4 things to consider before you ride on the wings of angels

Before you seek financing from angel investors or angel networks, make sure the fit is right. If you or one of your co-founders has built a business before, sold it, and made profits for your investors, you can probably break the rules. Otherwise, take note of the following guidelines:

1.) What stage are you at? In general, your chances of raising angel funding are much greater if you’ve already got a product developed. It doesn’t have to be full-blown, but the most critical features should be operational. Get that product created any way you can – with financing from your savings, your credit cards, or from friends and family, by giving away equity to partners, by bartering for services – whatever it takes. Just have it up and running.

2.) What’s the money for? As per the paragraph above, many angels are reluctant to spend money to help you build your site. They’d rather see you put their money towards proving customers want your product. Use angel money to find out what percentage of people who see your product use it, pay for it, stick with it, and tell friends about it. Have quantifiable targets in mind, and measure your results.

3.) How much do you need?  An angel round is typically between $100,000 and $750,000, and individual angels tend to write checks for $25,000 to $100,000 each. Looking for less? Go back to friends, family, savings, etc. Looking for more? Either find a way to make do with less, or take a shot at raising venture capital.

4.) What’s your exit strategy? Your rich Uncle may invest because he loves you, but angels have other goals in mind. Yes, many angels get off on helping to create new business, but for the most part they are economic animals. They want a return on their investments. How and when will you turn their $25,000 into a much bigger amount of cash? You can’t know for sure, but have a reasonable hypothesis in mind before you pitch.

3 lessons from the Harvard B-School business plan contest

I’m in town to judge the Harvard Business School Business Plan Contest. We held the semi-finals yesterday, narrowing the field of student teams from 85, to 10 semi-finalists. The winner will walk away with $100,000 later this month.

My fellow judges were an impressive group. They included venture capitalists form Polaris, Bain Capital, Flybridge, and Highland, and entrepreneurs from BlueMercury, HubSpot, Care.com, TripAdvisor and Trader Joe’s.

My panel judged consumer-oriented plans, including ecommerce, travel, dining and retail. Most of the pitches I judged were well-organized, polished, and thorough. A lot of the students were ex-McKinsey and Bain consultants, and they were particularly strong on strategic and quantitative analyses. But even the HBS students could stand to learn a thing or two about pitching in the real world. Here are two lessons in particular:

1)  Sell, don’t just inform.  Reading off of slides with dozens of bullet points and busy, number-filled charts may work fine in a consulting firm boardroom, but not at a pitch. We want to see more than just the facts. Tell us how you came up with your idea, and what inspired you. Show us your passion.  Bring your vision to life.

2) Teach us about your industry. Some companies pitched businesses in fields where the judges had limited experience, like airlines or restaurants. If that’s the case, educate your audience. Tell us the three keys to a successful restaurant chain. Explain why airlines tend to fail, and how you’ll avoid common pitfalls.

3) Big investments are not always the answer. Students coming out of business school are surrounded by venture capitalists. But some business ideas are better off bootstrapped. Some founders looking for million dollar seed rounds probably should be taking a different approach. They could consult on the side to fund the development of prototypes, use off the shelf technology at first instead of building their own, add founders with key skills instead of hiring employees, and get traction before seeking substantial funding.

Been to a business plan contest lately? What did you learn?

More evidence in favor of deck, not doc

You’ve heard it from me before, and you’ll hear it again: Do the all the important thinking behind your business plan, but create a 15 slide deck instead of a 40+ page term-paper style document. Here are two more data points:

1. Sequoia Capital is the venture capital firm that backed Google, Yahoo, YouTube, eHarmony, LinkedIn, and PayPal, among many other winners. On their site, they offer the following advice: “We like business plans that present a lot of information in as few words as possible … 15-20 slides … is all that’s needed.”

2. New York Angels is one of the leading groups of angel investors in the U.S. They’ve invested over $20 million in 65 early-stage, New York-area technology and new media companies. On their site, you’ll see the following suggestions about the format of business plans: “Slideshows with under 20 slides are generally most effective … Use the limited time you have for your presentation to emphasize the compelling factors about your investment opportunity and save unnecessary technology details for future meetings…”

Need help building a business plan presentation? Contact UpStart Advisors.

Beware bad partners bearing cash

I met with a successful consumer products entrepreneur today, and he told me how he spent the past few months unwinding a partnership–complete with legal costs, wasted time, and frustration.

Long story short, he took investment capital from a wealthy person with nothing to do and a desire to be involved in running the business. That person proved to be a lousy operator and awful partner. The story made me cringe, not only because I’ve heard it before, but because I made the same mistake many years ago.

I know, I know, you need capital now to start–or preferably to grow–your business. But be very careful about mixing investors and partners / employees. Think about whether you need to fill a specific role on your management team. Then profile the skills and experience of your dream candidate for that role. Before you even consider having an investor fill the role, be sure they are a great fit, and that they’re someone you know very well , trust, and want to work with every day.

4 things you should NOT say to potential investors

1. “I really don’t want investors meddling in the business.” I heard this beauty from someone who asked me for an introduction to an investor. Needless to say, the conversation stopped there.
2. “Our financial projections are conservative.” Puhleeese. You’ve got revenue of um, zero, now. And within three years you’ll have $x0,000,000. Sounds very conservative to me.
3. “I’ll send you my pitch deck.” NOOOOOO. Send a 1 page synopsis. You should present your pitch in person, or at least via web conference.
4. “Before I tell you the basic idea, I’ll need you to sign an NDA.” If you think your basic idea is the true source of the value you’ll create over the next 3 – 5 years, you’ve got bigger problems. It’s (nearly) all about how well you’ll execute.

17 questions to ask yourself when planning a business

Here are questions I ask my clients when helping them develop business plans to raise capital:

1. What are your goals for the business? Is there a revenue number you’d like to hit? Do you want to sell the business, and pull out some amount of personal wealth? Do you have other motivations (e.g. fame, press, a bridge to other opportunities, etc.)?
2. Who is on your current team, and why are they uniquely qualified to execute your plan? As you expand your business, what are the key management roles you’ll need to fill? Have you identified candidates for those roles yet? Do you know what the cash / equity compensation will be?
3. Do you have recent data on the size and growth rate of your industry? What are the key trends driving the business?
4. What customers will you be targeting? Can you prove that they’ve got unmet needs
5. What will be your unique positioning within the market?
6. What businesses most closely resemble the one you will build? Do you have data on how they built their business, including the evolution of their product lines, distribution, and revenue
7. What will your product offering consist of, and how will it evolve over time – including categories and price points?
8. What’s your marketing strategy?
9. What are the unit economics of your business? What does an average sale look like in terms of revenue and variable costs? What’s your break-even volume?
10. What’s most likely to go wrong with your plan, and how can you prevent it from happening? How have similar companies failed / what obstacles did they run into?
11. Who are your competitors? How are they doing? How will you differentiate yourself from them?
12. What are the next phases of implementation? What tangible milestones will you aim for in each phase?
13. What have you accomplished to date that helps prove you are capable of executing against your plan?  That can include:  the team you’ve built, distribution channels and performance in those channels, revenue, branding, etc.
14. To what extent have you projected your future revenues? Expenses? Team structure? Distribution?
15. How much capital are you raising in the current round? Where will the money get you? How will you spend it? Will you need additional funding? When? How much?
16. What’s your exit strategy? Who will buy your company? Why? What will they pay? What transactions can you point to that lend credence to your exit strategy?
17. What is the valuation of your company today, and the basis for that number? How much equity are you willing to give up to new investors in this round?

Lottery vs. venture capital

I was just reading in Crain’s that only 19 companies in the NY-metro area closed early-stage venture capital funding last quarter. 19!!!

That got me thinking, are you better off playing the lottery? The numbers aren’t apples to apples, but just for fun, consider this:

• 1,600 people per year in the U.S. win at least $1 million in the lottery.
• 483 companies raised seed stage VC funding in 2008, and another 1,072 got early stage funding.

Not far off!! So, unless you’re sure you’ve got the right stuff (e.g. team with previous startup wins, chance to generate $100 million+, significant traction to date, a network of vc contacts, etc.) – stick to bootstrapping or angel funding through your early stages.

Bootstrapping pointers

A friend and business partner, Beth Schoenfeldt, from Collective-E, just asked me a couple questions about bootstrapping for a webinar. I thought you might find the Q&A helpful:

Beth: Can you name any big brands that were originally started by bootstrapping?

David: Apple, YouTube, Facebook, Yahoo, Microsoft, Google and Whole Foods all got traction via bootstrapping before raising significant outside capital.

Beth: What are a couple great ways to get services or products for less?

David:

• Hire less experienced employees with raw potential. Train them yourself (but avoid giving them inflated titles). Bring in top talent later. Use freelancers where possible – especially for one time or part time needs.
• Forget the pr firm. Instead, use social media to create your own voice to the public, via blogging, Facebook, Twitter, LinkedIn, etc. Establish yourself as an expert, and develop a rapport with bloggers and journalists so they reach out to you when they need your POV.
• Syndicate. Tap into other properties with audiences you’d like to reach via guest blogging, active postings on message threads.
• Barter. Find products or services you can provide with minimal / zero cost, that other companies may find valuable. Got an email newsletter or website that makes money from advertising? Give away some of your inventory (better yet, unsold inventory) in exchange for products or services.

Beth: What if you have bootstrapped it for a while now and feel stuck, any suggestions?

David: You can always raise capital after boostrapping. In fact, it’s often better to bootstrap your way until you’ve made significant progress (e.g. revenue) BEFORE raising capital. Having that traction will make it faster and easier to raise money, and usually lets you keep more equity.

Anatomy of a vc funded startup

More insight into the Mint deal, and how the stages of financing and growth play out in a venture-backed model from Christine.net:

The straight shot: Why should you raise money, and how much?

• Step 1: When you’re ready with an Idea: Raise $100K from friends and family, and use it to build a prototype.
• Step 2: Once the prototype is done: Raise < $1M in seed capital, and get into market with an alpha launch.
• Step 3: After that initial launch has traction: Raise $5-10M, and use it to prove/scale the model.

Garage Phase: What are the costs and milestones?

Here’s how MINT spend its $100K of garage money:

• Founders: $30K/year living expenses
• Engineering 1st hires: $30-50K/year
• Office: $400/cube/month
• Tech: $10K
• Legal: Deferred payments for 0.50 – 0.75% of company

Roughly, 2 founders + 1 engineer/contractor = $150K/year burn. This gives you 6 – 9 months of runway before you need to raise a seed round.

In order to get that seed round, you’ll need to understand your competition, and come up with projections. Everyone knows this will change…but you need to show your thinking around it anyway. As an example, MINT originally projected $30/user/year for lead-gen and CPA. (Aaron noted that the company is pretty close to this today. But this is the exception rather than the rule.) Know how the business model works. People do X behavior and it turns into $Y income, add up those $Ys and it’s a $Z business. If you can walk people through these assumptions convincingly, you’ll get that seed round.

Seed Round: What are the next costs and milestones?

• Salaries: $50 – 90K/year ($450K/year for 5 people)
• Overhead: +20% ($100K/year)
• Legal: $25K + $2K/month ($50K/year)

MINT.com raised $750K in its seed round to cover these expenses for 12 months, which is about how much time you’ll need to develop into the Series A stage.

What model do you build next in order to raise the Series A? Testing and learning from your seed model, show user growth, retention, COGS, revenue per sale/user, and profit. The accumulated loss is how much you need to raise, and a well-though funding strategy combined with an understanding of (hopefully good) business economics is what will speed the Series A process along.

Series A: Now what?

• Salaries + Overhead: $200K/year/person
• COGS: Varies, but even one-time expenses magically add up to $150K/month
• Legal: $10-50K/month

Total burn for a 30-person team: $6M/year. Naturally you don’t start out burning this much, as it takes time to grow the team. However the numbers work out, your goals should be the same: Get profitable within 2 years. Raise the capital you need to do this without much distraction.

If you want to raise more after this in order to grow more aggressively or extend otherwise, your success in achieving those first two goals will speak for itself.

Economics of an exit

Just read an interesting article on Silicon Valley Watcher, describing the economics of a vc-backed exit:

“…Here’s how the math works against EVERY employee at an overfunded startup – take the mint deal for example: $170M exit (maybe $70 or so is future perf related so that leaves $100M), even without liquidation prefs, the employees get basically nothing. $40mil VC = maybe 60% of the company, 20% for the founder CEO, 3% each for the next 5 guys. That leaves everyone else sharing $5mil to vest over the next 4 years. And even that’s skewed for a few people. So with the biggest VC exit of the year, the employees are basically vesting a $20k annual bonus. gee thanks. Huge VC rounds are only good for people who own big, early, preferred chunks already.”

Of course, that kind of exit is pretty rare, especially lately. And usually there are a few founders splitting that 20%. Plus, of COURSE there are liquidity preferences up the wazoo, so the pie gets reduced (VCs get their investment amount off the top, or sometimes 2x that amount, before the pie gets divided among them and the others).