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Pursuing Investment Financing in Difficult Times

It goes without saying that the past couple of years have been a challenging time for fund raising for start-up companies. The Internet bubble, the decreasing net worth of individual investors, and the gun-shy nature of venture capitalists have left a wake of companies unable to secure the financing they needed to grow and thrive and some of them are very compelling businesses.

by Mark Friess
http://wired.MD

This fallout in the fund raising market has forced us, as entrepreneurs, to be ever more diligent and creative in our fund raising efforts. At http://wired.MD Inc, due to a combination of factors, we nonetheless were able to close on a $1.1 million Series B Round in November 2002, primarily from angel investors. I believe our ability to do so was attributable to four factors: 1) We told a compelling, demonstrable story 2) We reduced investment risk 3) We developed strong relationships with potential investors and 4) We reached a critical mass that accelerated the momentum of our efforts.

A Compelling Story

First and foremost, you must tell the story of your business in a way that includes the necessary facts and figures that demonstrate you really are building a business that ultimately can be self-sustaining, as well as create a return on an investor’s money. This point clearly refers to the basics of business planning and execution: a business plan and financials that build a framework around the vision of your company. Such an effort involves your taking your pie-in-the-sky dream and putting it down on paper, backed up by industry numbers and simple mathematics. The exercise demonstrates that the intended result is possible, even though you must still execute to reach the desired goals.

Tied into the plan and financials are the historical results of your business. In other words, if you accelerate the practice of your business, versus just the theory of it, you can begin to make predictions based on reality, not just guesses. If you can describe how your customers react, interact, and buy with a reasonable sample size, then you can extrapolate to the masses of customers you have yet to touch. This information will demonstrate to potential investors that you have unique business intelligence that you can only gain by executing on the business plan.

An important third component to telling a strong story is that other credible people believe in the potential of your approach to your industry. Market research that supports what you are attempting to create should be actively pursued and hopefully continues to trend toward your business approach. Second, you should seek out any scientific research that backs up your product, your approach, or your vision. Lastly, and today almost required, you need the voice of existing customers, applauding what you are doing compared to your competitors. The combination of these three critical voices: the market, industry research, and your customers will assure potential investors that you are not the only person who believes in what you are doing. The more people corroborating your story, the more powerful it will be for investors.

A "Low-Risk" Investment

Following a period in which investors aplenty have been burned by the bubble, corporate malfeasance, and here-one-day-and-gone-the-next industries, it is critical that you lower the risks for your potential investors in any way you can. It is easier today for them to choose not to invest, so you must make an investment in your company a compelling opportunity they can’t pass up. How do you do this? One way that is painful for the entrepreneur, but may be necessary, is an adjustment in your valuation. This will decrease your position in the company, but a recalibration has been necessary over the past two years. In our case, we made a significant change in our valuation that not only brought in the first investor we needed at the critical moment at the beginning of our round, but based on the fact that we believed enough in the company to make that move in valuation, the investor increased his initial investment in the company.

An adjustment in your valuation from previous rounds is important in how it frames the potential return on investment for your investors. If your recent valuation changes can increase a potential return on investment, comparable to others in your industry, from 10 times to 20 times, it will be easier for investors to say yes.

Lastly, to create a decreased risk for your investors, you can get creative about how invested monies will be dealt with before the company spends them. This may include an escrow account or an investment minimum on the round. You may be raising $1 million, and if you have a minimum on the round of $750,000, make sure that amount is more than sufficient to get you to your intended milestones for this round of financing. That way, your investors know that once you get to that point in your round there is enough gas in the tank to bring the company to the desired destination. In our case, wired.MD adjusted the valuation of the company and established an escrow account to decrease our investors’ risk. Without these moves, we would not have been able to raise the money, plain and simple.

Strong Relationships

Like most things in life, the relationships you develop with your potential investors are critical. This is why serial CEOs often have an easier time raising money; they already have established relationships with investors. If you are not yet a serial entrepreneur, you will need to develop these relationships quickly and sincerely. If you are developing a network of investors, you will often meet an investor through introductions. Although this may be how you meet an investor, it is important that the relationship evolve to a personal bond between you and the investor, apart from the relationship that the investor has with the individual who introduced you. The introduction is merely opening a door; you must prove yourself capable of keeping the door open. A one-on-one relationship with each investor is necessary.

In a world where corporate scandal is a daily headline, you must demonstrate to your potential investors that you are worthy of their trust, and that you will manage their hard-earned dollars wisely. This can be demonstrated as much by the past actions of your company as by what you promise in the future. Your investors are smart, experienced folks, and they must sense in their gut that you are not going to misspend or misuse their investment. I have made a statement to every investor in our company that we respect their hard-earned dollars, and that we will work our hardest and do our best every day to bring them a return. If it is sincere, it will increase the trust and responsibility between you and the individuals funding your company.

The last point regarding relationships is what I call triangulation. In the same way that satellites communicate with each other to determine your position on a GPS system, a successful financing will involve investors meeting and talking about your company at a time when you are not in the room. Not only must this happen, but the investors then need to say positive things to each other about your company when the topic comes up. In our case, we found out after every investment in this round that the investor had spoken with existing investors or potential investors to get their take on our company. You have no control over this situation when it occurs, and it will, so your personal relationship with each investor prepares that individual for the inevitable due diligence from other investors who are reviewing the company. Much like research and experts backing up your story, the support of your company by the trusted peers of your investors will be a component that will be necessary to get funded.

Critical Mass

When you meet with an investor, he or she will likely have a mental checklist of 50 items required before making an investment. If you have 47 of those in place, you may still have a chance to prevail even though the final three are missing, but that is about it. You must have a critical mass of check boxes completed to attract today’s investor. These include not only previously discussed necessities, such as business plan, financials, valuation, customers, and relationships, but also those that you may not sense or know are being watched.

As you prepare for and progress through a financing round, seek out your areas of greatest weakness and work to solve those as quickly as possible. You never know when you will fill that final check box that will push the round over the top. You may hire for a missing position, you may acquire the right customer, or you may add that critical feature which changes the entire equation, and thus make your company one in which investors must put their funding.

With that in mind, make sure that your company continues to progress while you are raising money. Along with your major milestones, make sure you have other milestones that are set during your fund raising. For new investors, your company is at point A, and while that may be quite an achievement, they do not have a sense of how you got there. Showing them how you get from A to B and then to C, while they are doing their due diligence, will demonstrate how you execute in your company. Keep all potential investors abreast of everything you are accomplishing during that time. Does this put pressure on you to perform? You bet it does, but if you do it right, you greatly increase your chances for funding.

These four factors are critical in securing funding in today’s environment; at least they were for my company. Unless your company is self-sustaining, you will need to raise additional funds for it to grow. A compelling story, a low-risk investment, strong relationships, and a critical mass around the business proved necessary for wired.MD to raise money in today’s world. I am also the first to point out that in addition, a bit of luck must be present to make it all come together, as it was for us.

There are still investors who are actively pursuing start-up companies. They are gutsy, and I believe they are wise. Good companies exist, and they are cheaper to get a piece of than they were in the past. If and when you find these rare individuals, stay close to them, and let them know that you value their participation in your efforts. You can’t live without them, and they will likely become valuable partners.

Building a fantastic company today is not for the faint of heart. I applaud anyone pursuing that goal. You know your business well and you know which of the suggestions I have offered are applicable to your circumstances. Take the ones that work for you, and best of luck in your fund-raising efforts.

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