Category Archives: Business Financing

Looking for Investment? Understand Startup Valuation

Angel investment, Valuation

How much equity do I have to give to angel investors? If you’re a startup founder looking for angel investment, you need to understand valuation. It’s a buzzword that people use in other contexts, too, which adds to the confusion. But it’s ultimately what determines how much of your company your investors will get, and how much you keep, if you manage to land an angel investment deal. So it’s a critical question that comes up a lot.

Equity means ownership. So 25% equity is 25% of the ownership of the business. Usually that’s a matter of shares. The math is fairly simple, but important: Logically, if an investor gives you $250,000, on a valuation of $500,000, that means half your company. The investor owns half, you own half. If the investor gives you the same $250,000 on a valuation of $1 million, then that means the investor gets 25%, you keep 75%. (Technically that’s what they call pre-money valuation, and there is also post-money valuation, but I’m not going to deal with that here. You get the point.)

Startup valuation in practice

What I’ve seen in practice, in nine years of membership in an angel investment group, is that valuation is an agreed-upon guess. There are no formulas commonly accepted formulas (although there are some formulas, such as you’ll see in this post from the angel capital association; it’s just that I rarely see them used in practice). In my experience, what really happens is all about saying no. Investors say no to valuations that are too high, startup founders say no to startup valuations that are too low. When the startup needs $250,000, the founders are rarely going to accept valuations of less than $1 million, because they need to maintain substantial ownership. When investors aren’t comfortable with valuations that high, they most often simply pass on the investment. I don’t see discussions in detail of components of valuation, like one sees in home buying transactions when buyer and seller go into details of square footage and comparable deals in the neighborhood.

Angel investment deals often postpone valuation by using convertible notes. The note is debt, supposedly to be paid off; but convertible means both sides intend to convert that debt to equity shares later, so that it should never be paid off, just converted to shares. In that case, angels are saying essentially, “we believe in you enough to give you this money, but we’re not sure of your valuation, so we’ll postpone that for later.” What both sides want is a follow-on investment, they hope for more money, from venture capitalists, to set the valuation later.

 

Five things you need to know about valuations

  1. The word has vastly Different meanings: don’t you hate it when the same words mean different things? Valuation means at least three different things:
    1. What a business is worth to accountants for legal purposes, such as divorce settlements, inheritance taxes, and gift taxes. A certified valuation professional, usually a CPA, makes a guess. Most of them use financial statements and analyze financial details.
    2. What a business is worth to a buyer. Small businesses go up for sale with  business  brokers. Hardware stores, for example,  get about 40-50% of annual sales plus inventory, as a starting point. Plus a bonus for growth and special strengths, or a discount for lack of growth and special problems.
    3. The pivot point in an investment proposal: it’s simple math, but tough negotiations. If you say you want to get $1 million for 50% of your company, you just proposed a valuation of $2 million.
  2. What’s anything worth? Like your car, your house, and a share of IBM stock, something’s worth what somebody will pay for it. The valuation in A is theoretical, hypothetical, but legal. With B and C, though, valuation is as real as agreeing to buy a house. It’s not what the seller says it is; it’s what the buyer is willing to pay. And this cold hard fact drives many entrepreneurs crazy.
  3. For Small businesses, there are guidelines and rules of thumb. If you do a good search, or work with a business broker, you can find general rules of thumb for what your long-standing small business is worth. For example, a hardware story is worth roughly half a year’s sales plus inventory, with bonuses for positive factors like  recent growth,  and discounts for negatives like lack of growth.
  4. For Startups, it’s what founders and investors negotiate. Startups and investors and culture clash over valuation.  Investors care about valuation. Founders often misunderstand valuation. And never the twain shall meet. I’ve seen these kinds of problems many times:  Founders walk into the valuation discussion full of folklore and fantasy like stories of Facebook and Twitter. They want lots of money for very little ownership. Investors see two or three people with no sales history thinking their dream startup is already worth $2 or $3 million.
  5. Irony: sometimes traction, and revenues, make things worse. It’s easier to buy the dream than the reality. The same investors who’ll seriously consider a $2 million valuation for a good idea, business plan, and a credible 3-person management team – but with no sales ever — might just as easily balk at a valuation of $600,000 for a company with three years history, 20% growth, and annual sales of $300,000.  Despite the irony, it makes sense: few existing businesses are worth more than a multiple of revenues, but, still, before the battle, it’s easier to dream big. Or so it seems. I’ve been on both sides of this table, and I don’t have any easy solutions to offer.

If it hasn’t come up yet, it will. Every business deals with valuation eventually. The place any business sees it is during the early investment phases; but most businesses don’t get investment, so they can ignore it at that point. But then if it survives, or grows, valuation comes up again, because even if the business is immortal, the people aren’t: so eventually you either sell it or pass it on to a new team, an acquiring company, or your own family. And there’s the divorce and estate planning elements that require valuation. So every entrepreneur and business owner should have some idea what it is.

(Image: courtesy of wordle.net)

Angel Investment vs. Bootstrap: Startup Sweet Spot

Angel investment, Bootstrapping

Successful angel investment is a win-win for both sides, the startup founders and the investors. And I mean win-win right at the beginning, at the time of the investment, not the obvious win-win later when years have gone by and the business succeeds and investors exit. The win-win sweet spot exists from the beginning, when both sides agree that there’s an opportunity for deficit spending to produce dramatically accelerated growth. Simply put, it’s when the startup has an exciting use for other people’s money; it’s going to grow much faster with that money than without it. So much faster, in fact, that it’s a great way for investors to spend their money, and a great way for startup founders to spend (share) their ownership. Otherwise, bootstrap (build your startup with your own resources, not outside investors) is better.

Understanding the sweet spot for angel investment vs. bootstrap

Investment-Sweet-Spot.jpg

At the sweet spot, years before failure or exit, investors have spent their money on a good risk-return ratio, and founders have given up ownership for good prospects of much better growth and much better end value than they’d get if they kept their ownership and didn’t spend the extra money.

It’s about milestones and inflection points. Inflection points are when a business is suddenly worth more than it was, in a short time, because of factors like risks reduced, milestones met, assumptions validated, and so forth. In my simple chart here, the sweet spot shows up after startup founders have met some initial milestones to make their valuation better before they talk to investors. Those milestones are things like recruiting the team, testing the concept, developing the website, gaining traction, gaining users, registering the intellectual property. Then they turn to investors to get money they will use to meet new milestones which will produce another inflection point, when valuation pops up even more. Milestones depend on the specifics, but it might be getting the key people on board, developing the prototype, getting the first critical mass of users, going through some critical regulatory step, and so forth. In my chart here, we can see the first inflection point when the founders get going, the second inflection point when the investment money is put to good use, and the sweet spot, for both sides, in the middle.

In my illustration, valuation is that theoretical agreed-upon value that determines how much equity is exchanged for how much money. That’s a critical concept I explained in setting an initial valuation, an articles here on bplans.com.

There’s plenty of information about angel investors here on my blog, and elsewhere here at bplans.com,  about what investors want, how to approach them, and so forth. But I think we miss the essential, fundamental concept of what makes a startup investment a win-win situation for startup founders and investors. It’s about both sides wanting the same thing, seeing the same opportunity, and betting, together, on the outcome. Win-win is easy to say afterwards, years later, when and if the business was successful. This sweet spot win-win is for beforehand, when the investment is made.

If you’re not in the sweet spot, don’t seek angel investment. Bootstrap.

What’s also important about the investment sweet spot is what to do if it doesn’t apply. For startup founders, if you don’t need the outsiders’ money to generate more growth than otherwise, then don’t seek investment. Never seek investment money unless you really need it. Other people’s money comes at a high cost in ownership, so you should only even consider it when it’s going to give you a much bigger value.

If you can do it yourself, and get there alone, do. Then you own the whole thing.

There’s a classic analogy that’s often used wrong. People will ask, “which is better, a piece of a watermelon, or a grape?” The rhetorical question is supposed to lead to a rhetorical answer in favor of the watermelon. That’s because it comes up in the context of startup founders sharing ownership with investors.  But what if the better analogy is you have grapevine (your own business, entirely yours) vs. a piece of a watermelon?

Good angel investors don’t want to invest in a business that doesn’t need the money. And startup founders should not seek angel investment unless they need the money.

 

10 Things Angel Investors Ask About Startups

Angel investment, Business Pitch, business plan

Today the angel investment group I’m a member of (Willamette Angel Conference) finished our eighth year of choosing a startup to invest in. Our investment runs $100K to $500K, roughly. It’s announced every year on the second Thursday in May. The announcement comes later in the day, not here.

Our annual angel investors process

Every year we review 40 or so submissions from startups. We look at summaries, videos, financial projections, and pitches posted online at gust.com. We invite our favorites to pitch to us live in a series of meetings. We assign due diligence teams to read their business plans thoroughly, check documents, talk to customers, test products, look at their legal situations, and so on. And eventually we choose a winner (or two or three).

My personal list of 10 things I want to know

Push PinDuring the process, we’ve had to review again what we want to know from startups as we review them. What information is essential? With that in mind, I wrote up my own list of what I look for in startups, from the outset. This is what I want a startup to tell me from the beginning.

  1. The startup team’s background, experience, and credibility. Specifically, what experience do you have with startups. Have you run a startup? Have you been an employee or team member of a startup? And of course your education, degrees, schools, etc. And your work experience. That goes for founder or founders, and main team members. If you don’t have a complete team, have you identified the key skills you need and candidates to hire? Are they likely to come on board? What are their backgrounds, skills, and experience? Who will do the administration, production, marketing, and sales?
  2. What problem do you solve, and how? I want to understand the needs and wants so I can decide for myself on product-market fit. What kinds of people or organizations have that problem, and how badly do they need or want what you are going to sell? For that you have to give me the whys and the background, the stories, not just the numbers; but numbers are good.
  3. And why you? Why are you more qualified than anybody else. How can you keep others from jumping in on your business if it’s successful?
  4. And who else? Who else is doing what you are, or solving what you solve? How do they do it?
  5. Key Metrics. What traction do you have so far? How long have you been up and running, and how many customers or subscribers or sales or visits or downloads or conversions or leads and inquiries? What are your metrics so far? Where do you see them going.
  6. Milestones met and milestones to come. I want to see both what you’ve done and what you plan to do. Your valuation today is about what you’ve accomplished already. What you plan to accomplish gives me an idea of possible future valuations.
  7. How much money are you raising and what are you spending it on. Investment should be used to finance deficit spending that’s going to generate a lot of growth and increased valuations. If you can relate your financial ask to milestones you plan to meet, then that’s great.
  8. Strategy. Strategy is focus. What markets, what products, what specific attributes of your business make this focus realistic? What markets and solutions are you ruling out, or leaving for later?
  9. Tactics. Tactics are essentials like pricing, channels, online, social, marketing, sales, financial plans.
  10. Essential projections. Sales forecast built from bottoms-up assumptions, spending budget, projected P&L, balance, and cash flow. I’m annoyed if you don’t provide these, but I should add that I’m also not going to eliminate a startup for bad financials. Bad financials are the easiest problem to fix.

I should note that I do care a lot about exit strategies, and even more so about the intention to exit. But I assume the intention is there when you seek angel investment. And I want to go from your product and solution to your market, your competition, and my guess about future exits. Exits happen 3-5 years from now. I want you to focus on your business, and I’ll decide whether I believe you’ll eventually become an attractive acquisition so we can get an exit.

Also, on financials, I look for understanding the relationship between spending and growth, how much you need spend in the main spending categories, in broad brush, to be able to grow. I expect growth to cost a lot of money and almost always rule out profits. If you were going to be profitable, you wouldn’t need investment, and you wouldn’t offer a great ROI. I don’t hold you accountable for accurately projecting your essential  numbers, but I do expect you to understand the assumptions and the drivers that you use to develop the forecasts.

And, a third point: We usually get this information several ways, starting with the summaries our startups post on gust.com. There are summaries, slides, videos, and financials. I do always want to see a business plan, but I don’t care about all the text summaries and descriptions. I do want the business plan to include strategy, tactics, metrics, milestones, and essential business numbers.

How Can I Get Startup Funding Without Giving Away Half the Company?

Angel investment, Business Mistakes, Starting a Business

I’m surprised how often I get asked the question in the title, or variations of it, from people in startups. And you will hear discussions in which experts recommend ways to get investors who take less equity and demand less control. That seems short-sighted or worse.  I posted here years ago dumb investors is a dumb idea. But this question keeps coming up.A Bad Idea

If you’re working on a startup, understand the tradeoffs. Don’t try to find investors who don’t take ownership. Asking that question is like asking “how can I get somebody to spend their money without giving them anything?”

Ask yourself why somebody, anybody, would spend their money to build your business instead of to build their own, buy a house, car, or go on vacation? What do they get out of that? They aren’t the government. They can spend their money any way they like. So what – besides a share in ownership – can you give them for their money?

“Giving away” is the wrong way to say it. You share, in return for money; and, if you do it right, help, contacts, and collaboration (if you find the right investors). It’s like a marriage.

How much ownership your investors get is a matter of agreeing on how much your business is worth, and then dividing how much money you get into that. For example, if you can convince your investors that your business is worth $1 million, and they spend $500K, then yes, in that case, you gave up half. And it’s not that easy, either. If investors aren’t convinced you have a good team, good product-market fit, scalability, defensibility, and a reasonable chance at exit, then don’t worry about what you share with them, because they won’t want any part of it, for any amount of shared ownership.

If you worry about giving up ownership, that’s valid, but instead of complaining about investors, look up Bootstrapping here on this blog. Most startups bootstrap because few have what it takes to attract investors. It’s harder, but if you make it, then you own it all yourself. Or, if you have a startup that needs more money than you have, and offers a good business opportunity for that money, then think of investors as partners and find investors you can work with, and respect. Or bootstrap.

This question came up again on Quora over the weekend. If you’d like some alternative answers, here’s the link: How can I get funding for my startup without forfeiting half my ownership in the business?

(Image: Flickr cc, by snail_race)

Video: Startup Funding. Bootstrap. Then “Be So Good They Can’t Ignore You.”

Angel investment, Bootstrapping, Business Pitch, Valuation, Venture Capital

I stumbled on this brilliant video of an after-hours startup funding event at the Stanford business school, a panel discussion putting two of the best-known, most influential, and most successful investors (Marc Andreessen and Ron Conway) together with another successful entrepreneur (Parker Conrad, founder of Zenefits), a moderator, and a group of interested entrepreneurs. The video format is perhaps less than optimal, unless you like the rapid-access panel on the left (I do, actually) … but the content is outstanding.

Make sure, please, that you hear Ron Conway suggesting “bootstrap as long as you can.” You can find that with the navigation on the left.

And also, what both investors say about how they choose investments, what makes them successful, and valuation. And Marc Andreeson quoting Steve Martin on “be so good they can’t ignore you, and then, adding:

“Focus on making your business better, not making your pitch better.”

The original for this is on Sam Altman’s online course. Click here for that.

Some excellent quotes:

Marc Andreessen on startup funding as hit or miss:

The venture capital business is one hundred percent a game of outliers, it is extreme outliers. So the conventional statistics are in the order of four thousand venture fundable companies a year that want to raise venture capital. About two hundred of those will get funded by what is considered a top tier VC. About fifteen of those will, someday, get to a hundred million dollars in revenue. And those fifteen, for that year, will generate something on the order of 97% of the returns for the entire category of venture capital in that year. So venture capital is such an extreme feast or famine business. You are either in one of the fifteen or you’re not. Or you are in one of the two hundred, or you are not. And so the big thing that we’re looking for, no matter which sort of particular criteria we talked about, they all have the characteristics that you are looking for the extreme outlier.

Ron Conway on bootstrapping before startup funding:

Bootstrap for as long as you can. I met with one of the best founders in tech who’s starting a new company and I said to her “Well, when are you going to raise money?” “I might not,” and I go, “That is awesome.” Never forget the bootstrap.

10 Reasons Angel Investors Don’t Like Your Plan

Angel investment

Once again, for the eighth year in a row, I’m involved as an angel investor with the Willamette Angel Conference and screening investments. We’ll announce a decision in May, and between now and then, we’re looking at startups. About a fourth of them get what we call due diligence, and about half of those become finalists, which means even more due diligence.Willamette Angel Conference 2016

Just in case you don’t know the term, due diligence is when investors research the startups. We read business plans, listen to pitches, talk to customers, look at technology, legal situations, and so on. We take several weeks. We divide into teams to do it. We have volunteer MBA students to help too.

With that in mind, here are 10 reasons I see for a startup not getting picked by angel investors. And to be clear, all of this is my opinion, and mine alone; I don’t speak for the group. I post this because I think it might be helpful.

Let me also clarify that not being a good candidate for angel investment does not mean a startup isn’t a great opportunity for its founders. It means only that it’s not a great opportunity for its investors.

My reasons here are not ranked in order. That would be too hard.

  1. Not enough growth. We see some very good startups that look well positioned to grow from zero to a million or so, maybe even two million, dollars of annual sales over the next three years. That’s enough growth to make the founders happy, but not enough to make a startup a good prospect to offer a return to angel investors.
  2. Exaggerations and simplifications. I’m surprised how often we see startups whose materials gloss over problems, forget to mention some hurdle that matters, or underestimate noise and competition. That doesn’t work. One such problem that gets caught creates doubts about everything else that was said.
  3. Not enough information. We’re looking for good information. We work with the gust.com angel investment platform that gives startups the opportunity to post video pitches, business plans, summaries, financial projections, and documents in Excel, PowerPoint, etc. We’re surprised how many startups fail to get us enough information. Having no business plan may sound good to the trendy types who say don’t bother, just do a lean canvas, or just a pitch; but not to us. We want the details.
  4. Too much competition. You can be a great business in a crowded, competitive market; especially when you do something different, and better. But it’s tough on angel investors and their return on investment when a startup is doing something that’s commonplace. We’ve turned down really good looking plans and pitches on catsup, growlers, baby bibs, and so on.
  5. You don’t need us. It’s quite common, actually, that we see good businesses that don’t need us or our money to prosper. If you can grow your startup without having to take on partners, and therefore you own it all yourself, then you’re better off. And if we invest, we take a minority share, and worry that if things go well you might not want to get more investment or exit, which leaves us with a minority share and no money. We want you to need our money in order to grow fast. What we get for our money is a share in your company and the only way we make money with that is when we can sell that share of ownership for money; which is what they call the exit. We don’t want to invest in the ordinary healthy company that pays its founders and grows but never sells out.
  6. You already know everything there is to know. In private conversations, discussing pitches after the founders have left, we’ll talk about the “teachable” factor. A founder who isn’t teachable is a disadvantage. Right or wrong, most of us have done startups before, and we’ve had some successes, and we think we can help as mentors. Some founders make it clear that they know everything. Maybe they do. But that makes us less interested in working with them.
  7. Growth not believable. You know the hockey stick phenomenon, right? The way startups pitching for investment always show a forecast that is about to shoot upwards? To some extent you’re damned if you do and damned if you don’t. If you don’t have a strong growth forecast, you’re hit the problem I listed as number 1 here, not enough growth. But if you do, it has to be believable. It has to be good growth, and credible. For that, check out what makes a sales forecast credible.
  8. Not scalable. Scalable means the business grow without the need for too many more services or more employees. Can you easily handle growth without losing quality? Does it take doubling head count to double sales? This might hamper the bottom line. Be sure to keep the future in mind. Angel investors like product businesses, or productized services, not service businesses. They want businesses that can increase sales overnight without increasing fixed costs.
  9. Not defensible. Angel investors want businesses that can’t be easily duplicated by competitors. They look for something proprietary, like trade secrets, copyright, trademarks, and patents. First-mover advantage is good but not enough. Is there a secret sauce? Are there barriers to entry? All this makes a business defensible.
  10. Doubts about the team. Risk is always a big concern with startups, especially for the investors. In fact, if you haven’t been involved in a startup or had some form of management experience, it could be close to impossible to find someone to take a chance on you. When you have people on board with startup and management experience, you are creating a team of strong leaders likely to build a healthy, marketable company. Don’t hesitate to reveal a failed attempt at a startup because it demonstrates you have experience and perhaps have gained some important insight.

And, with apologies for repetition, this is all just my opinion. I don’t speak for others.

Self-Assessment: Will Your Startup Get Angel Investment?

Angel investment, Starting a Business

Is your startup a good candidate for angel investment? If you can’t answer “yes” to the four questions here, then it probably isn’t.

cash_pile_iStock_000003690791XSmallAngel investors are as hard to predict as any other group of individuals, all operating in their own self interest. There are about a quarter of a million angel investors in the U.S., according to most estimates. But they are not an organized group, and not a public entity. They invest their own money and they normally want a return on their investment.  They tend to invest in startups close to where they live, and in industries they know.

Still, there are some predictable factors that will make some startups good candidates for angel investors, and others not. There are many special cases, but in general, you need to be able to say yes to the four questions or you are not likely to get angel investment.

Question 1: Does it Have Attractive Potential Sales Growth? 

Do you have a credible growth story? Given about 60 seconds to do it, could you convince a seasoned investor that your startup can grow its sales from where it is now to $5 million, $10 million, or $20 or more millions per year in 3-5 years?

Numbers aren’t enough; you need the story. The story starts with a problem potential investors can understand, one shared by enough people to make an interesting market. It then describes the solution your startup offers, along with details to make that credible such as your startup’s qualifications and background. Investors won’t care about your numbers unless they already see market potential in your problem and solution. They’ll take your story and build their own guess about potential. At that point, numbers – market analysis, demographics, research – are useful if the story rings true. And if your numbers don’t match what investors see in their imaginations, then you’ll have to work hard to prove you’re right. If the story works, then numbers are a welcome addition.

Question 2: Is It Scalable? 

Scalable means that a business can increase unit sales very fast without having a proportionate increase in fixed costs, headcount, and marketing expenses. Most product businesses are scalable because it’s relatively easy to add capacity to a product manufacturing process. Most web businesses are scalable because it’s relatively easy to add hosting bandwidth to increase users of the same site or application. Most service businesses are not scalable because services are provided by humans, not machines, so it’s not easy to increase capacity without increasing fixed costs and payroll.

One way around this is franchising, which supposedly duplicates a service formula to offer the equivalent of scalability. However, franchising isn’t credible, in angel investor terms, until you have a very successful working first location (or two or three).

Question 3: Is it Defensible?

Defensible means a startup can protect itself from a competitor jumping into its market and spending more resources faster than your startup, taking a market over. Intellectual property including copyright, patents, and trade secrets make a business defensible. This is often called the secret sauce.

Some otherwise great ideas fall flat with investors because they are something that will invite competition and involves no secret sauce to keep larger companies away.

The legend is that the so-called “first mover advantage” makes an idea defensible if the first mover grows fast and builds its market very quickly. That works sometimes, but not always. Investors will use their own judgment on that one, not necessarily what you tell them.

Question 4: Is Your Startup Team Credible? 

Angel investors are not likely to invest in any startup that doesn’t have at least one founder who has already been involved in a startup. This frustrates many of my email correspondents who complain about the chicken-and-egg problem of having to have been funded before to get funded; they ask how anybody gets experience if angels won’t fund them. My answer is that you have to get experience by joining an existing team and spending time with a startup first, or by finding co-founders with experience, or by changing your startup to make it small and focused enough to survive without outside investment.

This is not a problem that angel investors feel compelled to solve. They are all just individuals, not foundations or government entities, so they don’t feel responsible for fairness to anonymous hypothetical startups. They just want investments.

Conclusion: Answer “Yes” to All 4 Questions or Forget It.

Yes, there are always special cases and exceptions. But the executive summary is that if your startup can’t meet these four essential conditions, you should be either scaling down your plan to cut expenses so low you don’t need investment; or looking for alternative sources, such as friends and family.

7 Financial Facts Every Entrepreneur Should Know

Business Financing, ,

You don’t have to be CPA or MBA to start or run a business. You don’t have to understand debits and credits, or be able to balance your books. But there are some financial facts you just plain need to know. Here’s a list.

  1. Every single dollar in Accounts Receivable (AR) is a dollar less in cash. AR is the standard for business-to-business transactions. You deliver the goods or service along with an invoice, and the client/customer pays you later. That money shows up as sales in the Profit & Loss (P&L), but it’s not in the bank; it’s in AR. This brings up AR aging, collection days, and a flock of related concepts that are all important because a business can die over failing to collect on AR – even profitable businesses choke on AR. Corollary: if you sell to consumers, in cash, check, or credit cards, this is not as important. And if you manage to get business customers to pay you a deposit in advance, that helps a lot too.You_iStock_000014706975XSmall
  2. Every dollar in inventory is a dollar less in cash. As with money you have in AR, money spent on inventory doesn’t show up in the P&L until you sell the stuff and it becomes cost of goods sold. So whatever is in inventory isn’t in your bank account. As with AR, companies that are profitable in the P&L can run out of cash in the bank because they got their inventory constipated. In some extreme cases, expenses get misdirected to inventory, and the system clogs up with inventory that pretends to be assets and creates a fiction that ends up with the reality of no cash in the bank. Corollary: most service businesses don’t have inventory to worry about, and those that do need inventory usually have less of a problem because they need less inventory per transaction.
  3. Every dollar in Accounts Payable (AP) is a dollar more in cash. Most businesses buy stuff on credit, meaning they get the stuff along with an invoice they have to pay in a few weeks. Almost nobody pays bills in cash immediately. Ideally, you finance inventory and AR with the money you owe to your vendors. You have to manage the pull between paying on time, paying late, and stretching AP without getting a reputation for late payments or a bad credit rating. It takes management. That satisfaction you get from paying everything immediately, and not owing anything to anybody – that’s not good financial management.
  4. Debt repayment doesn’t show up in P&L. It costs you money, but you won’t see it if you don’t track cash flow. The interest portion of payments is an expense, so that shows, but principal – debt repayment – doesn’t show up. You have to watch and plan for it.
  5. Buying assets doesn’t show up in P&L. It takes money to buy your assets (equipment, plant, land, furniture, etc.) but those don’t count as expenses, so you don’t see them in P&L.
  6. Fixed vs. variable costs matter. That’s because the trade-offs come up often and matter a lot, and this area is full of choices you can make. Do you hire the person as an employee or contract out for skills? Fixed costs are generally lower than variable costs, but they also increase the risk.
  7. Sunk costs don’t matter. It’s so not intuitive. We so often think we have to continue down some path because we’ve already spent so much money on it. It’s hard to let that go. But the money already spent is a sunk cost. You don’t get it back by spending more. So decide based on whatever decision criteria make sense, in a specific situation; money already spent is never a good reason, by itself, to spend more.

For the record, this post started as one of my answers on Quora: The original question was What are the most important financial concepts an entrepreneur should know?

Contrarian Advice on Investment Pitches from a Pitch Veteran

Business Pitch, , ,

“We coach entrepreneurs ‘think big.’ ‘Think change the world.’ That doesn’t mean use adjectives that are not credible. Everybody’s revolutionary and everybody’s disruptive now.” 

That’s Bill Reichert, managing director Garage Technology Ventures, veteran investor, a board member on multiple startups, and someone who has heard and reacted to hundreds of investment pitches. In this talk he offers really good advice to people doing pitches now and in the future. 

“The point of the first 20 seconds is to earn the right of continued engagement. If you aren’t compelling and clear in the first 20 seconds this [pointing to a picture of a turtle trapped on its back] is where you end up.”

Bill (a former classmate, by the way) surprised me several times in this excellent talk. He’s not afraid to question standard advice, particularly what pitch coaches tell too many people too often.  For example: 

  • He advises that you don’t spend so much time on the problem. If you start with it, make the point and move on. Investors will recognize it quickly. 
  • Don’t overemphasize the story. Here too, if it’s valid, investors get it quickly. 
  • Don’t believe the common pitch-coach advice about the first 2-3 minutes. “You have 20 seconds.” (That’s around 19 minutes into this video) 

There’s 60 minutes here. Make sure you watch the first 20-25 minutes. From there, having set up some surprises, he goes into techniques. If you’re pitching, this should be really interesting to you. 

Where Startups Get Their Money

Angel investment, Business Financing, Starting a Business, ,

Where do young companies get money? I ran into this three-minute video over the weekend. It’s a great summary. If you’re not already up to speed on the range of startup options from personal savings to venture capital, just watch this:

(Note: Here is the link to the original on YouTube: https://www.youtube.com/watch?v=U470xXKfDyE)

My thanks to the Kauffman Foundation for providing this, and kudos to narrator Paul Kedrosky, a well-known expert on venture capital. 

It does, however, skip over the influence of angel investment, which stands somewhere between friends and family and venture capital. Angel investors generally focus on seed money – early investment for startups at early stages of growth – for amounts less than $1 million. Several experts have different definitions of angel investment, on how many angel investors exist, and how much money they invest. As I write this, the latest available statistics come from 2013. Approximately 300,000 angel investors invested about $25 billion in 71,000 startups, mostly for seed financing and early stages. Venture capital invested about $30 billion that year, but in only 4,000 companies. (For more on that, here’s a link to a draft chapter from my latest book, on Lean Business Planning: Angel Investment.) 

I wonder if that’s just to simplify the landscape as Kauffman explains it, or, possibly, because so many people bunch venture capital and angel investment together, as if they were the same thing. 

And, changing the subject, I found this interesting number to reinforce what the video is saying. Wells Fargo Bank did a study of startups about 10 years ago and found that the average startup cost in the U.S. is $10,000.