12 Tips for Funding in the Post-Disaster Economy

Tuesday, April 16, 2002

Damir Perge, Futuredex, http://www.futuredex.com

Better Business Management & Planning Practices

The Basics for Early-Stage Startups

An important part of the Futuredex mission is education. Having the right information at the right time is crucial to molding venture relationships. In general, we focus on the sophisticated, in-depth information our clients depend on. But, in times of turbulence, we believe it is important to reassess our basic assumptions about how to search, conduct, and negotiate the early stages of finding investors. Are investors still present in an economy that has downshifted dramatically, and in a world that changed forever on September 11, 2001? What follows is a compendium of opinion from angels, VCs, consultants, analysts, and early-stage investment bankers.

Tip No. 1: It’s Not Business as Usual
After the terrorist attacks of September 11, Americans are reviewing new strategies for doing business. Even before the attacks on the World Trade Center and the Pentagon, the world of venture capital was unrecognizable from the previous 18 months. Then, it was an
environment of “free money,” as Bob Bozeman, general partner of Angel Investors, L.P., calls it. “It was just a question of whose free money you were going to take.”

Today, it’s a different story. It’s back to business basics such as building products and/or services, acquiring customers, managing employees, keeping costs under control, and paying attention to operations. It’s easy to forget the basics when you live in the world of hype, but entrepreneurs who are still stuck in the dot-com bubble need to break out and listen to the market. And what the market is saying is that it’s all about credibility.

Like all business people, entrepreneurs need to keep an eye on the specific ramifications of the September 11 events. Without question, there will be a new focus on personal safety with a trend toward conducting business remotely. According to analyst Brian Alger of Pacific Growth (www.pacificgrowthequities.com), "We can expect to see a significant increase in demand for video conferencing equipment and
services.” And, entrepreneurs that plan on interacting with far-flung partners must be technologically prepared to do so remotely.

Tip No. 2: Keep Politics in Their Place
Today, every national dispute is global to some degree. A blow to national security
demands recognition of the fact that financial markets are largely based on mood. The
mindset of the moment is, unfortunately, one of trauma: venture capitalists—as well as
the rest of the business world— are reeling from the implications of the terrorist
attacks. Therefore, startups and entrepreneurs must adjust to the possibility of an even
tougher funding climate. On the other hand, it should not be an excuse to give up on
dreams or suppress passion.

“The negative consequences to the future of investing are obvious,” says Mark
Heesen, president of the National Venture Capital Association (www.nvca.org). For
example, Heesen reports that venture capitalists are concerned that the IPO and M&A
markets may continue to stay weak, forcing the focus on existing portfolio companies
rather than new opportunities. And heightened security and increased delays at
airports may discourage them from investing far from home.

But many venture capitalists find some hopefulness. For instance, in a recent
presentation to the New York Venture Group, Heesen explained that investors are
cheered that Congress has appropriated a new $40 billion pool for, among other
things, beefing up national security, strengthening the military, and rebuilding New
York City. No doubt a portion of this fund will be earmarked for buying leading-edge
technologies from venture-backed companies.

Wharton finance professor Jeremy Siegel agrees, and speculates that some
industries—those in the defense and security business—could fare better in the
aftermath of the attacks. As in the Gulf War—where consumer confidence fell—the
war against terrorism will not generate heavy industrial production, and is not expected
to be beneficial to the economy.

“The only types of wars that boost the economy are long, drawn-out wars,” says
Andrew Kraft, executive vice-president of Basex (www.basex.com), a research firm.
“I’d rather have a lower economy and no war. But terrorism is not a deathblow, and
certain industries—especially tech—will be able to pull themselves together to help the
economy come around.”

Tip No. 3: Devise Strategies for the New Economy

For entrepreneurs in the early funding stages, there’s an abundance of wisdom out
there, and much of it, this month, is pessimistic. Indeed, there are some hard realities
to look at:

1) This year and next year, some VCs are looking at minimal revenues in their portfolio companies. Why? Because in a down economy, the companies in their portfolios are going to have difficulty acquiring paying customers. Many investors are overloaded with companies and are now cleaning up their portfolios or reinvesting in the subsequent rounds of their portfolio companies. Because of this, early-market stage investing is getting tougher every day.

2) The days of having an idea and getting a $3 to $10 million pre-valuation are completely over. Sixth grade mathematics has returned and the investor will want an ROI that warrants this huge risk: Many want a 10-fold return; some look for even higher returns because they know they will have some losers. Hindsight is 20/20 vision. It has been shown in the last three years that early stage investing is much tougher than expected.

3) Investors are no longer swinging for the fences, says David Adams of Rocket Ventures. Instead, they are hoping for a bunch of base hits.

4) Investors are also less eager to fund unseasoned management teams anymore, a
common occurrence a couple of years ago, says David Adams of Rocket Ventures.

5) And finally, money-seekers must recognize that there is now a bigger gap between
angel and VC investing. Before now, angels would fund a company knowing that a
VC was ready to fund subsequent rounds within six to nine months. Today, that
time period has stretched considerably. Learning that getting subsequent rounds
from VCs is now much more difficult, angels are more prudent and look for lower
valuations. Their risk has significantly increased because it now takes more cycles
to get second rounds completed.

That’s the bad news. Early-stage funding expert Michael Dart of Taproot Ventures has
some good news:

“If you are passionate about your business, and the impact it will have on our community and you can see how it will make a difference, then you won’t have problems. It will sustain you through the process of finding funding. If you have a marginal idea, it’s a tough time to be promoting it. It’s also a bad time for those with ‘me-too’ ideas, or products that just make an incremental, ten-percent-improvement-of performance-difference instead of an order of magnitude of difference.

“But if you have something you believe can make a material impact on the lives of
people today, whatever it is, there are a lot of investors who really want to help people
do that. If you have faith, if you deeply believe it has the potential, then don’t lose faith.
There are still a lot of investors who want to help great companies be built and great
products get to market.”

Tip No. 4: Do It Yourself
Where business plans are concerned, a DIY (do-it-yourself) attitude is the best
strategy. And do it now; you may need it sooner than you think.

Why “build” instead of “buy” or “borrow”? It’s not just about money. Unlike building your
own infrastructure, the value of writing your business plan is not just in the end-result;
it is in the process itself. Obviously, scores of skilled consultants can help you write a credible business plan. But writing it yourself forces you to think through all the issues that VCs or other investors will raise. And they may raise them sooner than you think—-as early as that first phone call. I recommend using the proven business planning software template like BizPlanBuilder from JIAN (www.jian.com) I would say that it is the best one out there.

After crafting your business plan, you’ll be able to answer questions from potential investors with absolute clarity and complete conviction. In addition to the business plan, create a short PowerPoint presentation of 8 to 12 slides along with an executive summary. While an executive summary works for some VCs, others prefer a simple, graphic presentation that’s direct and informational. Include an overview of financial milestones, along with any other specific information that may be relevant to that particular VC or angel. Early-stage investors are comfortable considering companies in the slide-ware stage, but only if their business plans demonstrate a clear market focus.

“An experienced investor needs a very short list of information to determine whether a business plan is worth reading,” explains Paul Gelburd, managing director at GE Equity (www.geequity.com) in San Francisco. Gelburd only considers business plans that start with “a concise executive summary that describes the business and the key financial information—revenues and expenses for this year and for next year.”

Tip No. 5: Outline a Clear Path to Hitting Cash-Flow Positive
The glory days of funding big ideas with no ROI are over, and there’s no sign that this
‘90s-era brand of investing is coming back. Therefore, it’s essential that your financial statements lay out a clear path for return on investment. A few of the basics:

1) Make sure the cost-side of equation is really tight. Prove that you are very frugal about company costs as well as your salary. Showing a salary of a couple hundred thousand in the early stage suggests you don’t have a grip on reality. A more common early stage salary for the founder would be zero to whatever the business can afford.

2) The concept of burn rate must go. Companies can’t build value that way any more. Costs must be aligned with sales projections.

3) Be sure your sales forecasts are realistic. Seasoned investors will tell you that they can almost predict what the sales forecast slide will show: “In year five, we’ll sell $100 million.” These type of sales forecasts will not promote credibility. Give realistic projections; by now investors have been burned so many times that if you give them a realistic picture, you can buy yourself valuable credibility.

4) Don’t be too optimistic about the market sector. Investors often hear that it’s “a billion-dollar sector and your company can get 10 percent in three to five years.” If those market projections were true, then you would end up with 20-30 competitors, which would automatically lower the market size for you! Look for niches where there is minimal competition and where you can get 30-50 percent of is the kind of home run an investor wants to hear.

Other voices from the venture community have the same advice.
“There is no more concept funding,” explains Chuck DeVita, founder of Growth Process Group (www.growthprocess.com), a consultancy that works with emerging and established technology companies. In order to land significant funding “a company has to have a real product close to shipment.”

Brad Feld, managing director of SOFTBANK Venture Capital (www.sbvc.com), concurs, although he offers a slightly different timeline. His firm pushes companies to generate customers and revenue within their first year of life, with year-two revenues being significant enough to see trend lines and a solid gross margin ramp.

While VCs like Feld may not ask for complete financials at the first face to face, be prepared to produce at least a list that includes significant revenue milestones such as product shipment dates, and break-even projections. And when you crunch the numbers, do enough homework to feel secure in your predictions.

Entrepreneurs also agree that today, venture financing is centered on a company’s path to profitability. “Financing terms are tougher,” says Jim Hake, founder of technology startup PersistX (www.persistx.com ). “And expectations are tougher. But they are really just leveling out at what they should be.”

The post-attack economy has also influenced VCs’ upfront financial management of their portfolio companies. “For new investments, I will probably want them to have 24 months of cash rather than just 18,” says Bryan Roberts, general partner at Venrock Associates (www.venrock.com), in an interview with The Daily Deal.

Tip No. 6: Make Partners and Advisors Your Personal VIPs
The importance of partnerships and an advisory board cannot be exaggerated. Both are crucial to your success as an entrepreneur.

With partners, be advised that investors are smart enough to know a true partnership vs.
a “Barney” deal (“I love you, you love me, we’re a happy family where no money or real
strategic benefits are exchanged”). Deals made just to add a name to your partner list
have little or no value, and investors know it. They’re looking for alliances that bring
specific benefits to your organization, such as the ability to open distribution channels, or
provide resources, or intellectual know-how for solutions. It’s quality, not quantity that
counts.

Forming a good advisory board is an equally important challenge. It reduces the degrees
of separation between you and your potential investors and obviously, it increases the
likelihood that one or more industry gurus on your board is known to your investors. But
again, investors are smart enough to see through the window dressing.

Angel Bob Bozeman admits that while the stature of advisors does add value, investors
are more interested in what role advisors play. How much do you use them? Are they
plugged in? “VCs love to see the attitude of the entrepreneur with regard to advisors,”
says Bozeman. “If the advisors say this guy calls me, then the VC says, that guy is doing
a good job. Otherwise, if he or she never gets a call, then that advisor is just for show.”
And he warns, the investor will find out what your relationship with your advisors is.
The importance of advisors as intermediaries between you and your investors cannot be
overstated. Getting introduced to a VC by a friend or an advisory board member
increases the chances of getting funded exponentially. “One of the critical few questions
I ask,” says Ash Vasudevan, vice-president of strategic initiatives and investments at
CommerceNet (www.commerce.net), “is who’s on the advisory board. In these economic
times, it’s critical to have an advisory board that backs an idea.”

Tip No. 7: Solid References may Produce Solid Gold
Whatever the state of the economy, another basic requirement that remains is the need
for references, especially if you don’t have existing working or personal relationships
your potential investors. If that’s the case, put together a list of references that—if
possible—includes a name or company name that may be immediately recognized by
your VC or investor. References could include vendors, employees, consultants, media
contacts, or industry experts.

Although this may mean preparing a new list of references for each potential investor,
your effort could be good enough to get you and your business plan into a meeting.
GE Equity’s Paul Gelburd confirms that from the investor’s point of view, getting an
introduction from well-connected references may provide the necessary foot in the door.
“I get a lot of proposals via e-mail,” he explains, “and I do not open an e-mail from an
unrecognizable source.” From the startup’s point of view, Tom Ruppaner, CEO of KindMark (www.kindmark.com) was even more direct on the subject of cold calling. “Don’t even bother trying to get in the door if you don’t have an introduction.”

Tip No. 8: Assemble the All-Important Customer List: Ones that Pay
Especially in this economy, you must be able to show potential investors a well-defined list of potential beta customers and having paying customers puts you in a much better position. And in addition to the list, you should clearly outline a game plan that
demonstrates how you will use marketing, advertising, or some other reliable form of
customer acquisition to pull in those clients. Do not propose customer acquisition
strategies that require huge advertising budgets. If you do, Investors will run for the hills.
Conduct market research on the best ways to acquire customers at the lowest possible
cost. It’s all part of the business plan.

Even if you don’t have any seriously interested customers, you must show early results
and relationships from pilot development projects. Companies that have helped you test
your product or service can be your best salesmen, both for VCs, and for the media.
Unfortunately, after being burned by so many beta testers that could not be converted
into paying customers, investors really want more than promises. There’s a chasm
between beta and paying customers. Investors are looking to reduce risk by the proof
you bring: people willing to pay for your product or service.

Tip No. 9: Look for Money in all the Right Places

In the ‘90s, technology entrepreneurs with saleable products or services could get away
with following the traditional routes. Today, seekers must leave no stone unturned.

Family and friends
Finding seed money from friends and family can provide leverage that goes beyond
money alone. Certainly, it can be a way to get enough seed capital to begin developing
your company. But it can also reassure investors and employees that you’re serious
about your financing, and that your ideas—and your new company—are supported by
those closest to you. There are numerous stories out there of enterprising entrepreneurs
that raised small amounts of money from large numbers of friends and ended up with
enough capital to start the business. It may seem like small potatoes from where you sit,
but VCs often look favorably on that brand of initiative.

Some sources go so far as to claim that in order to raise professional money, sweat equity must be supplanted by your own personal investment in the company. They want to see that you have some skin in the game. Angel Bob Bozeman counters that argument. “Don’t take money from anyone who can’t afford to write it off. Before borrowing their parent’s retirement money, entrepreneurs need to understand that professionals can afford to write off a bad debt, where maybe parents can’t. As soon as there is emotional money, you can get into trouble, which is why I prefer professional money. As it gets less risky, there is still an opportunity for family and friends. But on first round, no.” Bozeman believes that instead of focusing on changing trends in funding—like insisting that an entrepreneur puts skin in the game—investors should focus on the business
aspects of the proposition. The question should be: is it worthy of funding, or not?

Seek the divine
Besides praying, if you are early stage, the best bet is to get in front of as many angel organizations as possible. There are some wonderful organizations out there such as
Angel Investors, L.P. (www.svangel.com), Diablo Alliance Ventures (www.diabloventurealliance.com), CommonAngels (www.commonangels.com), and
Alliance of Angels (www.allianceofangels.com) that are helping entrepreneurs get meetings with the right investors.
Even though angels have been hammered as hard as VCs, there are still angels out there who will invest in deals, but definitely at a lower valuation. Furthermore, angel
money is often defined as smart money, since members of the angel network can help guide and groom a company for more venture funding and crucial business partnerships
down the road.

The roads less traveled
Rather than spend all your time pursuing well-known VCs and angels, seek out nontraditional
sources such as non-profits, associations, corporate venture arms, and even
boutique, regional venture firms. For one thing, many traditional venture firms are finding
themselves shoring up their existing portfolios instead of spending as much time as they
would on new investments such as yours. You may have better luck with smaller
boutique firms that aren’t overburdened with managing multiple—and often failing—
companies.
Some not-for-profit organizations such as Cupertino, CA-based CommerceNet divvy out
a substantial amount of funding through grants and investment seed money. Although
the criteria for funding can sometimes be very vertical in nature—e.g., CommerceNet
Investment Initiatives (CNI) only funds companies that are competing in the e-commerce
marketplace—these groups are not as bombarded with business plans as the average
investment firm. And since they consider far fewer proposals than the average VC or
angel, they are more likely sit down long enough to hear your pitch.
ICIC (www.icic.org) is another wonderful non-profit-organization that was started by the
famous Harvard business guru Michael Porter. It is a great place for Inner City
entrepreneurs to look for funding and resources.

Corporate dollars
Don’t overlook corporate investment arms or divisions. Even in a receding economy,
corporate venture-funding is still alive. Corporate VC’s have definitely slowed down their
investments but there is still hope if the investment makes strategic sense to the
company. For instance, Intel Capital (www.intel.com/capital/index.htm) has investments
in more than 600 companies. And in addition to financial backing, companies in the Intel
Capital portfolio have access to some of Intel’s tech resources such as a private intranet
chock full of resources, including a partner database and several startup business basics
-- human resources forms, and management and staff recruiting assistance.
Like the not-for-profit associations, many corporate venture groups try to review all
proposals. “If we get an inquiry through our website, we offer people who are looking for
funding the opportunity to present the details of their company through a self-service
type website. Then we review it and pursue it if it’s of interest,” says Brian Sutphin, vice
president of strategic investments at Sun Microsystems. Sutphin adds that although Sun
hasn’t made many investments in companies that come through the Website, his group
looks at each one, nonetheless.
However, as might be expected, corporate venture-groups generally have very specific
agendas; the bulk of them only invest in startups that promote or enhance their core
business products and services.

An ounce of caution
Turning over every stone may mean aligning yourself with venture accelerators or
brokers. The difficulty is knowing which brokers are for real and which are not. So don’t
pay money to either up front; history has shown many cannot produce as promised.
There are exceptions; a few highly reputable players—but only a few.
The key thing to remember is that it is not always the strong personal relationships that
help you find money. Many entrepreneurs have been funded through the weak
connections in their relationships. Don Pickering, CEO of Memetic Systems
(www.memeticsystems.com), said it was the weak connections that enabled him to get
funded in this tough environment.
At the end of the day, it still comes down to a numbers game.

Tip No. 10: Don’t Lose Track of Timeliness
As Robert X. Cringley of PBS’s The Pulpit (pbs.org/cringely/pulpit/) said recently, “In high
technology, like comedy, timing is everything.”
Determining when to deliver your pitch is key, especially among VCs who are
bombarded by proposals. On any given day, Dr. Lori Rafield, general partner and healthcare investment specialist at Apax Partners (www.apax.com) in Menlo Park, CA, says that she’s simply inundated with business plans. And her workload has only increased, especially as the biotech and stem cell investment boom went into full swing
this fall.
“Usually we can get through all the plans submitted each week and have an answer back to the company within seven days of receiving their plan,” says Rafield. “Now, it’s
taking us two to three weeks to get through the high number of plans we’ve been receiving each week.”
The right timing can come along with the quickness of a lightning strike. For instance, a lucky handful of biotech firms were given a market boost from President Bush’s recent
decision regarding government funding of stem cell research. When two year-old startup CyThera (www.cytheraco.com) of San Diego announced that it was the holder of nine federally approved stem cell lines, six VCs contacted CEO Michael Ross in the first week. More subtle trends—in fields as diverse as lifestyles, industry, medicine, sports, and technology—can also help build your case. Watch for them. It’s up to you to turn them into leverage. Don’t forget that this doesn’t happen as often as it did during the dot.com
era. Investors do not want to compete against other investors as much anymore.
They are looking to syndicate deals to reduce their risk.

Tip No. 11: Do Your Homework
There’s one piece of advice that you can take to the bank: not every investor is right for
every startup. That’s why Futuredex formed the matching service: it reduces the time
and increases the chance of talking to the right people at the right time.
Based on Futuredex research, entrepreneurs spend 60 to 80 percent of their time
seeking funds, while spending 40 to 50 percent of their time meeting with the wrong
investors. That’s why before meeting with investors, spend more time on the phone
making sure if you should really meet. It’s certainly one of the biggest challenges in the
process, since time is one of your biggest enemies in a startup; if you spend too much
time talking to the wrong people, you are not adding value to your business or increasing
the chances of getting funded. Focus on quality meetings as much as quantity.
Getting to know your potential investor can be challenging, especially if it is an angel.
Joining entrepreneur associations and attending their local functions is one way to get
an edge. Many groups, such as the Silicon Valley Association of Start-up Entrepreneurs
(www.svase.org), host breakfasts where startup CEOs can do elevator pitches to invited
venture capitalists. Nothing is more effective that a face-to-face meeting, and
statistically, about 15 percent of short pitches lead to more meetings.

Tip No. 12: Don’t Look a Gift Horse in the Mouth

Don’t let anyone convince you that you have the luxury of negotiation today. The
investors will not compete for your deal. If someone's giving you a fair deal, take the
money and run. And run fast. Current market conditions can make any investor skittish
about doing a deal.

That makes it doubly important to make your own decisions. Use your attorney for advice, but don’t let your attorney dictate your terms with the investors. This can turn many investors away. Obviously, entrepreneurs are in a much tougher position today than during the dot-com bubble, and the room to negotiate has significantly diminished. Put yourself in the investors’ shoes. Think about what they have seen the last few years: billion dollar aspirations and companies crashing like a house of cards. Focus on creating great ROI for your early investors. There are still too many entrepreneurs trying to do deals with high valuations based on zero revenues or high burn rates or low sales projections.
Think about how you would act if you were an investor. When trying to pin down the
valuation, work backward by figuring out what their ROI is going to be based on their
invested dollar.
Also, trying to pit investors against each other won't work today. You can suggest and
encourage co-investing as a possibility, but only for investors who are interested in what
you are offering.

Conclusion
Clearly, some of the old rules about raising money still apply. Some do not. Without question, venture capital has become more elusive. But the fact that deals are still getting done reinforces one truth that is unlikely to change, no matter what the political or economic climate: knowledge is power. The most important thing to remember is that you need to become a survivor entrepreneur, not a victim of the dot-com bubble. Those entrepreneurs who acknowledge changes and have a solid understanding of the prevailing investment economy will always have an edge.

Futuredex (www.Futuredex.com) is a complete Venture Relationship Management (VRM) network that allows startup to pre-IPO companies, investors, advisors and associated service providers to dramatically reduce the time and business cycles spent researching, prospecting, raising and managing venture relationships. Futuredex provides a one-stop destination for startup to pre-IPO information, focusing on private companies and providing a view of the future’s business landscape.

Damir Perge, CEO, Chairman and Co-Founder of Futuredex, also serves as President of Tesla Capital, a new $32 million fund that has invested $16 million in eight companies this year. Prior to his founding of Futuredex, Perge was Director of Business Development and Strategic Alliances for the Net Market Makers division of Jupiter Media Metrix. In addition, Perge co-founded and secured angel funding for startups of his own, including Impulse Software and Vision Merchandisers. A mechanical engineering
student of Southern Methodist University in Dallas, Perge is on the Board of Directors for MONee Group, KindMark, and Headpedal.
2001 Futuredex, Inc. All rights reserved.

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