Helping you build and grow your startup. Marquette's Entrepreneurship graduate certificate!
Helping you build and grow your startup. Marquette's Entrepreneurship graduate certificate!
Posted at 12:22 PM | Permalink | Comments (1) | TrackBack (0)
Sometimes the dog really does eat it. And sometimes it's a big dog. Tom Perkins, in telling the Tandem Computer story says "when the first product performed as expected, the company went to $100MM very quickly."
We all have heard/repeated the investment mantra about "big, growing markets" with "unfair advantage IP" position. And I'd like to think that's a great place to start when thinking about ventures.
But it just doesn't happen that way as often as we'd like to think.
When we talk to entrepreneurs (or explain to others what we do) we often explain this in risk terms. Will the product work? How do we know how much the customer will buy and how long it will take? How big is the customer problem being solved? Are we displacing a major competitor or a lot of smaller players? How disruptive will this be, and therefore, how fast might adoption be?
It's not very often that all of these forces come together at the same time - as they did with Tandem Computer - and the company's growth explodes.
But that hoped-for explosion only the beginning. The company's ability to go to scale rapidly and (relatively) efficiently is going to be a very big part of any future success.
Growth generated by market demand and sales can be very complex.
Growth financing, for example. Investors would like to see lowest cost - but with certainty. That can mean a variety of venture debt-type structures - but servicing and cash flow will be really important. Working capital lags mean delivery lags.
Hiring the right folks with broad experience beyond what is immediately called for is a great idea - if you can find then and if they'll work well with the entrepreneurs.
We often forget that the first CEO at apple was -- Mike Scott - not Steve Jobs. Mike Markulla came with the first investments - as a cofounder -- because investors felt the company needed leadership that could attract talent to be able to grow and he brought in Scott.
And manufacturing - most of the time means outsourcing. If the market demand ramps quickly enough there isn't enough time to consider much else. This again involves a complex series of skills and challenges.
And then the partners come calling. And that leads to all sorts of legal structuring issues. Making early long term promises to solve short term problems can often lead to real indigestion later on.
When an investor thinks about these issues, leadership is really the central inflection point.
An enthusiastic, capable, singleminded leader with an orientation to overcommunicate and build great teams dedicated to the growth process is perfect.
Posted at 04:00 PM | Permalink | Comments (0) | TrackBack (0)
"In a networked world, trust is the most important currency."
---Eric Schmidt, University of Pennsylvania Commencement Address, 2009
Posted at 11:46 AM | Permalink | Comments (0) | TrackBack (0)
First develop a business model.
If you've been through a plan review with someone like a potential investor, think for a moment about the questions you get asked.
"How did you calculate the cost of goods?"
"What are your assumptions about how long it will take to get customers?"
"When do you expect the growth rate to stabilize?"
"Where do you expect to find these customers?"
"How many are there and who are the competitors?"
"What's the current solution these potential customers are using today?"
Behind all these questions is the idea of checking and validating assumptions. In the process of asking questions, and answering them, it's sometimes hard for this not to feel like grilling. If the conversation goes in that direction it can be a bit of a problem.
Think about having the same discussion in a different way - by preparing your sales forecast by making your assumptions explicit.
Table 1:
Competitor XYZ is $450 but solution takes 30 minutes to implement each time; we are less than 30 seconds and feel we would test a $50 price increase in support. (NOTE: test concept underlies validation of the first assumption.) Etc
You get the idea.
This is also the way I'd present it. That is, I'd walk through the assumptions on each item and explain them.
In every case, where I can get comparables, I'd use them. Where I cannot I'd say so. It's important to make sure that none of my assumptions are better than anything ever before achieved so that the whole financial results system is based on hypotheses that are within the realm of achievable.
This whole process avoids the common problem of sounding like you are overselling an opportunity and creating doubt when, in fact, if your assumptions are strong and your comparables reasonable, you arrive at the same numerical result with a confident and enthusiastic audience.
Then, what about "five year" projections that everyone seems to ask for?
They're an exercise in spreadsheet math, of course. Growth rate is based on the whoel equation of individual customer acquisition rate (like the 1 per 5 calls in the theoretical example above) the presence of alternative products or services for the target customer (did you include a Porter 5 Forces anaylsis in the presentation?) your ability to scale your sales efforts, future costs in acquisition, product, etc., presence of new competitors emerging over time, size of the served market, ability to expand, etc.
I'd think that a savvy investor gets to the same place pretty quickly. So instill confidence by your explicitly demonstrated ability to analyze and pivot your tactics and strategy, show the audience your assumptions about growth rate, and leave it. This really gives the investor the ability to assess you the entrepreneur - which is where the decision is going to inevitably end up.
Posted at 10:39 AM | Permalink | Comments (0) | TrackBack (0)
It’s a deceptively simple question: what is the optimal way to finance a new startup?
And the answer is also devilishly simple: It depends.
This seems like an easy topic – debt where there is appropriate cash flow, equity when there isn’t. But details in each category vary dramatically.
The overarching idea, of course, is to reduce the cost of capital while maintaining appropriate flexibility for the venture.
And, while debt is less costly than equity, it can bankrupt a company more quickly than more expensive equity might.
Business success is the ultimate goal. But, what constitutes success for the parties involved – investors, entrepreneurs, employees, and customers – can vary dramatically. Misaligned interests that lead to poor financing choices are often very problematic for first time entrepreneurs in young companies. And – they can be avoided if both parties – investors and entrepreneurs – are knowledgeable and well-informed about each others’ goals and interests.
When will the company have positive cash flow? If the answer is relatively soon, then bootstrapping is a very serious consideration. Even if it isn’t soon, early bootstrapping can reduce risk and increase chances for success, resulting in more aligned interests for entrepreneurs and investors.
I’ve written a lot about that topic (http://www.timkeane.org/.services/blog/6a00d834560a4c69e200d83420a4fc53ef/search?filter.q=bootstrap)
and won’t repeat it all here.
But, this should lead to a thorough, well-planned review of bootstrapping alternatives, since bootstrapping can reduce cash requirements in the pre-cash flow phase.
One common reaction to that statement, though, is the need to accelerate the business, often for competitive reasons in the marketplace.
However, this need for acceleration necessarily occurs only after thorough, cheap and fast initial testing has been performed – and financed – by the entrepreneur to eliminate or reduce the opportunity for failure based on a faulty hypothesis.
In other words, the need for acceleration isn’t in conflict with bootstrapping – it is step two. Sometimes, the bonus in bootstrapping is that the venture finds it doesn’t need acceleration financing. See Greg Gianforte’s story (http://www.timkeane.org/2009/04/bootstrap-your-venture.html)
So, if time to cash flow is well understood, and estimates have been as thoroughly supported by testing as possible, then we consider two broad choices.
If cash flow is far in the future and not guaranteed, (but early testing has proven we have a viable opportunity) then the entrepreneur probably is not going to have the wherewithal to support a current debt payment[1] structure. Some form of patient capital will be required. (Do not mistake the meaning of “patient” capital. Here it only means that no debt service is required in the near term, or perhaps at all, but an agreed method for repayment will almost certainly be involved in the investment agreements.)
If, on the other hand, there is some near term prospect of cash flow (say within six months or a year) but no ability to repay in the meantime, then the entrepreneur may try and find a way to finance his “pre-revenue period” using friends and family money that accepts a somewhat lower payment in recognition of a relationship beyond just investing.[2]
It’s axiomatic that in a perfectly priced market, a specific level of investor risk in any business should price identically across all companies. Things don’t work that way in the real world, of course. One investor who has market knowledge and/or the ability to help affect the outcome may either accept a somewhat lower price since he perceives his risk to be lower, or may take advantage of comparables to obtain a higher price and make a higher return based on his added value.
What are the reasons to choose one financing structure over another?
John has had ten years of successful experience in cabinet-making and has established a loyal following in his hometown of 750,000 people. He sells entirely locally and bids his own work and often provides design assistance for cabinets purchased by homebuilders. His entire income is based on his personal output and he’d like to hire several woodworkers, expand his sales to existing customers, and generate a profit in addition to his contributed labor. He needs $250,000 of expansion capital.
First question: What are John’s plans to repay this money? This is a critical alignment of interest question. If he would like to pay it back out of future cash flow that leads to one set of options; if he would like to sell the business to a competitor within a fixed period of time that may be[3] another set of options.
Second question: Does John have the cash flow to support debt payments? If he can support partial payments, perhaps some sort of accelerating payment plan might work.
Third question: Based on the answers to questions one and two, who are the likely lenders/investors?
Possibilities:
1. If plenty of cash flow regardless of plan for sale/retention of business:
2. If not enough cash flow but with the desire to retain the business --
3. If even less cash flow but with the desire to retain the business:
4. Cash flow levels inadequate as in #2 and #3 but desire to sell the business:
Sarah is a scientist at a national research university focused on water quality. She has developed a water additive that purifies brown water making it suitable for drinking. Substantial market testing has proven its scalability in use and early manufacturing tests by a major chemical manufacturer indicate it may be economically feasible from a manufacturing cost point of view. The marketplace of buyers seems to be expanding worldwide. The company is pre-revenue and Sarah’s intention is to sell the company within three years.
John the cabinet maker has decided to expand to several cities within several hundred miles of his location, to develop several standard lines of custom products, and to seek growth at annual double digit rates. He feels now is an excellent time based on his local experience and believes the high end of the homebuilding and remodeling market is seeking new solutions.
Angelina is an orthopedic surgeon with a specialty in hip replacement surgery. She has designed several new devices that promise to allow arthroscopic hip replacement surgery. Given the approval cycle required for a radical new innovation, she knows the time to revenue will be long and difficult but feels this is breakthrough technology. She needs $4MM to get the product through the normal approval cycle.
None of this is exhaustive. And I’ve avoided beginning to describe specific terms in this note. Specific terms are an additional way that investor and entrepreneur interests get aligned in the investment process. In addition there are several new intersting methods - royalties is one - that help in term structuring.
Note: Thanks to Bill Stone of Townbank in Delafield, WI for his comments and work in helping me prepare this note.
[1] From a lender’s point of view, of course, the conditions under which the lender accepts a fixed interest rate in return for the promise of regular payments is based on considerations beyond the ability to repay.
[2] One of the huge mistakes entrepreneurs make at this stage is accepting friends and family money and assigning huge valuations to the company to reduce the size of future payments required. This practice will do that, but, if other investment is ever required, the inevitability of a reduced valuation leading to a lot of heartburn is highly likely. Always better to do this with some sort of convertible debt instrument.
[3] I say “may be” because if the business will support senior debt then that is less expensive and allows more flexibility whether John intends to keep the business or sell it.
Posted at 08:30 AM in Funding startups | Permalink | Comments (1) | TrackBack (0)