Entrepreneurs, use right words to woo investors – Communication is the key to raising capital

I remember sitting in an investment meeting with an entrepreneur who had a great product.

One of the investors asked him when his company would reach "break-even." His answer was confusing and was the beginning of the end for the meeting. It was clear he didn’t understand cash flow, pre-money valuation and other concepts, and that convinced the audience that his company was not ready for an investment.

By Gary Williams
Brigham Young University

http://deseretnews.com/dn/view/0,1249,595061619,00.html

Command of a few financial terms will make a big difference in successfully communicating with investment professionals, bankers and share- holders. Following are a few of the key financial terms that every entrepreneur should know.

Test your own knowledge of the term by defining it before reading the remainder of the sentence.

• Break-even — Sales revenue is equal to total expenses. The break-even point is calculated by dividing total fixed costs by the contribution margin per unit. Contribution margin is the selling price of your product less the variable costs (cost of goods sold) associated with the product. The result will be the units that you must sell to break-even, and can be related to a time period by comparing the unit number with your sales forecast.

• Pre-money valuation — The value of your company before you raise funds. If your company is worth $1 million and you are raising $250,000, your pre-money valuation remains $1 million and the investors will receive 20 percent of the company for their investment.

• Post-money valuation — The suggested value of your company after you raise the money. The value of the company mentioned above is communicated to potential investors as $1.25 million.

• Start-up costs — The total cost of bringing your company to market. Costs may include new product development, setting up your manufacturing facility or store, equipment, training personnel, initial inventory, advertising and other expenses.

• Capital expenditures — The cost of physical items — including your physical plant and equipment — that have a useful life that exceeds one year.

• Fixed costs — Expenditures that will not change with sales. These costs may include loans, leases, rent and salaries.

• Operating losses (burn rate)— The loss that can occur before your revenues equal your expenditures. For example, you may accumulate a loss of $20,000 per month for 5 months. The $100,000 loss will need to be covered in some way. Adding in start-up costs of $150,000 to this example, you may need as much as $250,000 from investors. Your financing partners will expect you to know and to defend these numbers.

• Assumptions — The building blocks for the above numbers and your ability to justify these components. Many business owners do a poor job in justifying the various parts of their plan. Some research combined with simple logic will go far in convincing an investor that you are reasonable and have a well thought out plan.

• Integrated financials — Tying together in one financial model the key components of your financial projections. Your income statement, balance sheet and cash flow statement should be linked, allowing you to consider "what if" scenarios with your potential investors. In his book "The Portable MBA in Entrepreneurship," Bob Ronstadt suggests that "financial projections must be tied together, or integrated, to have much utility — not just for strategic purposes but for everyday financial decision making."

It does not matter to an investor whether you have a business, technical, engineering or other background. What will matter is whether or not you know your numbers and can be conversant with the key financial terms of the business world.

Gary Williams is affiliated with the BYU Center for Entrepreneurship. He can be reached via e-mail at [email protected].