8 Know your strengths. Investors know that you aren’t going to be an expert at all aspects of running a business. They want to know the truth about what strengths you have and more importantly what you believe are your weaknesses. Then you need to explain how you are going to overcome those weaknesses by outsourcing, hiring experts, or another way.
9 Have a team. A team is important for investors to see. They need to know you understand a business isn’t built with just one person. You don’t have to have specific individuals in place right away and they don’t have to be employees. They can be mentors, board of advisors, board of directors, managers or independent contractors. At minimum have an organizational chart based on a time line for growing the business and what team members you will add over time.
10 Maintain focus. The last thing investors want is to invest in a business only to have the entrepreneur get sidetracked with other ideas. They also want to see focus when you are presenting your deal to them. Don’t have too many projects, product lines or ideas. Maintain focus on what you are offering and investors will find clarity in your offer. Clarity = Power.These tips can be very helpful but if no action is taken to implement them, you’ll remain in the same position you are today—little to no chance of getting funded by an Angel. So take the steps to put yourself in a position to get funded:
Step #1 - Develop your elevator pitch and one page presentation.
Step #2 - Write out your business plan.
Step #3 - Join networking groups and attend conferences where investors are likely to be.3
B ROUND ($1,000,000–$3,000,000)
This amount of investment in an operating company is usually made only when the company has the platform ready for expansion and the roll-out of new products and services that require additional working capital. The baton is passed from family and friends or angel investors to the next-up round of funding. This raising of equity oftentimes falls into the venture capital arena. These formal financial institutions, besides infusing cash, also bring value-added subject expertise. They operate in a zone where they often have complementary investments, and they can create joint operating synergies. This could range from using existing sales forces to deploy another company’s products to creating licensing and marketing joint ventures.
Convertible debenture: a loan issued by a company that can be turned into stock at a given point in time; usually has a lower interest rate than otherwise because of the convertibility factor.
For a traditional operating company (non tech/software), this type of investment is more rare as business owners are loath to give up the equity in the firm to outsiders who will be seeking to recoup their investment in a three- to five-year window. Owners who want to hold their businesses indefinitely have a much more difficult time getting investors, as there is no exit. In these situations, the ownership may want to take on a convertible debenture, which is a loan against the company that can be converted into stock by the holder of the loan and, thus, has a lower interest rate than otherwise. Because the group lending the money has the right at certain junctures to turn the loan/note into equity, they obviously do this only if the company looks promising. Conversely, the owner is not always pleased to have the debt suddenly become equity, especially when it looks as if the company is about to make positive growth or increase in value. But this conversion also takes the debt off the balance sheet and converts it into stock that makes the company healthier with less debt. This conversion oftentimes allows the company to get traditional bank financing to continue growth that was previously withheld.
Note: a loan from a bank or private individual.
This round of financing often propels a company onto the playing field of industry giants that now can see this firm with its recent growth and enhanced offerings as a welcome player to the sector.
C ROUND ($5,000,000–$10,000,000)
This round of funding is often seen as the last step before a company is acquired and gives the firm enough cash to implement the strategies that were created and started in earlier rounds of funding. Many times, this round of funding combined with earlier investors has the founder losing majority interest in the company and thus operating control. This change of control is usually implemented at the board level where, by this time, the board should have five members, which could conceivably be the founder, a friend or family investor, an angel, a representative of the B Round, and one from the C Round. The professional investors whose interests are all aligned now would have three of the five seats so they could steer the company to a sale or other event over the objections of the original founder.
STRATEGIC INVESTMENT
Virtually all exits or sales of a growing or mature company are made to a larger industry player from the same sector. There are often a multitude of dialogues between a larger player and the smaller company (the entrepreneurs) about joint synergies, but the discussions most often evolve into an outright sale of the smaller company. It usually makes no sense for the smaller company to be partially owned by a bigger industry player as that would inhibit the growth of the smaller target business. Operational constraints put on a subsidiary company recently bought could hamstring the small firm’s value in the long term as well.
EBITDA: earnings before interest, taxes, depreciation, and amortization; most-used method of assessing a company’s profitability.
The vast majority of sales of companies with values over twenty million dollars (which is approximately the minimum size a company would be if it went through the full growth cycle of funding outlined above) are made to strategic buyers. Very rarely does an individual or entrepreneurial buyer have the cash and/or the sector experience to buy such a large organization. The price or multiples of EBITDA (earnings before interest, taxes, depreciation, and amortization) to buy bigger companies is much higher and oftentimes do not make financial sense to the individual buyer. The high price these larger professionally run firms demand make it almost essential that a buyer have the ability to merge the two companies and save operating expenses.
Multiple: a number used to multiply against revenues, profits, or EBITDA of a company to find its valuation. (See next chapter, “Valuation: What Is It Really Worth?” for more information and examples of multiples.)
Strategic sales are also preferred buyers as they are predominantly cash buyers or, at the very least, pay out over 80 percent in cash and the balance in shares of stock, or earn outs, over time. Post Great Recession, many strategic buyers have practiced much stricter financial controls and have fattened their war chests. This allows them to pay big premiums for smaller firms that on paper make no sense.
The strategic buyer is most times the preferred exit vehicle for entrepreneurs.
Earn out: part of the purchase price of a company, paid over time, that a seller must earn based upon the specified post-sale performance of the company.
THE MYTH OF GOING PUBLIC
When I hear a small business owner chattering about going IPO (initial public offering), I immediately understand this owner is not in tune with the marketplace. You have as much chance of seeing a white elephant on Main Street as a ground-zero ramp-up of a firm that drives to a successful IPO. If this IPO mirage were an actual possibility, the firm would already be surrounded by high-end handlers and most likely not be a play for the readers of this book. A firm with this much potential would have to have an unprecedented value proposition.
An IPO involves a huge time commitment that can potentially distract business owners from other strategic priorities …
The Small Business Administration (SBA) says the fees and expenses of going public can reach into the six or seven figures. U.S. investment banks managed to charge a 7 percent spread on IPOs in the past decade, about