Nesheim Online

TIP OF THE WEEK: Before you speak to an investor, be prepared!

"Hey John! Give me a couple of names of VCs.  I need a seed round and want to contact them right away, I'm running out of my savings!"

That's a common call I get from enthusiastic entrepreneurs.

Nothing wrong with it except for one thing: that first call will be your last unless you are prepared.

What does it mean to be prepared for a call to an investor to talk about your startup?

Try this dialogue to see if you can get what I mean:

SITUATION (dialing the phone for the tenth time after a dozen emails, the founder has finally gotten the great venture capitalist to answer the phone).

FOUNDER: "Hello Mr. INVESTOR. Thank you for taking my call."

INVESTOR: "Glad to, you had a fine introduction from Brad. What can I do for you?"

FOUNDER: "I have this great idea for a startup. I need a seed round. Here is what it is all about . . ."

INVESTOR: (Interrupting) "How much are you seeking?"

FOUNDER: "Well I haven't a specific amount in mind. What do you think is about right?"

INVESTOR: (Ignores answering) "What is this idea of yours?"

FOUNDER: "I was thinking that if somebody did XYZ . . .: (He talks rapidly, stumbling around, for about two minutes, mostly speaking in general terms about the idea, then stops after realizing the investor has been silent). "So what do you think about my idea?"

INVESTOR: (Again ignores answering) "Who else is working on this with you?"

FOUNDER: "It's me and a couple of techie friends so far. I worked for Google for a couple of years after school and quit last year to work in this. I thought you could help me find the people Ineed."

INVESTOR: (Again ignores answering) "Which of you has run a business before?" (He repeats the same question about marketing, business development and engineering leadership).

FOUNDER: (Responds with answers that reveal the startup has people with no managerial experience, have not managed profit centers or been leads in their field of expertise. In fact, most are solo contributors or students with modest working challenges).

INVESTOR: "Send me something in an email." (By now he is looking at his emails online, preparing to end the phone call.)

FOUNDER: "What do you have in mind?"

INVESTOR: "Send me a deck [he means PowerPoint slides] about your idea. I have to go now, thanks for the call. I wish you the best." (Click, the phone call is ended.)

That is how an unprepared founder gets treated by busy, sharp investors. In this case, the investor is being polite to Brad who did the introduction. The founder does not know that over the past four months the investor already has seen a dozen related ideas in the same general area. Two of those have impressed him enough to lead him to dive into research about the related market and competitors, especially potential startup competitors. The result is that our FOUNDER is supplying information and not knowing it, and is not very likely to be contacted again. The INVESTOR did not find outstanding management or idea or market or technology in the idea of the FOUNDER.

How could our FOUNDER have been prepared? Simple: by spending the time (ouch!) and effort (groan!) to write a solid business plan before making the first call to an investor. The result will include an Executive Summary of two to four pages. That is what should be sent to the INVESTOR, not a PowerPoint deck (which lacks the comprehensive words needed to enrich the idea and stir emotions of the reader). After that hard work the FOUNDER will be prepared with solid answers to any question asked by the INVESTOR about management, people, market size, ideal customer, competitors, strategy, unfair advantage, cash needed, when.

BOTTOM LINE: It sounds so easy to take a good idea to an investor, get some money, pay for yourself and some people to figure out what to do next and then build a great success. But my experience shows me the great startups are well thought out before anyone dials for dollars. That is how serial entrepreneurs do it. It is how they become successful, startup after startup. It is part of their unfair advantage. You can do that as well. I highly recommend it.

Think like the Boy Scout motto: "Be prepared." Then you'll have a much greater chance of success when you make your first call to an investor. When you do, you'll be like serial entrepreneurs. You'll have an edge over other startups looking for money.  It will be your unfair advantage.

I wish you The Best on your Adventure!

TIP OF THE WEEK: Study how a real bootstrap went from $24,000 to a digital studio

Bootstrap is a well documented story of a real company that accomplished a lot on next to nothing in seed capital.

Study it and mark the differences with your bootstrap idea.

Then think about (1) how long it took and (2) if you want to got that long on your savings.

BOTTOM LINE: Bootstraps are very difficult and rarely succeed. They can build an unfair competitive advantage, but the personal cost can be very high. Think before you leap.

SEED ROUND TIPS: What you should watch for and aim at in today's special market for startup capital

Today's market for startup money has altered. You should understand what to do about it.

I found this article an excellent update and useful guide for planning your seed round in today's changed market for startup funding: The New Seed Round .

The author, Caine Moss is a corporate and securities partner at Wilson Sonsini Goodrich & Rosati. He is very clear on what an entrepreneur will face when negotiating the terms of a seed round for startup capital.

Note carefully the percentage you will be expected to give up and the special terms VCs will ask for.

I suggest you decide what you will aim for in the negotiations before you start to raise your money. That will save you a lot of time otherwise wasted in fruitless negotiations.

Note also the value of hiring an lawyer who is active in doing seed round deals with startup investors. That person can be strong when you are uncertain about what you should insist on.

A simple term sheet is also available from TheFunded.com. It will help you get started in the direction more favorable to you, the founder.

BOTTOM LINE: Knowing the current market for startup money will get you the best deal. Today's new seed round terms have changed. Study them and prepare for a seed round favorable to you. It will be one of the stronger elements of building your unfair advantage.

 

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?

=======================================================================================

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.

TIP OF THE WEEK: It's a great time to get seed round money

Don't listen to the dooms day bloggers that cry there is not seed round money for startups. Ignore depressing stories by depressed reporters. This is a great time to get startup money, anywhere in the world.

The great venture capitalists and respected angels are all actively looking for the next great startups. They know the weak have given up. The strong are easier to find (like you). They are eager to locate leaders with clever bplans and unfair advantages. They want to find you before their competition does. That is how they got wealthy.

Depressed economic times are the times when the next wave begins to rise. You want to hop aboard and ride its energy to success. So do eager investors and those top quality employees. Both are looking for the next Google in a new space. You can attract them now, with a great bplan. It is what they are seeking.

Bloggers and reporters are depressed because everyone out there in startup land is depressed (except the winners-to-be of the new wave of startups). So stand up, stand out and you'll find eager investors welcoming you with open arms.

When you read of smaller and smaller rounds of financing taking place, you can be assurred the next round of startups has begun. Seed rounds are smaller than the D, E and F rounds of old, struggling startups. That is your clue to get into action, go find your money.

BOTTOM LINE: Get your money when others think there is none for startups. There has never been a shortage of capital for startups. What we are short of is startups worth financing. So make yours so outstanding that VCs line up with their check books. That will happen when you start with the right attitude and prepare a bplan based on an amazing unfair advantage. That's how you will get your money.

BRIDGE FINANCING (Part of a series): When is it a good idea?

When I am fly fishing, I go out with a plan and as I start fishing, I usually soon find I must deviate from what I expected to do. Sometimes the fish are keyed on a specific insect hatching that I did not expect to see at that time of day in that place on the water. Or I might spot a large fish in a location I did not anticipate. And quite often the fly that I expected to attract the fish does not work well, or even at all. So I change my plan and that usually results in catching more fish and improving my time on the water in a beautiful place.

That is also where bridge loans can be especially useful: when your plan need a significant alteration.

Here are some events that have made companies I've coached very glad they could do a bridge loan:

• Got started right away. Waiting three to nine months for a second venture firm to join your seed round can be dangerous, allowing competitors to leap ahead of you. I'm watching this happen right now with one of my startups. They have sales traction and are becoming acknowledged as THE company in a new space thanks to a bridge loan from a first class startup.
• Powerful strategic partner arrives, unexpectedly. In this case the public giant was amazed at how well the startups' software ran on the giant's machine. The result is a commitment to showcase the startup and a declaration of desire to invest in it. That will alter the plan for the B round, allowing a bridge loan so the B round can take place later, when the startup has grow more and has a higher valuation.
• Lead venture firm wants to continue but others in the syndicate do not or can not. You want a VC who will stick with you in the hard times. They will bridge you through the dark valleys. It is not uncommon for other VCs to stop putting fresh cash into your startup when the trouble arrives. Some run out of cash. Others are stymied by their contact with their limited partners.Or they simply get cold feet and give up.
• Buy time to get to higher valuation. Startups confident of their growth can attain milestones that give a huge boost to their valuation. This includes sales to a couple of giant public corporations and delivering the next version that makes the machine greatly out-perform the competition. Then you will find investors eager to sign checks instead of reluctant. And your dilution will be significantly lower.The extra cost (discount on the per share price) of the bridge will be overcome by the much higher valuation.

BOTTOM LINE: Bridge loans are not a sign of bad things happening to your startup. They have a special role to play in your growth. Rarely is the plan of the startup executed as you anticipated. There are too many surprises along the way. Bridge loans finance the unexpected events. Done well, they can be a very positive tool in your march to IPO and are a good tool to use as you build your unfair competitive advantage.

IT'S AN "A OR E ROUND WORLD" TODAY: Seed or pre IPO deals are hot, the rest are not

Does your startup need a seed round or is it ready for IPO? Those are either the A or the E rounds. Like two balls on the end of a rod, they are large and the rod is skinny. Seed rounds are in, mezzanine rounds are doable, the rest in between are hard. Valuations are very low. Investors are reluctant to reach for their checkbooks.

This has occured often in startup history. I've seen it in wave after wave over thirty years. But there are things you can do to get through the storm.

Here are some tips for the A or E times:

• Assume VCs are all scared. Do not count on your lead VC to come through with the new, golden VC powerhouse to price your B or C or D round. You will have to do that alone. It is up to you.
• Plan for the worst. While you have time, adjust your burn rate. Your current cash must get you well past that next giant milestone: star customers signed up, one million concurrent users, whatever it is. Then your startup has a much better chance of getting the money you need to continue growing successfully at a valuation that is not a fire sale.
• Raise more money than you plan on using. This is especially important for the seed round. The CEO must assume the B round is going to be at least six months late in coming. The mezzinine round CEO must be prepared for a longer IPO drought than he plans, a year or more later.
• Cultivate long lists of VCs well before you need them. Introduce your company casually in advance of the next round. Get higher on the list of the top tier VCs.
• Beware of large corporations investing in mid-term rounds. They take forever to decide. They have slow moving machinery at corporate. They are public companies with a ton of paperwork needed for every decision. That takes a very long time. Your cash may not hold out long enough while you wait for the big bucks from giantco.
• Tell stories about the accomplishments of your company. As you describe month to month successes, small and larger, investors will become more and more confident of your accomplishments. Send a short newsletter monthly to interested VCs and venture startup bankers. Everyone likes to read of progress and success during these times. That is part of the process of building your unfair competitive advantage.
• Be ready for doing more than one bridge loan from your current investors. I've been writing about that in recent weeks. Understand the terms, cost, discount and conditions. This has become a way of life during the A or E phase of startup money raising.
• Be honest with your employees. Make it clear when you are going to run out of cash. As I have written before, you may have to miss a payroll (make it up after the next round is closed). That is not the end of the world. It is how startups work. But you must not surprise employees. Helping them prepare for a short drought increases their trust in you. That is priceless. It is also your job.

How long will this A or E phase linger? The answer is simple: longer than you want. So get started working on reducing the pain. I expect the current troubles to go away within a year, but not before we get through the coming winter.

BOTTOM LINE: The VCs are currently especially cautious. They see the startup investing as a glass half empty. It is a great time to begin a startup with a seed round. Or to get pre-IPO money. All else in between is very difficult. There is a lot you can do to thrive during this phase of your startup's life. It is a primary job for the CEO. When the startup can continue to grow during such difficult times, investors will broadcast its unfair competitive advantage and eagerly reach for their wallets to invest.