The CEO’s Handbook Volume Four
The Money Chase
Dr. Earl R. Smith II
Published by Dr. Earl R. Smith II at Smashwords
Copyright 2011 Dr. Earl R. Smith II
Smashwords Edition, License Notes
This ebook is licensed for your personal enjoyment only. This ebook may not be re-sold or given away to other people. If you would like to share this book with another person, please purchase an additional copy for each person you share it with. If you're reading this book and did not purchase it, or it was not purchased for your use only, then please return to Smashwords.com and purchase your own copy. Thank you for respecting the hard work of this author.
Raven Press
Other Books by Dr. Smith
The CEO's Handbook - Volume One Note for a Thinking Chief Executive
Leadership - Notes From a Successful Entrepreneur and Experienced Coach
Websites
Table Of Contents
Fred Got Funded – And He Hasn’t Had a Good Day Since
Venture Capital – The First Meeting
Presenting to Early Stage Venture Capitalists - A Few Things to Remember
Presentations from the Investor’s Perspective
Conversations with Investors – Chapter One
Conversations with Investors – Chapter Two
Conversations with Investors – Chapter Three
The Money Chase - Oil and Water
The Money Chase - Breaking the Truce
The Money Chase - Who They Do Not Invest In
The Money Chase - One Way to Avoid Being Avoided
The Money Chase - What Does Investment Grade Mean - Part 1
The Money Chase - What Does Investment Grade Mean - Part 2
The Money Chase - What Does Investment Grade Mean - Part 3
The Money Chase - What Does Investment Grade Mean - Part 4
The Money Chase - What Does Investment Grade Mean - Part 5
The Money Chase - What Does Investment Grade Mean - Part 6
The Money Chase - What Does Investment Grade Mean - Part 7
Red-Teaming - Improve Your Chances of Getting Funded
Protecting Investor Interests - Quick Assessment, the Short List
An Alternative to the Money Chase
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Introduction
The Money Chase has been the death of many good companies. There are a range of reasons why this is so. Some companies simply do not deserve funding - they are not an attractive investment opportunity. Others embark on the money chase too early. They haven’t established the business base to justify funding. Still others are run by people who seem to like the money chase better than running the business. All of these reasons and more make embarking on the search for venture funding a perilous business which risks your company and all it may become.
Over the years, I have worked with a large number of companies and management teams that have sailed these choppy seas. I’ve written this book to let you in on some of the knowledge - sometimes hard won - that I have accumulated.
If you have been successful in building your company to a certain stage, you will be tempted to search for the financial resources that will allow you to take it to the next level. The question is not if but how you will pursue that funding; whether you will adequately understand the new world that you enter when you begin to talk to angel investors and venture capitalists.
The money chase is a high-speed race through a darkened labyrinth that has many blind alleys and circular paths. It is easy to get lost in that labyrinth. The judges are unforgiving of amateurs and their blunders.
The idea of being judged by potential investors is often an uncomfortable one for founders. That has always been strange to me because they are constantly being judged by their customers, team members and stakeholders. But investors seem to present a particular challenge. I suspect it is because of the ‘mercenary’ vision that investors can bring to the table. They are providing funding and are looking for a major return on that investment. The perspective is so tightly focused that founders, who have a more holistic vision of their company, can feel threatened or offended by such an opportunistic approach.
If the goal is getting funded - as opposed to ineffectively grousing about how unfair the world is and how narrow minded investors are - then founders need to understand the money chase from the investors point of view. Helping you do the latter is one of the major objectives of this book.
Dr. Earl R. Smith II
Georgetown, Washington DC
April 2011
Fred Got Funded – And He Hasn’t Had a Good Day Since
Most entrepreneurs dream of the day that the investor’s check clears and they have the funding to grow their business. It is a day that they struggle to achieve. Most put in long hours of preparation. They polish and re-polish their elevator speech and dog-and-pony show. The slide stack is revised and re-revised. The diligent ones even look to their own performance and appearance during the presentations to find ways to improve results and finally greet that sunrise on funding day.
Fred was one of those types. He lead his team on a magnificent money chase. Over the course of about six months, they probably made two dozen presentations before finding an angel investor willing to write a check. They went into that last meeting in full stride. Fred and his team had honed their presentation skills to a fine point. They had developed effective responses to all the important questions and were able to, easily and professionally, respond to every question. Fred’s team was the epitome of persuasiveness. In the broad scheme of things, they only had one weakness – Fred’s business idea was not ready for prime time. They had not done the spade work to mature the business model – particularly the revenue model.
The Short Honeymoon
The first months after funding were euphoric for both Fred’s team and the angel investor who had funded the company. Sure, there were some rough spots; the investor seemed more intrusive than Fred had anticipated and customers were not responding to the value proposition as anticipated. “But that is just the fog of a start up,” Fred observed. The team was working out how to interact with the investor. The investor was working out how to work with Fred’s team. Everything would work out in the end.
One major bump in the road did cause Fred some concern. The investor was much more focused on the numbers than Fred had anticipated. He seemed to see the company in terms of spreadsheets and constantly pressured the financial person on the team to come up with more and more sophisticated analysis of the numbers. It finally got so bad that the controller quit. The first member of the team left after only two months. “Good riddance”, was the investor’s response, “I have somebody who will do a far better job.” When Fred attempted to recruit a new financial member for his team, he got a shock. The investor showed him that the funding agreement required investor approval for major hires and the investor would only approve his anointed candidate. For Fred, the question became “who is running this company?” For the investor, the statement was “I am”.
The Straw …
While the struggle over control was going on, something else became clear. Fred and his team had spent so much energy and focus on perfecting their investor presentation that they had neglected to refine and test their business model. Over the six months prior to funding Fred had spent almost all of his time chasing money. He had neglected the developing contacts with potential customers. As more and more of his team were drawn into the money chase, they ceased to evolve their understanding to the business and its value proposition. They became very good at selling what they had – but what they had was not sufficient to become a profitable business.
That straw that broke the camel’s back was the need for the team to go back to the drawing boards and redesign the value proposition. Instead of using the funding to establish a market position, the team drew salaries and revamped the business plan. As the bank balance diminished the tension between the investor and Fred’s team increased. Eventually, things erupted into open warfare. The investor accused Fred and his team of conning him into investing in a poorly formed and tested idea. Fred defended himself and his team. They were doing the best they could under the circumstances. The investor’s intrusive tendencies had caused a drop in morale. The new financial person was not fitting into the team. Some of the key team members were thinking of leaving.
May I Have the Mediator Please
There is often very little to do in such situations but try to get the parties separated. Tragic experiences are sometimes best left behind and all parties are better off if they can lick their wounds and move on. I was asked to intervene in this situation by the investor. Even though the investor suggested my involvement, Fred welcomed it. From his point of view, there had to be some relief no matter what the source. Things were falling apart. It did not take long for me to present initial findings:
The focus on the money chase and then the use of the funding had been very bad for Fred’s team. They lost their entrepreneurial edge. Instead of thinking how to build a business – of new ways to implement on a shoestring – they had focused on the need to convince an investor to write a check. Their tendency to think creatively and to focus on innovating their space was substantially reduced and eventually virtually eliminated by the pressures of the money chase.
Fred’s team came to think of their most important audience as the investor instead of their base of potential customers. They spent a lot of time trying to figure out how to make the company attractive to investors and not nearly as much time trying to figure out how to make the company’s value proposition attractive to potential customers. The result was that they won the battle but were in danger of losing the war.
The investor had substantially overstepped his prerogatives and had acted as a ‘shadow CEO’. His passion for financial analysis had overridden prudence. After writing the check, he should have reduced his footprint and became much less of a distraction. In other words, he should have let Fred and his team get about the business of building a business. He was, after all, only an investor and not a member of the management team. But that did not happen. Instead, he became a major distraction and eventually destabilized Fred’s team.
Once the focus shifted to restructuring the value proposition, the investor found himself in the middle of a re-development process. The team was doing what they should have done before embarking on the money chase – they were trying to figure out how to build a business out of their vision. But, this was not what the investor signed on for. He expected that this work would have been done before funding. He had a point, but he was also culpable as a facilitator of an inadequate process. He invested before it was prudent to do so
.
Facing Reality Often Means Looking in the Mirror
There were no smiles in the room after I had presented my findings. Both the investor and Fred’s team had major roles in creating the train wreck. The question was, “now what do we do?” That was going to be the hard part because there were no easy or painless solutions.
“Look,” I said, “there are only a few ways forward that make any sense. The first is to put the company out of its misery; declare bankruptcy and close it down. You can then work out who owes whom what. The second is to renegotiate your understanding and find a new way forward. That would require both sides to find reasons for doing so. I would be glad to facilitate that process but would insist on certain undertakings from both sides beforehand. The third option is to reach an agreement that allows you to go your separate ways without closing the company. That would involve the management team ‘buying out’ the investor. It is not possible that the investor could be made whole if that means returning the funds advanced. But there may be alternative arrangements that would make sense.”
It took a couple of days for both sides to sort out their options and preferences but they finally decided on the third way forward. We set about negotiating the terms of an amicable separation. But that is a story for another time. For now, the lesson I want to highlight is -
Be careful what you wish for. Wishing and having are two very different things.
Investors Are Human Too
I recently sat in on a gab fest of entrepreneurs and wannabee entrepreneurs. The subject of investors and how best to approach them came up and I was taken aback by what I heard. If you listened to these guys investors were stupid, arrogant, greedy, short-sighted, overbearing, intrusive, difficult to deal with and distinctly neither a recognized nor welcomed part of the human race. Investors were the scourge of the business world and responsible for most of the failures in it. What set me back were the obvious questions:
“OK, if these people are this way, why would you have anything to do with them?”
“If these people knew how little you thought of them, why would they ever consider investing with you?”
Uncharacteristically, I held my questions and decided to ask the ‘other side’ what they thought about the conversation. So I organized an informal session of investors and put the question to them. After I had described the ‘bitching gaggle’ and named the most prominent participants, here is a bit of what they offered:
“Yeah, we know about these types. The grapevine brings us their names and we don’t take them or their proposals seriously.”
“These guys are so busy ratifying their own provincial perspective that they never see the process from ours. Most of them think they can simply present a good business plan to strangers and get a commitment on the spot. They treat us like an ATM”
“They are only one kind that I see … the majority, to be sure, but not the only kind. Some – the very best of them – learn that they need to get to know us and let us get to know them. They approach us as serious people and work to establish a relationship based on trust and mutual respect.”
The last comment echoed something that I have been telling founders for years. “You need to start a year or more in advance to establish relationships with potential investors before attempting to raise capital from them.” Most investors respond professionally to this possibility; that is to say, they either pursue or turn away from such approaches depending on how well the founders and their value proposition resonates with the investor’s interest. This process takes intelligence, sound judgment, planning and perseverance. The founder who misses the boat tends to have the ATM perspective. They wait until it is far too late to begin the process of building relationships with investors. By that time, their company can’t wait for a year to raise the capital it needs.
The unavoidable fact is that investors are humans focused on a human purpose. And, as such, they are not, by definition, stupid, arrogant, greedy, short-sighted, overbearing, intrusive or difficult to deal with. They typically won’t invest unless they have direct or indirect relationships with founders and companies. Every investor has many investment opportunities. The ones they invest in are companies they know more about than they learn from an elevator pitch or a business plan.
Through all the companies I founded and companies I have worked with, I have never known one to successfully raise capital from total strangers. Typically, the investor had a relationship over a significant period of time with a member of the founding team. The relationship was based on trust and experience. In other words, those founders who were successful in raising capital most often saw investors in positive, rather than negative, lights.
To summarize, according to my informal focus group, the key to successfully raising capital from investors is to establish a relationship with them so that the investors can get to know the founders, their business ideas and the kinds of business people they really are. If the relationship develops into a good fit, these investors become a champion to other investors.
Now let’s return to the group. I wanted to see if the investors that I had gathered had any opinions as to why certain founders saw them is such negative lights and held them in such low esteem. “OK guys, what drives these types to think so poorly of the very people they need to help their business grow?” Here is some of what they offered:
“I see it as a form of immaturity. These are essentially angry children. Many of them puff up their chest, proclaim a long and successful career (such pretensions seldom survive even a cursory diligence) and pontificate on things they know little or nothing about.”
“It is the uninformed showing the unwilling how to do the unnecessary. These people are really nobodies parading as somebody. They do a lot of damage to the chances of other founders. By the time they begin to think this way, they are not founders anymore; just proselytizers.”
“It’s just background noise mostly. But there is some benefit. We tend to keep close track of those who pontificate in such a manner and politely decline to engage with them in any way. The internet is such a great source of information. I once was approached by a founder who pitched me an interesting idea. I Goggled him and found lots of derogatory comments he had made about how stupid and destructive investors were. Needless to say, I did not pursue discussions with him.”
“Who in their right mind would do business with somebody who thinks you are an idiot?”
I keep a cartoon on my desk. It is from the Simpsons TV show. It is called “old man yells at cloud”. I am amazed at how young some of these old men are.”
I suppose that my logical next step would have been to re-gather the group of founders and discuss my experience with the investors. But I long ago lost the passion for kamikaze raids on vacant lots. So, instead of wading into the fray, I have decided to put these thoughts down and float them out into the clouds.
Investors are people too and like all people they respond better to others who both understand and have compassion for their chosen role in life.
Venture Capital – The First Meeting
You seldom get a second chance to make a first impression. This is a very important lesson when it comes to meeting with venture capitalists.
~~~~~~~~~~~~~~~~~~~~
I do a lot of work with companies seeking financing. Whether it is a first round or follow-on, funding for further research and development or marketing and branding efforts, equity or debt financing, a start-up or mid-market company or financing to prepare for acquisition by a strategic buyer, there are strategies which can significantly improve the prospects for success. In this chapter I want to focus on preparations for and managing the initial meeting with a venture capitalist.
First meeting with venture capitalists presents multiple challenges. Many of these challenges are best addressed with guidance from an experienced professional. There is simply no substitute for having been through the process successfully multiple times. Over the years, and as a result of working with a large number of companies, I have developed a ‘first meeting’ checklist. Here are a few of the items on it:
1. Pre-screen the funds you approach: Focus on funds which understand and have a preference for investing in your space and your phase (seed, early-stage, etc.). Most venture capitalists make their list of portfolio companies available on their website. That makes it easy to identify those who prefer to invest in your stage, industry and technology. But identifying the fund is not enough. You need to identify the partner who will be the most interested in your presentation.
2. The rifle is better than the shotgun: Avoid ‘wallpapering the world’. It is certainly a good idea to approach a small number of potential investors at the same time. But you do not want to give the impression that you are shopping your company on the street. Also, be careful not to get yourself into an ‘auction’ frame of mind before you actually have more than one serious bidder.
3. Avoid presenting to investors who lack a general understanding of your space: I have sat in on presentations by companies whose value proposition was so alien to the focus of the venture fund that I began to wonder if the presenters had not entered the wrong door along the hallway and should be presenting to one of the other venture funds in the building. If your value proposition and technologies are completely foreign to the fund’s investment strategy the meeting will be over early on.