Robert Ochtel’s Blog

An Experienced Approach to Venture Funding

Six Things Venture Capital Investors Never Want to Hear from Entrepreneurs

Venture capitalists by their very nature are risk adverse and a very skittish bunch.  They do not like to hear things that do not ring true in their minds or underline the credibility of the entrepreneur. This is especially true for an entrepreneur when presenting their investment opportunity to venture capitalists or any venture investors for the first time.  More often than not these same potential investors do not know the entrepreneur, and while they are trying to understand the business opportunity being presented to them, at the same time they are making a realistic assessment of the CEO and the accompanying management team that will be running the start-up company. As such, there are six things that a venture capital investor does not want to hear from the entrepreneur during the start-up company’s first road show presentation.  These six items outlined here are not the only things that will get the entrepreneur off on the wrong foot with their potential investors. There are many other things that will get potential venture investors nervous regarding the potential investment opportunity.  But, in the whole scheme of things, the six items outlined here will often provide these same investors a reason to pause.  In addition, mentioning any one of these six items may also result in not receiving a follow-up call or sincere interest from these same investors.  This article addresses these six items and provides the entrepreneur the reasoning behind the investors’ concerns.

There is No Competition.

Many times entrepreneurs make the mistake of telling their potential investors that there is no competition for their technology, product or service offering in the market.  Investors never believe this statement. Why, because it is not a true statement.  There is always competition, whether it is established players, new entrants, or substitute products, etc.  As an entrepreneur you need to understand this and take it to heart.  Also, telling investors there is competition, undermines one of the underlying truths in capitalism, if there is money to be made, the competition will come. 

Claiming to your potential investors there is no competition in the market is an instant “red” flag for these same investors.  In addition, it is also an instant credibility killer.  This statement indicates to these same investors that the entrepreneur has not done their homework to understand the market and their position within this space. It also immediately informs these same investors that the entrepreneur is either naive or does not really understand the underlying difficulties, which face this same entrepreneur when bringing their product successfully to market.   So, as an entrepreneur, you need to know your competition when talking to potential investors. It will provide you with credibility and at the same time provide you with a realistic picture of challenges ahead for your start-up company and its technology, product or service offering.

I Need to Raise $1.0M to $3.0M in Funding.

Potential investors need to understand that you know exactly how much money is necessary to make your start-up company successful. Remember, investors always think it is going to take twice as long and two times the money to get your start-up company’s technology, product or service offering to market.  Therefore, if you provide them with a requested funding requirement of $1.0M to $3.0M, this immediately indicates to the potential investors that you have not done your homework on the funding needs of your start-up company and to not have a complete picture of what it will take to make your product successful in the market. 

It should be understood, that potential investors do not want to invest one more penny than they have to in order to get to a cash flow positive situation.  Why, because investing more money to make your start-up company successful substantially lowers their return on investment.  So your potential investors want to know that you, as an entrepreneur and CEO of your start-up company, have really studied your funding requirements and necessarily know where all of the invested monies are going to be allocated and in what associated timeframe.  Providing a range of funding requirements undermines your credibility as a sophisticated and fiscally responsible entrepreneur.  So, know your exact funding requirements.  As the fiduciary of your start-up company, this will provide you with the necessary credibility with your potential investors.

I Need to Be the CEO.

There is nothing more important to potential investors than to have a “first” rate team running their start-up company.  This is imperatively important to your investors and cannot be overstated.  As it is often said, investors would rather invest in an “A team and a B product than a B team and an A product”. Hence, they need to know that they can count on the start-up company’s management team both through thick and thin.  This is especially true for the CEO of the start-up company.  Therefore, never tell your investors that you necessarily need to be the CEO of the company. By doing so, you will immediately turn off your potential investors.  Why, because investors understand that the CEO who founded the start-up company is not necessarily the same person with the required skill set to guide it through the needed growth to make it a successful long term investment opportunity. Therefore, more often than not, potential investors necessarily believe going into an investment opportunity that they will have to replace the CEO at some point in time in the near future.  So, by telling your potential investors that you need to be the CEO, you are in effect tying your investor’s hands. This is something investors do not take too kindly to.  Remember it is the investor’s money and therefore they necessarily set the rules. So, be flexible, and look at the big picture.  As the founder of your start-up, you want the company to grow such that your equity position multiplies for both you and your investors.  This may require you to take another position within your company, but in the long run it will be beneficial to both you and your investors.

I’ll Have to Talk to the CFO About the Financials.

As the CEO of your start-up company you need to know and understand everything there is to know about your company.  This includes having a deep knowledge of your start-up company’s financials.  When presenting to investors, as an entrepreneur, you need to be aware that the first thing investors look at are the financials. Why, because potential investors are first and foremost, financial managers.  So, be aware, the financials are the first thing potential investors look at when considering a potential investment opportunity. If the underlying financial business model does not make sense to them, they will pass on the investment opportunity. Therefore, when presenting to potential investors you cannot tell these same investors that you will need to talk to the CFO regarding the details of your start-up company’s financial statements. This is a huge mistake and undermines your overall credibility as the CEO of your start-up company.  Hence, as the CEO of your start-up company, you need to intimately familiar with your financial statements from the income statement revenue projections, to the operational cash generation of the cash flow statements, to the accounts receivables of the balance sheet.  These are the details investors are interested in and will ask about to get an understanding of the underlying financial business model, as well as to get a better assessment as to the credibility of you as the CEO of the company.  So, as an entrepreneur familiarize yourself with the financial details of your start-up company.  It will serve you well when presenting to potential investors.

I Don’t Have a List of Significant Milestones.

Investors need to know that the money they are investing will be adding significant value to their start-up company.  Why, because investors know from experience, that there most likely are going to be multiple follow-on rounds of funding.  Hence, they want to be sure their initial investment will result the completion of significant milestones, enhance the underlying value of the start-up company, and in the end increase the stock price during these subsequent funding rounds. Therefore, as an entrepreneur, you need to be intimately familiar with the necessary significant milestones required to develop and bring your start-up company’s technology, product or service offering to market.  If you tell your investors you do not have a list of significant milestones that go along with your funding requirements, you will again lose instant credibility with your potential investors.  Remember, in the early stages of a start-up company it is the significant milestones define your company’s progress and are necessarily used a measurement tool by investors to ensure that the entrepreneur and its management team are meeting their defined objectives and goals to move the start-up company forward.  Therefore, know your significant milestones – they define the value of your company to your potential investors.

I Do Not Have A Go To Market Strategy.

More often than not, entrepreneurs solely focus on the development of their technology, product or service offering.  This, although extremely important to the success of your start-up company, is only half of the underlying problem facing these same entrepreneurs. The other half of the problem is securing market traction through the development of their target customers.  Therefore, investors necessarily want to know that you have a go to market strategy.  Why, because “time-to-revenue” is key to securing the return on investment necessary to meet the investor’s financial investment objectives. So, it is never good to tell potential investors that you do not have a go to market strategy or have not thought about it.  This again is a “red” flag, as the best technology, product or service offering in the world is no good unless your start-up company has the ability to secure paying customers.  Remember, investors are looking to mitigate their risks and at the same time ensure that you not only have a great product, but that you have a proven go to market strategy that will secure traction in the market. Therefore, spend the time to think through your start-up company’s go to market strategy, this will alleviate potential problems when talking with potential investors.

Presenting your start-up company and its associated road show to potential investors is always a difficult and trying task. In addition to being risk adverse, there are certain things investors consider deal breakers when reviewing potential investment opportunities for the first time.  As an entrepreneur, you need to be aware of these items and at the same time make certain you do not trip over things that raise “red” flags for your potential investors. This article has outlined six items that will make your investors pass on your start-up company and the associated investment opportunity.  You need to be cognizant of these same items and avoid them when presenting your start-up company to potential investors. This will provide you with a much smoother road ahead when looking to secure venture funding.

This information was taken from Robert’s new book: “Business Planning, Business Plans and Venture Funding – A Definitive Reference Guide for Start-up Companies”.  Available at www.amazon.com.  For more information on the book go to www.carlsbadpublishing.com.

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August 31, 2009 Posted by | Competition, Customers, Finance, Funding Requirements, go to market strategy, Market Traction, Milestones, Venture Capital, venture finance, Venture Funding | 1 Comment

When Seeking Venture Funding Don’t Forget to Focus on Your Business

The process of securing venture capital or any other type of private equity funding is very time consuming.  With all of the preparation, travel, presentations and required follow-up, entrepreneurs often forget to focus on their business.  This article reminds entrepreneurs that while focusing on their venture fund raising activities is important to move their start-up company forward, they need to remember to focus on their business and to move it forward, as this is just as important of an activity as is venture funding is for their start-up company.

Fund Raising is a Time Consuming Activity.

Ask any entrepreneur that has secured venture funding, and they will tell you that it is a very time consuming activity.  First, there is the materials preparation, including the development of your start-up company’s:

  • Executive Summary,
  • Business Plan, and
  • Road Show Materials.

Each of these documents, individually, can take substantial development time, working and then re-working to get them to the level of being investor-quality documentation.  As such, it usually takes several months of research, due diligence, creation, writing and then re-writing to develop the appropriate investor documentation.  Also, getting the attention venture funding investors (e.g., venture capitalists), just to schedule a meeting, can be very laborious and challenging for entrepreneurs.  This is especially true if you do not have a lawyer or some other person to provide your start-up company with the appropriate “soft” introduction to the investor community. Then, there is the required travel, presentations and follow-up with each of the individual venture investment groups, just to get to the next level of potential investor interest.  So, as can be described by seasoned entrepreneurs, venture fund raising is a very time consuming and difficult task that can take all of your available time, if you let it. This leaves little time to focus on your start-up company’s day-to-day business related activities.  This is not a recipe for a successful start-up business as there a multitude of issues that need to be addressed daily to ensure your start-up company in moving in the right direction and at the same time creating value for your company.

 Fund Raising Takes Time.

Many entrepreneurs assume that they can secure venture funding in two months or less.  This is not realistic.  Even in a good economy, it takes a typical start-up company 6 to 12 months to secure venture funding for the development of their technology, product or service offering.  This time table assumes that you have contacts in the funding community, and can set up your initial meetings with investors fairly early in the funding process.  If this is not the case, then you can add on a few months to just schedule your initial meetings with targeted investors.  Also, in today’s economy, this funding time table is even longer, given the fact that in slow economic times, investors tend to stick with their current investments, making it just that much more difficult for entrepreneurs to secure funding, from these same investors, than it would be in a strong economy.  Therefore, as an entrepreneur, you need to look at a realistic time table for securing venture funds, and often the resulting time table is much longer than originally anticipated.  This can make the funding process and the associated time frame can be even more detrimental to the overall development of your start-up company.

You are in Business to Create Value for Your Company.

As an entrepreneur, you are in business to create value for your company.  This means that in addition to securing venture funding, you must work diligently to move your company forward, with or without funding, such that you are creating value for your company every day.  This should be your personal expectation and it surely is the expectation of your investors.  They have to believe that even without funding that you and your executive team can continue to use creative ways to move your company forward and at the same time creating underlying value for your company in the market.  This can include:

  • Securing customers,
  • Aligning with strategic partners,
  • Developing your sales channels,
  • Continue to market your company to target customers,
  • Working with early “beta” test customers,
  • Moving product development forward to the next level, and
  • Other.

All of these activities and many others can create inherent value for your start-up company, both in the market and to your potential investors.  So remember, that securing venture funding is only one vehicle that can be used to move your company to the next significant value level. There are many other things you can do on your own through securing customers, the development of a strategic partnership, or bootstrapping that can also create near term value for your start-up company, and at the same time prove to your investors that you have the ability to move your start-up company’s business forward, even in non-ideal financial circumstances.

Continuing to Focus on Your Company’s Business is Often Beneficial.

During the venture funding process, focusing on your company’s business can take you away from the everyday hassles associated with venture funding.  This can be a good thing. By continuing to simultaneously focusing on your company’s day-to-day business activities, you can move your company forward to the next level and accomplish significant milestones that will be beneficial to your company.  This business focus can also create new opportunities that were not originally available to you and your company at the beginning of the venture funding process.  Remember, the venture funding road is a long one, and continuing to knock down significant development milestones, securing customers, or developing strategic partnerships, etc. can be just the ticket to get the attention of your investors.  Also, often, significant business opportunities often take time to develop and by continuing to focus on your business, while your are raising funding, can often provide the required time period for such opportunities to develop and take hold for your start-up company. 

Focusing on Your Business Can Facilitate Funding.

In the end, by focusing on your business while working to secure venture funding may be the vehicle that facilities the funding for your company.  No company can go for 6 to 12 months, without focusing on their business.  In addition, by developing new business opportunities during the funding process, you continue to create value for your company and its potential investors.  One or all of these business activities together, may be just the ticket that gives your potential investors the proof that your company is the one they are willing to risk their monies on to provide the types of returns they require.  Therefore, continue to focus on your company’s business and your investors will recognize the value you are creating during for your start-up company, even before you secure funding from third party investors.

Focusing on venture funding is just one phase of your start-up company’s development.  But, your company’s business is the real item that needs to be developed to create value for your company.  Therefore, while you are trying to secure funding for your start-up company do not forget to focus on your business.  By doing so, you can create significant value along the way and at the same time help facilitate the venture funding of your start-up company.

June 1, 2009 Posted by | Business Planning, Finance, Venture Capital, venture finance, Venture Funding | , , , | 1 Comment

To Become an Expert in Your Field – You Must Become an Externally Focused Entrepreneur

Throughout history some of the most successful companies ended up in failure.  There are many reasons for this, but many times the most telling one is that many of these same companies, as a result of their success in the market, became internally focused and not externally focused companies.  As an entrepreneur, to develop a successful company you need to focus on the external factors that drive your business. This external focus will ensure that you know the key drivers in the market, understand the general trends, and develop a long term sustainable competitive position in your targeted markets of interest.  This article focuses on the external market factors that all entrepreneurs should focus on to become an expert in their field on their way to developing a successful company.

Know the General Market Trends

 

To become an informed, externally focused entrepreneur you need to understand the general, long term market trends.  This is accomplished by studying the markets, analyzing growth opportunities, and determining the consumers’ needs as well as the technology and service trends in the market.  Understanding these long-term macroeconomic indicators will provide you as an entrepreneur a basis to determine the strategic opportunistic market needs that are not being met in the market today. This will allow you to position your start-up company’s technology, product or service offering to address the unmet needs in the market. By doing this high-level analysis, an entrepreneur will be better equipped to provide their company with a long-term vision and associated product roadmap that will ultimately provide their start-up company focus to drive their success in the market. 

Target Your Markets

 

As an entrepreneur, determining your start-up company’s target markets of interest is one of your most important externally focused activities. The task of targeting specific markets of interest is usually easier said than done.  There are many market opportunities out there, and as an entrepreneur you need to determine which markets or market segments best fit your start-up company’s technology, product or service offering and at the same time will provide the highest return on investment for your start-up company.  To do this properly, as an externally focused entrepreneur you need to take into consideration the market size, maturity, and growth of all of your potential target markets.  All of these factors will have a tremendous affect on the long term viability of your start-up company.

  

Market risk is also a key factor to consider when choosing to target smaller, burgeoning markets for your start-up company.  Market risk, is defined here as the ability of a targeted market to grow at a rate necessary to create the appropriate amount of opportunity to sustain your start-up company, and a number of competitors. This is a key consideration when targeting smaller markets.

 

Finally, as an early stage company, it is often important to identify multiple target markets that are applicable to your technology, product or service offering.  By doing this, you provide the opportunity to support multiple revenue sources, higher return on investment, and at the same time mitigate individual targeted market risk for your start-up company. 

 

Analyze the Competition

 

As a start-up company another external factor to consider is the competition in your target markets of interest. Competition may come from large, medium or other small start-up companies.  Competition may also come from other existing companies that have complementary products or that have the capabilities to compete in related markets.  So, as an entrepreneur you need to analyze all possible competitive threats in your target markets to determine the competitive advantages of your technology, product or service offering in the market.  A complete competitive analysis is time consuming, but it often provides the entrepreneur with significant insights to the competitive positioning, and the ultimate competitive advantages of their own technology, product or service offering within their target markets of interest.

An excellent way to develop a complete competitive analysis is to list all of the product features, functions and capabilities that are important to your customer base. At the same time, develop a complete list of competitors in your targeted markets.  This information can then be easily presented in a table format to show how the competitors stack up with regard to these required product features, functions and capabilities.  If done properly, this table will show how your start-up company’s product offers compelling advantages over the competitions’ products. For an explanation on how to develop a complete competitive analysis and examples for various real world applications, refer to my book, “Business Planning, Business Plans and Venture Funding – A Definitive Reference Guide for Start-up Companies.”

Develop a Successful Business Model

 

All start-up companies must offer a business model that is financially viable and ultimately profitable in the market.  More often than not, your start-up company’s business model will primarily be developed and then driven by other successful competitors in the targeted market of interest and their existing business models.  A successful business model, along with the market size, will drive the potential revenue generation capabilities of your technology, product, or service offering.  Therefore, to compete effectively, as a start-up company you must analyze the other competitors’ successful business models and determine where you may have targeted cost advantages.  These cost advantages can be based on the underlying technology or by lowering the costs associated product itself, its development, or the distribution channel, etc.  The key here is to clearly delineate where and how your start-up company’s business model differs from other successful competitors and results in a significant and disruptive competitive advantage for your start-up company and its targeted customer base.

 

Call Your Customers

 

The final component of becoming an externally focused entrepreneur is to know your target customers.  This is only accomplished by calling and then meeting with your customers and discussing your technology, product or service offing with them.  This is where many entrepreneurs fall short and is often what differentiates a successful entrepreneur and their start-up company from its competitors. Only by calling on your customers can you determine what is really important to them in terms of your product’s features, functions and capabilities.  All of the analysis in the world is not a substitute for “real” customer feedback.  Remember, by definition, your customers will know the end market application better than you do.  In addition, as is often the case, what you as an entrepreneur believe are important features, functions or capabilities of your product offering, are many times not really that important to the customer.  Therefore, real customer feedback will provide you with significant insight and at the same time make start-up company a stronger competitor in the market.

To become an expert in your field, as an entrepreneur, you need to be externally focused.  Only then will you have the insight, background, and ability to develop a vision for your company and at the same time determine a long-term sustainable competitive advantage in the market for your start-up company’s technology, product or service offering.  By addressing the items outlined in this article, the entrepreneur will ensure that their start-up will have the proper focus and at the same time be better prepared when presenting to investors.

April 20, 2009 Posted by | Finance, Venture Capital | 2 Comments

Attractive Financial Statements – The First Step to Getting the Attention of the Venture Capitalists

Many first time entrepreneurs have given expertise in a certain area, be it engineering, marketing, business development, operations, etc. When developing their start-up company’s business plan these same entrepreneurs generally leave the development of their financial statements to last. There are several reasons for this, the most compelling of which is they do not understand finance or how to generate the required financial pro forma statements for their start-up company. This can be a big issue for many start-up companies, and one that needs to be addressed appropriately to get the attention of the venture capitalists. This article discusses several general issues facing first time entrepreneurs regarding the generation of financial pro forma statements that are attractive to the venture capitalists.

Venture Capitalists Are “Glorified” Financial Managers

It has been my experience that many of today’s venture capitalists are the products of top tier business schools with no personal experience in being an entrepreneur or starting a company on their own. On the other hand, what they do know is how to analyze financial statements. So, this is what they focus on first when considering a new start-up investment opportunity. This financial statement focus is necessary, since these “glorified” financial managers need to first justify any start-up investment opportunity from pure financial objectives, as defined by the financial return requirements set by their investment fund. Therefore, up front, to determine their initial interest in a new investment opportunity, this is what venture capitalists focus on. If the opportunity does not fit their pre-defined investment criteria, they quickly move on the next potential investment opportunity. This is not an emotional decision; venture capitalists have a board of directors to report to and predetermined investment criteria that are defined in the bylaws of their investment fund, usually an LLC. To these same venture capitalists, it is a numbers game, if a particular start-up investment opportunity does not fit their defined criteria they move on. This is why venture capitalists are generally very short with entrepreneurs and do not see it as their role to provide advice to these same entrepreneurs. A simple “not interested” or “no” is sufficient to them. This often leaves the entrepreneur confused and perplexed.

Return On Investment – Necessary, But Not Sufficient

The return on investment for your start-up company is a necessary, but often not sufficient criterion for consideration by venture capitalists and other professional third party private equity investors. Remember the rule the general of thumb for the venture capital community is 5 to 10 times return on their initial invested monies in three to five years, respectively. This is a goal and not necessarily a reality.

As an entrepreneur if your financial pro forma statements are projecting $50M to $100M in revenue in your fifth year of operations, these numbers, along with those projections for years one through four are discounted substantially by the venture capitalists according to perceived risk. This can be market risk, margin risk, technology development risk, competitor risk, etc. The key point here is that venture capitalists then take your start-up company’s financial projections and run them in their own financial models. This is done for a multitude of scenarios to see if your company’s financial projections hold up to their investment criteria under “worst case” condition assumptions. Therefore, your start-up company’s return on investment projections is only a single data point in considering your start-up company as an investment opportunity. It is only through their own thorough financial analysis that the venture capitalist determines if your company is a worthy investment opportunity and will consider moving forward to the next level of discussions.

Industry Standard Financial Pro Forma Statements

One of the most important factors venture capitalists consider for new investment opportunities is whether a start-up company’s business model is reflected in the market. That is, does your start-up company have a proven business model that is represented by successful companies in your industry segment in the market today. Or is your company’s business model new and unproven in the market. This is an important factor for venture capitalists to understand when considering investing in any start-up company.

Today, almost every venture capitalist I have talked to claims they would have invested in Google. In reality, this 20-20 hindsight does not consider that fact that at the time, Google’s business model was unproven in the market, and as such there were no reference companies that the venture capitalists could refer to that would indicate that there was little risk in their business model and projected financial returns. Hence, I believe that many of these same “Monday morning quarterbacks”, are most likely not telling the truth when they claim that they would have invested in Google, as one of the original venture capital investors.

The key to developing acceptable financial pro forma statements for the investment community, is to develop industry standard pro forma projections, for your start-up, based on similar companies in your SIC code. This can be accomplished using information available on the internet or at your local public library, and is completely explained in my book “Business Planning, Business Plans and Venture Funding – A Complete Reference Guide for Start-up Companies.”

Understand Your Financial Statements and Their Assumptions

When presenting to venture capitalists, the CEO of your start-up company needs to be an expert in all aspects of your company, including its financial statements. It is not a good idea, as the CEO of your start-up, to defer the financial statement related questions to your CFO or another third party. As the CEO, you are the one where the “buck stops”, so venture capitalists expect you to be able answer any and all questions regarding your start-up company’s financial statements. Therefore, as an entrepreneur you need to study your company’s financial statements from an investor’s point of view, including being able to recite the underlying assumptions of your financial statements. If you cannot do this, you will not get far with the venture capitalists and your ultimate goal of securing funding.

If Necessary, Get Help

Developing complete financial pro forma statements for your start-up company is difficult and a daunting task for first time entrepreneurs. This is especially true if this same entrepreneur does not have a financial background. So, given this, the important thing to do is to seek help to generate the required financial projections. By securing a qualified financial consultant, you, as an entrepreneur and the CEO of your start-up company, will be much more confident in your company’s financial projections, and this will show when you present your company to your potential investors. Remember, as a minimum, you need to generate five year financial projections for your start-up company’s income statements, balance sheets and cash flow statements. Typically, for years one and two this is broken down by month and/or by quarter. For the out years, yearly financial statements are fine for venture capital investors.

As discussed, financial projections can make or break your start-up company with the venture capital community. Your start-up company’s financial projections are the first step to getting into the door of the investment community. Therefore, to be considered, your start-up company’s financial statements must provide an attractive return on investment to the venture capital community, while at the same time reflect generally acceptable industry standards. Also, it is important for you as a first time entrepreneur and the CEO of your company, to become the expert on your start-up company’s financial pro forma statements. This will set the appropriate tone and earn you respect with your potential investors.

April 13, 2009 Posted by | Finance, Venture Capital, venture finance | Leave a comment