‘Blog’

How to determine valuation of my start-up in 3-5 years for VC funding?

Wednesday, June 15th, 2011

Valuation is in the eye of the beholder, and cannot be taken in isolation. When we say valuation is in the eye of the beholder, we mean that what a company is worth to me may be different from what it’s worth to you. I may have an idea or proprietary technology that will transform the company, whereas you may only perceive value in liquidating the company. Moreover, in VC deals, value is something that is negotiated, so a lot will depend on your negotiating skills. This is particularly true in the case of early stage companies, where profits (or even sales) have not yet started to roll in. There are many well known examples of very valuable companies that have not yet figured out a “revenue model”; they are valuable simply because they have a good story and a very credible management team.

Valuation is also something that cannot be taken in isolation. For example, you may be willing to give up a little in valuation in return for more control over the company (e.g. through board representation or veto rights). Alternatively, you may insist on a higher valuation if the VC asks for a higher multiple in terms of liquidation preference (i.e. the number of times the VC wants to multiply his investment before any proceeds of a sale go to the founders).

For early stage companies in particular, valuation is a very amorphous – and contentious – concept. The correct way to think about how to value an early stage company is “it depends”. While this may not seem like a very satisfying answer, if you adopt this approach you will find the fund raising process far more interesting.

Why do VC’s or Angel Investors insist on large fundings…greater than $100,000

Tuesday, June 7th, 2011

The typical angel deal is about $500,000, but angels often co-invest via an angel network, so each individual angel might only invest 10% of the total deal. It’s not unusual to find transactions where there is only a single angel investor who invests less than $100,000. VC firms, on the other hand, typically don’t invest less than a few million dollars in a single company. That’s because VC funds are structured as limited life entities, where the fund manager gets a fixed percentage (usually around 2%) of funds under management as a management fee, plus a percentage of profits. Since the entity has a limited life, typically around 10 years, the funds have to be deployed and liquidated in a finite amount of time, so there are only a certain number of deals that can be done. Since you can only do a finite number of deals, the larger the fund size, the larger the size per deal. Also, since fund managers get a 2% annual management fee, they have an incentive to manage larger funds –a small fund results in a lower salary for the fund manager.

Although a VC that manages a $100 million fund might want to do about 20 deals where he or she can deploy about $5 million, there may be some flexibility around this. For example, if you say to the VC that you ultimately need $5 million, but would like to take it in stages (starting with $100,000), they may be more receptive.

Bootstrapping vs. Venture Funding Statistics: How many large companies (eg Fortune 500) ever received venture financing? What percentage of venture funded companies succeed (or fail)? What percentage of startups seeking venture financing ever receive it?

Monday, May 30th, 2011

Many well known companies today have received private equity funding at some point in their history – about a third of them. The number would be higher, but many of today’s largest companies are older than the venture capital industry. Well known companies that received venture capital include Google, Apple, Amazon.com and Facebook.

Getting venture financing doesn’t mean that your startup will be successful. It’s hard to give a percentage because it varies over the course of an economical cycle, but it’s safe to say that between 20 to 50 percent of venture funded companies fail (the failure rate in hyped sectors are at the higher end of the range), and only about 10-15% succeed; the rest survive but are not great successes. Most investors would agree that most of the ventures they back are flawed, perhaps as many of two thirds of venture funded companies have some major drawback.

Venture backed companies are usually able to grow much faster than non-funded companies, not only because they have more resources, but also because being venture-funded gives a company a certain cachet, which can help a company in building confidence among customers and lenders.

Less than 1% of startups who seek venture funding ever receive it.  Today it’s harder than ever because many venture capital firms are focusing on “growth companies”, not start-ups. If you are trying to raise money for a start-up, it might be better to speak to angel investors.

Will you use your own money or capital to start-up your own company based on your brilliant idea? Should you use your own capital in starting-up or look for funding?

Thursday, May 26th, 2011

Most entrepreneurs do not start up with a large amount of capital, unless they have cashed out of a previous successful venture. However, unless the entrepreneur demonstrates that he or she really believes in the venture, it may be difficult to demonstrate to other investors – even friends and family – that the venture is worthwhile. The one thing that entrepreneurs have to offer is their own time, so if the money is required to pay for salaries, that’s a red flag for investors.

Some ventures require very little money while starting up. For example, if you write well you could start an online publication with yourself as the writer and editor in chief. In such cases, it would not make sense to seek external funding initially. However, if the start-up proves successful, you may decide to raise funds for marketing. If you have been able to achieve a certain amount of revenues or profitability, you may be able to negotiate with investors from a position of strength.

On the other hand, some start-ups require so much money that it’s impossible for the entrepreneur to start small. In such situations, the entrepreneur has no choice but to look for external funding. A venture capital or private equity firm might back you if they feel that you have the skills and experience to make the venture a success. However, you may end up with only a small stake in the company, unless you are able to negotiate additional sweat equity for achieving pre-agreed targets.

Can You Recommend Resources for A Women-Owned Start Up?

Sunday, May 22nd, 2011

There are many government-sponsored programs to encourage the greater participation of women in business, as well as private initiatives that support women entrepreneurs. The Small Business Administration (SBA) and SCORE have well-known programs that support women, and they’re completely free. In addition, there are many private organizations that support women entrepreneurs, including all-women angel networks (e.g. Golden Seeds ) and VC firms that focus on women-led companies (e.g. Isabella Capital). Also, many Fortune 500 companies have given their purchasing departments a mandate to develop vendors that are owned or operated by women, so it’s a good idea to reach out to them and let them know about your company.

 

While there are many resources exclusively for women entrepreneurs, it would be a mistake to only consider such resources and not consider the many other resources that are available to both men and women. That would be like limiting your choice of college only to all-women institutions. After all, women entrepreneurs face many of the same challenges as their male counterparts, and there are many more resources for entrepreneurs in general than for women entrepreneurs alone. All entrepreneurs need to think strategically, execute flawlessly and earn the trust of investors through good governance; to really succeed in these three areas you should not limit your options to women-only resources .

Can you recommend resources for a women-owned start up?

Thursday, May 19th, 2011

There are many government-sponsored programs to encourage the greater participation of women in business, as well as private initiatives that support women entrepreneurs. The Small Business Administration (SBA) and SCORE have well-known programs that support women, and they’re completely free. In addition, there are many private organizations that support women entrepreneurs, including all-women angel networks (e.g. Golden Seeds ) and VC firms that focus on women-led companies (e.g. Isabella Capital). Also, many Fortune 500 companies have given their purchasing departments a mandate to develop vendors that are owned or operated by women, so it’s a good idea to reach out to them and let them know about your company.

While there are many resources exclusively for women entrepreneurs, it would be a mistake to only consider such resources and not consider the many other resources that are available to both men and women. That would be like limiting your choice of college only to all-women institutions. After all, women entrepreneurs face many of the same challenges as their male counterparts, and there are many more resources for entrepreneurs in general than for women entrepreneurs alone. All entrepreneurs need to think strategically, execute flawlessly and earn the trust of investors through good governance; to really succeed in these three areas you should not limit your options to women-only resources.

I would like more information about raising capital. Anyone have ideas on how to do this?

Sunday, May 15th, 2011

There are many sources of capital for businesses, including both debt and equity. Government grants can also be a source of capital for start ups, particularly if there is a large R&D component.

Early stage companies typically rely on equity since their future cash flows are hard to predict, and fixed schedules for interest payments can make the company very unstable. Entrepreneurs typically rely on their own savings to raise equity capital, and then enlist the support of friends and family, angel investors and venture capitalists.  Raising money from angel investors and VCs requires a thorough understanding of the process, including how to market your equity and how to negotiate the terms of the deal.

As a company matures, it may make sense to consider debt financing, and many banks offer loans for small businesses, as long as they are guaranteed by the entrepreneur in his personal capacity. Venture backed companies may be able to get loans without personal guarantees from banks that specialize in “venture debt”. Supplier credit and customer advances, both of which are forms of debt, can also help finance a company’s growth.

When a company becomes large enough, it may be able to raise additional equity capital by listing on a public exchange via an Initial Public Offering (IPO). The advantage of this approach is that the equity shares become more liquid, making it easier for investors to enter and exit. However, public listing has several drawbacks, such as more onerous reporting requirements.

International angel investing. Can it work?

Saturday, May 14th, 2011

Angel investing is a rising phenomenon around the world. In the US it is a major source of capital for start-ups, and in emerging markets the deal flow has started to grow from a negligible base. Each country, or even each major city, appears to be the locus of at least one angel group. However, the concept of cross border angel investing has not yet taken off, because investors typically want to be near the companies that they invest in. However, there are several reasons why international angel investing might work:

1. Start-ups are often global on day one because of the availability of the Internet. A company that starts off in the US may find that most of its customers are coming from India. The original angel investors, therefore, are effectively investing in an international company.

2. Angels are not just investors, they’re also people who may have idiosyncratic reasons for investing abroad. For example, they may have a fondness for a particular foreign country, and investing in that country would give them a reason to travel there. After all, it’s their money, so they don’t need to justify their investment purely on the basis of ROI.

3. Angels who have already invested in a successful company in their home country may want to invest in a similar company abroad, since one might be an acquisition candidate for the other, thus increasing the probability of an early exit.

What are some common pitfalls in raising non-profit funding?

Tuesday, May 10th, 2011

Raising non-profit funding can be counter intuitive. While one can justify the funding of a business based on ROI and other practical considerations, non-profit funding is often based on a sense of obligation. For example, if a donor asks what he or she gets in return for a gift, one logical answer would be the satisfaction of knowing that the money would be spent tackling a problem that the donor cares about. Other reasons for donating, stated or unstated, would include the satisfaction of letting the world know that you made the donation, thus enhancing your reputation.

Non-profit organizations need to be careful however, because donations can often come from unsavory individuals or institutions who are trying to improve their reputations. For example, a company that is a notorious polluter may be eager to improve their image by donating money to an organization that supports the environment. In such cases, the poor reputation of the individual or institution can damage the reputation of the non-profit organization. Another thing to be wary of is the strings that are attached to the money. A non-profit organization may find that they need to give up control or compromise on their objectives in order to secure a large donation. Clearly, non-profit funding can have some serious pitfalls.

How can an angel get returns from investments that turn out to be mediocre?

Saturday, May 7th, 2011

The problem with angel investments that turn out to be mediocre is that it’s difficult for the angel investors to exit. The ideal way to exit would be via an initial public offering, or IPO. Alternatively, one could look for a large strategic investor. However, companies that are small are generally cannot go public, and potential buyers (e.g. larger, deep pocketed competitors) are unlikely to be interested in doing small deals. Often the only potential acquirer is another small company, but such companies typically don’t have the resources to pay full value for any company that they might want to acquire. Mediocre angel-backed companies tend to become lifestyle businesses that generate only enough income to pay salaries to, and thereby support the lifestyle of, the top managers.

One potential solution is to sell the illiquid shares to another angel investor, or to get the investee company to buy back your shares. There are even some online exchanges where angel investors can post the illiquid shares that they wish to sell, so that potential buyers can contact them. It helps if your shareholder’s agreement stipulates that the company must buyback (or “redeem”) your shares within a certain time period. If you don’t have such a clause, then you may find it very difficult for you to ever get any return from your investment.