Getting laughed out of the room

Getting investors to put their money into your startup is not easy, even for exciting high-tech companies. Here’s an overview of different kinds of investors and their attitudes to help you understand how to raise funds, and from whom.

Angel investors

Angel investors are wealthy individuals – well maybe not really wealthy, but compared to you they are. They may be willing to put at risk between $10,000 and $50,000 each.

$50,000 may only be 2 months of wages to you and your startup, however, to an angel investor this might be a large part of their savings.

This is really the key point for these investors, they made their money the old fashioned way – over years of building their own business, or scrimping and saving. They genuinely want to help out up and coming businesses but they are in no hurry to lose their money – so be respectful as these guys have forgotten more about business than you have learned to date.

What they are looking for is a solid idea that can monetise relatively quickly for a low fee. If you are lucky a consortium of angel investors can pool $200,000 up to $1 million for a truly great idea.

The good ones realise that they are providing seed funding for your company and that other investors will come in the future. Consequently, they would like to set up the deal so that they aren’t totally diluted out in future rounds.

The other thing to remember about angel investors is that they only really understand businesses they have been involved with in one way or another before. For example, I have seen world class energy technologies go down like a lead balloon in front of investors from the property industry. So you need to try and meet people who understand your business.

Also, angel investors are investing in your ability to make the business work, so be prepared for interviews and ongoing discussions. They may like your idea, but they want to make sure that you like it enough to persist through the rough times so they don’t lose their money.

In the current market angel investors have stretched their involvement from the seed stage, right through the valley of death and into the growth stage. They are doing this as venture capitalists are getting harder to find.

Venture capitalists

Venture capitalists (VCs) in many ways are pretty much well organised and professionalised angel investors.  The VC partners set up a fund with a 5-7 year life. They establish the kind of market they will invest in e.g. social networking, agriculture and GPS products, or whatever. Then they go raise funds with the promise to spend it in that sector.

The fund buys shares in startup companies in return for high risk funding and know-how. A few years later the fund is closed down through exiting the investment – i.e. IPO, trade sale, etc.

A VC fund may contain $10 - $30 million, and will make 5-12 investments (scale varies). These investments will occur in several rounds. Instantly you can see that an energy technology company whose initial pilot project will cost $20 million is out of the market. So, VCs are really limited to smaller scale companies that could potentially make a lot of money in the future.

So, this means that 99% of new companies do not meet VC funding criteria – because our potential returns are not exciting enough.

Some people are now positing that the VC model is now broken as the returns haven’t matched the hype.

I’d ask whether it was actually the classic problem of too much money chasing too few deals. And now that we have reached the inevitable conclusion of that situation many people are saying the model is broken.

Most VC money will be put into whatever the latest fashion is. From a larger market perspective this helps innovation as if a lot of companies try and crack an idea those who come later can learn from the mistakes and succeed. From an investor point of view this sucks as it means you will be lucky to get your money back, let alone break even. For you, it means an easy way to raise funds – just be on trend.

If your idea is truly revolutionary and will make a lot of money then there are very few VCs prepared to understand you and your idea well enough to give it a go. I can explain why from my own short experience screening investments.  Given that you might only invest in one in every 100 opportunities, and that it takes 1-2 days to do a proper basic due diligence on a company, that means one investment (at best) every 100 – 200 days. If your idea is novel it could take weeks to understand a business model and whether it makes sense or not – so given the amount of truly delusional startups out there (after all, everyone has a unique idea that will make squillions) the odds are that I would be wasting my time looking at non-conventional deals.

If you really are a smart company then you need to chase the smart money – that is the VCs who have a depth and breadth of knowledge in your industry.

Good VCs come from a startup background themselves and have a lot of technical smarts, unlike private equity managers who usually have banking and fund management as a background.

Private equity

Private equity usually funds the high growth stage to growth consolidation stage of a company. That is, you have taken all the risks of establishing your product offering and ironing out the problems, and now you are getting a lot of orders and you need some serious cash to take on the people and the premises to deliver on the demand.

Banks still won’t look at you as they don’t take risk and there is still a whiff of potential failure about you. Remember, banks don’t take risks, equity owners take the risk.

So, private equity firms are usually set up and run by ex-bankers and fund managers who want to take a bit more risk, but not too much. By their mindset they do not understand startup risks. To be explicit, they come from large organisations with well developed systems and procedures with the right people in the job. You on the other hand are working in the chaotic and unpredictable world of startups. Your staff come and go, customer interest waxes and wains, your product seems great one minute and like a stinking turd the next. You never have enough people or money, and you are constantly catching problems just as they are about to go critical.

So private equity funds only want to know you when you look like a real company as they know it, and they want you to have firm orders from large and reputable buyers.

Stockbrokers

If you ask a stockbroker what to do they will likely say – hey, let’s get you listed. Yes, I am caricaturing the industry a bit, but that is what they do for a living.

Yes, you can raise funds this way, and a lot of funds if the market is in the right mood.

The issues to consider here are both immediate and longer term.

The immediate issue is that it costs a lot of money to list. They would normally ask $1 million or more to put together your prospectus and comply with all the regulations of your regulator (SEC, ASIC, etc.). Then they will ask for a percentage of raised funds which leaves you with even less in your pocket.

In other words it is all fee for service and if you don’t have any money in the first place how can you afford it. 

Some investors may be willing to pay for the upfront costs if they think the market is hot and they will make their money back from the percentage of funds raised. I.e. they are loaning you funds upfront and then take it back later.

The longer term problem is that you have already IPO’d, so unless you are a screaming success you have just entered the funding cul-de-sac. Nobody will ever want to know you again. The reason is simple – any further funding will require a massive issue of shares which not only upsets existing shareholders who are now diluted, but means that the future revenues of the company have to be very large to make it worthwhile investing. 

For example I knew of one listed company looking for $50,000 for an investment that would likely make $1 million a year. They couldn’t raise funds and didn’t understand why. I tried to explain that they had several tens of millions of shares on issue so that $1 million per year would only make a couple of cents per share difference to the price – any investor with a basic handheld calculator can figure this problem out.

Investors only invest in longshots if they think there is a really big payoff potential, kind of like dropping some money on the horse in the race with the long odds.

Put it this way, if Facebook had listed years ago it wouldn’t be able to try and ask for the $100 billion valuation it is now as it IPO’s.

Getting laughed out of the room

All of the above will help you understand your investors. Just remember that ultimately all risk taking investors are investing in you to deliver this idea. You have to be clear about what you want the company to do and how to make them and yourself fabulously rich. You also have to have a clear record of finishing off difficult things in your past (i.e. you don’t give up when the going gets tough.)

If you go into a meeting with an investor and tell them how good you are and expect to be funded, then you’d better get used to laughter.

For 99% of us the above is a nice dream. If your business is a mundane conventional business then you might have some foundation investors and you might be able to score a personal loan or re-mortgage your house to cover off a growth stage investment. Good luck.