Technopreneurship - Raising Capital
The end of the Internet bubble means that there is a dearth of good deals. In fact some venture capital funds have been returning money to investors because of this. The combination of plenty of money and lack of good buys has opened a market that has been available only to a selected few in the past.
Start-ups almost always raise capital in stages. Hopefully for the technopreneur the value of the business increase at each stage. But this may not always happen. Market conditions may be difficult (like now) or there may be internal problems in the company. The reason for different rounds of investment is that the significant risk involved in a start-up decreases as the business manages to prove its technological concept, develops a product or service, markets the product and generates income through selling it. As time passes, the business is able to project its cash flows more accurately; investors will sink money into the ventures more confidently .
Financing in rounds mean that investors usually put in only a small amount of money initially, increasing the amount gradually. Usually the technopreneur is happy with this arrangement even though there is the danger he may not find funding at a critical stage. This is because the larger the initial amount the investors put in, the more equity he would have to give away. He prefers only to raise what he needs because as the business becomes progressively less risky, he can get a better valuation.
The following illustrates the typical rounds that a business raises money
Start-up seed stage: The concept and management are in place. There are some projections (more like guesstimates) of viability and commercialisation. This is typically priced at around $100,000 to $5 million.
Development stage: The product or service has been developed and there is some product confirmation on viability and commercialisation. Typically priced at around $2 million to $5 million.
Sale stage: Products and services confirmed with sales and customers. Revenue Generating. Valuation is based on capital required and for what purpose. Can be pre-money or post-money valuation. Typically priced at around $5 million to $10 million.
Expansion stage: Company has achieved great results in a small market. Expansion is being made into new markets or products. Valuation is based on profitability. Higher valuation is due to profits. Typically priced at around $25 million to $100 million.
Liquidity stage: Good company, great solutions, located in the right markets. Pre-IPO stage or exit stage funding round. Valuation substantially higher and based on cash flow, future potential and so on. Typically priced at twice the price of previous round.
Cashing out stage: If the company is listed, it is valued based on market sentiment, peer group comparison and company's potential. If it is acquired then the valuation is based on start “a willing buyer-willing seller“ model. Typically a good exit should be priced at 50 to 75 times of the seed stage valuation. And after various levels of equity dilution, a typically early stage investor looks to make a gain of 20 times the amount he put in.
Venture Capital
Venture capitalists are organisations that specialize in private equity investment. Their key objective is to get a higher valuation after each financing round and ultimately cashing out their investments. Venture capital is the key for innovation, and VC firms (and angels) provide the capital to start-ups with unproven track records. They incubate tomorrow’s great ideas at today’s cost. The dynamism of the venture capital industry in the US during the 1990s contributed substantially to the overall economic prosperity that was created mainly due to the higher stock market valuations.
Unlike banks, venture capital firms are willing to take more risk for greater returns. Since they invest in every round from seed to pre-exit, they tend to distribute the risks of the new incoming investors. As mentioned earlier, while companies at seed stage typically carry very huge risks, they do also provide returns which are exponential.
They also balance the risks by diversifying their portfolios among various sectors of the economy.
Since VCs will win some and lose some on most deals, their only recourse is to invest in companies with some execution capability in a substantially larger market. Due to the high risk, high return game, it is understood the only one in ten or so of their portfolio companies will ever be able to provide the returns that the VC firm seeks. Therefore they seek companies with higher ROI and the guarantee for this is the quality of management, the project and scalability.
Venture funds access funds from various investors, who look to invest for these objections. A VC like any other fund taps capital from high net-worth individuals, pension funds, insurance companies, governments, publicly-listed companies and other sources.
With the collective pool of a capital, VCs then operate their own set of funds and invest mainly in private equity, with the angle of taking each and every company of theirs to the public via an initial public offering. If the IPO route looks hard and difficult than VCs will look towards him a merger with another firm which can acquire their companies and provide them with an exit.
VCs have their own business plan and modus operandi. They have a specific model and mandate to follow pertaining to their investment styles, guidelines, levels of risks and a maximum amount of money to be invested in each company. They also invest in specific industry sectors.
Some specialize in certain specific sectors because they believe the greater the degree of specialisation the less the risk - they can avoid the landmines without spotting the opportunities. As an example of an industry-specific fund is Illinois-based Nomand Venture Partners. It was set up in early 2001 to focus on start-ups in the wireless realm. And earlier in 1991, Franklin Templeton Group set up the region-specific Franklin California Growth Fund to enable investors to tap into the state's economic diversity.
There are some VC firms that will invest mainly at the seed stage. An example of a seed-stage venture capitalist is Blueprint Ventures. It is committed to building next generation communications and IT infrastructure companies. Then there are others which will only invest in companies that are at the pre-IPO or exit stage. While this reduces risk significantly, the price paid is the highest valuation round prior to the exit.
Others may only invest in deals worth about $5 million or more.
A technopreneur needs to study each VC firm's investments criteria and approach only those firms that offer the best value in terms of growth and expertise that the start-up may need.
Some venture capitalist firms are also run by technopreneurs, who after one or two rounds of success and capital, have headed out to help other technopreneurs build, craft their niches and create greater success stories, with their experience in a start-up environment. Their added input can be invaluable, so start ups should first turn to these ex-technopreneurs.
With the market downturn since the dot.com crash, most VC firms are hibernating like bears in winter. At the present time, there is very little VC activity at the seed stage. VCs should ideally be approached once a company has completed product development, has a few customers and revenue is coming in, that is, at the second or third round. Fortunately there are other places where a start-up could turn to for capital and resources. They are as follows.
Incubation Centres
Incubation centres tend to be like laboratory centres that hatch ideas under one roof. They share resources as their main contribution instead of capital and offer start-ups a procreative environment.
Incubation centres often understand business dynamics and needs which technological companies face. They provide free office space, consultancy services, Internet access, data contre facilities and networking opportunities within the same centre and elsewhere. They allow founders to concentrate on their early stage core competencies of research and development without worrying about raising money.
As the start-ups mature, they provide mentorship and networking opportunities so that newly researched and developed products could be cross-sold to other incubates and matured further before they hit the markets. Another key benefit is that solutions are tested in a cohesive environment.
Once the need for capital and expansion arises, they work on structuring business plans and financials. They also provide assistance to plug gaps prior to pitching to venture capital firms for growth capital.
Incubation firms are a great idea for technopreneurs who lack the business know-how and commercial viability of their products. It is a great place to hone business skills before stepping out on their own. The downside is that incubation firms will take a 10 percent to 30 percent share of the equity, depending on the roles they play and the assistance they offer in the projects. However, the technopreneur ahould not be too bothered by giving away equity because each party has to justify it share.
In recent years, many intubation firms have gotten into big trouble. They were driven by greed and not performance. Many real estate companies, landlords adn Old Economy companies with excess resources were pushing their services to technopreneurs, trying to build a portfolio of companies so that they could be pushed to the public. Such firms offered very little value to take technopreneurs. Techfnopreneurs should check to see if incubators provide R&D facilities such as software development tool kits, application development, training guidance and technical support. They then need to provide incubates with help on the commercial viability of their products, feasibility studies, implementation plans and finally with support in sales and marketing.
Incubators also need to understand there is need for additional resources such as hardware and software licenses which are a requirement for the development of scalable solutions.
Incubators nurture young firms, helping them to survive and grow during the start up period when they are the most vulnerable. But an incubation company, just like the venture capital firm, is driven by its own set of goals. It is therefore important that the incubation firm is chosen carefully as the wrong choice can kill any or all potential that a start-up may have. Technopreneurs, once they have decided to work with one, should ensure an agreement is drafted, setting out both parties' roles and responsibilities, so as to lessen any possibility of future disputes.
Those who have the management and technical expertise but are too early in the cycle to approach a venture capital company and do not not want to use incubation,could look for an angel.
Angels
The word "angels' brings to mind a fairy in a white dress who comes to ones rescue in dire times. Well, this is exactly what an angel does for a start-up compnay. Angels are usally high net-worth individuals or individuals with a budget for investments. They are often stock market investors or observers who, understanding the stock market and the valuation theory behind companies listed there, preer to get closer to the value chain by investing directly in start-ups.
Angels come in different sizes and roles. An angel may be a university professor, an investment strategist, a business person or even a retired civil government servant. The shared characteristics among angels is the understanding of how the stock market functions, the valuation game, technology innovation and its evolution, and the business need for capital.
His appetite for risk grows as he gets more successful. It is estimated that for most start-ups, the angel is the key driving force behind them. He is responsible for the largest source of start-up capital in new businesses. It is extimated that one-seventh of the 300,000 early growth firms in the US receive funding from angel investors. This translates into over US$20 billion of investments over apporximately 50,000 deals each year.
Angels are not interested in controlling the start-ups business and they will typically invest in companies within their immediate geographical location. They simply want to be mentors to the start-up and ensure that their capital is well taken care off. They look for sincerity and honesty in the founders. Those who simply don't have the time to mentor founders themselves can pay someone else part of their profits to do the job would simply hand over the management of their capital to another professional, usually a venture capital firm
The benefits of going to an angel over a venture capital firm or incubator is that angels are usually more informal. They do not tie down founders with mandates, milestones and performance clauses. The angel will simply discuss the opportunity and his potential reward for his contribution, which may be his expertiese or money or both. An angel is less likely than a VC or incubator to have a hidden agenda, for example, trying to get cheap proprietary information for their portfolio companies.
The angel does not need to have a complete business plan and seldom questions a founder on value creation or competetive advantage. He may work with a founder in the early stages to do all that is required to build a sustainable business strategy.
The first search for an angel should usually begin at home; friends, parents, teachers, associates and others can be a part of the angel chain. Anyone who understands the business of the start-up and what it is trying to do can be a potential angel. The deal can be closed once the angel trusts and relies on the founder's goodwill. A deal with an angel can be concluded in less than a month.
Government Assistance
If all efforts to get funding fail, start-ups can get capital and assistance from governments via enterprise grants, innovation grants, or venture capital assistance. When everyone else has stopped investing due to the economic downturn the only party that can promote the wheels of commerce are the governments themselves, because start-ups could potentially boost employment, create opportunities in the economy and enhance a lacklustre stock market.
For governments, the motivation is simple: they need to boost use of technology and they need solutions which can make businesses react efficiently to economic cycles and changing business environments. They also want to see companies lower costs, penetrate new markets and become more efficient.
Government assistance can be used for subsidising research and development costs and the building up of the start-up's core business model. In the US, the Small Business Administration has funded companies like Apple, IBM and Hewlett Packard. Established since 1953, the SBA has offered financial technical and management assistance to almost a million companies yearly and is one of the world's largest financial backers of small businesses. The results speak for themselves.
The added benefit is that government grants need not be repaid. The drawback is grants are in range of $10,000 to $500,000 only. They are suitable for R&D, not for cash flow. Therefore if a start-up is looking for more than R&D money, they should consider approaching government backed venture capital companies.
Fortunately, government bodies operate VC funds. They too operate in the same manner as commercial VCs. Unlike the latter VCs, the key agenda for government venture funds is to see how the project will benefit the economy and the country as a whole. Having the government as a shareholder can open business doors and can provide credibility for the new company.
Contacting Them
Venture capital
The best way to reach VCs is via contacts that can vouch for you. The other mechanism is to contact a venture capitalist via e-mail, followed by a telephone call. VCs evaluate close to a 100 plans a month and may invest in five to ten businesses a year.
Sell your idea to the VCs by sending them a short business summary via e-mail. Do not use any flashy technical words, terms and jargon.Your e-mail should outline the opportunity, the innovation, its scalability and the market need. Also how much equity is available, how much and how will the raised capital be used?
The info is ideally part of the business plan. Do not contact a VC if you have not taken the time to prepare a business plan. The next time after a business summary e-mail is following up with a telephone call and trying to make an appointment with the executive who is handling your investment inquiry. This executive's job is to review all documents with due diligence. Most technopreneurs will falter at this stage. If you are persistent enough, you may get an appointment, after which if you have sold your idea to the executive, the next step is to present it at a board meeting to the VC firm partners who will collectively decide whether to pursue or pass the deal. The board follows a mandate code for all their investments so ensure that the venture capitalist you are approaching has similar interest as your opportunity.
Silicon Valley venture firms are known to be more efficient in such processes and a decision should be reached in six to eight weeks' time. Elsewhere it varies. IF the board meeting has reaped good results, then the VC firm will present to you a letter of offer and investment agreement, outlining the terms and conditions of the investment and both parties' roles and responsibilities. This document also serves as a term sheet, which outlines the investment amounts and how it will be disbursed to the start-up.
Incubation company
Contacting an incubation company is a simple process. The process begins with contacting the incubation firm via telephone or e-mail, which introduces the start-up and the opportunity briefly and its requirements.
At its simplest, a founder picks up the phone and calls the incubation firm, "Hi, we are a start up in the web services space, we build software applications and we are integration partners to so-and-so. We seek incubation services, could we visit you?"
THe phone call gets the ball rolling, as much as the start-up is in need, the incubation company also has a similar need.
Visit the incubation house, see the facilities, office space, working environment, management services, capital raising associates, networking and mentorship. Whatever they offer, put a cash value on it.
Angels
There are no hard and fast rules in contacting an angel. YOu could bump into someone in a coffee bar or a restaurant and start talking to the person. If he has an interest, he is your angel.
In looking for angels, most technopreneurs start with people they know, Immediate relations, people who they have come in contact with and people who they think have a keen interest in where value is being developed. The key deciding factor is whether this individual has something that you need and can jumpstart your venture. If so, he is an angel.
Raising capital from an angel is much easier and simple than from anyone else. What an angel wants to know is easy, "How much and what is the return?" Stay away from technical issues, valuations and other types of jargon as much as possible with angels. They are simple investors whose due diligence is not at the same level as venture capital firms. At times you may not even require a full fledged business plan but a summarised version instead.
One of the mechanisms that has worked for most technopreneurs is to approach a successful businessman whose venture has worked and is sitting on investable cash. Seek him out and offer the deal just as a stock broker or insurance agent would sell investments or future opportunity, you are selling an angel your investment opportunity - your start-up.
An average sized angel could invest as low as $10,000 to as high as $300,000 into your business. It all depends on the level of capital you seek.
Networking sessions are good places to meet angels.
Placing an advertisement in the local papers is also how you can find angles or you could solicit these individuals directly.
Just be careful. There are regulatory issues governing the offering of private individual publicly. Structure your offering appropriately and you should be fine. If placing an advertisement in the local papers, an example of how the advertisement should be structured is as follows:
"High tech start-up seeks early stage financial and growth partners. Call XXXXXX."
"Mobile Commerce Company. Ready Product, Revenue and Partners. Seeks capital for expansion. Call XXXXXX."
"Technology Start-up. Proven Track record and Management. IPO Exit 2003, investment opportunity. Call XXXXXX."
This should generate some sort of interest. Specify the investment amount required and the opportunity briefly over the telephone. And if there is an interest, continue the conversation over a tabletop meeting and do your best to conclude.
Offbeat Sources.
It will take time for every technopreneur to master the art of raising capital, and there are other areas where capital can be tapped for day to day operational issues. Here are some to get your collective juices thinking.
* Equipment leasing: An excellent way to finance your start-up if the capital is needed to buy equipment. Lease it instead.
* Factoring: Factoring allows you to collect cash immediately based on your accounts receivable. Factoring involves selling tomorrow's receivables today to a finance company.
* Convertible debt: COnvertible debt works as a loan to the company and if the company's progress is commendable then lenders can convert their debt into equity of the start-up.
* Asset-sale leasebacks: If you own a lot of expensive equipment but have little cash, sell your equipment to someone and lease it back from them.
* Purchase order advances: Use customer purchase orders to gain some funding. A lender may advance money for sales based on purchase orders you hold.
* Private placements:Consult a financial consultant to offer your stock privately. Usually you can use private placements for stock offerings of upto $3 million or 35 investors.
* Employee ownership: Offer ownership to your employees.
* Joint ventures/strategic partnerships: Match your product, assets and needs with another company's products, assets and needs and pool your resources.
* Equity for revenue deal: Offer your company's equity in exchange for revenue to another company and create a win-win deal for both parties.
Worst Case Scenario
If all else fails, serasone technopreneurs recommend bootstrapping your start-up by mortgaging your house, maximizing your credit cards and credit lines and borrowing money from family, friends and associates.
Just keep on going and keep that vision alive. Failure is a path towards success and the level of risk that you are willing to take is the level of success that will come your way., Some of the best companies were built with only about a thousand dollars in start-up capital and if Michael Dell can do it, so can you.
Chapter 12 Raising Capital >>>
Technopreneurship Development - A Role for Society in Technopreneurship Development, a chapter written in 2002, explains the creative destructive forces at work in practically every aspect of human life and the reasoning for the massive confusion, leading up to revolutions, lack of employment opportunities and governments fiscal deficits. Technology is usually blamed for making the world a smaller place, the writing was on the wall since the late nineties, this chapter refreshes our memories.
Technopreneurship - The Successful Entrepreneur in the New Economy - Daniel Mankani. Published 2003. Pearson Education Asia - All rights, copyright reserved Daniel Mankani { ISBN0-13-046545-3 }
