‘For Enterprenuers’

Raising Funds for new start-ups: Actions and Strategies?

Thursday, February 24th, 2011

Startups find it unviable to raise debt because they cannot afford to be burdened with a fixed interest payment in their early stages. Moreover they do not usually have any collateral to offer the bank and thus are constrained in their ability to raise debt. Therefore, before they raise debt startups rely on equity investment by angels. However even those investments are hard at the very beginning of the journey. The initial equity therefore, typically comes from personal savings.

Further funding without equity is usually obtained in the form of soft loans from friends and family.
In addition, startups looking to get funding without equity have a number of government sources of funds available to them. Government agencies provide grants, especially to startups that have a strong R&D component.

Startup funding without a significant amount of equity can also be provided through some incubators, Such funding of startups is usually in kind rather than in cash. Incubators provide subsidized office space, hardware and software, mentorship. In return startups may be required to repay the subsidies received over the course of their tenancy at the time they exit the incubator.

To sum up startups looking for funding without giving away shares in their venture can rely on

  • Friends and family
  • Government schemes
  • Incubators, (usually government sponsored ones)

However while looking at the question of sources of funding it is also important to look at how much funding you need. While funding is critical there are ways in which this requirement can be reduced in the early stages of a business. Here are three good ways to reduce the quantity of seed money a business requires:

  1. Eliminate fixed costs: Fixed costs are costs that get incurred irrespective of the sales of a business: rentals, equipment, fixed salaries, etc. Avoid these like the plague.
  2. Experiment, then say Eureka: Every idea an entrepreneur has appears like the ultimate ‘aha’ moment, no matter how many false epiphanies he/she has had in the past. Don’t burn your cash on your latest brain wave. Start small, and get a feel of the landscape before running through the streets of Syracuse screaming Eureka!
  3. Scrounge like crazy: You may eat (in order to live, and work on your startup) but anything beyond for you or your team can be considered a luxury. Well, not exactly, but you get my drift.

If you follow this advise you will be surprised how far your money will go.

What is the role of a VC association, like NVCA? Can they help me raise funds?

Thursday, January 27th, 2011

There are dozens of VC associations around the world (Stern Fisher has prepared a list of them, which you can view online), and most of them provide the following services: advocacy on behalf of the industry (e.g. with respect to government regulations), promulgation of professional standards, training, conferences and research. While VC associations do not typically provide direct assistance to entrepreneurs, the work they do in the areas of training, conferences and research can indirectly help entrepreneurs raise funds.

The training programs organized by VC associations typically cover issues such as term sheets, shareholders agreements and instruments (e.g. redeemable convertible preferred stock). Understanding these topics can help an entrepreneur negotiate with a VC firm, and during the training program the entrepreneur can meet investment professionals of all ages – including both junior associates and senior professionals that are part of the faculty.

Conferences sponsored by VC associations are another good way to meet investment professionals, who otherwise can be somewhat elusive. While you may not have time to have a meaningful discussion, you should be able to at least exchange contact details and set up a time to meet.

Research conducted by VC associations can also be very useful as you plan your fund raising efforts. For example, the directory of members usually contains not only contact information, but also the sectors and stages preferred by each VC firm. Knowing this can save an entrepreneur considerable time and money.

What is the best type of incorporation for a tech company seeking funds (angel or venture capital)?

Monday, January 24th, 2011

Every country has its own corporate laws, but in general angel investors and venture capital firms prefer to invest in corporations in which it is possible to have different classes of shares, such as common shares and preferred shares. This is true not just for tech companies, but also for non-tech companies.

In the USA, Angel investors and venture capital investors typically invest in C corporations with the word “Incorporated” (i.e. “Inc.”) or “Corporation” tacked on at the end. In other countries, there are similar entities.
1. In Germany, Austria and Switzerland best type of incorporation (from the point of view of angel and venture capital investors) is the GmbH (“Gesellschaft mit beschränkter Haftung”, meaning “limited liability business association”), as well as the AG (“Aktiengesellschaft”, meaning “business association with shares”).

2. In the United Kingdom, the usual form is Ltd. (abbreviation for limited company) or plc (abbreviation for public limited company).

3. In France, Switzerland, Belgium and Luxembourg the best form is “SARL” or “société à responsibilité limitée” (“company with limited liability”) or SA “société anonyme” (abbreviation for anonymous partnership).

4. Italy uses “Srl”, or “Società a Responsabilità Limitata” (limited liability company) and “SpA” or “Società Per Azioni” (stock corporation).

5. In India the usual form of incorporation is a “Limited” (i.e. “Ltd”) company, also known as “Private Limited” if the number of shareholders is small.

Angel investors and venture capital firms typically do not seek to invest in partnerships, sole proprietorships. Pass-through entities, such as S Corporations and Limited Liability Companies, are also not preferred by angel investors and venture capital firms. There are many reasons for this – for example, unlike corporations, LLCs are not required to have a board of directors or officers.

If you received Venture Capital then do you have plan to return this fund to Investor ?

Wednesday, January 19th, 2011

Even if you don’t want to prepare a plan to return the funds to investors, a good Venture Capital firm will ask you to prepare one since the funds that they are investing do not belong to them; their funds have a limited life and they’ll need to liquidate their holdings in order to return the funds to their investors (called Limited Partners) before the dissolution of their fund. Some term sheets will include a redemption clause, which will specify a date by which you will need to return the funds to the venture capital firm. The typical exit options for venture capital include the following:
1. Company buyback of shares: This assumes that the business will be generating relatively large cash flows, which is often not the case for early stage companies that are focusing on growth rather than profits.

2. Sale to another VC firm: This is called a secondary private equity transaction.

3. Initial Public Offering (IPO): This is often preferred by entrepreneurs because they can continue to manage the company.

4. Sale of company to a strategic investor: In this scenario, you will probably have to give up control of the company. Also, the venture capital firm will be entitled to a liquidation preference, which means that when the company is sold, they (as preferred shareholders) will get to collect their funds first before any of the common shareholders.

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

Wednesday, January 12th, 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.

How to Organize Working Capital for a Start-up Company?

Thursday, December 2nd, 2010

Startups usually start off with self-funding or funding by friends, and family. Sometimes the founding team will look for a partner who can bring in capital. However, it is important to ensure that the partner shares the vision of the founders.

Startup can also approach angel investors, though angels can be quite hardnosed about parting with their hard earned money. They will look for the ability of the team to deliver, the size of the business idea, and the possibility of creating a sustainable competitive advantage through patents etc. There are intermediaries who can help startups to find funding. These intermediaries can be useful provided they can provide honest feedback on the idea and connect the startup to a network of investors.

Do You Get to Draw a Salary, if funded by a VC?

Thursday, December 2nd, 2010

Heavens, yes! One of the purposes of bringing in an angel/VC firm may be to provide cash to disburse salaries to founders and new employees. Of course, you will own a smaller part of the company than you did before the VC came in. But if the inputs of the VC can increase the value of the company you will end up with a higher value in your hands, even with a lower percentage of ownership.

However a VC may also want to restructure the management team, so if you are the CEO, you may want to check on whether the VC thinks you can take the company to where the VC would like it to go. In other words, you’ll get paid a better salary than before, provided you retain your job! Often what happens is that the CEO position is taken over by someone else while the founder CEO takes on other senior leadership role in the company.

What do I need to do to get VCs’ interest?

Friday, November 27th, 2009

I’ve tried contacting VC/PE firms, but they have not agreed to meet me. What do I need to do to get their interest?

Many venture capital firms receive queries from literally hundreds of entrepreneurs each month, and simply cannot meet all of them. Moreover, the typically invest in only a small fraction of the entrepreneurs that they meet. In fact, one of the biggest challenges for venture capital firms is how to efficiently screen out the entrepreneurs who don’t fit their investment criteria, without inadvertently screening out those who do.

In order to utilize their time in the most efficient way, venture capital firms often rely on referrals. A referral could be from a common acquaintance, or it could be via an intermediary that specializes in raising funds for entrepreneurs. An intermediary that understands an investor’s preference in terms of deal size, industry, geography and stage (i.e. the age or maturity of the company) can ensure that an entrepreneur only contacts investors that are appropriate for his or her company. An intermediary can also advise the entrepreneur on how best to present to the investor, further increasing the likelihood of a deal.