• Venture capitalists -- invest in new companies. They tend to focus on certain stages of development, and on certain businesses. They define market segments in which they have expertise and knowledge, and decide who to deal with on those bases. With these guys, there's a formal presentation after the due diligence process, and investment isn't guaranteed until after a formal vote.
• Early, growth, final (within about a year of IPO) stages . These guys are structured solely on making orderly investments. The stages have fairly hard definitions:
  • Early stage/seed capital = initial outside funding
  • Early stage = beyond seed but before full-up sales
  • Growth stage = beginning to develop markets, and you have your first sales (up to $1M or so) in hand. This stage is perhaps the most critical, timing-wise, because windows for expanding markets will only stay open for a limited time.
  VCs generally don't supply seed money (less than 10% of all the companies US VCs fund are getting seed money, and nearly all of those are "high-tech"). They tend to get involved in the growth and pre-IPO stages. Two major reasons for this:
  1. They want a seat on the board of companies they invest in, and there are only so many partners in the group to go around.
  2. They want to invest on the order of millions (or tens of millions) of US dollars, and most seed-stage companies don't need that kind of money (and may indeed not even be able to spend it).
  The goal when dealing with VCs is a "term sheet," which precedes a formal agreement (and a check), and which spells out the nature of the relationship:
  • who the investors are
  • the company's valuation before the investment ("pre-money") and after the investment ("post-money")
  • investors' dividends (in terms of "preferred" v. "common" stock)
  • conditions of stock liquidation
  • prevention of dilution of investors' stock value
  • call for non-disclosure and non-compete agreements among the company's principal partners and employees (if those aren't already in place)
• Angel investors -- wealthy individuals who invest in start-ups. They tend to be loosely organized, if they are organized at all. They may find out about certain investment opportunities through affinity groups/clubs. With these guys, if you get to due diligence, it's likely that they at least PLAN to invest. Characteristics of angels include
  • they expect a lower rate of return than VCs, from a smaller investment
  • they will wait even as long as seven or eight years for a return
  • they understand (maybe even just a little) the technology and market
  • they enjoy mentoring the start-up

• there's a limited amount of money and a lot of competition;
• the investors will sometimes want a say in how the company is run, or at least in how the money is spent;
• they will want some sort of "antidilution agreement" in case the company valuation is lowered from one round of financing to the next
• they will want nondisclosure/noncompete agreements for key personnel
• they might be more receptive to an entrepreneur's experienced "campaign manager" than to the entrepreneur

Here are two means of company valuation:

1. comparison with existing companies in the same industry
2. estimate of volume growth based on previous fiscal period(s)

Whatever valuation means is used, you generally want to be more conservative for investors than for your employees. This is not to fool employees into working harder; it's because most investors will try to independenly confirm your valuation, and they won't be as confident in your performance as you are.

The charm and evangelistic fervor of the entrepreneur often takes precedence over the company's products and services, in the eyes of potential investors. :-)

Here are some "alternative" sources of funding:

• State loan pools -- organizations exist that provide portions of loans, guaranteeing those portions, from $50K to $1M. The interest rate on such loans varies from 5% to (prime-1)%.
• Loan guarantees tied into certain types of businesses -- for companies that will create many jobs, or locate in an economically distressed area, or represent an important economic sector. These guarantees can amount to up to $1M of working capital, limited to 30-50% of the loan amount.
• Direct loans -- up to $500K for fixed assets, $250K for working capital, for up to ten years, at interest rates varying from 5% to (prime-1)%.

• that only a relatively small portion is guaranteed,
• that the money must be used in certain ways, and
• that to qualify you have to be in certain industries or locations.

Due diligence is the process by which investor groups will determine for themselves whether what a start-up says about itself is true. The rigor of this process is pretty much a function of the experience of the investors. Groups will pay different levels of attention to such issues as intellectual property, technical development, etc. Due diligence requires the start-up's participation, because so much must be provided to the investors. There'll be weekly, and almost daily, contact as the process nears completion. Your management will seem burnt out by the process. :-)

Critical elements of a due diligence package, from the perspective of the company seeking investment, are

• a marketing plan
• valuation/financial projections
• references from those your company has dealt with
• the company's legal standing
• the company's intellectual property standing
• the company's management profile
• what makes your technology unique, or powerful

Remember when dealing with investors that not all of their suggestions are going to help you. Even with the due diligence process, they still don't know your industry, and depend on you to know it for them. For example:

• Even if a potential investor says that joining an industry association is a good idea, it may not be. The associations tend to be *expensive*, and they may find that while their *intent* is to set standards for the industry, what actually happens is that competitors watchdog each other, making sure no particular competitor can get an advantage over the others.
• For all the research the investors do during the due diligence process, they will depend more on your Web site (and on related sites in the industry) than on most other sources. Your Web site should therefore be clean, navigable and informative. It's better to include more information than less. You may find investors asking for certain features. They aren't Web design scholars -- they won't expect you to create your own custom CGI -- but they may want you to have advanced features that you can get for free from other hosts.

Signs that the Climate is Right for Campus Ventures

• A college has a strong entrepreneurship program, or at least some interested faculty.
• Small amounts of early-stage investment money is available.
• The neighborhood has a concentration of technology.

Value Added

Investors can give a small company more than money. Sometimes MUCH more than money. The following list shows ways investors can assist the start-up, and some of these items are beyond price for a company struggling to get up and running:

• attract other investors (depending on their profile)
• assist with business plan
• (sometimes) offer legal counsel (e.g. for intellectual property, liability issues, and contract negotiations)
• assist with finding market niches
• locate members of management team and/or board
• assist with valuation

References

National SBIR Resource Center (USA)
SBIR home (USA)
Inc. Magazine has monthly tips on fundraising
University Ventures (USA)
Mangelsdorf, M. "Terms of Endearment." Inc, 09.2000.
Singer, T. "Venture Capital." Inc, 09.2000.

1. Use jargon sparingly in describing your technology to investors. (If they want to know more technical details, they can and will always ask.) Concentrate on the impact of your products on the marketplace instead.
2. Show your commitment to continuous improvement in products and service. They love it! They will want to know also whether your products have reached limits in their capability.
3. Have plenty of information ready before the due diligence process begins. A strong Web site can help you here.
4. Independent assessments of your technology will benefit investors. Perhaps more than your own assessments! Can you get anyone to write a "white paper?"
5. Look into SBIRs. The USA Small Business Innovations Research program funds many start-ups, with what essentially amounts to a grant. During Phase I of an SBIR contract, you conceptualize a product; during Phase II (if the government agency issuing the grant likes the Phase I results) you make a prototype.