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Startup Success: People, Money and Opportunity (Part 2)
[ Cross-posted on I started off the first part of this article with the common question “What should come first, People or Money?” and I answered it with People. This is true, but it is also false because without Money, there is also nothing except your ideas. Without funding a Startup is Just a Hobby. Strategies for Successful Fund RaisingThe OpportunityHere’s the first test: can you realistically commercialize your idea without having to seek millions of dollars in financing prior to even making your first sale? If you can’t, you should seriously consider another opportunity. A spending goal of between $250k-$500k for commercialization is the sweet spot in the funding game. OwnershipAsk yourself this question: ‘Do you want to own the entire pond, or own an island in the larger ocean?’ Most entrepreneurs have a problem with losing some control over their brilliant idea. They will always value it more than their investors will and that causes most startups to fail. Your acceptance to dilution is crucial in how your startup gets funded and stays alive and prospers. ValuationAccording to Robert Koturbash, the Managing Director of the new Toronto-based Maple Leaf Angels, the biggest mistake that entrepreneurs make is on valuation. Rob says “Don’t hold off for the highest valuation – you will waste valuable time getting to market and will often take money from the wrong types of investors.” The average angel deal has a pre-money valuation of just over $2m according to the Angel Capital Association. Insisting on a higher valuation will simply cause capital to flow to other startups, leaving you with few options for raising money. FrugalityBe frugal. Period. There isn’t any phase that you shouldn’t be frugal, but when you are starting off and looking for funding, frugality will make or break your success. Don’t hire too fast, and don’t spend excessively. Rent, contract and lease wherever and whenever you can. You will need to stretch the funds that you have longer than you are expecting – it’s just a fact of life. Raising capital always takes longer than anticipated.Have a realistic view of how long your cash will last and then add a buffer. Always be FundingAs the CEO of your new venture, your number one priority is to make sure you never run out of cash – ever. Therefore, you should be devoting a large portion of your time to bringing money into the company. Whether incoming cash is through revenue on sales (highly unlikely in a startup), or through investment (your greatest chance of success), cash needs to be always coming in. There is a saying in the sales world that you need to ‘Always Be Closing’ (the sales deal), but for a CEO you also need to ‘Always Be Funding’. How will your Investors Make Money?An investor isn’t going to give you money just because they want to see you succeed (except for your mother). They need to understand how they will make money off of their investment. Prove to them how your exit strategy will bring them a sizeable return on investment. This will demonstrate that your goals are aligned. You will not get rich off of your salary – you could potentially become very wealthy off of your exit, though.Too many entrepreneurs forget to think about how their investors will be able to make a profit. Don’t be surprised if there are specific exit conditions written into the shareholders’ agreement by outside investors. It is that important to them. Ask for HelpMake sure to use the knowledgeable people in your community who have gone through fund raising before. Also, you can use Venture Catalysts or ‘Finders’ to help you ‘find’ finding. They will either take some equity or cost you some cash, but their contacts and experience will prove invaluable in getting funding quickly. Phases of Funding a CompanyBefore you go out and start raising investment, you need to know how most startups are funded. First off you bootstrap the startup with funding from yourself, then go out to your friends and family. This allows you to do market research and refine the solution that you want to bring out to the market. You will be expected to develop at least a proof of concept to demonstrate to outside investors that your solution is feasible. The Seed round is typically raised through Angel investors and high-net-worth friends and family. This infusion of capital often occurs when the product is in Beta, you have a few pilot projects and are looking to begin your sales and marketing drive in earnest. The next major funding raising event is the Series A round, which will be your first MAJOR fund raising campaign. This is typically handled by VCs only and the proceeds should be used to aggressively ramp your sales and marketing and start generating significant (>$1m per annum) revenue. If you ran out of your seed money before completing your Series A (which isn’t uncommon), then you will need to get a bridge round of financing from your Seed round investors. Be sure to start the bridge process well before you are out of funds, as it is a difficult task to be raising two separate rounds of financing at once. There are always multiple rounds of financings, so your A round will lead to a B round, which will lead to a C round. Each time you go back for more investment, you will typically lose more control. Also each time typically brings in more investors (ie. VCs) and “too many cooks in the kitchen sometimes spoil the broth…” The last phase of a startup is how your investors get their money and their profits back out; the exit strategy. This will either be a M&A activity (mergers & acquisitions), or turning to the public markets, which will provide for liquidity in their investments. Where to Get FundingThe 2007 PROFIT 100 just released their list of the top 100 Canadian companies.Accompanying that list is this table of how Canadian Companies found funding in th past 5 years:
Friends and Family (and Fools)This is where you will get the first few dollars to start looking at the market and your solution. You need to convince people that care about you that the opportunity that you have will make them money. You also need to live with the fact that you will be seeing these people again if your opportunity doesn’t work out. For an investor, this is the round that has the most risk. Angel InvestorsAngel investors are a great source of funding and advice for early stage companies. In Toronto the new Maple Leaf Angels, is the only major organized group, although there are some individuals that invest in startups. The benefit of an Angel group is that you can find 3 dozen angel investors all in one place and they will almost always invest in groups. Thus the amount that you can raise at one time will be higher than going to multiple individuals. Angel investors will either take an equity position or some amount of debt (and typically a combination) in exchange for their investment. They will also take a board seat on your board of directors, which they will use to monitor their investment and to provide invaluable advice. Sometimes they can actually take an active role in the organization and get it kick started into high gear. Venture CapitalistsWhen thinking of raising money for a startup, everyone always talks about Venture Capitalists. We have all heard of the famous VC firms on Sand Hill Road in Silicon Valley who invested in YouTube (Sequoia Capital), Google (Sequoia Capital and Kleiner Perkins), or Cisco and made a fortune when their investments became very successful.It is the High-Tech industry’s version of Hollywood movie stars and we all want to be like them. Unfortunately, examples such as YouTube are not representative of how 99% of high-tech startups work and get funded. Also, behind the perceived glamour of becoming funded by a VC, there is the reality that it is very hard work and most times will not pay off. Raising a funding round with a VC is like dating. Not dating just to get lucky for that evening, but dating to get married. Yup, it will take that long… They will need to be as comfortable with you, your team, your product, and your company as they are with their spouse or best friend. VCs are looking to make 10 times their investment within several years. They know that more than 50% of their funded companies will fail and they will never see a return on their investment. They also know that approximately 10% of their funded companies will make it big and bring in a larger than expected return on investment.That leaves about 40% of companies that become ‘the living dead’, or are sold or go public and make a marginal profit for the VCs. So they look for companies that they believe will make a $100M in five years knowing that most will never work out. A note about how different VCs operate in the US versus Canada. As a Canadian looking south to Silicon Valley or the Boston Technology Corridor, you hear about startups getting funded quickly and sometimes having VCs battle over a startup. The major difference that Canadian VCs have against US VCs is that their process will take longer (plan on 6-9 months), much longer in some cases, than their US counterparts.Remember though, that only local VCs will invest and looking 3000 kilometers away will typically not yield any funding. NOTE; (Currently, the amount of VC funds available for early stage companies in the Toronto area is rather small). Make sure that the VC has an active fund that has enough for what your organization is asking for. Lots of VC firms have older funds that are all tied up with prior investments and thus aren’t going to be able to fund you. With, or without an active fund, VCs rarely say ‘NO’ outright (and if they do, then you really have problems), but not saying ‘NO’ doesn’t mean ‘YES’. Know when the funding relationship isn’t going anywhere and either move on or get introductions to other funding sources that may pay off instead. VCs bring a lot more than just money to the startup. They bring operational experience that can advise you on growth and how to jump over pitfalls. That experience is a huge boost for a young company, but good VCs will also bring their network of connections to your assistance and that in the end may make your startup’s exit successful or not. Please remember what being funded by a VC really means. They are now in control of your organization. Regardless of weather they actually hold a controlling interest in the company after they poured their millions into it, they will still have a lot of power over how the company runs and how they will get their money out. You will be forced to go down directions that you may not be too happy with. But then again, without their money, you wouldn’t be this far… The best way to get noticed by a VC, is to get introduced by someone that they already know and respect. Spamming VCs with your business plan is about as effective as buying a lotto ticket. VCs working in the Toronto, Waterloo, Ottawa and Montreal areas include:
CustomersYou can get one of your first few customers to fund your startup. Most companies would be interested in this if the problem that you are solving is big enough for them. There are three major benefits to this:
There are however things to be careful of when accepting an investment from a customer;
GovernmentExport Development Canada and Business Development of Canada consider themselves VCs, although they operate very differently. Regardless, they can be a great source of funding on top of your lead investors. The Ontario Centres for Excellence (OCE) will be shortly offering a co-investment fund that will disperse $29M over 4 years. The ‘Market Readiness Program’ will fund up to $500k to sustain and/or grow your organization’s competitive edge in the marketplace. The National Research Council (NRC) has the $100M Industrial Research Assistance Program (IRAP) fund. It is intended to help Canadian companies build new technology and offers a very quick turnaround to receive the funding (typically 6 weeks). The NRC also offers another option called Scientific Research and Experimental Development (SR&ED) which is a larger fund ($2B), but typically pays out 18 to 24 months after registration. Both funds from the NRC are great tools to assist Canadian startups to receive the proper funding that they require. Public MarketsGoing ‘Public’ or having an ‘IPO’ (initial public offering) is almost never on the radar of early stage companies as they are costly and require a regular quarterly revenue stream that should be above $10M/year. That said, companies that went to the TSX Venture Exchange saw a larger influx of capital than was available from VCs. Canadian corporations on the TSXV raised $8B in 2006, compared to $1.69B raised in 2006 from VCs. Private EquityMost private equity firms only fund post round A and thus aren’t going to be an option for startups and early stage corporations. According to Canada’s Venture Capital and Private Equity Association (CVCA), private equity firms invested $10.9B.
Next time, we will discuss Opportunity and the importance of your solution being a marketable solution and not just a cool idea. [ Edit | New ] |
