Crack the Funding Code: How Investors Think and What They Need to Hear to Fund Your Startup272
Crack the Funding Code: How Investors Think and What They Need to Hear to Fund Your Startup272
Lack of funding is one of the biggest reasons small businesses fail. In 2016 in the United States alone, more than 31 percent of small business owners reported that they could not access adequate capital, and the lack of capital prevented them from growing the business/expanding operations, increasing inventory, or financing increased sales.
This book will show you how to find the money, create pitches that attract investors, and then structure fair, ethical deals that will bring them new sources of outside capital and invaluable professional advice. Crack the Funding Code gives you the broader perspective on:
- how funding works,
- how investors think,
- and what they need to hear to put their money where your mouth is.
Every entrepreneur who reads this book will get easy-to-follow deal checklists, a roadmap of where and how to locate the best funding resources and top business mentors for their industry or geographical location, and a step-by-step process to create pitches that make their idea or business irresistible.
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THE FUNDING MINDSET
How to Think Like an Investor
Learn to raise capital by any means. That's your primary job as an entrepreneur.
— RICHARD BRANSON
Imagine that it's 1491 and you're Christopher Columbus, looking for your next profitable venture. You notice that all the trade routes from Europe to the lucrative markets in India and China are long and perilous. You believe that if you sail west across the Atlantic Ocean you can find a new, shorter trade route to the Far East — but you need money to build and equip the ships for your voyage. You approach the king of Portugal and then the merchants of Genoa and Venice, but they all turn you down. Finally, you get an audience with Queen Isabella of Spain. You'd been building relationships within the Spanish court since 1485, but this is your last chance to raise the money you need. You walk in and make your pitch for Spain to finance your great venture.
What do you imagine Queen Isabella is thinking as she listens to your proposal? "Let me see if I understand: This guy wants me to give him a lot of money to build three ships to reach the East by sailing west, which, according to every expert, can't be done. Smart people in Portugal, Genoa, and Venice have already turned him down flat. Why should I be crazy enough to give him money?"
Of course, Queen Isabella was crazy enough, and the Spanish court gave Columbus the modern equivalent of $14,000 to build his ships. Columbus sailed west, "discovered" the New World, and (for good or ill) created the foundation for the great Spanish empire. And because of Columbus's voyages, during the sixteenth century Spain laid claim to much of North and South America and became a dominant world power.
By the way, it also extracted the equivalent of $1.5 trillion in gold and silver from its American colonies. Not a bad return on a $14,000 investment.
Columbus's story is a metaphor for what entrepreneurs are doing every day: inventing new or better products or services that solve problems, and then starting businesses to turn those ideas or inventions into reality.
The Global Entrepreneurship Monitor estimates that approximately 100 million businesses worldwide — that's three businesses every second — are launched each year. In 2017 in the United States alone, approximately 540,000 new businesses were started each month.
But while some legendary enterprises began on a shoestring in a garage or basement, even the "leanest" startup needs capital to open its doors. According to a 2015 study by Intuit, 64 percent of U.S. entrepreneurs started their businesses with investments of less than $10,000. That money either comes from the entrepreneur's personal savings (57 percent of the time) or a combination of personal funds plus investment by family and friends (82 percent of the time).
However, starting a venture isn't the same as keeping it up and running. The Kauffman Firm Survey (which studies business activities of startup companies) estimates that, on average, it takes a minimum of $80,000 to operate a small business in its first year. That's a lot more capital than most people can raise every year, either from personal assets or from friends and family. So like Columbus, at some point many entrepreneurs will need to find outside investment to finance operations.
The good news is that today, a lot of outside money is available to fund great businesses. Consider the following:
* The National Small Business Association reported that 75 percent of small businesses used some kind of financing in 2015–2016. Sources of these funds included loans, credit cards, venture capital, and crowdfunding.
* In 2015 bank loans going to small businesses totaled approximately $600 billion. That same year, businesses received $593 billion in funds from venture capital (VC) firms, angels, and finance companies other than banks.
* In 2016 "angels" (individuals investing their own money in companies) funded 64,380 entrepreneurial ventures to the tune of $21.3 billion.
* In 2017 VCs invested a total of $84 billion in 7,783 companies — the highest level of investment since the early 2000s.
* In 2017 the number of direct investment deals funded by family offices (which manage investments for high-net worth individuals and families) was more than twice the number of deals funded by traditional VC firms.
* Alternative finance lending (which includes crowdfunding and P2P online lending) is growing rapidly as a resource for businesses. In 2016, $8.8 billion in alternative business funding was raised in the U.S. by 143,344 businesses. U.S.-based companies used equity-based crowdfunding to raise $569.5 million, while revenue/profit-sharing crowdfunding produced $28.5 million.
* In 2017 companies worldwide raised $5.6 billion through initial coin offerings (ICOs), where investors used funds to purchase tokens or digital currency that could then be traded on online exchanges.
In some ways, entrepreneurs are in what could be called a "golden age" of fundraising, with the advent of P2P online lending, equity and revenue/ profit-sharing crowdfunding, tokenization, and blockchain-based digital currency adding to the healthy numbers for venture capital, family offices, and seed and early-stage angel investing. But while it seems as if the funding landscape is expanding dramatically, the same perennial three questions exist for anyone who needs capital for their business: (1) Where's the money? (2) How can I gain access to the people and institutions that have it? And (3) what will it take to persuade them to give/loan it to or invest it in my startup?
Unfortunately, entrepreneurs often lack the time, expertise, or knowledge to take on the complex task of finding the funding that can help them reach their goals. As a result, for every startup that becomes the next Airbnb, Amazon, Lyft, or Warby Parker, thousands of other, equally great companies never get the money they need to get off the ground or to keep going. According to Fundable (a business crowdfunding platform), in 2014 less than 1 percent of startups received funding from angel investors, and 0.05 percent by VCs. Banks weren't much better sources of capital, providing funds for only 1.43 percent of startups.
The problem with most startup businesses isn't their ideas, or even their businesses: it's that they don't know where to look or how to present their businesses in a way that "closes the sale" with investors. How can startups find the cash they need to open their doors and keep the business going until they turn a profit? It begins by thinking like Isabella rather than Columbus. Whether you're going to your community bank for a business loan, pitching a top venture capital or angel investment firm for millions of dollars in exchange for equity, or posting your product or startup idea on a crowdfunding or peer-to-peer (P2P) online lending site, in every situation someone will be evaluating your offer based upon one fundamental question: Will your business make them money? Entrepreneurs must do what they can to access the investors' mindset so they can meet their needs and convince them to invest.
Cindy Padnos is founder and managing partner of Illuminate Ventures, an early-stage VC, and she remembers when she was an entrepreneur seeking venture capital for her own startup. "A very experienced VC investor corrected me when I said that I was 'fundraising.' 'To be clear,' he said, 'I raise funds for investment. You raise capital to build a company.' Fortunately, I remembered the sound advice I had received to focus on what was actually important and not to argue semantics. This perhaps overly picky investor ended up being incredibly helpful, making introductions that led to our first round of financing."
One of the core tenets of business is to think like your customers and deliver what they want, rather than what you think they should want. The same principle is true when it comes to your investors. In the same way you conduct market research to help shape your product or service to meet your customers' needs, you must understand the type of investors you want to reach, and then shape your business proposition to meet those investors' needs.
The Three Things Entrepreneurs Need to Get Funded
As someone who has spent more than thirty years helping entrepreneurs find and connect with sources of capital, and then guiding them through the process of pitching and closing the deal to get them the money they need, I believe only three things separate entrepreneurs whose ideas and businesses get funded from those who don't: information, access, and expertise.
Many startup entrepreneurs believe that their only funding options are (a) savings or personal credit, (b) friends and family, or (c) bank loans. But personal savings and credit can run dry long before the business is profitable, and friends and family can be relied upon for only so long (and for a finite amount of money). The next logical resource is a loan from the local bank — if you have the collateral necessary, and if your local bank is still around. (After the Great Recession of 2008–2009, many bank branches that provided loans to small businesses disappeared, and other, larger lending institutions have not picked up the slack.) In 2015 a Federal Reserve survey reported that only 38 percent of startups that had been in business for less than five years were approved for loans. And businesses that are able to secure loans are often subjected to strenuous terms and high collateral requirements that can restrain the growth of a struggling enterprise.
Entrepreneurs need information about a wider portfolio of funding sources, such as VCs, micro or seed-stage VCs, angel investors, super angels, angel syndicates, and family offices, to name a few. In addition, recent regulations have opened a new category of lending to entrepreneurs: crowdfunding for businesses, online angel/investor "matchmaking" sites like GUST, and P2P online platforms like Lending Club, Prosper, and Upstart. These sites bypass traditional lending institutions and allow accredited and non-accredited investors to invest directly in businesses. Many municipalities, states, and even large corporations also offer grants to startups (often in conjunction with training programs). Finally, accelerators and incubators provide guidance as well as financial support to help entrepreneurs turn their ideas into viable startups.
Different categories of investors are active at different stages of the funding cycle, and they have specific requirements and guidelines for the kinds of businesses they sponsor. Entrepreneurs need to understand the differences between investors while being able to deliver the universal basics of a solid business plan, a great pitch, and a deal that works for all parties. We will discuss categories of investors, and when in your business development it is best to approach them, in Part II.
The good news is that people with money are always looking for companies with potential for great deals and great returns. Angel investors and VCs need to have a series of deals in various stages of development. When one deal matures and the business either goes public, is sold, or the investors receive a return on investment in some other way, this frees up capital to invest in the next great business. It's paramount that these investment firms have quality "deal flow" — that is, new deals in the pipeline. If your startup has potential, you are solving a problem for investors who need to put their money in great businesses.
But to access these investors and investment firms, you either need to know these people yourself, or find someone who knows them to introduce you. The number one way investors find deals is through referrals from people they know, like, and trust. According to Case Western Reserve University business professor Scott Shane, most early-stage investors won't even look at a potential investment unless someone they know and trust brought them the deal. Therefore, unless you already know who these investors are, or better yet, you know someone who knows who they are, you're unlikely to get a chance to tell them about your business.
When it comes to someone trusting you with their money, your personal connections are some of the most valuable currency you can have. You need to build a quality network of business connections, and then use them to reach the investors you need.
Let me give you an example that I wrote about in my first book, How to Be a Power Connector. My good friend Dr. Annette Lavoie had invented a permanent contraceptive device for women, but she spent eight years trying to obtain the funding to get it to market. I had already put Annette in touch with several of my investor connections and helped her develop a funding strategy. Then one day I was invited to a breakfast in Salt Lake City, Utah, where Geena Davis and Gloria Steinem were in attendance. I quickly called Annette and asked her to come over to talk about her device. Gloria Steinem offered to introduce Annette to someone at the company that manufactured the "next day" pill to see if they would be interested in investing. In short order, Annette used the funding from investors and the company to go into production. Not long after, she sold her device to the corporation and her investors received a 300 percent return on their investment. The combination of a great product, a great founder, a solid business plan, and access to the right people in the right industry allowed Annette and her investors to succeed.
Nowadays it may be easier than ever to find the names and contact information of pretty much anyone you want to reach, but knowing who you need to reach and then finding a way to get a warm rather than cold introduction can make the difference between getting a chance to pitch your idea and being stuck in the back of the line.
A 2009 U.S. Bank study revealed the challenges many businesses have with cash flow and described two important causes of business failure: 73 percent of entrepreneurs stated they had been overly optimistic about achievable sales, money required, and what needed to be done to be successful, and 70 percent said they had failed to recognize (or they had ignored) what they didn't do well, and they had not sought help from those who were experts in those areas. In other words, almost three-quarters of entrepreneurs whose businesses failed believed it was because they lacked the necessary expertise.
Many entrepreneurs have a great idea for a product or service, but they aren't great at the business side of their businesses. However, when entrepreneurs seek outside investment they are forced to think strategically about every aspect of their enterprise. They must examine concept, customer, sales, marketing, financials, processes, and execution to ensure that the fundamentals are sound. They also have to "sell" their business well enough for investors to want to say yes. Therefore, in the fundraising process most entrepreneurs become better businesspeople. They understand more about their market, their customers, and the "nuts and bolts" of their business systems. They become experts in their businesses rather than simply being someone with a great idea or product but no plan for long-term profitability.
There is a second advantage that comes from seeking outside investment. Outside investors not only provide access to greater capital than entrepreneurs can raise on their own, but they also bring access to extensive networks of industry and financial professionals with expertise entrepreneurs may lack. As part of many financing deals, investors ask for representation either on the business's board of directors or advisory board. (In fact, having an advisory board already in place can be a positive sign for investors that you are smart enough to recognize that you don't know it all and are willing to accept advice and direction from others.)
"Entrepreneurs have limited time, knowledge, and resources. Therefore, they need to focus on what matters most to them and what they need to do better than their competitors," writes Punit Arora, assistant professor of strategy and entrepreneurship at the Colin Powell School of Civic and Global Leadership, City University of New York. "But the rest still needs to get done." Advisors and industry experts can provide a wider business expertise and viewpoint so that entrepreneurs can focus on whatever makes them truly unique.(Continues…)
Excerpted from "Crack the Funding Code"
Copyright © 2019 Judy Robinett.
Excerpted by permission of HarperCollins Publishers.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
Table of Contents
Foreword Kevin Harrington xiii
Part I Cracking the Code of Entrepreneurial Success 7
1 The Funding Mindset: How to Think Like an Investor 9
2 The 3 Cs That Investors Seek-and the Dealbreakers That Will Make Them Run 23
Part II How to Find the Right Investors 33
3 Who's Got the Money? Where to Look (Including Some Places You've Never Heard of) 35
4 Your Funding Roadmap: How to Find and Reach the People Who Can Help You 55
5 Network Your Way to the Right Investors 71
Part III What Investors Are Looking For 85
6 The Right Founder and the Right Team 87
7 The Right Business Plan and Clear Financials 101
8 Secrets of Creating and Delivering a Compelling Pitch 127
9 Risk Mitigation: How to Make It Easy for Investors to Say Yes 145
Part IV Closing the Deal 159
10 "I Have an Investor: Now What?" The Valuation, Deal Terms, and When to Say No 161
11 Due Diligence and Closing 179
Are You a Power Connector? An Assessment 191
Judy Robinett's Top Ten Power-Connecting Tips 200
Successful Pitch Deck Example 201
Due Diligence Questions 203
Due Diligence Checklist 207