Venture Capital and Angel Investor Questions

VCs setting your valuation

info@InvestorQuestions.com (IQ) — Mon, 7 Jul 2008 07:44:56 GMT

In response to the FundingPost email for the event on June 5, 2008: The event will focus on best practices in raising capital.... how they determine your valuation.

This one caught my attention... you never let a VC tell you how to determine your valuation. Lol. It's like letting you home buyer tell you how much you should sell the house for!!

I notice the tone of this e-mail focuses on Entrepreneur sucking up to VC. I am an entrepreneur and the way I see it is, it's a privilege for VCs to invest in my company that i bust my chops to make it happen (and not the other way around).

VC and company's are partners in a single mission. Funding post should position it such a way. It's very immature to have entrepreneur who are the having to suck up to VCs. It doesn't have to be that way. It should be a place of gathering for two people with common goal to meet.

I dont think its about sucking up, but you Do need to impress the VC with your company. Positioning your pitch to make it out to be a "privilege" for the VC to invest doesn't often work....Unless you are a serial entrepreneur with large exits under your belt. Yes, you are busting your chops and working hard to grow your business, but if you need capital to grow, you need to impress the guy with the check book.

As for Valuation, yes, its a negotiation. You think its higher, they think its lower. So, how do they determine your valuation? Do they just take your word for it? probably not. They look at several factors, including the team, the technology, the market, what you have put into it (cash and sweat), competitors, how far along the company is, etc.... That mixed with a bit of their gut feeling is the number they come up with that they would buy in at. This is what they determine your valuation should be. Now, You dont have to take their money if you think they are valuing it too low, just as they certainly dont have to write you a check if they think you are valuing it too high.

When you buy your next house, I strongly recommend that you dont write a check for the listing price. Look at the other houses in the area, look at the quality of the house, the market, the schools, etc. and then make an offer of what you think the value of the house should be if you were to write a check.

Valuation is often a deal-killer. If the entrepreneur and the VC spend so much time negotiating this, it can be seen as a reflection of things to come. I often hear that getting rid of a business partner is harder than getting a divorce. You guys are in this for the long haul with a common goal. Its always in your benefit to understand how the VCs think, and what their expectations are right up front. Thats the goal of our events.

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Raising Venture Capital for a store

info@InvestorQuestions.com (IQ) — Mon, 7 Jul 2008 07:44:56 GMT

I have a small pet shop that is presently a sole proprietorship. Would I have to incorporate to raise venture capital?

This is a great question - Company is a Sole Proprietorship, should you Incorporate to raise capital? Yes. Investors wont invest in a Sole Proprietorship for the simple reason that there is only one owner. The VC or Angel Investor cant buy any stock. However, you can still raise money by things like factoring, bank loans or venture leasing.

The main thing I wanted to explain is why would a small one store pet shop want to raise venture capital? You probably don't. First thing I want to explain - cause I hear this So often is: Venture Capital is not a synonym for Money. Most early stage entrepreneurs hear the words Venture Capital and are not sure what that really means, except that they can 'give' you money. Most of these people who say they need to raise Venture Capital don't need to, and wouldn't want to if they know what it actually means.

Now, this might not be the exact scenario of the question above, but Im going to generalize and say that people who own small pet stores, or other small businesses and want additional capital are looking for anywhere from $25,000 to $100,000 to buy more product, expand into the store next to them, or to pay off bank loans and other debt.

If you say I need to raise venture capital, it means a number from $1M up (typically) and the VC is buying stock (ownership) in your company. The VC is looking for a LARGE multiple on his investment - typically 10X +. That means if he invests $1M in your corporation, he will eventually want you to Sell the company (or go public) earning him $10 million + in a few years. This means you want your small pet store to go head to head with some of the larger chains and have them eventually buy your company for many millions of dollars.

Now, I don't want to dissuade people from raising money from VCs or Angel Investors. In fact, that's my business at FundingPost. FundingPost maks introductions from Investors to Entrepreneurs every single day raising $250,000 to $10,000,000+. Almost every large corporation out there has raised money from outside investors at one point.

You just have to consider what you are raising the money for.

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Investment capital to build a factory

info@InvestorQuestions.com (IQ) — Mon, 7 Jul 2008 07:44:56 GMT

I need about $1,000,000 to build a factory in Japan. Do I need to give away shares of my firm to get a business loan from angel investor? Can I just give away a percentage of the future profit?

If you can get someone to give you a million dollars for only a percentage in future profits, you are a better salesman than anyone I know!

That's sorta risky for an investor. He gives you $1 Million. Then he has to wait till you build a factory, then get your business going, then start selling your product, then get profitable before seeing a dime! This could take years and you may never get profitable.

What happens in 4 years when you are about to get profitable, then you go out of business? Or you Sell the business? What does the investor get? There is no way any investor would agree to that.

Even a bank loan holds something as collateral. Though to actually build a factory, they would hold a lot more than buying an existing factory.

Now if you gave the investor equity in the company (part ownership in stock) and secured his investment with the equipment you are buying with his money, and gave him a split of the profits you may have a better shot!

You might now be thinking: No Way! That's too much!

Well, I guess it goes back to the Golden rule: He who has the Gold, rules.

I hear all the time from investors speaking at my venture capital events that the money is out there, you just have to be reasonable in your negotiations in order to get it. Having a great product and an amazing management team helps too!

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VC and Angel Investor - stages of financing

info@InvestorQuestions.com (IQ) — Mon, 7 Jul 2008 07:44:57 GMT

What does it mean to finance different stages: Angel, Seed, 1st round, 2nd round, later stage?

This refers to the various stages of a company lifecycle.

The first would be founder, friends and family. This is you at the idea stage. You put in $10K, and you get some close family and friends to put in a few thousand dollars (or more, depending on how much money they have and how much they like you :) to get the business started.

Angel and Seed usually go together. They are the First outside investors that put money into your company - usually $50,000 to $1,000,000 (depending on the company) They are usually rich individuals who have some knowledge of the industry and like to take a gamble for the potential upside.

First Round is just after that. This is typically a company that has more structure, a product, a basic management team, you could have some revenue/sales, but you are not a $10M corporation. It's Early-Stage. Typical investments range from $1-$5M.

Second stage is after that. The company has a lot of traction, strong sales, a solid team, and they are looking to heavily expand nationwide or internationally, and are on track to pull in several million dollars in revenue. They an raise anywhere from $7-20M in VC capital.

Later Stage is after that (or at the same time) This is often grouped with the LBO (leveraged buy out) category. This would be for raising a large amount of money to Buy another corporation, position yourself to be purchased, or to go public.

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Investors for a bar without giving up equity

info@InvestorQuestions.com (IQ) — Mon, 7 Jul 2008 07:44:57 GMT

I would like to find a few investors for my Bar/restaurant, but I don't want to offer a percentage of interest in the business. How should I proceed and How do I pay off these investors?

What you want is a Loan. Investors typically take an equity stake, and/or a profit share in the business.

Banks will invest a sum of money, usually secured by something like your house, or the restaurant, and you pay it back, with interest, in monthly increments. They take no equity in your business and once its paid back you don't owe them anything.

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