Creative Financing for Startups

The Smart Startup Guide www.antiventurecapital.com TM Creative Financing for Savvy Entrepreneurs Who Need to Launch Their Startups Now Without Venture or Angel Capital Peter Ireland VOLUME 1 Copyright © 1996–2006 Peter Ireland All Rights Reserved Volume 1 COPYRIGHTS All title and copyrights in and to the manual are owned by the author, Peter Ireland, and they are protected by copyright laws and international treaty provisions. Accordingly, you must treat the manual like any other copyrighted material. Copyright © 1995-2007 Peter Ireland All rights reserved. No part of this manual may be reproduced, stored in a retrieval system, or transmitted by any means, electronic, mechanical, photocopying, recorded, or otherwise without written permission from the author. The Exclusive Licensee of this copy is John Smith. The Smart Startup GuideTM Vol 1 Table of Contents 1.0 1.1 1.2 1.3 1.4 2.0 So You Need Outside Capital to Start? ...............................................6 Starting Up the Old-Fashioned Way ...................................................6 The Benefits of Growing Without Investor Money............................... 13 A Venture Capital Rant .................................................................. 14 Protecting Yourself Against Money-Raising Scams.............................. 22 The Smart Startup ........................................................................ 26 This is just the first chapter. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 2 The Smart Startup GuideTM Introduction The AVC Smart Startup Guide was written for entrepreneurs who need to create cashflow quickly and with minimal up-front investment. This is the startup guide that I wish had existed back in the mid-1980s when my entrepreneurial career began. Since it didn’t, I began collecting stories about how innovative entrepreneurs launched their companies when outside capital wasn’t available. Someone once said that entrepreneurs are the artists of the business world because they create something out of nothing. The really good entrepreneurs certainly can. From both being an entrepreneur myself and working with other entrepreneurs for over two decades, I have come to divide them into two groups based on how they handle the startup phase. The first group weds itself to a particular product which then requires a certain sum of capital to launch. This group then takes the 1990s approach to startup by first writing a business plan and looking for investors to provide the funding. The problem with this approach is that most startups are never able to raise the necessary capital and, therefore, either die on the vine or finally morph into something else more do-able after six to twelve months of a futile capital quest. The second group consists of entrepreneurs who announce their intentions to go after a given market opportunity and are, seemingly magically, in business a month later with bona fide customers and sales revenues. What is the difference between these two types of entrepreneurs? What is the magic used by the second group? These are the questions that inspired the research which culminated in The AVC Smart Startup Guide. The objective of this manual is to help you to discover how to get into a cashflow positive situation first. That pet project requiring investor capital may, therefore, have to wait a few months. First things first, as they say. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 3 The Smart Startup GuideTM Shoot for cashflow immediately. Do not make the 1990s mistake of wasting 6 to 12 months writing a business plan and then shopping it around to strangers. Very few companies succeed at raising capital from outsiders. I want you to think of entrepreneurs as being like chefs. Some chefs are very rigid in their style requiring that a specific list of ingredients be made available to them before they can start cooking. This is fine as long as you are not too hungry and can wait for the required ingredients to arrive. However, if you are hungry now and lack the cash to buy more groceries, you will need to be flexible and work with what you have. Other chefs, the more entrepreneurial ones, will not wait for someone else to deliver a bag of groceries to them, but will instead immediately begin to search the pantry, refrigerator, and vegetable garden for what’s available. They then use the items at hand to create a feast. This is what true entrepreneurship is all about. The AVC Smart Startup Guide defines two basic startup models: the rigid Sitting Duck Model wherein nothing can happen until a specified sum of money is raised, and the flexible Smart Startup Model, a transitional model, which helps you to get started with whatever you have at hand. In entrepreneurship it’s all about cashflow and paying your bills. It’s not about wasting a half-year or more of your life shopping a business plan around to strangers as the bills stack up at home and your spouse fumes. Take my word for it, you may love a certain widget which you want to introduce to the world, but you will love positive cashflow even more. If your widget requires a considerable amount of money to launch, focus on cashflow first and launching the widget second. Peter Ireland Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 4 Manual Organization The first chapter introduces the invariably fatal Sitting Duck Startup Model. It also includes a rant on why accepting venture capital is, in most instances, a “Faustian Bargain” and concludes with tips on how not to get scammed when pursuing outside investment capital. The Smart Startup Model is introduced in chapter 2 which is the heart of this manual. The third chapter cover topics relating to entrepreneurial image management. Chapters 4 through 7 relate back to chapter 2 and elaborate on means for creating a “cash float” to serve as a substitute for the startup budget, which would normally be provided by your personal savings or outside investors. Chapter 8 offers advice on dealing with both angel and venture capital investors, should you decide to pursue them after you have attained positive cashflow with Smart Startup Model. Believe me, you will command far more respect with both types of investors, as well as enjoy a stronger bargaining position, if you have the cashflow which allows you to walk away from a bad offer. Chapter 9 in Volume 3 ties everything together by teaching you how business modeling can be used to speed up traction in the market as well as minimize startup capital requirements. One final point, if you are not familiar with the three terms: breakeven, variable costs, and fixed costs, please familiarize yourself with them and understand what they are. They are important concepts you will need to fully understand in order for this manual to help you. You can first read their definitions in the Glossary (Appendix C), and then review Appendices A and B for more detail. The Smart Startup GuideTM 1.0 So You Need Outside Capital to Start? "In hindsight, my first VC deal was a lot like being mugged. Never again will I allow that to happen." Anon Entrepreneur This chapters covers the following topics: Starting Up the Old-Fashioned Way The Benefits of Growing Without Investor Money A Venture Capital Rant Protecting Yourself Against Money-Raising Scams 1.1 Starting Up the Old-Fashioned Way Let me tell you what prompted the writing of this manual. It’s the repetition of a basic startup mistake made by countless entrepreneurs. This scenario plays itself out time after time, yet most first-time entrepreneurs appear to have to learn its lessons first-hand rather than learn them from their predecessors. Unfortunately it takes them as much as a year of wasted time and effort on average to finally see the light. I, for one, prefer to learn from the mistakes of others, whenever possible, and assume that you do as well. To illustrate my point about this basic startup mistake, let me describe to you what happens in all too many startups. The founder has an idea for a new technological product. He initially performs sufficient market research to convince himself that the project has real potential in a specific industry. He then begins formulating a business plan and putting it down on paper for potential investors. At the same time he begins recruiting management team members with complementary skills. All are decent journey-men types but not industry stars. In most cases, these are individuals with day jobs who promise to join the startup once it can afford to pay them. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 6 The Smart Startup GuideTM After about three to six months of research and writing countless drafts the business plan is finally deemed ready to be shown to potential investors. To launch the company an investment of $500,000 will be required to produce the product and start marketing efforts 1 . At this point enthusiasm and optimism are at their highest levels. Even the most pessimistic assumptions by the founding team call for the financing to be completed in 60 to 90 days. So with business plan hot off the laser printer, the team members begin compiling a list of people who might have some spare cash to invest in the company. Given the size of the capital requirements, the team decides to go after both angel investors and so-called “early-stage” venture capital firms, as the “3 Fs” (aka, “family, friends, and fools”) are deemed incapable of pooling together the required sum. During this first month of actively seeking capital, several angel investors are identified through business associates of the team members. These associates agree to pass executive summaries of the business plan onto the angels. By the fourth week the first meeting is set up with one of the angels. When the meeting finally takes place the team’s presentation goes well and afterwards they feel that they may “luck out” and obtain funding from this first investor. However, the team wisely decides not to ease up pressure in the hunt for additional investors. The first investor turns out to be not interested after all, but no worries, there are many other leads to follow-up with. Over the next month four more presentations are made to wealthy business-people. 1 I just pulled this number out of the air. The actual sum is not as important as the fact that the company needs cash it doesn’t have to start up. However, $500,000 is typically the smallest sum that investors will consider. Below that level it’s not worth the effort. See Transaction Costs in Appendix A for an explanation of why this is. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 7 The Smart Startup GuideTM All go well and the team is still riding high on the initial euphoria. Surely, they all feel, one of them will call back to announce that he wishes to invest. The attempt to attract early-stage venture capital interest is for the most part met with deafening silence. While the startup’s potential growth and cashflow make it appear to meet their investment criteria, the actual response is one of disinterest. So the team shifts it focus entirely to finding an angel investor or group of angel investors. Surely the right ones exist who will see the incredible investment opportunity that this startup represents? Four more presentations are made over the next month. As always, the investors look impressed and tell the founder that it’s a great product and that they will think about it. As before, they are never heard from again. By now three or four months of active capital raising efforts have gone by. The initial euphoria is starting to evaporate. The founder’s spouse begins hinting that it might be time to call it a day and go look for a job. After all, the bills are beginning to pile up. At this point the founder meets a businessman who offers to act as a finder. If he raises the money through his contacts, the finder wants to be paid a fee equal to 5% of the total funds raised. The founder agrees to the arrangement and sets the finder loose. Three more presentations are made as a result of the finder’s efforts. But these too go nowhere. At the end of his second month the finder drops out as well. By now nine months have gone by in total, including the three invested in writing the plan. The founder is beginning to notice that his calls to the other Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 8 The Smart Startup GuideTM team members are no longer returned quickly—if at all. One team member announces that he has to drop out of the venture. It can be safely assumed that others are weighing making the same decision. At this point, sometime in the six to nine month range, the venture begins to unravel. Without the $500,000 no progress can be made. And without progress it’s very difficult to keep team members motivated and committed. In summary, the founder has lost 6 to 9 months of his life, on average, along with the associated income because chasing capital is not something which can be done with a day job. 1.1.2 The Sitting Duck Startup Model Welcome to the rigid and inflexible world of the Sitting Duck Startup Model. The Sitting Duck startup cannot make one inch of progress until it raises the necessary investment. It’s an all or nothing proposition entirely contingent upon the investment dollars being raised. (That’s why I call it the “Sitting Duck Startup Model”.) I have seen entrepreneurs waste over a year of time and effort trying to make something happen with the Sitting Duck Startup Model. Inventors are particularly prone to investing years and years into trying to fund a pet invention. Why doesn’t this model work in most cases? It's quite simple. Raising money has always been done through personal networks and not through cold calls to strangers or the use of finders. The people who invest in your startup are the people with first-hand knowledge of your industry and its problems. As a result, they quickly recognize the value of the solution you are looking to provide. Finally, and most Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 9 The Smart Startup GuideTM importantly, they know you and your track record of success and accomplishment in the industry at least by reputation, if not personally. So in a nutshell, the entrepreneurs who are successful at raising startup capital from investors are the entrepreneurs who are already known personally by these investors or by their reputation as “industry stars”. Industry “unknowns” do not raise capital. Let me repeat: Industry “unknowns” do not raise capital. It’s that simple. An unsolicited inquiry will not lead to dollars being invested in your startup. It's akin to a cold call to an uninterested stranger. You may as well be a telemarketer interrupting a stranger’s dinner to pitch life insurance. Likewise, the best researched and written business plan will not help the unknown entrepreneur to raise cash. In many cases, the time spent on writing anything more than a brief two page executive summary is a total waste. I know the capital raising game from two decades of experience in working with hundreds of startups. Your odds of raising venture capital look like this: Maybe one in every 500 companies which tries to raise venture capital is successful. 2 (This is the company with the team of industry “stars”.) 2 This is based on the ratio of business plans reviewed to invested in by a typical VC firm over the course of a year. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 10 The Smart Startup GuideTM Of the successful ones, the founder is fired by the venture capitalists within the first 6 to 12 months in 50% of instances. So your odds of being a successful entrepreneur with outside capital are really about 1:1000. The odds are pretty much the same for entrepreneurs pursuing angel investors instead of venture capitalists. Why? Well, angel investors usually rely on venture capitalists to follow them in the second round so they will evaluate a startup in pretty much the same way that a venture capitalist does. If they cannot see the company being able to attract venture capital a year down the road, they will pass on it themselves. (Think of the financing game as a four-man relay team event in which the “baton” (company) is passed from angel investor to venture capitalist to investment banker and, finally, to John Q. Public via an IPO or Initial Public Offering.) The point here is that all investors are looking into the future trying to see how they will be able to exit an investment with their principal plus gain. If they can’t see someone else investing later in order to take them out, they will pass on the deal. In the post dotcom era, the venture capital investing standards look something like this according to a well-known figure in the industry: -management team comprised of industry stars in the CEO, VP Marketing, and VP Operations slots -technical team with at least one outstanding member -half a dozen Fortune 1000 customers who have been buying for at least a year positive cashflow for a year or more. This is only a slight exaggeration of the reality in mid 2003. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 11 The Smart Startup GuideTM Well then, what is the solution if you don’t meet venture capital investing criteria? If you don’t have the above team and track record, the answer is to avoid the Sitting Duck Startup model and instead design a startup model, which will enable you to start generating cashflow before any investment of outside capital is made. With the rigid and inflexible Sitting Duck model absolutely nothing can happen until the total required sum of money is raised and in the company’s bank account. Not an inch of progress can be made until then. In this day and age, wherein raising outside capital is impossible unless you are a recognized industry “star”, the smart entrepreneur commits to creating cashflow rather than wedding his fortunes to a widget which requires a lot of capital to launch. This lesson is repeated time after time by successful entrepreneurs. Rule # 1: Your startup business model is more important than your widget. Ask yourself, do you want to be generating cashflow in a month’s time, which ultimately could enable you to launch your pet product later? Or do you want to stubbornly stick to an all or nothing course based on the Sitting Duck Model where nothing happens until a lot of money is raised? 1.1.3 Introducing the Smart Startup Model The Smart Startup Model was created to help you design a startup strategy for creating cashflow quickly and with minimal financial resources. This model focuses on being flexible in your approach (recall the flexible chef analogy) and making the best of your current circumstances and resources. The inspiration came after observing that there are two basics types of startup entrepreneurs: Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 12 The Smart Startup GuideTM One group consists of founders who first write a business plan for the express purpose of raising a specific sum of startup capital from outsiders and who then spend the next 6 to 12 months in what is most often a futile campaign to attract dollars. The other group consists of founders who launch quickly without investor capital and then grow rapidly (sometimes rapidly enough to qualify for the annual Inc 500 Fastest Growing Companies 3 list). So ask yourself, which group do you want to belong to? The Smart Startup Model will be introduced in Chapter 2. It is derived from research into successful fast growth companies which substituted a winning startup strategy for a big startup budget. 1.2 The Benefits of Growing Without Investor Money Although growth fueled almost exclusively by internally generated cashflow brings with it certain consequences: 1) internally financed growth can be relatively slow, and 2) some potential profit opportunities must be by-passed due to limited cash flows, there are important advantages derived from starting with the bare minimum of capital as well. These advantages in most cases far outweigh the disadvantages over the medium and long term. The advantages of growing without outside investor capital include: 3 Inc is a registered trademark. Don’t say that I didn’t warn you. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 13 The Smart Startup GuideTM forcing you to grow the old-fashioned way: i.e., through actual sales of product and/or service, allowing you to focus your undivided time and energy on understanding your markets and providing the best value to your customers, allowing you to retain control over your venture, instilling survival skills that help you to survive the difficult times building up true confidence in your ability to grow a profitable business. There is a wealth of research to show that self-financed startups fare better over the long-run. At least one university researcher has stated that the strongest competitors in a variety of industries began without OPM. A study carried out by one of the largest accounting firms of several hundred successful fast growth companies showed that the vast majority were started with nothing more than their founder’s money. Sixty percent of today’s Fortune 500 companies were started with less than $20,000. The facts are that most successful companies did not utilize OPM (Other People’s Money) early on and are probably where they are today in large measure because of that important fact. They gave themselves time to grow in a controlled manner. Entrepreneurs can and do grow the majority of successful companies without the assistance (or interference) of outsiders. Let me now take a few minutes to rant about why I dislike venture capital so much after all these years. Feel free to skip this section and go to the last one in this chapter if you have no interest in the subject. 1.3 A Venture Capital Rant While the venture capital industry plays an important role in the economy its investment dollars are given to approximately one in every 500 or 1000 Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 14 The Smart Startup GuideTM companies which attempt to raise it 4 . Although entrepreneurs can thrive in situations where the odds are stacked against them, these particular odds are just too onerous to make it a worthwhile pursuit in the great majority of cases. The same time and energy would be better spent on building the company in a more gradual and less dramatic manner. Unfortunately, many new entrepreneurs hold the belief that the solution to most of their business problems is an infusion of OPM whether it comes from venture capitalists or private investors (a.k.a. “angels”). The harsh reality is that OPM by itself is no magic bullet. It will not add a single dollar of sales or profits to your income statement. In fact, it will work to radically reduce your level of autonomy. The truth is that OPM typically brings with it as many restrictions and problems as it allegedly solves. Its hidden costs are numerous and substantial. The following section covers the disadvantages that come hand-in-hand with outside money. The examples described may appear anecdotal but are in fact universal experiences of entrepreneurs who have accepted outside investment dollars. The most expensive money available from legal sources It is by far the most expensive money an entrepreneur can ever tap into. Let's do the math to see why this is. Suppose you and a venture capitalist agree to a "pre-money" valuation of $1 million for your startup, and the venture capitalist then invests $1 million for 50% of the equity. After the investment, the company is said to have a "post-money" valuation of $2 million. Being 50/50 partners sounds acceptable, right? 4 No one knows the real figure, so I use the more optimistic 1 in 500 ratio in this manual. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 15 The Smart Startup GuideTM Three years later the company is sold to a Fortune 500 corporation for $5 million. Do you and the venture capitalist each get $2.5 million from the proceeds? Not on your Nellie! The venture capitalist will have a so-called "liquidation preference" built into the original investment agreement which allows him to first take out 2 to 5 (or more) times his principal before anyone else sees a penny. So, let's say that in this example he takes out $3 million (i.e., a very modest "3X liquidation preference"), plus any accrued dividends on his preferred stock. After exercising the liquidation preference and cashing in his dividends only $1 million is left. You, the founder, and your team, will then split this remaining money on a 50/50 basis with the venture capitalist. This is a simplified example of what happens. In real life the founder and her team would probably receive far less than even the $500,000 due to all the fine print clauses and higher liquidation preferences. At this point, you really have to ask yourself if it's even worth the effort. Chasing VC is a distraction from the real work So why do so many entrepreneurs spend so much time in a pursuit of venture capital? Chasing venture capital financing is often a tempting distraction for some rookie entrepreneurs wanting to avoid the real task at hand in building a business. Let’s face it, writing a business plan, while a tedious task, is infinitely simpler than developing and producing an actual product or service to sell. Moreover, shopping a completed business plan around to a finite and readily identifiable list of local venture capital firms is much easier relatively speaking than trying to find potential customers and persuading them to write a check. By pursuing venture capital some entrepreneurial wannabes can indefinitely postpone the day of reckoning when the market tells them whether their business idea will fly or not. In most instances chasing venture capital is not a good use of the entrepreneur’s time. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 16 The Smart Startup GuideTM Raising VC is war The search for venture capital is akin to psychological warfare because the venture capitalist’s goals are at odds with the entrepreneur’s from day one. Furthermore, the venture capitalist is out to make the best deal for himself and maximize his protection (read "control" over your company). It takes on average anywhere from six to twelve months just to find a venture capitalist who maybe interested in your opportunity. This search phase is normally very exhausting both physically and mentally for the entrepreneur because by the time serious investors are finally identified the company and founder are beginning to either run out of cash or are in danger of being leap-frogged by a competitor. So by the time the serious interest has been identified, the entrepreneur is most likely to be suffering from severe stress. The venture capitalist understands this fact and uses it to his advantage. “The Classic VC Trap” At the point at which serious negotiations finally commence the stress level takes another major jump for the entrepreneur — particularly if the venture capitalist sees a cash-desperate company which can be squeezed for extra equity in The Classic VC Trap. When venture capitalists see that you are going to run out of cash within a short period of time necessitating the shutdown of your company, they will sometimes deliberately stall negotiations to push your company to the edge of bankruptcy. They will then ask for more equity in return for the same investment amount. The venture capitalists know that if you face a choice between shutting down or accepting a bad deal from them, you will in most cases do the latter. While this strategy appears a smart move to the wonderboy MBAs running the venture capital firm it is not in reality. Over the long term the added dilution of the founding team’s equity serves to dis-incentivize them not to mention fuel resentment against the venture capitalist. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 17 The Smart Startup GuideTM Some venture capitalists would sooner kill your company then let you walk away from their offer. VC deal terms can destroy your incentive The conditions for investment by a venture capital firm can be onerous, particularly if the company finds itself in The Classic VC Trap. Let me give an example of what is likely to happen when they put money into your company. Under the investment agreement terms signed by one founding team anyone who left the company before serving a full ten years would have his equity purchased back by the company for 1/10th of its book value. This is an accountant’s euphemism for, "If you leave before ten years are up, you will get nothing." Imagine being a loyal and productive employee for nine and a half years and then being forced to accept next to nothing for your equity because you need--for good reasons or bad--to leave the company. The truth is that many venture capital deals are signed under duress by cash-strapped entrepreneurs and are therefore quite draconian. VC reduces your freedom Venture capital brings with it a loss of control for the entrepreneur. Suddenly the founder who held complete control over the company finds him or herself with a minority interest and answering to VCs with minimal or non-existent industry operating experience. Rarely will outsiders provide capital without first gaining a controlling interest or at least a veto on major decisions. Expect input in almost every aspect of your affairs once outsiders become involved. Response to new opportunities and changing market conditions will no longer be swift, but rather a matter of consensus building, a process that can be excruciatingly slow and all too frequently fatally slow. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 18 The Smart Startup GuideTM Despite your equity and status as founder you become a de facto employee as soon as venture capitalists enter the picture. VC reduces your effectiveness Successful entrepreneurs tend to be good sales-people. They are also people who get excited by the opportunity to blaze new trails. Their passion centers on taking an idea and turning it into a profitable reality. Once the big challenges give way to pencil-pushing tasks as necessitated by investor interests, the entrepreneur’s effectiveness begins to diminish. Entrepreneurs tend not to make good bureaucrats. It's a matter of temperament. And once outsiders step in the entrepreneur's responsibilities will begin to shift away from the things he or she is good at towards more bureaucratic functions: preparing reports and policy manuals, sitting in meetings, writing memos, and hand-holding nervous or meddlesome investors. Ironically, these types of political activities are the things most entrepreneurs had hoped to escape by becoming their own bosses. Ask yourself if you want to experience this again. Brainsucking Many rookie entrepreneurs cannot tell the difference between sincere interest by an investor (or acquirer) from attempts by an unscrupulous party at merely uncovering their secrets. Larger companies will frequently feign interest in your company as a potential investment, strategic alliance, or outright acquisition in order to uncover proprietary technological or operational details. This unethical practice has come to be known as “brainsucking” in the technology sector. Dealing with venture capitalists dramatically increases the risks of being “brainsucked”. Venture capitalists never sign non-disclosure agreements (a.k.a., NDAs), and for good reason. They simply review and invest in too Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 19 The Smart Startup GuideTM many similar deals to be able to risk leaving behind a trail of NDAs which could be used against them by an unethical party. However, despite their verbal assurances that they will not divulge any of your information, the reality is that they often do share your secrets with both their portfolio companies and colleagues in the industry. Information is often just as valuable a currency as money itself. VC amplifies the pressure An investment always brings with it expectations of both cashing in and, ultimately, cashing out for venture capitalists. They expect a healthy return on their investment to compensate for the high risk that they perceive comes with it. Therefore, the pressure on you to grow and show profits rapidly mounts once they are in the picture. Furthermore, the venture capitalists want to be able to exit in a specified period of time. All this can result in products being launched before they are ready; entry into the wrong markets; and a host of other bad decisions being made due to pressure from parties whose sole interest is a quick financial pay-off. Venture Capitalists are sheep Venture capitalists behave like sheep by investing only in whatever industry has currently attracted the flock’s attention. If your company is not in the flavor of the month industry don’t bother applying. Venture capitalists tend to put the cart before the horse For some reason unbeknownst to experienced businesspeople, many of the young MBAs running venture capital firms these days have bought the old adage “if you build it, they will come” hook, line, and sinker with regards to their portfolio companies. So when sales are slow or nonexistent the venture capitalists settle for the appearance of “growth” through an increase in the Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 20 The Smart Startup GuideTM company’s staff and infrastructure. Venture capitalists call this forced expansion of the company’s resources and assets “ramping-up”. Somehow the sight of a well-populated “cube-farm” is comforting to venture capitalists. And by ramping-up venture capitalist logic assumes that sales will automatically follow. Unfortunately, the anticipated sales do not follow in many instances and the company is shut down once the cash is gone. Of course the founding team is always blamed for the failure by the venture capitalist who never accepts any responsibility for what transpired. The “Resident Entrepreneur” A recent trend is for venture capital firms to have a “resident entrepreneur” on board. Ever ask yourself who this is? If you’re the founding CEO think of the resident entrepreneur as your interim replacement once you have been fired. And fired you will be in most cases within the first twelve months. Whenever there is a problem the venture capitalist’s knee-jerk reaction is to fire the founder and replace him or her with their own lackey. The venture capitalist’s one answer to all problems A venture capital firm’s one answer to almost all problems faced by its portfolio companies is to fire the founder. The “resident entrepreneur” is then parachuted in to take over the controls until a permanent management team can be put together. The replacement team typically consists of big company executives who then do exactly what they did at their Fortune 1000 jobs: hold endless meetings, write memos, and hire their consultant buddies to do everything. Big company executives are wholly unprepared for the issues in a small company and usually end up running it into the ground by spending money like the proverbial drunken sailors. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 21 The Smart Startup GuideTM Then the venture capitalists blame the replacements as well as the founder for the failure. The venture capitalist’s main strength Even the venture capitalist’s main strength works against the entrepreneur. Venture capitalists negotiate investment contracts (a.k.a., “term sheets”) for a living and at this they are very good. They are far better at it than 99.9% of the entrepreneurs out there, so from the beginning they enjoy a marked advantage over you in negotiations. Moreover, they are under no pressure to close a deal as is the cash-strapped entrepreneur in most cases. As a result most startup management teams lose control of their companies to the VCs on the first financing round. The venture capital firm may have a minority equity position on paper but the fine print will reveal that they have the power to oust the founders anytime they so choose. 1.4 Protecting Yourself Against Money-Raising Scams Finally, before we proceed with how to grow your company without investor capital a few final myths about the money-raising process need to be demolished should you ever decide to pursue it for expansion purposes after successfully launching first. 1.4.1 Money Middle-men Almost everyone is a middleman these days promising to help entrepreneurs raise venture capital or angel money. Indeed the middlemen sector is a fast growth industry far outstripping the numbers of actual entrepreneurs appearing each year to launch a new venture. Let's take a quick look at the four main types of intermediaries. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 22 The Smart Startup GuideTM 1. Money Brokers There are many individuals out there who represent themselves as people who can raise investment capital on behalf of companies. They typically charge to write a business plan and then shop it around to their list of “eager investors". The truth is that bona fide investors tend to not be impressed by entrepreneurs who utilize intermediaries to solicit capital on their behalf. Investors prefer to deal directly with the principals rather than with a finder who will have only a cursory understanding of the company and its industry. Ideally the company should appoint a senior team member to manage the capital raising campaign. Beware especially of people who ask you for up-front fees and/or retainers to cover their “expenses” while they search for money on your behalf. Someone who is certain that they will be able to raise the money you need should be willing to wait for payment once the capital has been transferred into your corporate bank account. Internet match-making services are to be found advertised in almost every business publication today. They also rarely—if ever—raise capital for the entrepreneur. In fact, the entrepreneur who utilizes these services, in most cases, ends up with less money than when he started due to the various upfront fees charged by them. 2. “Pitch Night” Organizers During the insanity of “dotcom mania”, which lasted from about 1998 to mid 2000, some individuals organized monthly “pitch nights” wherein cash desperate entrepreneurs could mingle with and pitch to alleged investors. Having attended quite a few of these events in various cities, I can vouch for Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 23 The Smart Startup GuideTM the fact that the bona fide investors were far and few in between. Rather the “crowd” tended to be comprised of sales-people looking for leads. The typical experience had by entrepreneurs networking at these events was to be deluged over the following week with calls from “investors” who were in reality commercial real estate brokers, insurance agents, PR specialists, consultants, and a host of other service providers looking to pickup new clients. 3. Money Raising “Boot camps” During the dotcom era one outfit charged rookie entrepreneurs over $1000 to attend a weekend training camp on raising venture capital where the basic lesson was: “When it comes to raising money, it’s not what you know but who you know.” Needless to say, there were many dissatisfied attendees on Monday morning once it sank in that they had paid a significant fee to hear the obvious. 4. Attorneys and CPAs If you can afford to spend $150 per hour or more for worthless advice and empty promises of “introductions” to monied clients, then use the services of a professional firm. If you really think that they will risk their relationships with wealthy clients by introducing them to rookie entrepreneurs who will most likely lose the former’s money, then there's some prime ocean-front property in Kansas that I’d like you to take a look at. 5. Venture Capital Directories Word to the wise. Do not waste your money, whether it's $29.95 or $499, purchasing those CD directories of VC firms. Two reasons for this: Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 24 The Smart Startup GuideTM 1. Venture capital firms are easy to find for free using nothing more than the local phone book and google.com. They want to be accessible. 2. You only need the names of the firms within an hour's drive of your company anyway. Venture capitalists are far too busy to invest in anything farther than that. Ask yourself, if you were an investor, would you want to be able to reach your portfolio company with a short drive or a plane ride. So why purchase a directory which lists 3,650 VC firms of which 3,648 are at least three states away from you? Just “Yahoo” or “Google” it! Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 25 The Smart Startup GuideTM 2.0 The Smart Startup Entrepreneurs who devise startup strategies which enable them to focus on generating sales in the first months, rather than on pursuing investment dollars, tend to do far better over the long run. This chapter covers: Business is About Cashflow Entering the Stream of Opportunities The Smart StartupTM Model Model Building Questions Suggested Reading 2.1 Business is About Cashflow Rule # 1: Your startup business model is more important than your widget. Savvy and successful entrepreneurs commit themselves to creating quick cashflow rather than to finding funding for a particular widget. Business is about creating the cashflow to pay your bills, enjoy an income, and build wealth over time. The specific widget used to accomplish these goals is of secondary importance. Unsuccessful entrepreneurs stubbornly wed themselves to finding money to launch a specific widget. They unwittingly act as if the widget was more important than the cashflow. Most widgets turn out to be un-fundable, unless you have strong pre-existing relationships with investors and a proven track record which inspires their confidence enough to write you a check. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 26 The Smart Startup GuideTM Okay, so if you don’t commit to a particular widget, what do you commit to? The answer is you commit to creating cashflow in your targeted industry or market. Startups are all about cashflow. By the time you have finished this Guide you should have at least two or three ideas for a fast, low-budget launch that can get you started. The Positive Feedback Loop When it comes to the pursuit of cashflow be as agile, flexible, and determined as water flowing downhill towards the ocean. Quick cashflow triggers the all-important positive feedback loop which boosts your confidence which then, in turn, boosts your performance. Rinse and repeat. There is probably nothing more important for your entrepreneurial success than this positive reinforcement. Do you want to create a negative feedback loop? Then simply shift your focus to trying to raise startup capital instead. Let me tell you about how musician Kid Rock got started to illustrate the importance of going for cashflow instead of sitting around waiting for some kind stranger to drop money into your lap. Many aspiring musicians will complain bitterly about not having the funds to produce their initial CD. Kid Rock didn’t. Instead he arranged to live in a recording studio for free in exchange for cleaning the offices and running errands. Then he would record the songs for his first CD in the middle of the night when the studio was not in use. Afterwards, he sold his CD at concerts and out of his car when fans recognized him on the street. Kid Rock didn’t wait for anyone to hand him a check. Instead he just focused on finding the shortest pathway to his goal. I offer this story as an illustration of the kind of determination and creative problem solving that is required to succeed as an entrepreneur. Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 27 The Smart Startup GuideTM ~ End of transmission ~ To read the remaining 63 pages of Vol 1, 83 pages of Vol 2, and 48 pages of Vol 3, you need to get your own copy of the Smart Startup Guide right now. There are four stages of learning: Stage 1 - Unconscious Incompetence - you don't know what you don't know. Stage 2 - Conscious Incompetence - you now know what you don't know. Stage 3 - Conscious Competence - you now know it, but you have to concentrate to use what you know. Stage 4 - Unconscious Competence - you know it, and you can do it without thinking about it. If you’re looking for startup capital on the Internet, you’re most likely at Stage 1 when it comes to both starting a business and raising capital. Within 48 hours of buying the Smart Startup Guide you will be at Stage 4. Stop Wasting Time Chasing Dead Ends And Start Moving Forward. http://www.antiventurecapital.com/avcguide.html Copyright © 1995-2007 Peter Ireland www.antiventurecapital.com 28