How to find the right investors for your business The three critical stages of right kind of investors and then learn borrow test equipment or ask for free development—startup, incubation, everything about them so you can samples. People are usually happy to and growth—call for three work with them effectively. help. different sources of funding. You’ll have a better chance of inter- If the founders are contributing a acting productively and negotiating portion of the $50,000, try to arrange successfully if you can look at the sit- the combination of “sweat equity” and uation from the other person’s point cash investment so that later, when the of view. You’ll want to understand not company is successful, the distribution ow that you’ve written your busi- N only the opportunities investors look of ownership will be consistent with the ness plan and lined up one or two key for, but also the particular problems role of each person. You can base the founders, the next step is to raise they face. Banks, for example, almost price of the stock on fair market value enough money to get going. In this ar- never take risks because they typically determined by what outside investors ticle, the sixth in our Business Engineer- make only 1 % profit on their loans. are willing to pay. To determine the val- ing series, I’ll try to answer some of You may want to establish how much ue of sweat equity, subtract what you your questions about raising money for risk you’re willing to assume before get paid during startup from what you the three critical stages of your busi- talking to a banker. Even venture capi- could have made on the open market. ness development: getting started, in- talists rarely venture outside the partic- You may also consider accepting in- cubating your first product, and imple- ular range of target companies in which vestments from friends and relatives at menting a plan for orderly growth. they invest. They follow strict guide- this stage. Conventional wisdom says The most important advice I can lines, some of which are established that’s a bad idea because you stand to share with you is to take money only when the partnerships are formed. lose a friend if your business fails. But if from people who have confidence in you present your opportunity objec- you. Let me put that even more strongly: you must not take money from anyone unless both sides are totally comfortable with each other. Since investors are really part of the team, the need for mutual trust and confidence in your working relation- ships is as important here as it is in building an organization (see Laser Fo- cus World, July 1995, p. 61). Before deciding how to finance your company, you want to establish your personal goals and think about how you will repay investors for taking the tively, state the risks clearly up front, risk. Remember, once you take on Funding the startup stage and remain open and honest through- shareholders (investors or partners), Let’s assume your projection of star- out, your relationship will probably en- the company is no longer your own. tup costs shows you need $50,000 to dure, and it may even be strengthened. For ethical and legal reasons, you must demonstrate proof of principle. In- It is actually more important for you put the interests of minority share- vestment money is very expensive at not to take it personally when they turn holders before your own, however this stage because the risks are high you down. Keep in mind also that most small their investment might be. when all you have is an idea. friends and relatives have limited re- Professional investors specialize to The founders should do everything sources and are not professional inves- minimize risk, and they develop differ- possible to fund the startup stage tors — they can’t help you out in future ent paradigms based on their own cir- themselves. The company has a better rounds of financing as professional in- cumstances. You can waste a lot of chance of success if the people with vestors can. time dealing with investors who the greatest day-to-day responsibility wouldn’t invest in your kind of compa- also have the greatest incentive to ny anyway because it doesn’t fit their succeed. You’d be amazed how far Funding the incubation stage profile with respect to size or you can stretch a dollar when you’re Once you’ve proven that your idea is risk/reward. So you want to target the strapped for cash. You become very sound, you will want to raise money to resourceful; for example, you might build a prototype and get a few work- ing models into customers’ hands. R&D expenses come out of profits for scenarios for growing the business and You’ll also want to begin paying the an operating company, every contract optimize the tradeoff between how founders a small salary and to hire one dollar you get means one less dollar much you give up and what you get at or two people with administrative or you have to earn or fewer shares you the end. In working through the details, additional technical skills. The big is- have to give up to an investor. Howev- be creative about ways to stretch your sues to resolve now are how much er, it’s essential that you limit yourself capital. In some cases, customers are money you need, where you can get it, to contracts that fit into your long- willing to pay in advance when placing and how much of your company to term product strategies and that these the order, suppliers are willing to stretch give UP to your investors. products do not face “window to out payments, and government agen- A detailed projection of how you market” concerns. You may experi- cies are willing to pay within ten days expect the business to develop will ence delays and uncertainty in funding, with only a small prompt-payment dis- give you the most accurate numbers, and the allowable profit is only a few count. In today’s environment, a high- An investor’s rule of thumb is $100,000 percent of the contract amount. You tech business can rarely become self- per person, assuming the group is will be using up brainpower, your most sufficient with less than $1 million of in- composed mostly of engineers. That valuable asset, for a small profit if your vestment in the growth phase, and it amount would cover their salaries and work doesn’t lead to any product or can certainly require a lot more. benefits and support their ongoing ac- create a capability that can lead to Venture capitalists are your most like- tivities. Let’s assume you now want to products. ly source of funding at this stage. They raise $250,000; giving up 15%-35% is a prefer investing in companies that can reasonable starting point (See Funding the growth stage gain liquidity quickly. To simplify their “Determining your company’s worth,” At this point, your products have been decision-making process, they tend to below). well received, and you’ve developed a specialize and to work with other ven- Chances are this amount would be good feel for their market potential. ture capitalists in teams. beyond the scope of the founders and Professionals are joining you to manage You’ll need an experienced adviser on their friends and relatives but not large day-to-day activities, ship products, your side of the negotiations. Remem- enough to interest venture capitalists. and build the business infrastructure ber, venture capitalists are used to Private investors, referred to as you need to achieve orderly growth. dealing with entrepreneurs, but this is “angels” in the financial community, That’s good news, but now you need probably your first experience in dealing are a good source of funding for this money to ramp up. with them. Don’t expect them to make level. Angels are often wealthy individ- The amount of money you need de- decisions quickly. They follow a rigorous ual investors who dabble in high-risk pends on how fast you want to grow. procedure, and they understand that startups after building successful busi- You can work through several time translates into more options for nesses themselves. These people are optimistic. They can identify with what you do, help you by sharing their ex- periences, and give you credibility in Determining your company’s worth raising additional capital. Some of them are even willing to combine their The investor is buying a portion of supply optics for multimedia appli- equity investment with a loan, thereby your company. How much owner- cations, you could compare your allowing you to retain a bigger portion ship he or she gets for the invest- company to other optics compa- of the company. You can ask your ment depends on the valuation of nies or to other multimedia compa- lawyer, banker, accountant, and any- the company. That figure is not just nies and come up with two quite body else you know for introductions. a simple addition of what the com- different valuations. By evaluating Some investment brokers can help you pany is worth today plus the invest- an investment in several different find these individuals, but as a rule you ment input. Investors try to fore- ways, you can derive a self-consist- want to be extremely selective be- cast what their holdings will be ent number.