10 Important Techniques To Get Your Business Financeable(Part 2)

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Anyone can sell cold drinks to thirsty people. Marketing is the art

of finding or inventing ways to make people thirsty.

—Herman Holtz, Consultant

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In our last post we reviewed on 7 techniques with which to get your business financeable, we shall be looking at the remaining 2 techniques below:

8. High margins are always desirable to investors. They understand that it will take longer than anticipated to bring a product or service to market, that it will take more money, and that it will take longer to realize revenues. Higher margins offset such adversity, offering a sorely needed cushion. It is estimate that 90 percent of all the ventures reviewed in practice will end up needing more money than has been presumed by entrepreneurs in their business plans. This is precisely why sophisticated investors always discount projections, or give “haircuts” to forecasts from entrepreneurs. Without an understanding of the role that Murphy’s law plays in the development and growth of a company, entrepreneurs are doomed by presenting unrealistic milestones to skeptical investors, subjecting themselves to negative consequences of missed deadlines, loss of investor confidence, even the role in and share of ownership in the enterprise.

Investors must be made to understand that your early-stage venture is not making money now, but it is your job to convince them that you will make money and be profitable within a reasonable time

Post-Bubble risk profiles associated with financial attributes of the venture must possess reasonable targets. the company in its pro formas must demonstrate with confidence the ability to generate revenue streams, if not profits, that will position the investors to get not only a return of their investment but a return on their investment. There is a wide range of acceptable levels of profit potential in deals that have been completed in the market. But typically investors are looking for a real opportunity to realize a 20 to 50 percent ROI per year compounded annually over the term of the hold of the investment. By experience 15 percent of an investor’s private portfolio accounts for 85 percent of returns, a slight variation on the Pareto Principle, but noteworthy regardless. On an eight-year hold, investors aim higher, but will be attracted by 35 percent per year returns, even when swinging for the fence. The central point for entrepreneurs to understand is that they must make clear, compelling cases that their venture will make money.

Investors must be made to understand that your early-stage venture is not making money now, but it is your job to convince them that you will make money and be profitable within a reasonable time. This requires clarifying what will drive revenues and costs, and thus margins. It is precisely the size of these margins that create insurance for the venture to absorb unforeseen problems,mistakes, and unexpected costs or slow-downs in revenue generation.

9. Capital intensity reflects the investment needed to prove to investors that a product or service will work. In biotechnology, for example, companies may spend years and invest millions of dollars before receiving Food and Drug Administration (FDA) approval to market a product. Significant financial risk before proof of concept is available reflects high levels of capital intensity less attractive to investors. Research, development, and good manufacturing process (GMP) of a growth hormone, for example, can take up to seven years before permission is granted to test in humans—seven years of preclinical testing to figure out if it works, if it is toxic, and if the correct dose is being administered. Add a few more years of separate phases of clinical trials to determine safety and efficacy. Then file a product license application (PLA) and wait a couple of years for the FDA’s approval. Finally,the company arrives 12 years later, having spent $200 million—the estimated average cost of bringing one protein to market. Such is the burden and risk that create capital intensity, and this example goes a long way toward explaining why highly capital intensive biotechnology ventures are less often funded in the current market.

On the other hand, being able to develop and bring a product or service to market quickly reflects a less capital-intensive circumstance. Investment will come more easily once the concept has been proven, permitting money to be used to move the product or service into the marketplace. Quick movement to the marketplace spawns a less capital-intensive situation.

10. Valuation is necessary to assess the financeability of your venture.Read any overview of market trends, and the entrepreneur will discover that the aggregate dollar amount of investments has declined and the number of “down rounds” is increasing. Entrepreneurs need to have reasonable expectations when it comes to valuations from investors, and to avoid overshopping their deal to attain unreasonably high valuation expectations. As you consider your valuation, compare it with these statistics and others that you can locate that are consistent and comparable with your venture. As ventures progress in the evolutionary life cycle to later stages of development,obviously the valuation will increase significantly. To raise money during the early stages of a company, when its valuation is lowest, more will have to be ceded to investors. This circumstance illuminates two things that influence the financeability of a deal:

The investor must feel that the valuation is credible (in other words, it has to fall in line with valuations occurring elsewhere in the market); and from the entrepreneur’s point of view, valuation should be based on achieving milestones so that more money than is presently needed is not being raised. This prevents giving away more of the company than is necessary when it is at a low valuation.

A clear and believable exit plan must be part of the picture. Investors who invest in companies directly, in most cases, will not be able to harvest their investment (especially in equity investments) until those equity investments are liquidated. And although a number of workable liquidation options exist, the plan for liquidation must be explicit. The investor must know whether liquidation will occur through a “claw back”—a sale back to the entrepreneur—or through the merger or acquisition by a public company and the trading of that illiquid stock for publicly traded securities. Liquidation may also occur through the sale of the company to other entrepreneurs, or through an IPO.

The second exit factor to consider is the implication of the amount at which companies go public or are purchased or sold, and the implications such amounts have for investors’ targeted multiples of return at liquidation.Remember that investors make big profits and achieve high-level interest rates of return for their portfolios only when a company they have invested in goes public or is purchased by a public company at a significant premium.How much of the stock in your company will the investor require to achieve targeted multiples over the term of the hold to compensate the investor for loss of use of capital?

The astute entrepreneur needs to think about all these things in determining whether your deal is financeable and whether—given its time-intensive and resource-intensive nature—the Sturm und Drang of raising private capital is merited.From experience it is known that added points need to be raised. Do not risk overshopping your deal by introducing your venture to investors before it is ready. Most companies, before meeting with investors or retaining placement counsel, determine that their product or service solves a problem for their customers. Some obtain orders or at least conduct research with customers or potential customers. Many develop a backlog of orders.Also, packaging, or the packaging idea, is developed, a prototype completed, and data from test runs are ready.

 

Is Your Business Venture Financeable ?

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Finally, progress has been made in developing pro forma financial statements that meet reasonable economic preconditions. In addition, the team must also acknowledge its responsibility in raising the necessary funds for the venture. Although this feat often takes months to accomplish, the task belongs to the team, not to others. Also, team members must be willing to travel to meet with investors. Experience has taught that money cannot be raised by proxy or through impersonal contact or through presentations on the Internet. Raising money is accomplished only by meeting face to face with potential investors.

Do not risk overshopping your deal by introducing your business venture to investors before it is ready

You must be realistic about raising capital for your business. Give yourself reasonable time to complete the financing; do not allow desperation to hover over a deal. Remember this well: In the eyes of an investor, desperation is a deal killer.Determining the financeability of your deal should form the basis of your situational awareness, a term that jet fighter pilots use to establish the position of their aircraft, especially in relation to the ground. At such sizzling speed, their lives depend on knowing precisely where they are, even when flying upside-down. Although not as breath-taking or life-threatening, your situational awareness—the management team, market, competition, industry,proprietary technology, production, channel economics, high margins,profit potential, capital intensity, projections, valuation, and exit plan—depends on sensing where you are in relation to your “ground.” It is one thing to think about whether your deal is financeable, quite another to ponder whether you yourself are capable of being funded. Yes, it is important that your deal is financeable, but more important is whether you can inspire the confidence in an investor to write a check. Do you have the traits that will assure an investor that you can accomplish your goal and make good on the proposed ROI?

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