to "ea" in product descriptions so that searches for Electronic Arts programs would hop to those of Digital Chocolate (Digital Chocolate has stopped using the abbreviation). Lost is not where you want your products to be.

You can use a business model to stand out. It can make your new enterprise distinguished. Customers will find you, understand how you are special and immediately make a clear distinction between you and your most direct competitor.

Think about how a startup stood out when it was the first to offer large software applications for rent that had up to then been available only at price tags starting at $100,000 plus the cost and time and delays inherent in the traditionally painful upgrade and installation projects in Fortune 500 corporations. That is what lead to the IPO of Salesforce.com.

Think about how it hit the news headlines when the first semiconductor startup announced it would design and sell chips but the company would not own a factory to manufacture them. Today it is the way all new semiconductor startups are born.

Can you recall the first Internet stories about the Korean gaming companies that began selling virtual clothing for avatars? Even you may still be amazed at that way of making money (if you don't live in Asia where that business model is booming).

Notice the obvious: Fresh business models are bold. It takes guts to depart from the norm. It takes confidence to tell investors that you will leave the proven business models and launch in a fresh direction. If your personal character can not do that, reconsider your interest in being an entrepreneur. The boldness required to stand out is needed to get investors, employees and bloggers.

BOTTOM LINE: To stand out in today's crowded startup world calls for every creative skill you have. Inventing a fresh business model is one way to be distinguished. That distinction can add a powerful element to your unfair advantage. Such boldness can be quickly labled "unfair" by your competitors.

STARTUP BUSINESS MODELS: Where is the power coming from?

Over the last three years, business models have risen in importance. Now they have become the core of the method for converting a good idea into a wining startup. In this series I'll explore what a business model is and how you can use it to win.

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There is power in a startup business model. Use it to overcome your adversaries and win.

Where does the power come from?

Here are some examples:

• Instant positive cash flow. Does that sound too good to be true? If so, think about what Michael Dell and then Jeff Bezos said when they discovered business models that generated positive cash flow from the first day that Dell Computer and Amazon went into business. Each figured out that their customers would be paying with credit cards. And they learned that credit card companies send cash in 4 to 6 days after the customer purchases with the card. And each knew they could get traditional terms of credit from the corporations they purchased things from. The computer parts suppliers and the book distributors offered up to 30 days before payment was due. So cash was coming in faster than going out, thus generating positive cash flow from day on. Presto, instant cash generation machine! Now that's power!
• "Freemium" power. In the old days, startups sought to create customer loyalty. During the Internet boom it was sticky eyeballs. Today it comes from clever business models designed to retain first time visitors and move them on to purchasing using real money. For instance, there is a new category of gaming company dubbed "freemium". Companies in that space offer lite versions of a game in hopes of getting users to move up to superior versions accessed via subscription paid in real money. And then they offer virtual items for purchase such as game icons, avatar identities and so on. The gaming services also offer social networking via chat. You can purchase a drink for a fellow poker player on the Texas Hold-Em online game from Zynga. U. S. based Outspark.com uses Asian games to build a business model that picks from the successes in its cousin startups in Korea and China who record billions of dollars of virtual item sales each year. Think there is power there? Zynga has raised $36 million of venture capital. Outspark claims 5.4 million daily unique gamers.
• Click and purchase ease. This simple sounding power source comes in clever versions. In its fledgling days, Amazon made it easier to decide on purchasing a book by getting readers to voluntarily contribute book reviews (at nil cost to Amazon). Music fans were quick to click on Apple's slick iTunes plus iPod and millions turned into $ millions for Apple. Google's Adsense takes but a few minutes to set up on a blog or web site. It dominates its space. Software as a service (SaaS) burst the purchase hesitation barrier and Salesforce.com rockted to IPO.

Those are but a few examples of how to think about finding the power in a business model for a new enterprise. There are many more.

 BOTTOM LINE: There is power in business models. It's your job to figure out yours. When you do, you will add a critical element to building your unfair competitive advantage.
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More tomorrow.

STARTUP BUSINESS MODELS: What are they? Why are they important?

Over the last three years, business models have risen in importance. Now they have become the core of the method for converting a good idea into a wining startup. In this series I'll explore what a business model is and how you can use it to win.

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QUESTION: "What is a startup business model?"
ANSWER: It is a description of how your new enterprise will make money.

Sounds simple, doesn't it? But let's dig deeper and then see how simple it sounds to you.

• How should you measure "make money?" Most people start with a measure of profit. Sales minus expenses minus taxes equals profit. Implication: You need a model of your income statement. That calls for a financial forecast. Can you do that? And did you know the business model also calls for an explanation of how much cash you will need to keep the business growing? That calls for a balance sheet. Can you build one?
• What year should you use to measure making money? Your first years will be showing losses. Should you use the year before you to IPO? Or how about the year before that? All of them will show different profit compared to prior years.
• Should you use a "typical year" whatever that means? Is any year typical or normal? Probably not. Each has special conditions: Year of Launch, Year of Growth, Year of Break even and so on. Yet you have an idea of what it means to make money with your business. So let's continue.
• What are your sources of sales and revenue? That is a good place to start talking about how you'll make money. Describe your customers and what they'll pay you for. Put products and services into your financial forecast, in detail. What mix of customers will purchase what mix of products and services at what prices? How may clicks will the most active end user make per weekday on your product page? And so on. Information like that will start a description of your business model. And it will trigger other needs for other information and that will help you further describe your business plan.
• How many people are needed (to attain your forecast of sales)? Now you are getting somewhere. Why do you need that number of customer service employees for your forecast of sales? What are you expecting in productivity of your engineers? Why did you choose the number of business development people? Keep going, give quantified reasons for each department, every employee. Remember to similarly justify outsourced services. All of them will work to produce the sales you have forecast. They are part of your business model. And their wages will account for over half, perhaps even two thirds of your cash spent each month.
• What expenses must be spent (to attain your forecast of sales)? Now for the rest of the story. Here is where you add up all the costs needed to purchase what your people need to do the work you hired them to do. Do it line by line for each department. Justify every expense. This will complete your story. Add these expenses to the wages, subtract from sales and revenue and presto you have profit.
• How much equipment will you need? That should be very easy to explain. Most startups will purchase very little equipment other than computers and a bit of furniture for each employee. Explain every item purchased. That goes into your balance sheet. It is part of your business model.
• What is the time needed to collect cash from your customers? How fast will you pay for things you have purchased? This is the next set of numbers for your balance sheet. How fast will a credit card company send you cash? How slow do you intend to pay your suppliers? Your decisions will be a huge determinant of the cash you will burn each month. That number is central to your story about your business model.

That is what you need to tell the story about your business model. Use Excel to build your mode. If you want to use a simple prepared model, try the one I sell for $25, QuickUp. With your numbers ready, go on to summarize your story in no more than three simple Power Point slides. After that you are done.

QUESTION: "Why is it important to describe my business model?"
ANSWER: In today's market for startup investors, you cannot attract them without a great business model.

The days are over when "Build it and they will come" ruled. No more will investors finance a Facebook that "will figure out how to make money some day." Twitter number two has to know how to make money.

Also, experienced, talented people will look for the same thing: a business model that can make a lot of money, quickly. That is how you attract them to your new enterprise.

BOTTOM LINE: To get your money (and top talented people) in today's challenging conditions, turn your brain on and innovate a clever business model. That's what it takes. Yes, it does require a lot of work. But you know that nothing worth doing is easy. So get going. When you have created a clever business model, you'll be way ahead of your competition. It will be central to your unfair competitive advantage.