Sunday, March 6, 2016

Start Ups: How is Your Financing Going (or Not)?

Every day, our company receives calls and emails from companies seeking investment.

The large ones we route to our investment banking practice and the small ones to our investment conferences in New York, where they can represent themselves to investors without an intermediary.  (Others call about our narrow angel investment criteria in telecom or board positions).

But the great majority of callers do none of the above.  Some want something for nothing.  Others are dreamers whose aspirational companies are unlikely to get off the ground, but remain the subject of loving and lengthy monologues.

It is pretty easy to separate the wheat from the chaff –
(a) those callers who understand the endurance race aspect to raising capital vs.
(b) those who think  they just have to talk someone's ear off to collect no-questions-asked checks.

The following paragraphs include snippets of  seven, initial conversations with members of the latter group (the naive idealists or what?) followed by my behind-the-scenes interpretation.  What is your first impression?  Do you think the caller will be taken seriously by a finance professional?  If not, do not be like them!

Entrepreneur 1: “I don't need to hire your investment bank or present at your conference.  I will be funded by then.”
Us:   “Then how can we help you (I'm wondering,  uh, why did you call us)?” and “Wonderful news!  Are you currently negotiating a letter of intent?  (No)  Do you have a closing date on the calender (No)."
Entrepreneur 1:  “But we have several initial meetings scheduled and they'll love us.”
Interpretation: This caller does not know that investment is often a needle – in-a-haystack search, followed by a lengthy period of due diligence, a letter of intent, negotiated terms, legal advisors, finally culminating in a well defined closing date.  In other words, it entails a protracted and wholly predictable schedule of milestones.  Therefore, this blithe comment reveals that s/he has never worked with investors before.  Some service providers may take advantage of that.  In any case, s/he has lost credibility with professionals who know what s/he does not.

Entrepreneur 2:  “I cannot pay to attend your conference or hire your investment bank.  I thought you could just give me a few names of investors who would be interested.”
Us: “Well, why don't you leave me a short, two page summary, and if we run into someone interested,  we would be happy to pass it along.”
Interpretation: Really?  If a stranger gave you a box and asked you to send it to other people without opening it, would you ever do so? Of course not.  As licensed securities brokers, we have a fiduciary duty to both clients and investors to do due diligence on any business and management team BEFORE introducing a company to an investor.

Asking us to do so without due diligence reveals a caller unfamiliar with U.S. regulations about raising capital from investors.  It paints the caller as naive.  Asking us to do so for free, takes time and effort away from our clients who are paying us to do just that.  So suffice it say that no licensed securities professionals, including us, will just “send around” a business summary from a company we do not know to investors who respect us and whom we respect in return. It would undermine our professional credibility.  These entrepreneurs should regard a phrase like, “if I run into somebody” as a polite brush off to someone who has asked for a freebie.   Furthermore, why would any professional give away valued contacts to a stranger who has said up front he/she will not pay?  Does this guy walk into a restaurant and say, “I'd like a steak dinner with all the trimmings but I don't plan to pay for it.”

Entrepreneurs have to prove themselves to investors, financiers, or bankers.  Those who hope others will just "send it around" probably also hope that posting it on various websites will attract bonafide investors who field better prepared entrepreneurial inquiries every day.

Entrepreneur 3: “I would like to schedule a one hour conference call with you and our management team.”
Us: “I'm sorry, but we do not invest in this business sector/stage of company development.”
Entrepreneur 3:  “Well, then let me just tell you about it now (ad nauseum).”
Interpretation:  This person is not listening and does not value his/her own time, much less ours.  Any entrepreneur should ascertain the investment criteria of a potential investor and be respectful of it.  Most investors can be very clear about their investment criteria.  Ask before launching into a monologue.  If you run hair salons and they invest in telecom, not a good fit.  Simply ask, politely, Sorry to bother you.  Can you recommend anyone/ any group I might contact?"
Entrepreneur 4:  “I seek investment for an idea/invention I have” or “for a non-profit.”
Us: “Gee, it sounds like a terrific idea.  But, unfortunately, investors invest in corporations, not ideas, because corporate law protects their interests.  Why don't you establish a company first and then call us back.”

Or “Donors donate to non-profits in exchange for tax deductions. Have you established your charity as a 501C3 with the IRS to protect the donor's contribution? Have you researched grants and contacted foundations that fund your area of interest? We don't work with non-profits professionally, so how can we help?”  
Interpretation:  These bright and well meaning people need to do some homework on setting up business or charity structures before trolling for investors and donations. A knowledgeable mentor is in order, too.  In most cases, I think such inquirers would do well to work for a larger organization that knows what they need to learn.

Entrepreneur 5:  “Why should I pay to attend your conference?  I am invited all the time to present my fantastic business model for free.” 
Us: “So how is that working for you?  Any letters of interest or finalized investment? (No) Have you evaluated whether those free conferences have a financial model that benefits the organizers (like being paid by sponsors and service providers to entrepreneurs) that is unrelated to your search for capital?” (Uh, wow, no)
Interpretation:  Many people confuse being busy with doing business. Time absolutely is money – it is finite and valuable. Entrepreneurs who rush around to meetings, calling everyone in their contact database, feeling busy, should assess their  productivity, especially as it takes time away from actually running their business. How many actual investors have given them realistic comments on their business plan? Have they adjusted their concept to reflect that market feedback? If they are talking only to service providers, what is the point?

Entrepreneur 6: “I'll pay you a success fee (also called a back-end fee), but not a retainer. We don't have to go through your broker-dealer.  This could be just between us.”
Us:  “That's very generous of you.  But, as FINRA licensed securities brokers, we are required to run any compensation offer through our firm. Why don't you contact our managing director with your business summary and discuss a possible contract?
Interpretation:  A "success" or "back end" fee means that we do not get paid unless an investor funds the company, at which point we are paid an agreed-upon percentage of funds raised.  That is a gamble, of course, embarked on only after we feel confident that we understand the company and know potentially interested investors - in the words of our industry, "our sweet spot." 

Furthermore, this person is suggesting an end-run around a U.S. securities regulation!  If so, why would we want to work with someone who starts out proposing something unethical?  Alternatively, he/she is naive enough to not understand securities regulations in the US, and who, therefore, will require lots of hand holding to meet legal requirements for due diligence, document preparation, audits, legal review, and investor suitability.  In general, these are going to be expensive and time consuming clients. All for no money unless we land a suitable investor.  How likely is that?

Entrepreneur 7:  “Why should I pay you?  I'll just go to one of those crowd-funding sites and get funded there.”
Us: “Great idea. Do that first, and if that doesn't work, or if you succeed and later wish to pursue a second round of funding, you can always call us back.   We wish you all the best."
Interpretation:  Entrepreneurs are wise to explore all options, starting with those that cost the least and offer the best bang for the buck.   For example, a credit card interest rate may be 18-21%.  A promissory note may cost 14%.  A Kickstarter campaign costs about 4% but the entrepreneur gets access to the funds only when the whole campaign amount is reached, largely through the entrepreneur's own outreach to friends, family, and others (strangers?  not so much).  
An investment bank charges 4-10% depending on amount to be raised, plus, usually, a monthly fee to cover the due diligence, financial modeling and sales materials.  Then, they  target a short or long list of likely investors that the client does not already know.  I encourage all  entrepreneurs to research the percentage of companies in their category funded on various crowdfunding sites and angel networks and assess the size of his/her own database of potential funders.  Then develop a campaign based on this research.     

Running a business is hard work.  Raising funds for it is, too.  Both require different sets of skills and knowledge and sometimes, alternate personality types. 

My recommendations for start up entrepreneurs are these:
1) You only have one chance to make a first impression.  Don't come across as an idiot in your first phone call (!!!!).  Do some homework.  You are asking for money.  Sound knowledgeable and deserving, not needy and ignorant (and verbose).
           a)  For the person you are about to call:  
           Check the website first, regarding services and investment criteria. Practice a            BRIEF (20- 30 second) soundbite explaining the reason for your call and                          ascertain whether you are talking to the right person. For example, “I see on                  your website that you are an angel investor.  Do you have a moment to                            elaborate on your investment criteria?”       
          b) For your business goals:  
  Is anyone investing in your type of deal?  Find some evidence.  Only Mom will               trust your "gut feeling." If you don't know and can't find out, seek out a                           knowledgeable mentor BEFORE dialing for  dollars. Be able to answer logical                 questions financiers will ask about your business, financing needs, use of                       funds, financial prospects.   Small Business Administration courses in your city             can be very helpful, and very inexpensive.  (I have taught several to classes of very attentive entrepreneurs).  Have short documents already prepared when someone asks for a summary.  If you don't have a well written business summary, with all its components, you have demonstrated an inability to review the lengthy legal documents you may get in the future... when investors are interested. Every entrepreneur seeking money is competing against entrepreneurs who are MUCH BETTER PREPARED.  I repeat, both for my phone bill and your success:  DON'T SOUND LIKE A LONG WINDED IDIOT ON YOUR FIRST CALL. 

Obviously, in writing this article, I wish that most of our callers would read this before dialing.  We may be able to help those who do.  

On the other hand, the callers I describe above are the LEAST LIKELY to do so.  
All I can say is, "We recognize you when you call."   

To those of you who read to this conclusion:  you are now armed with information to distinguish yourselves from those other guys.  Thank goodness.

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