Discussions About Financing Your Business Venture
We now want to circle back to Financing the Emerging Growth Venture. To set the stage for this discussion, here is what Anita Roddick, founder of The Body Shop, once said: “There are only two ways of raising money: the hard way and the very hard way.” As we said in a previous Article, the world of venture capitalism has its own language, its own process, and its own methods of communication between entrepreneurs and potential investors.
All entrepreneurs must go through a standard process when raising money from outside investors. The three steps are packaging, placing, and presenting. Packaging is researching and writing an effective business plan. Placing is skillfully introducing the opportunity before the best investors. Presenting is communicating and making the deal happen in a formal meeting at the investors’ closing table.
What makes fund-raising so hard is not only understanding this process, but also at the same time putting your deal into a package that can be communicated and shared quickly and efficiently. Venture capitalists, especially those that focus on financing early stage ventures, get carpet-bombed with packages outlining business concepts at various stages of development. Facing such an information glut, venture capitalists have been conditioned to consume data at only two speeds. One is very slow, used when they are reviewing and editing investment agreements and the financials of deals before them. The other is very fast, as they become highly skilled at quickly sifting through slush piles of business plans and scanning thousands of e-mails. Therefore, your potential investor is likely to make an instant judgment call just on the strength of the first few words you speak at a networking event, or the first few lines in your Executive Summary. We know of some VCs who consider the strength of the contents by looking only at the “Subject Box” of entrepreneurs’ e-mails!
So how do you get around this communication problem? How do you get what you want said before the right person, at the right time, and in the right way? First you must “disambiguate” what you are attempting to communicate. Disambiguate, a word the Pentagon actually created, means to simplify and clarify.
Harvesting from Your Venture’s Value
This Article supports our belief that having a harvest goal in mind and creating an exit strategy to achieve it are what separate successful entrepreneurs from the rest. Clearly, the main objective of professional entrepreneurs is to create economic value. It is unfortunate that little attention in the entrepreneurial world has been given to exiting a business venture, or what has come to be called harvesting the business.
In their book, Venture Capital at the Crossroads, William Bygrave and Jeffry Timmons help introduce this topic: “Just like farmers, venture capitalists seed, tend, and feed portfolio companies in the hopes of reaping a bountiful harvest.” The professional entrepreneurs and investors know that harvesting an entrepreneurial venture is the approach taken by the owners and investors to realize terminal after-tax cash flows on their investment. It defines how they will extract some or all of the economic value from their investment.
But just because a venture team can build a successful business doesn’t mean they can become rich from it. Investors who provide equity financing to high-risk ventures need to know how and when they are likely to realize a return on their investments before they commit any funds. They invest not for eternity but on average for three to seven years, after which they expect to make a profit that reflects the scale of the risk they have taken on in making their investment. An exit should be seen as a critical milestone that focuses on the transferring of ownership. It is at this stage in the entrepreneurial life cycle that the capital gains (or losses) occur, or, in other words, that there is a harvest (or exit) from the investment.
Why Is an Exit Strategy Important?
Your exit strategy is important because it helps you define success in business. When entrepreneurs have not thought through an exit strategy, it may be an indicator that they are not focused on the eventual transition of the venture. There is a saying among venture capitalists, “It’s easy to get into an investment, but how do we get out?” And investors do not want an exit strategy to be difficult or bloody. In essence, having a harvest goal and a strategy to achieve it is indeed what separates successful entrepreneurs from the rest of the pack.
Discussions About Preparing Your Financing Strategy
We discussed the importance of finding out what works in your business model and then creating an operating plan with a detailed cash budget. In this discussion we help you determine the capital you will need for financing the growth strategy you outlined in in a previous course.
What is a financing strategy?
1. How much do you need?
2. When do you need it?
3. How will it be used?
4. Who could be potential investors? (Why?)
5. What do they get? (valuation, exit)
Your concise financing strategy threads these important elements together.
If you are looking for outside funding, you are not alone. We found that 49 percent of the CEOs leading the Inc. 500 companies, who raised later-stage financings, got it from venture capitalists or other private-equity investors.
But entrepreneurs leading an emerging growth venture face a myriad of challenges: an ever-increasing pressure for recruiting and retaining skilled workers, the need to defend against new entrants, and shortened product life cycles that demand higher investments in R&D to continually pioneer and introduce new products.
As a result, today’s average venture-backed company needs to raise some $16 million of venture capital during its first five years, and complete five or six financing rounds to get from start-up to a liquidity event. This is a 129 percent increase from the amount raised by the average five-year-old venture capital-backed company in 1985. And the median number of months between financing rounds is about fifteen months.
The fund-raising process can ruin a venture’s prospects if it is not prepared for the harsh realities inherent in the process itself. It cannot be done casually nor can it be delegated to another party. The process can drain the entire venture team’s time and energy. In fact, about 25 percent of the CEO’s time and 20 percent of the time of those reporting directly to the CEO will need to be dedicated to raising capital during the first four years. Not knowing this critical fact, many of the venture teams and entrepreneurs we have worked with over the years first show us their business plan, and then ask us to help them with their financing strategy.
It could not be more backwards.