In their infancy, most startup companies lack the requisite credit history and hard assets to obtain conventional bank financing. As a result, if the business does not generate sufficient cash flow to maintain its operations, it may be necessary to seek out funds from angel investors or venture capital groups. One disclaimer here is that I strongly recommend that you exhaust every other opportunity to raise capital prior to seeking out a venture capital deal, as you will generally be required to make significant concessions that could affect the degree of control you have over your business going forward. That being said, many business models require significant capital to get a product or idea to market and in these cases, angel investors and venture capital groups can be saviors. Below are my top 5 tips for seeking them out:
- Keep it Simple: You will typically be talking to an investor who is savvy with business but not necessarily familiar with your industry or business. Even if they are familiar with your industry, investors are reluctant to believe that your consumers will be able to understand your idea if they can’t understand it! Aim to deliver your business model in a way a 5th grader could understand within the first 5 minutes of your sales pitch and you’re more likely to catch their attention!
- Know how Deals are Structured: Understand the basic structure of venture capital deals before meeting with anybody. For instance, know that due to the difficulty in valuing early-stage startups, you will typically be offered a convertible note rather than a more conventional investment for equity (often referred to as a Series A). You should also have been briefed by your attorney on the basic terms of convertible notes. Expect a relatively low valuation cap (under $2M), a 20% discount rate, 5% to 8% interest and a maturity date within 18 months. I will explain the nuances of convertible notes in more detail in another post.
- Be Prepared to Become a Delaware C Corporation: More often than not (and for reasons beyond the scope of this post), investors will only want to invest in a Delaware C Corp. For many reasons, it is not typically advantageous to be one! Fear not if you are organized in another state or as a different entity type as it is typically affordable to merge or convert into a corporation and/or adjust your tax elections. Nevertheless, you can avoid looking unsophisticated if you do not act surprised when a venture capitalist asks you to do this.
- Be Conservative: This has nothing to do with your political beliefs. Don’t be overly aggressive with your economic forecasts. It’s better to under promise and over deliver and the odds are you aren’t fooling these guys anyway! Also, be conservative with your projected use of the funds raised. Proposing a compensation plan that includes paying yourself a 6 figure salary to run a company that is yet to sell its first widget is a good way to scare away would be investors.
- Don’t be Shy: Contrary to the previous paragraph, when it comes to approaching would be investors, approach as many as possible. You will usually be offered more favorable investment terms if you can attract multiple investors. Also, most investors will not be interested so you will likely need to play the numbers game! I’ve had clients raise relatively small sums (every dollar counts!) from local accelerators and other clients who have made it onto the popular show “Shark Tank”. Never sell yourself short by being too shy to write and call every investment opportunity you can find. That being said, be wary of how many details or how much proprietary information you share with would be investors unless you’ve convinced them to sign a Non-Disclosure or Confidentiality Agreement. Lastly, don’t be surprised when they refuse to sign either as that is common!