Creating Value via Capital Access Planning
Entrepreneurs have heard they should begin with a business plan explaining their unique competitive advantage, sales and marketing tactics, and financial forecasts. However, the one essential ingredient to a ventures success is rarely addressed, except by those who know the cause of every business failure is simply running out of cash. The plan for funding a ventures growth, the capital access plan, is the foundation for enabling all scheduled activities, yet it is rarely set forth in writing. Without it, all other aspects of planning are often meaningless.
Plan for the next round
Most entrepreneurs approaching angel investors, such as the Ohio TechAngels, naively believe the cash they are requesting will be the last money in the final capital needed to fuel their planned growth and drive a lucrative exit. They are relying on hope instead of facing reality. Successful ventures always need additional capital, and wise owners maximize shareholders value by attracting non-dilutive capital at the earliest possible juncture. Consistently successful entrepreneurs recognize this, and instead of focusing solely on this financing round they design a complete funding strategy.
If you want to have any control at all, loosen your grip
Entrepreneurs should heed this golfing advice because most are overwrought by dilution fears. They begin with total ownership and seek to retain as much as they can, not recognizing this stranglehold grip will limit growth and is often fatal. Instead of trying to avoid dilution in the first round they should focus on achieving value-building milestones which modulate dilution in future rounds. While their individual ownership percentage will steadily decline with each equity injection, the growing value of their ownership stake will vastly overshadow dilution.
Grapes versus watermelons
Founders of ventures successful enough to be acquired may end up owning only 20percent of a company purchased for $50 million, but they started by owning all of an enterprise worth perhaps just $1 million. Most would rather own a slice of a watermelon than 100 percent of a grape, and so they welcome exchanging a large portion of their venture for the chance to build significant wealth. But taking on growth capital without a complete plan is very dangerous.
Two case studies illustrate this point. In the first, an entrepreneur convinced friends, family, and unsophisticated investors to provide $300,000 of capital for his revolutionary nano-techno-widget he felt certain would be worth $10 million. Retaining nearly 98percent ownership, he took the money and forged ahead. A year later he had spent the $300,000 on activities which did not impress his initial investors. He was forced to approach angels who expected a lucrative return for investing in an under-performing start-up. Ideas cannot become $10 million ventures after spending just a few hundred thousand, so this entrepreneur faced a dilemma. He could either run out of cash, or admit he failed at building the shareholder value he had promised. New investors perceived his underachievement to warrant only a $1 million valuation. He suffered the deadly down-round which angered his investors, and demoralized him because he felt unfairly treated.
In the second case an entrepreneur approached angels with a request for $300,000, but valued her company at $1.2 million. She understood the start-up CEOs primary task is to burn the least amount of capital to eliminate the greatest amount of risk. Her $300,000 was directed solely to reducing the four largest risk factors so she could tell next round investors a truly compelling story. They gladly agreed to a significantly elevated valuation for two reasons. The first is that baking out risk had significantly improved the ventures chances for success. The lower the perceived risk, the lower the return the investors expected. Investors could hit their return hurdles by owning less of the company.
Second, she demonstrated a record of spending discipline and execution focus. She took the steps needed to attract more cash, and her success justified a $3 million valuation. Her new milestones led her to entrepreneurial nirvana
.becoming self-sustaining (i.e. cash flow positive).
An Ideal Round
Ideally, each round is at a higher valuation and oversubscribed, meaning investors offer more funding than you have requested to reach your next milestones. An ideal round is also completed briskly, but rarely faster than four months. Commencing discussions with over six months of cash still in the bank is prudent. Otherwise, you will appear to be both desperate and a poor planner, not traits investors admire.
The Best-laid plans
A ventures performance is relative, not absolute. This means that exogenous variables, such as competitors responses to your success, are beyond your control and can be lethal. Business plans usually focus only on those endogenous variables the team plans to control. Although they can have little impact on the un-controllables wise entrepreneurs explain how they will expend capital to eliminate risks, and then replenish their capital. Plans about technology development, sales, and marketing are important, but investors are impressed most by a thoughtful capital raising roadmap which will enable your team to fully and swiftly optimize your exciting idea.