The right frame of mind for seed fund seekers

If only we had the right frame of mind each time we start a project, odds for success would be much higher. Imagine someone taught us the right way of investing in stocks before trading in the market or driving like a professional before getting into a metropolitan traffic. Most times though this is not the case.  Instead we start with limited experience, often fail and learn, and then possibly attain the right frame of mind.

Finding investors for a budding business is no different. Having missed numerous funding opportunities and benefited from few, I realize now that I did not have the right frame of mind for funding a technology start-up when I set on the exciting road of entrepreneurship. Today I still may not! Regardless, now I would like to share with you my frame. By doing so I hope that some other entrepreneurs, most likely founders of technology businesses, gain a better perspective in their approaches to seek equity funding.

Equity investors are different from relatives or banks. You do not meet one at a family barbeque, see its ad on a billboard or visit its customer service representative to discuss your business needs. Once found and reached, you will find that they are different from business owners and mostly importantly you. Many entrepreneurs ask themselves “how come I cannot get the attention of a serious investor?” or “why is it so hard to get money from a venture capitalist?” Understanding the aforementioned differences, I believe, is the key to having the right frame of mind to secure equity based funding.

Let’s first discuss finding the investors. Many seek investors as they seek jobs. They have a written ‘plan’ and submit it to angel and venture investors via mail, fax and websites. This direct approach may be futile as investors look for familiarity. Like in other businesses they prefer working with people they know or hear about. You can be in a fortunate position to know an investor from a prior work experience or through a relative. If you are not one of those, I highly advise that your first task should be to reach intermediaries first rather than investors. Your doctor, though not an investor, may help you connect with that investor that puts money in medical device companies. Your accountant may be counting the beans for an angel who likes start-ups like yours. If you do not know anybody connected to an investor, then go to universities and chambers of commerce. University research environment is my personal favorite as respectable professors have already contacts and working relationships with investors. You can explain them your endeavor and ask them if they can refer you to an investor. Suggest them if they would like to be more involved in your business. It might cost you some shares but it might be well worth it! The gist of my approach here is to go to investors through references rather than trying to reach them directly.

If finding intermediaries is proving to be difficult for you or for some reason you still want to contact investors directly, I highly suggest you having a target. A lot of investors would say that they would be interested in investing in your field. Check if they actually put money in any company that is in or close to your field. Try to understand why. Was it because they had a serious interest in the field or was it a one-time flair that looked irresistible because of hot-shot management of that particular firm? Contacting investors specializing in your field will save you a lot of time and frustration. Besides there is a good chance that your investor will become an active participant of your business after the investment gets secured. You want more knowledgeable people on your side at all times.

If you are advertising your fund raising efforts via major funding networks such as Merar, then you have to specify your business and exactly what you will do with the money sought. It is to your advantage to limit your target audience to investors that know your business. An adventurous, wealthy but “can do it all’ type of businessman can be more hurtful to your business than those who plan not to invest. Again proven to me with experience!

Also a common mistake I see in these sorts of advertisements is the lack of specificity: With “the more the better” or “whatever I can get” mentality, entrepreneurs seek a wide range of investment dollars. An advertisement goes “seeking $10,000 to $750,000 for a nano-technology project”. Well, this says the entrepreneur has not put so much effort into planning which steps he will take to a profitable business and how much each step will cost, doesn’t it?

I will not even delve into importance of executive summary, business plan and management team as these are the main substances to an entrepreneur like pencil, eraser and back pack to an elementary school student. There are many well written sources on these subjects, so you should definitely know how to make and write SMART plans [1]. The main goal here is to show potential investors how likely it is for your business to make money. Although especially in developing countries there are many funding deals happening over napkins, I believe an average entrepreneur must have these three elements in place to get backed up by an institutional equity investor.

So let’s assume you have reached a serious investor. How can you convince them to invest in your business? I believe the investor’s anxiety needs to be calmed down in three aspects of your business in order to start talking about money: your business’ past, current and future monetary positions.

Remember I said previously that an investor is different from a business owner or more importantly you! I repeat an investor is not a business owner. He might own shares of your business for the money he provides but his mind is not same as that of a business owner. You might derive joy out of having your own business, CEO written on your business card or being the boss of your own faith, even more than making money. For an investor the main motive is to make money. He wants to know how much he will put in, for what and when he will get out. Many entrepreneurs mistakenly believe that investors should like their business, project, field, etc like they do. No, not necessarily. You have to show an investor “here is my money-making system, here is where you put the coin and pull the handle and here is when you might get out with more money than you put in”.

So how do you show this to an investor? Again you have to demonstrate with proof the past, present and future monetary positions of your company. The past involves how much money has gone it to the business. Have you done any sales yet? Are you making profit yet? For many tech start-ups it takes at least a year or two to break even. For biomedicine or medical device start-ups the time frame is typically much longer. So if no money has been made yet, has anyone invested in your business? A relative, any other investor, a bank, or you? It makes perfect sense to me if an investor does not want to invest in a company since its founders have not put their own skin into their business. If you believe in your business so much, how come you are not behind it with your hard earned cash or a loan with collateral on your home? This is a plausible question you might hear from an investor. After all why would you share your business with somebody else, if you certainly believe that it will be a cash cow within few months? You have to be ready to answer that question!

Regarding the past of your company’s monetary position, the best proof that can be provided to an investor is a prior investment of another investor (besides your own investment), which is also known as entrepreneur’s chicken-egg problem! You need prior investment to convince an investor that you are investable, you need an investor to get investment, so which one comes first? May be the easiest way to break this circle is to get a small investment from a professional or a group of professionals in your business. This can be in the form of labor, services, materials, parts, office location, etc. if it cannot be in cash. A research lab testing your device, a company giving rooms and office supplies for your daily operations, or a college professor dedicating few hours of his and his PhD students’ time for writing algorithms for your software, all for few shares in return can be valuable to create credibility for your business. The point is to show investors that there are other people believing in your business.

As for the current monetary position of your company, obviously you are in a better state if your business is already generating positive cash flow. However, more often this is not the case for start-ups at seed stage, so those should work towards generating revenue with their own resources before seeking a major amount of investment. If you are three years down the line for generating significant revenue, your chances of securing venture funding is close to zero unless you have a flaming hot management team with very successful previous engagements and/or the backing of some very wealthy individuals.

What if you are few months away from breaking even? You have much better chances but here again comes your management team and business plan. You need to have a very detailed plan on how your team members will spend those precious few months to generate profit as soon possible. Some engineers tend to mesmerize themselves with the complexity and coolness of their projects, strive to make it superior to competitors’ systems. This technical superiority brings competitive edge and is definitely valuable for the business as long as it makes money soon! Therefore, it is very important for investors to see elements of business urgency in founding engineers or even better addition of experienced business and sales people in their teams.

Another way of increasing chances of generating significant revenue is to have customers! Even in the development stages of your project, can you have customers? They do not have to be paying customers at the moment. They can be beta-testing your product, or deploying it to only few people within their organizations for trials. Once your product gets in the field, it will be field tested, improved and talked about by other potential clients. Investors definitely appreciate a product more if some people are already using and liking it.

The last but not the least is the demonstration of the company’s future monetary position to investors. Entrepreneurs should keep in mind that equity investors make money only when they sell their shares. This might happen through IPOs, partial or complete sale or merger of a company. Regardless of the method you should define and clearly state which exit method is in your plans and how and when you will achieve it. You have to give examples of other start-ups in your field that got funded and how much time it took for their investors to cash in their shares. If you have such examples, you also have to show how your business is similar to those in investment sense.

In summary, my perception of equity investors is that they are very risk-wary. Your goal as an entrepreneur is to reduce the risks of your business to a level acceptable by investors. Obviously you should do this to improve your business not to impress investors. If your business has fairly low risk of bringing high return (typically 10x or more) on investment within less than 3-5 years [2], then your investor might be just around the corner! If you are not getting the love you want from an investor, identify which risk factor is scaring him away the most, minimize it and go through the process again.

Patience and persistence are must-have features for entrepreneurs. Good luck!

Umit Dogan Demir

REFERENCES:

[1] SMART goals by Duncan Haughey, PMP.  http://www.projectsmart.co.uk/smart-goals.html

[2] Post-Crisis Equity Financing for Startups by Monica Mehta. http://www.businessweek.com/smallbiz/content/apr2010/sb20100420_472554.htm