Why No Term Sheets... at all? or "They Just Aren't Into You"

Laura Emerson

laura@starlightcapital.com

March 24, 2013

Raising capital is hard, time consuming, expensive, and sometimes humbling. There are as many reasons that investors do not invest in companies as there are reasons why people who meet choose not to date. Sometimes “they just aren't into you.” On the other hand, if you have done your research and have found that indeed there are investors financing companies in your niche, just not you, it is WAY past time to assess whether you might be doing anything to sabotage your own game plan.

Below are five commonalities among companies that never get any term sheets at all. Do any pertain to you? Also, review the descriptions of unfunded (unfundable?) companies at the end of the article. Do any aspects sound uncomfortably familiar? If so, the most common problems are not difficult to address.

The five categories are: talking too much, talking to the wrong people, talking about the wrong things, a business plan with holes that indicate naivete or obfuscation, and inflated pre-money valuations. Do any of these sound familiar?

1. DO YOU WASTE TIME BY TALKING TOO MUCH?

Every entrepreneur I have ever met is as proud of his/her company as a new parent is of that wrinkly little baby. Both groups often make the mistake of being long winded, without first ascertaining the audience's degree of interest. Someone's polite inquiry at a networking event of “What do you do?” or “Tell me about your company” may welcome a 2 minute soundbite between drinks, not an uninterrupted oration.

If your monologue gets interrupted with some version of “I've gotta go,” you've talked too long. Besides, it is in YOUR interest as a social being as well as a finance hunting entrepreneur to be brief in order to ascertain something about the other person. (See reasons below). Don't be a blow hard who confuses stunned silence with abject interest.

2) DO YOU WASTE TIME BY TALKING TO THE WRONG PEOPLE?


Time is indeed worth money. For most entrepreneurs, their burn rate projects a go/no go date by which they need to grow the company out of current financing constraints. This date should be etched on an entrepreneur's wallet, if not his heart and mind. Therefore, value your time (as well as other people's) by being selective about who warrants your time.

In a spontaneous conversation with someone you don't know well, you can be brief and then ask a few pertinent questions such as “That's my soundbite. How about you? What does your company do?” Their answer will help you decide how to proceed. Before a scheduled telephone or personal meeting, you should review a company's website, do Internet searches about the company and management, or ask people who know the company. By whatever process, your goal is to determine whether this person or that meeting is worth your time for whatever your goals may be. Is it direct funding? Indirect referrals? Board members? Employees? Paid services? Customers? You may be juggling several interests. If you know something about the other person's potential for you, you can play toss and catch with the right ball. If you don't bother to find out, you are likely to (a) waste time, (b) blow an opportunity, or (c) worse. Maybe the stranger listening to your loving description of your company is actually invested in a competitor. Maybe she is a service provider masquerading as an investor. Check people out early in order to allocate your precious time appropriately.

• Once you determine that a particular person or company is a possible source of direct investment, what questions might you ask early on? Logical questions expected and appreciated by investors include:
• “What are the parameters of your investment interest (stage of company development, geography, industry niche)?”
• “What is the status of your recent investments? (within the last 3-4 years. Any follow on rounds? Failures? Liquidity events?).”
• “Do you prefer debt or equity? How much? Generally, what sorts of terms (they will hedge, but you can learn what percentage of a company they like to buy for equity, or the sort of interest rate they seek for debt)? A board seat or management role? Is the money doled out in tranches (for example, as certain milestones are achieved) or annually (after audited financials?

Many investor websites address such points very clearly in order to encourage appropriate inquiries and discourage time wasters. Read a few (any at all) to see what they consider important so you can ask the right questions next time. Research those that have invested in your industry or company size or geographic range. If you don't know them, it may be worth paying something to find them, whether buying a list or a hiring a service provider who knows your industry and the financiers in it.


If you conclude that the person or company is knowledgeable but that there is no fit between you, ask if they know anyone who does invest in a company of your stage/size/location. Many people are happy to provide referrals. With a cordial attitude, you may develop a valuable resource person in the future if you don't burn bridges with someone “just not into you” at this point in your company's history.


3) DO YOU TALK ONLY ABOUT YOUR OWN INTERESTS WHEN YOU SHOULD FOCUS ON THE INVESTOR'S ENLIGHTENED SELF-INTEREST?

In a meeting with investors, don't be like someone who walks into a mortgage broker talking about the great tuck pointing on the house he wants. That's NOT important to the lender. Rather, that person is a gatekeeper between you and the mortgage you want. The broker doesn't care about you OR the house. He/she wants to evaluate whether you are likely to make the company more money or cost more money than the other 40 applicants on the calendar that week.

Your conversations will be more respectful of the investor's time, and more targeted for your own goals, if you realize that they DON'T CARE ABOUT YOU. Nor do they care if you make the world's best widget. What they do care about is making money. And since they have some to spend, and you want them to spend it with you instead of all the other entrepreneurs calling for the same reason, the conversation is inherently uneven. AND IT IS NOT ABOUT YOU. You want to convey two messages. 1) You understand their goals and priorities (because you have already researched them) and 2) Your business plan can deliver faster, cheaper, better results for those goals than your competitors, who, at this point,are EVERY OTHER ENTREPRENEUR IN ANY INDUSTRY who is also vying for their attention.

Therefore, do not spend all your time describing your venture in loving detail. Rather, realizing that time is money, prioritize your time by talking about money, particularly those aspects that this particular investor is interested in. For example, you may want to point out in the first three -five minutes that your management team is well equipped to make money in this market because of a proven track record. It is prepared to defend its business from competitors or market fluctuations with some well planned defenses, and that the market is a “rising tide” of growth with high profit potential. THEN INVITE QUESTIONS. Whatever you do, don't spend your whole meeting time talking. You want, and you NEED feedback so you can assess their questions and degree of interest/knowledge, so you can reframe answers in that meeting or as a follow up. Ideally, have someone with you whose job is to keep notes of their comments and also of when they took notes during your presentation. Then debrief with your management team about the resulting notes. If you visited ten viable investors who repeated the same questions or criticisms, and then made no funding offer, for goodness sakes, don't disregard them with, “They don't get it.” Rather, with the curtains drawn and the phones off, re-evaluate your plan in light of what knowledgeable investors had to say. Do you need to say it differently? Do you need to change the plan itself? Do you need a different presenter? Do you need to start allocating more time to running the company instead of running to investors? How long to your go/no go date? Don't be like a pregnant woman looking for a meal ticket. You need to be the meal ticket in order to attract … well you get the analogy.

4. DOES YOUR PRESENTATION HAVE OBVIOUS HOLES? DO THEY INDICATE NAIVETE OR PURPOSEFUL OBFUSCATION? (Either way, you have sabotaged yourself).

Anyone can find templates for business plans and read good and bad examples. Anyone who doesn't have the time or talent to write appropriate documents to pursue funding can hire someone. You don't want to make an amateurish first impression in a world of entrepreneurs who took the time to do a better job than you. After all, why would an investor trust money to a management team that can't even write a coherent business plan? Such a fuzzy document pretty much proves a lack of attention to detail that most businesses require.

The following are frequent weaknesses or omissions in the business plans of unfunded (unfundable) companies:

• Biographies: Management team biographies fail to indicate relevant experience in THIS PARTICULAR business area, success in relevant comparisons, experience with prior investors, or, worse, are contradicted by publicly available information in a way that absolutely undermines their credibility and honesty.
• Financials: Financial projections may be based on “pie in the sky” assumptions, like “no competition” or “flat fuel prices” or an assertive market share grab right away. Balance sheets may neglect to show costs/profits/taxes for logical elements that a savvy investor will see at a glance.
• Market potential: Among companies with good business plans, the best buggy whip manufacturer's documents are unlikely to compete with a business in a growing market. Similarly, an industry with low barriers to entry, many competitors, and a low cost provider advantage is less attractive than one with few competitors and a defensible wall to keep competitors at bay. Thus, high up front costs cut both ways – they may deter others from entering the market space, but they may deter some investors (but not others). Some businesses have the potential to grow and make enough money for “Mom and Pop” to enjoy a profit, but not enough for partners.
• Use of Funds: The use of funds should be inextricably linked to a path to profitability, not paying back debt, litigation, or overhead.
• Investor protection: The investment terms on a private placement should protect the investor. This demonstrates that management respects the importance of its investors. For example, incorporation in an investor-friendly state, an escrow account, a minimum raise before funds can be touched, quarterly or annual reports and meetings, audited financials, a knowledgeable advisory board, well respected securities attorneys, all increase confidence of the people whose money you want. If you seek money without having these, without understanding why they are important to the people whose money you solicit then you are likely to be rebuffed time and again, except by tricksters who aren't who they seem to be at first.
• Consistency, but with a wow factor. Finally, nothing in your business plan should conflict with any other easily accessible information about you, your industry, and your management team. In other words, your business plan must demonstrate that you know what is important, both to the future of the industry, your company, and to investors. So yes, selling securities in your company as a way of raising money means that you have to climb several learning curves, one of which is securities laws.

5) YOUR PRE-MONEY VALUATION IS BASED ON POST FUNDING POTENTIAL

Many, many CEOS have highly inflated pre-money valuations for their companies, often based on projections achievable only IF they get first and second round funding to embark on the necessary steps to achieve any profit in the marketplace. If you need initial investment to launch the process by which to earn that high valuation, then your pre-money valuation is, like adding up the angles in a geometric proof, not the same as the total amount that depends on that initial infusion. It is much lower. This is wholly obvious to investors and should be to realistic entrepreneurs, too.

Inflated valuations may sound great, (“This company will be worth $10 billion!) but when entrepreneurs penalize the rare, early, risk taking investors with such an inflated pre-money valuation, they discourage the very money they need to even start the path to profitable dreams. Any start-up that can't even get off the business plan page, much less into the market needs to give up plenty of the company, like half, to make the high risk investment worthwhile. Some piddly 10% for the life blood needed at that point is insulting to the investor whose money you desperately need. Just as the guy with bad credit pays a higher interest rate, the company that needs the money the most has to give up the most to get it.

EXAMPLES of COMPANIES which, to my knowledge, never received a term sheet.

1. Touchy-feely: One CEO spoke with passion about how her healthcare solution could save lives, but she couldn't describe how and when it could make money.
2. A deep hole: One CEO had excellent reviews by past customers in a very crowded field of low cost competitors. To compete, he cut his prices just as fuel prices escalated, so the company has been losing money for several years. The solution? Solicit investment in the hope of having deeper pockets to wait out unfunded competitors who may bail out of the market.
3. A deeper hole: One CEO had an excellent presentation, but needed money so quickly and desperately that he scared away all but the vultures, who decided to wait until he went bankrupt to pick up the assets.
4. Bad financial reputation: The management team, which was obliquely described in the business plan, was revealed in Internet searches to have IRS liens, foreclosures, and bankruptcies. Prior “sold” companies appear to have been retained and renamed.
5. Unproven model: One business plan front loaded expenses for a national marketing campaign without having first proved receptivity in even a regional or local market for the product and price point, much less field testing its (to-be-developed) distribution network and manufacturing capability for large scale sales. In other words, they could envision the business as a huge success, but they couldn't demonstrate how to get there.
6. HUH? One inventor was so secretive about his invention that no one could figure out what he did, much less what the business model might be.
7. Takers: One company's PPM offered no escrow protection and no minimal raise required to spend investors' money. The potential company was to become a regional bank.
8. Day Late and A Dollar Short: Every few years the financial news is abuzz with the latest NEW THING for supposedly making easy money. (1) Develop vacation real estate in various parts of the world. (2) Develop specialty TV channels to sell jewelry, start a food show, pawn something, or move to Alaska. (3) A few years ago, a lot of unemployed financiers wanted to start hedge funds and now they want to get into crowd sourcing. What's the commonality? All of these eager people wanted to embark on these new adventures with SOMEONE ELSE'S MONEY.
9. No investor friendly structure: “I have an idea” is not a business. Investors don't invest in ideas. They invest in businesses, because corporations offer structures that can protect investors. Some businesses aren't even incorporated or are incorporated as S corporations or are registered in states less friendly to investors. In such cases, the entrepreneur is essentially asking for a personal loan/gift, not a protected investment, and will not attract any funding except from Mom, Dad or Aunt Edna (statistics vary, but the gist is that only 5% of start ups make it past the family and friends funding round to outsiders. This doesn't mean that they all fail. This means that the successes are able to move ahead with no further investment.
10. Use of Funds: The primary use of funds in a business plan was for a salary and an office, which happened to be rented from a relative. A subsequent round of fund-raising was envisioned to actually grow the company.
11. Not scalable: Some businesses are essentially local, “Mom and Pop” endeavors which could succeed with a profit for the owner, but are unlikely to generate enough in the short term to get an investor excited, much less pay him/her back.
12. Personality problems. Entrepreneurs are by nature creative, innovative, independent, optimistic people. But many early stage entrepreneurs tend to have difficulty letting go, and delegating to others who may have significant abilities to contribute. If you are soliciting a stranger's money, you are essentially recruiting a partner who will be looking over your shoulder. Take the money/take the partner. You can't have it both ways.
13. Note there are scurrilous “entrepreneurs” who are frauds and scam artists, soliciting investment in sham companies for personal gain. Make sure that your company name and management names have no taint upon them and no similarity to others. You don't have a second chance to make a first impression.

If you are not getting traction in your funding search, you are by no means alone. Recent research indicates that among angel-level investments circulated amongst American investors, about 17% attracted some funding during the first half of 2012. 83% did not. How many of them represent some of these five common mistakes? If worst comes to worst, maybe some learned that they did indeed make the world's best buggy whip, but the inventor needs a day job, a business in a rising tide industry, or perhaps, a financially savvy advisor and spokesman.