The Power of an Advisor

 

It is tough at the top. Lonely times. As the CEO the buck stops with you. Then of course finding capital for your venture. That is not easy either. It is not easy for 3 main reasons.

1) you may just not have what investors are looking for
2) you may not be telling them what they want to hear, and
3)  you may not be blessed with knowing where investors are and how to contact them, “effectively”.

This is why most entrepreneurs fail to raise capital, because of one or all of these reasons.

The power of an adviser, in any of these circumstances must be to distill what is relevant to your campaign down to one or all of these factors and drive solutions to ensure that you are equipped with the right tools to attract investment. But the secondary power of an adviser is that they will re-calibrate your expectations of what is possible, and at what cost to you. That is, what sum of capital would be reasonably attracted to such a venture, and at what cost to you in getting it, in terms of amount of equity you have to give away. It is rare that an entrepreneur will have a deep appreciation, at the start, of how it works without having sought advice from entrepreneurs who have done it before, or professionals who do it for a living. The last but very important power that an adviser offers is putting you in a stronger bargaining position when working with investors, and negotiating the final transaction, investors will find it less attractive in working with those that are not well advised, or those that are not well educated. This is the hidden benefit to entrepreneurs – that is direct marketing to investors is NOT effective for entrepreneurs seeking capital. It might just work, but investors would much rather your opportunity be screened by an adviser before they attempt to do the same. They just don’t have the time to look at everything that comes their way.

Advisers do not need to be paid for of course – and unpaid advisers can achieve the same outcomes for you. Friends, associates etc. But advisers are more accountable when they are paid to do what you need to meet your objectives.

 

Kiyosaki: The #1 Skill of an Entrepreneur

 

 

David S. Rose on pitching to VCs

Pitching to a VC is all about YOU. An investor is investing in you, as much as your idea and business concept.

Thinking startup? David S. Rose’s rapid-fire TED U talk on pitching to a venture capitalist tells you the 10 things you need to know about yourself — and prove to a VC — before you fire up your slideshow.

David Rose is a serial investor and a serial entrepreneur. Here’s his list of what is important in convincing an investor that you are the right choice.

It’s about
* Integrity
* Passion
* Knowledge
* Skills
* Leadership
* Commitment
* Coachable

And of course, it needs to be presented with an infectious enthusiasm!

On presentation techniques, and powerpoint, David says:

“Without question I’ve seen many presentations (both with and without PowerPoint) that are Too Slick, and to me they are at least as much of a turnoff (perhaps even more) than is one that is Too Rough. HOWEVER, that’s not the only choice one has. The slickness is *not* just a function of the slides; it has much more to do with how over-rehearsed, or patronizing, or ‘un-real’ the presenter is. I see hundreds (perhaps even thousands) of presentations each year, including many dozens at conferences like TED, where presentation is often elevated to a high art. And while great presentations are far from common…they do happen.

There’s a wonderful word, first used by Castiglione in 1528, that nails the concept. “Sprezzatura” is “a certain nonchalance, so as to conceal all art and make whatever one does or says appear to be without effort and almost without any thought about it.” That is to say, it is the ability of the courtier to display “an easy facility in accomplishing difficult actions which hides the conscious effort that went into them.”

If you watch the very best presenters at their very best, people like Larry Lessig and Rives and Steve Jobs and Seth Godin et al, there is absolutely NO feeling that they are Too Slick. But all of these guys spend absolutely enormous amounts of time preparing their slides, rehearsing their presentations and mastering the technology…so that the result comes off as “without effort…and thought”. ”

Risk Model For Investors

How big are your risks? What is the outcome? What can I do about it?

Simply treating all risks that you may be exposed to in your business “as equal” in your business plan doesn’t really help you manage them effectively, nor will it help an investor understand them. Further, whilst you probably know intuitively that some are more likely than others to occur, an investor who doesn’t really know you, will be left thinking you haven’t really thought them through.

I had a lot of exposure to risk in my investment banking career, and have subsequently carried this discipline to business. Of course, the risk metrics used in the investment banking world has been proven to be flawed post GFC, but the framework of assessing risk is a good one.

That is – for any given risk, a bank assesses what is the probability of it happening and what is the likely impact, and what are the mitigating actions to minimize the risk and or address the outcomes if it does happen. I don’t think Lehmans were very good at assessing risk to put it lightly but the framework was there I am sure.

It is pretty straightforward when all we are talking about is numbers – and when you have huge statistical ddatabases at your fingertips:

eg $100,000 invested in a company is a $100,000 at risk.

A) What’s the worst case scenario? $100,000 loss.

B) What is the probability of this happening? Using statistics, the bank would consider that, on average, it should be expected that a loss will occur x% of the time [averages proved to be a very expensive metric to rely upon in the run up to the GFC – as it was not an average event].

C) What can we do to reduce the impact of risk?

a. not take one [and not get a return] or

b.hedge.

Hedging is generally the preferred option.

I am not suggesting that it is necessary to develop the level of sophistication that a bank might have in their assessment of risk, but we can apply similar principals that will add enormous clarity on what the risks are in your business. It is not necessary to get too hung up on the exact score you give something your gut will tell you.

In business and ideally in your business plan, your assessment of risk can follow a similar framework as follows:

  • State the risk – in wordss is fine
  • Apply a score between 1-10 to show the probability of occurrence
  • Apply a score between 1-10 to show the impact of such an occurrence
  • Take the product of the probability and impact scores
  • Rank them
  • Add in a mitigating action to minimise the impact
  • Are there any actions that can be taken to minimse the actual risk of it occurring?

Here are some examples of how risk in your business might be presented – you wouldn’t have all these entries in your assessment only one for the risk of death of the owner for example – the ones listed are only for illustration purposes:

risk-assessment

Assessment of risk is A LOT more subjective in business in general than lending money. But attempting some sort of objective assessment like the above will go along way to demonstrate you have a handle on the overall risk of being in business.

"Imagine investing in Google at the start…"

Often you hear people compare a new venture to the opportunity that has passed us by … just as if we had been offered an opportunity to invest in Google (or Microsoft, or eBay, or amazon.com), and passed it up. By not investing in Google, or eBay, or amazon.com …just imagine your loss. If you had that chance now, of course you’d take it. Or so the logic goes. (The recent marketing by Dubli heads down this path…)

But here’s the funny thing … the start of Google had Sergey Brin and Larry Page wearing out shoe leather around Silicon Valley trying to get capital … endlessly pitching … and with lots of smiles. But no cash.
(Source: The Search, John Batelle)

It wasn’t until 1998 that Andy Bechtolsheim put in some cash, and the real success story starts from there and other funds coming in after that – including Jeff Bezos of Amazon fame. At the door knocking stage it didn’t even have a revenue model or a company structure (it did have a name, having just changed from being BackRub)

So, what did all those venture capitalists not see, that in retrospect seems like such an amazing opportunity.

Whatever it was… here’s the lesson: venture capitalists miss opportunities daily. And they don’t mind.

And this also presents your challenge. Even when you (think that you) have a sure thing, that the market needs what you have and that anyone would be mad to not want it… remember that you are competing with so many other opportunities put before them, that the chance of them passing on your opportunity is high.

If smart people can pass on Google, then they can pass on you.

There are some valid reasons for this. In the early days, Google had fantastic technology but a poor revenue model. In fact, it is possible that if it were not for the hype around dot coms, a plan as skinny on detail as Google’s would not get off the ground even now.

Your job as an entrepreneur, is to make sure you have a strong business model and can convey to a potential investor how you will commercialise your technology, and what their risks are. And of course what the upside will be.

For a great read on the steps that lead Google to where it is now, check out The Search. . Or here.

Just a note – the Google founders had a real life “start in a garage story” – much as Microsoft did. Their frugality extended to their celebrations on receiving their first investment: Burger King.

Is your goal big enough? (to interest a venture capital investor)

Many business owners are satisfied with making a good living, and creating a profitable business. And while many businesses are profitable, this is not really the stuff which will excite an investor.

Donald Trump once said, “if you’re going to think, you might as well think Big”, and it is big thinking that will create a vision grand enough that others will want to join you (staff and management for example). Running a successful and growing company is an exercise in leadership. Part of leadership is having and sharing an exciting vision.

Michael Schrage argues that those willing to invest in and test new ideas based on their hunches will often find their noses bloodied yet this is a risk which is necessary in order to create something which is truly massive. The Economist descibed that from 20 investments:
- 4 would go broke
- 6 would lose money
- 6 would do OK
- 3 would do well
- 1 would hit the jackpot.

So, one in 20 is brilliant, four in twenty do well (or better) and a full 50% go broke or lose money.

If you have run a business, you know that it can be hard work. If you are going to wear yourself out, you need to have a great reason for doing it. As a business owner your reasons might vary from noble, to mercenary, to altruistic. For an investor, it is far easier. It is about the money. If it doesn’t have a huge upside potential, why bother? *

Investors look for – and buy into this leadership and vision as well… for a couple of reasons.

The first reason is that the intended outcome needs to be substantial in order to be worth playing for. Almost no investor wants to play in the shallow end of the swimming pool and watch a million dollars turn into 1.5 million dollars over a few years (or see it shrink). If the predicted outcome was this minimal, then there are plenty of other investments that are more reliable – property for example which will give nice steady returns. There has to be the potential for the company to grow by a factor of ten or a hundred times in order to turn the seed capital into a massive return. This is not to say this will always happen… but the potential has to be there. It is estimated only around 3-5% of all businesses have the potential to achieve the type of growth that will attract a VC.

Venture capitalists expect some failures. In fact, they generally have a higher tolerance for failure than most (The very word “venture” implies some sort of adventure and rocky ride.). This is because they are looking for the big wins to make it all worthwhile. So if you expect to attract this kind of money, show off the potential. Guy Kawasaki makes the distinction between a business that is viable (and that there are many businesses which are viable) and those that are fundable (and very few viable businesses are fundable). Being attractive to fund is about scalability and vision. (Check out his videos also on this site).

The second part is about leadership. Investors are buying into a business idea, but they are also buying into a person, or a few key people who will make this vision a reality. Are you this person? And if so, how can you show an investor you have what it takes? Obviously having some runs on the board already will count – if you have previously built a business, grown a company, or lead a large team. If not, you need to show that you see how important this is, and what your tactics will be – maybe it is to hire a strong GM for example. There is no ‘right way’ – but you need to recognise that you need a plan. Just as an aside, quite often the skills needed to lead and the skills needed to manage, and the skills needed to oversee operations are different. Noone is expecting you to fill all these roles, but it is important to map out how you will deal with thesm. There’s many cases of business owners that are brilliant at inspiring, but know they are not the right person to get involved in day to day operations and therefore they make delegation a priority. Richard Branson springs to mind.

So, when you are writing your business plan, make sure you are conveying the potential of tapping into something significant and understand that your leadership will be as important – if not more important – than your business skills.

“The tragedy is not that we set our goals too high and fail, but that we set them too low and reach them”.

Here are some things that an investor will look at to decide if your goal (and potential) is big enough.

1. Market size
2. Growth rate
3. Market maturity
4. Fragmentation within market
5. Barriers to entry
6. Cost structure (% GP of sales)
7. Changes within market – dynamics of major players
8. Impact of product or service on people’s lives.
9. Nature of purchase (one time v ongoing)
10. Barriers to entry
11. Potential exit strategies
12. Strength of the leadership and management team.
13. Return
14. Differentiation of product or service.

* You may find investors that get involved for reasons other than monetary gain, but these are likely to be other categories of investors – not VCs.

Importance of valuation in the venture capital equation

Valuation raises its head as a subject after an investor has determined that the business is worth looking at. It is not the first thing that an investor will look at. In fact, considering the number of business plans that don’t get read past the executive summary, it is something which business owners spend far too long dwelling over.

Having said that, once a plan is actually being considered, it becomes an important factor.

There are two sides to the valuation.

For a business owner, it controls the “cost” of the funding that they are seeking ie how much they need to give up (in equity) in order to get money into the business.

For an investor, it controls what they get for their money.

An investor buys into a company (and its potential) so that it can earn some money and then get that money out again. The mechanism is generally an exchange of funds for a percentage of the ownership of the company. This means a calculation must be made about what the company is worth, and what the business owner is prepared to give up to get the funds.

In addition to the valuation question it’s a complex negotiation that has many factors involved:

The valuation of the company, and the method used for this
- How much the owner is willing to give up and how much the investor wants
- How much the investor needs these particular funds
(if cash is low, and there are no other sources, the investor will probably negotiate a better deal)
- How the deal is structured – debt or equity, a mix, or debt that converts to equity.
- What else the investor is putting into the deal – expertise, contacts etc (“Smart money” is better than just money)

A valuation that is too high, and by implication represents a higher cost of entry to an investor, means someone might walk away from a deal. A valuation that is too low means the owner is underpaid for their asset.

At the heart of this are two opposing forces. Generally the owner will want to give up as little as possible, and the investor will want to take as much as possible. With all other things being equal, and hoping that the owner isn’t out of cash (which means the investor will pretty much get whatever he wants!) then the valuation provides a mechanism for structuring a deal.

There are many methods for valuation. Some are explained here.

None of these is completely accurate, and in fact they may give wildly different valuations.

At the end of the day, the business owner has to decide if what he gives up is worth the cost (in equity). So, often the right question is not to look at what you have now, but to look at the potential you can have with this investor on board (with the benefit of the funds, plus the advice).

A few years ago there was a great show on Seven called Dragon’s Den which had budding entrepreuners pitching their ideas to four succesful Australian business people. The question that was often asked, and was foundational to the negotiation was “would you rather have a smaller slice of a big pie, or a big slice of a small pie?”. Venture Capital in prime time was great viewing, and there were some instant lessons on how to pitch and negotiate.

This remains as the question to you as well… what are you willing to give up to get to where you want to be?

Comic relief: How NOT to pitch your idea

Ali G pitches to various investors including Donald Trump with his ground breaking ice cream glove. I love his ‘Zen Diagram’ showing his market- “people who has hands”, and of course his indepth “Intranet search”.

Alternatives to Venture Capital

Venture Capital is a specific term that refers to funding obtained from a venture capitalist. These are professional serial investors and may be individuals or part of a firm. Often venture capitalists have a niche based on business type and or size and or stage of growth. They are likely to see a lot of proposals in front of them (sometimes hundreds a month), be interested in a few, and invest in even fewer. Around 1-3% of all deals put to a venture capitalist get funded. So, with the numbers that low, you need to be clearly impressive.

Growth is usually associated with access to, and conservation of cash while maximising profitable business. People often see venture capital as the magic bullet to fix everything, but it isn’t. Owners need to have a huge desire to grow and a willingness to give up some ownership or control. For many, not wanting to lose control will make them a poor fit for venture capital. (If you work this out early on you might save a lot of headaches).

Remember, it’s not just about the money. From the perspective of a business owner, there is money and smart money. Smart money means it comes with expertise, advice and often contacts and new sales opportunities. This helps the owner, and the investors grow the business.

Venture Capital is just one way to fund a business and in fact it is one of the least common, yet most often discussed. It may or may not be the right option for you (a discussion with a corporate advisor might help you decide what is the right path for you).

Here’s a few other options to consider.

Your Own Money – many business are funded from the owner’s own savings, or from money drawn from equity in property. This is often the simplest money to access. Often an investor would like to see some of the owner’s fund in the company (“skin in the game”) before they’d consider investing.

Private Equity – Private Equity and Venture Capital are almost the same, but with a slightly different flavour. Venture Capital tends to be the term used for an early stage company and Private Equity for a later stage funding for further growth. There are specialists in each area and you’ll find different companies with their own criteria.

FF & F – Family, Friends and Fools
– Those closer to the business and often not sophisticated investors. This type of money can come with more emotional baggage and interference (as opposed to help) from its providers, but may be the fastest way to access smaller amounts of capital. Often multiple investors will make up the overall amount needed.

Angel Investors – The main business angels vary from venture capitalists in their motives and level of involvement. Often angels are more involved in the business, providing ongoing mentorship and advice based on experience in a particular industry. For that reason, matching angels and owners is critical. There are substantial easily locatable networks of angels. Pitching to them is no less demanding than to a venture capitalist as they still review hundreds of proposals and accept only a handful. Often the demands around exit strategies are different for an angel and they are satisfied with a slightly longer term investment (say 5-7 years compared to 3-4 for a venture capitalist).

Bootstrapping – growing organically through reinvesting profits. No external capital injected.

Banks – banks will lend money, but are more concerned about your assets than your business. Expect to personally guarantee everything.

Leases – this may be a way to fund particular purchases that allow for expansion. They will normally be leases over assets, and secured by those assets. Often it is possible to lease specialist equipment that a bank would not lend on.

Merger / Acquisition Strategy – you may seek to acquire or be acquired. Generally even a merger has a stronger and a weaker partner. Combining the resources of two or more companies can be a path to growth – and when it is done with a company in the same business, can make a lot of sense – on paper at least. Many mergers suffer from differences in culture and unforeseen resentments that can kill the benefits.

Inventory Financing – specialist lenders will lend money against inventory you own. This may be more expensive than a bank, but might allow you to access funds you could not have otherwise.

Accounts Receivable Financing / Factoring – again a specialist area of lending that may allow you to tap into a source of funds you didn’t know you had.

IPO – this is normally a strategy after some initial capital raising and having proven a business is viable through the development of a track record. In Australia there are various ways to “list”. They are useful for raising larger amounts of money ($50m and up) as the costs can be quite high ($1m plus).

MBO (Management Buy Out) – This tends to be a later stage strategy, rather than a startup funding strategy. In essence debt is raised to buy out the owners and investors. It is often a strategy to gain back control from outside investors, or when investors seek to divest themselves from the business.

One of the most important things to remember across all these strategies is that they all require a significant amount of work in order to make them work – from the way the business is structured, to dealings with staff, suppliers and customers – need to be examined and groomed so that they make the company attractive as an investment proposition. This process of grooming and derisking can take anywhere from three months to a year. It is often costly both in actual expenses (consultants, legal advice, accounting advice) as well as changing the focus of the owners from “sticking to the knitting” and making money within the business to a focus on how the business presents itself.

De-risking – getting ready for investment

Make Your Business More Attractive to Venture Capital Investors By Derisking

Derisking is the process of removing risk factors from your business in order to make it more attractive to an outside investor or to an outside buyer. It is one of the most important factors in the grooming process in order to be an attractive company to invest in i.e. “Investor Ready”.

There are dozens of areas and hundreds of ways in which a business may be exposed without knowing it. In the normal course of business an owner may not worry about these factors, as they are within the “comfort zone” of operation. For an external party to get involved however, they need a much more transparent organisation so they are not confronted at a later date with skeletons in the closet.

It is important because businesses already face uncertainty. And while a venture capital investor may have a reasonable tolerance for risk, they will not welcome unnecessary risk. The goal is to control as many areas of risk as possible, so at least the risks are known. Most companies who have had an internal focus (i.e. have focused on sales, marketing and operations in order to grow) have not thought about all the areas in which they are vulnerable.

The process of derisking limits the areas of exposure, and therefore decreases exposure to uncertainty. It also increases the chance of success through improvements in clarity in almost all areas of the business.

Derisking falls into two areas – one is simply clarification (i.e. creating a contract where an informal arrangement was in place) and the other a change of substance i.e. changing a supplier because it lowers risks.

Some examples include:

  • Formalising employee agreements. This may mean creating contracts for employees that have previously operated without one, or strengthening existing contracts. Particular issues would be with protection of IP, ownership of IP, confidentiality and restraint of trade after employees leave.
  • Creating / clarifying written agreements with suppliers
  • Creating/ clarifying agreements with customers
  • Moving “ad hoc” sales to contracted revenue where possible
  • Formalising and documenting internal processes
  • Protection of IP – patents, designs, copyright and so on.
  • Protection of data by limiting and monitoring access to key systems (CRM, accounts etc)
  • Key employee insurance (including of the owners) in the event of death.
  • Creating or clarifying credit terms and policies. Getting credit offered back within trading terms, and ensuring that all credit offered is documented with the correct application forms and personal guarantees.
  • Removing reliance on key personnel, in particular vulnerability to information or relationships which may be lost on their departure. This may mean adding additional points of contact to key client accounts so individual relationships are less critical.
  • Documenting key processes – getting the knowledge out of people’s heads
  • Ensuring insurances of assets are up to date, and sufficient.
  • Lowering legal exposure (liability). Ensuring insurances are held that cover product liabilities and so on.
  • Ensuring compliance with all ATO and ASIC regulations. Creating systems for their ongoing compliance.

As you can see, this is a lengthy, but not even remotely exhaustive list. The due diligence process will highlight those areas which need further work. This might cost several thousand dollars, and lead on to significantly more expense than that. In some cases the process may take a year, and cost hundreds of thousands of dollars.

One of the important things to remember in raising capital is to build in the cost of raising the capital.

This falls into two main areas:

  • Actual costs – such as hiring consultants – legal, accounting, corporate advisors, strategists etc
  • Opportunity cost and change in focus. The process of raising capital for business can take anywhere from three months to a year (or more) of attention from key owners and managers of the business. During this time, it can be difficult to maintain a normal focus on things which are essential for survival – sales, marketing and operations for example. This cost can be significant, while at the same time be difficult to measure. In fact, this defocusing may have a major impact for any growing company that is pursuing two goals – new business, and business funding (or preparing for a sale of the business).

The need to derisk is apparent if you place yourself in the shoes of a buyer contemplating a purchase of (or investment in) your company. Without going through the derisking process, your company could contain any one of a dozen hidden time bombs (key staff who could leave and set up in competition, unsettled legal issues, poor data security etc). By transparently documenting how you have examined, reduced or been able to totally eliminate risks in your business then you are showing a buyer that you understand their concerns.

The flip side of the coin is that your company is now a far more attractive proposition to purchase or invest in. You will have invested a significant amount of money and time in the derisking process, but the result will be a company that is now sellable (all other things being equal) compared to a mystery. This means first of all that you may achieve a sale when previously none would have taken place, and secondly that you are likely to achieve a far higher sale price than before.