Try not. Do or do not. (No try, just do or do not)… Yoda (jedi master) If one is of the opinion that money will do everything, then that one may well be suspected of doing everything for money. But then money is just about everything and even more so if it is early stage company financing for start up companies. What happens then if money/ or financing becomes the overarching focus? For starters this is usually not healthy as it dilutes focus. Diffusion builds ambiguity – it distracts the entrepreneur from the key strategic and tactical issues needed to put the business on the execution road map. However when one runs out of money – it is indeed game over. How then can young/ first time entrepreneurs get on top of such situations and walk the thin rope – and stay focussed on the larger objectives of developing the business. Here are some workarounds that may be handy to early stage entrepreneurs and companies from the financing context: 1.Assess accurately ‘how much financing’ is required. A common problem observed is most new companies typically underestimate their finance requirements and cash flow needs, which often results in aborting projects mid way
2.Don’t hesitate to get the ‘right professional’ help. Carving out the right financial model, biz plan and financials is crucial to demonstrate the right business logic. Many new start ups falter on this aspect and as a result don’t even get into the consideration of professional angels or VCs, specifically when it involves projecting financials and valuations
3.Seek an outside and ‘professional perspective’. Financials and company valuations are complicated factors with critical ramifications. Take too much money now at a low valuation and you sacrifice a significant percentage of equity ownership of your company. And if you take too little, you risk running out of money. Apropos, it is crucial to balance short- and long-term cash needs with strategic and tactical plans (including all contingency plans) and the projected availability of financing for the new start up companies.
4.‘Don’t ever assume’ adequate financing will be available. In general financing for an early stage company is never easy. A common mistake entrepreneurs often make is to assume financing will be available, coz they have a great idea and a biz plan. In reality, ideas alone don’t bring money. It is the combination of the ip in the idea, the team composition & skills matrix and sound business plans. Still the terms of financing are mostly influenced (if not set) by the investors (and not the other way).
5.Evaluate and ‘understand valuations’ and term sheets well: Many entrepreneurs often toy with unrealistic valuation expectations. It is crucial for entrepreneurs to remain objective as valuations can become varied, complex, long drawn and difficult. Valuation of an early stage company (and defining) early financing round(s) in particular are very critical components. They significantly affect the size of equity, both immediately and in the future. Specifically pre money valuations, as most traditional valuation metrics cannot be fully applied on early stage companies. Pre money valuation is possibly more ‘experience talking’ than methods and metrics alone. It needs to get vetted by good professional advice and mature heads to arrive at proper dilution and equity ownerships.
6.‘Be aware (always) of your equity ownership’ in the company and how it could change. It is crucial for owners to be aware of their equity ownership, at all times – as this could change with circumstances (such as financing at low valuations, granting of new options & stock and/ or anti dilution rights etc granted to investors).
7.Understand the different sources of ‘early stage financing’. Most early stage companies do not qualify for bank financing. They typically start with “friends and family” financing, which involves receiving modest (getting started) funding from family members and/or pre existing friendly relationships (as the name suggests). This type of financing is often easy, quick and seemingly attractive as it is from known people. However it can have negative obligations and downsides if/ as when things go wrong. As a company progresses, entrepreneurs may have more progressive opportunities from sources such as angel investors, venture capital firms and private equity firms. Most of these options may be good sources of financing, but one must be extremely cautious (always), because of the sophisticated and professional natures of these parties. As a rule most angels, vc’s and pe firms are generally smart and dispassionate about their investments. On balance, entrepreneurs have progressive options involving combinations of equity capital and loans from shareholders and other parties. Where shareholders contribute equity capital, it is critical to document the percentages of equity that they receive. It is very common for professional investors to demand shareholders and principals to convert all prior loans to equity, so one has to be prepared for this. Ergo being flexible is the key.
8.It (always) helps to ‘have savvy investors’ at the very early stage. Savvy investors financing can often be called ‘smart financing’. It brings significant value to the company as goes beyond just the financial investments – involving mentoring, board advisory and hand holding on business operations. Most often savvy investors impose very strict and tough terms and conditions and are tough/ demanding, if not ruthless negotiators. They seldom allow for any bargaining power to avoid their terms and conditions. It is thus very imperative that entrepreneurs understand well what they are getting into and what all the associated obligations will be, as well as the consequences of not being able to comply with such terms and conditions – some of which could be extremely negative for young/ new companies.
9.As a rule ‘document all terms’ of any transaction or deal. Most new entrepreneurs are slow/ if not poor at documenting business related discussions. When dealing with OPM (other people’s money) albeit it being investments, it is always essential that one documents clearly and correctly all of the terms and conditions of any financing (and shares the same with due stake holders). As a rule never leave any term to be construed later, and don’t depend on friendships and relationships here. People, their perceptions and situations always change (sometimes 360 0 and radically), especially when money is involved. Also remember that financial & securities laws potentially impact every financing transaction, regardless of how small and informal. Best is to work via good legal advice from a sound lawyer. Remember laws when violated would invoke sig penalties and liability on the company and its officers and directors individually. In sum, the financing process can be complex, frustrating and painful, and is a way of life for most start ups. The above pointers in this blog post can help guide you through the process. Always leverage your advisors for specific advice here. The end result of a successful financing transaction can be extremely rewarding, gratifying and elevating for you (the entrepreneur) and your company. NV Subbarao (Dec 24, 2012)
The information contained in this blog post represents personal views. It is based on general principles and is intended for informational purposes only.