Category Archives: Business Financing

Use Business Lines to Read Warnings in Numbers

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Are you minding your business? I’ve found through the years of minding my business that most of the important insight in the numbers comes in lines, not dots. I mean that tracking the change in key indicators over time, with lines, is much more valuable than looking at them at any specific point, as a dot.

For example, if your business sells to other businesses, you probably deliver the goods or services along with an invoice that establishes what your customer or client owes you. We call that money your customer owes you Accounts Receivable. The sales you make like that, delivering an invoice instead of getting paid immediately, are called sales on credit.

For business that deal with sales on credit the Accounts Receivable balance can be critical to a healthy cash flow. Every dollar in that balance is a dollar that’s already in sales, but not in the bank. You are waiting to get paid. The higher the Accounts Receivable, the more the danger.

You can’t measure Accounts Receivable with a single number. $32,812 in Accounts Receivable might be way too much or way too little, depending on how long it’s been there, how it’s trending, how that compares to other balance items, and the original sales amounts.

I like to watch the number as a line chart so I can see how it’s trending. Your accounting or bookkeeping software might be able to do this, and if not then any of the leading spreadsheet software applications can. I recommend you generate a line chart showing sales on credit on one line and Accounts Receivable on the other. If sales go up quicker than Accounts Receivable, that’s good. That’s the case in the second line chart here. If Accounts Receivable go up quicker than sales, that’s bad. That’s the case in the second line chart here.

The sales in both line charts are identical, but the behavior of the Accounts Receivable balance is different. In one, there might be reason to worry. You start with the line chart, which is like an alert. Then you go into the details, like who owes your business how much, and how long have they owed it to you. You call, you ask, you investigate, you deal with a problem. In the second case, seeing how Accounts Receivable is behaving, you probably look at the chart and go on to deal with something else.

With most of your business numbers the trends — the line — tell you much more than the specific numbers — the dot — at any one point. If you manage inventory in your business, draw the line of inventory turnover. Every business should watch the lines of the trade payments you have to make (called Accounts Payabe), and of course sales vs. costs, sales vs. expenses, sales vs. profits, sales vs, employees, and so on.

It’s not the numbers you watch as much as the change in numbers. Draw your line charts. Every month.

Long-Term Successes Don’t Leave Out Investors

Angel investment, Starting a Business, Venture Capital, , , ,

For an investor in a startup, return on investment is as simple as writing a check now and depositing some related money later.  And since startups are risky, you’d expect to hit big when you win because you’re so much more likely to lose. Does that make sense?

So when the angel investor writes a $50,000 check today to invest in a startup, getting $100,000 back out of it five years later is not bad – it’s slightly less than 14% per year return – but it’s not spectacularly good either.

After all, that same investor could buy a cool car or put a down payment on a vacation condo instead. Or she could just leave that money in a bank with decent interest and have $70,000 in five years without risking losing it all.

But here’s the counter-intuitive catch: What happens if the $50,000 creates a healthy and happy company that grows and becomes independent and never creates any liquidity for its investors? The founders don’t want to get bought, and the stock market doesn’t accept it for a public offering, so the early investors are stuck with a share in a long-term business. Growing businesses don’t generally produce dividends, so that $50,000 investment is stuck.

The return on investment of a $50,000 check that never produces a deposit is way less than zero. Getting $50,000 back would be a zero return. Getting nothing back is – well, let’s just say it’s bad. Real bad.

All of which I post here to explain this statement:

Investors are more interested in companies that will be bought. Not in long term companies.

That’s not exactly what I said last Thursday in my credibilitylive.com session for Dun and Bradstreet Credibility Corp; but it’s close enough.  If you’re curious you can click this Youtube link to go directly to seven minutes into the interview where I was was saying that.

Investors appreciate long-term success as much as anybody. But a long-term successful company finds a way to reward its early investors. Maybe that’s through subsequent rounds, a partial liquidity event, a buyout, or some other instrument. But you don’t leave investors stuck in your company with no way to exit.

When my business confronted a situation like that, we practiced then what I’m preaching now: we bought our investors back out of the company.

Mark Suster: Be a Line, Not a Dot

Angel investment, Starting a Business, Venture Capital,

This morning I added Mark Suster’s Both Sides of the Table to my blogroll here because his post Invest in Lines, not Dots reminded me that I’ve been meaning to include his blog for a long time. His idea here is something everybody should understand.

His single line chart here,combined with his title, makes the point extremely well.  As a startup looking for investment, you need time to become a line. You start as a dot:

The first time I meet you, you are a single data point.  A dot.  I have no reference point from which to judge whether you were higher on the y-axis 3 months ago or lower.  Because I have no observation points from the past, I have no sense for where you will be in the future.  Thus, it is very hard to make a commitment to fund you.

So instead of that, Mark suggests, you need time to communicate progress:

For this reason I tell entrepreneurs the following: Meet your potential investors early.  Tell them you’re not raising money yet but that you will be in the next 6 months or so …  Hopefully by then you’ve made good progress.  You’ll be able to give them an update on key hires, pilot customers, key tech innovations – whatever.  Keep these interactions low-key and short.

Do you see the dots vs. lines concept in that? I think it’s one of those great concepts that seems obvious, but only after you’ve heard it. I also really like Mark’s emphasis on entrepreneurs and investment as a long-term relationship. Here’s his conclusion for entrepreneurs:

you might be pumped up with that super quick round done at a high price.  But just remember that raising money is a bit like Ireland in the 90′s – no divorces allowed.  I know VCs and sophisticated angels can be difficult, slow and price sensitive, but I also know that in tough times unsophisticated investors can be a right pain in the arse.  For some companies – they become deal breakers on further funding rounds.  By definition if somebody is investing in you as a dot (limited thought, limited due diligence, maximum price) they are a dot to you, too.  You can’t really know them in 2 minutes yet you’re letting them own part of your business.

That’s an excellent post. Go read the original. He has several additional line charts, and great advice.

5 Things Entrepreneurs Need to Know About Valuation

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Valuation is one of those four-syllable business buzzwords you’re going to have to deal with, eventually, if you either want to start a business or own a business. If it doesn’t come up when you start, it will come up later. Here is what I think you need to know, in five short points.

  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. You could read up on it in bizbuysell.com, bizequity.com, or business brokerage press. Or do a web search and check the ads for valuation experts.
  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)

How Much Money Do I Need for My Startup?

Angel investment, Business Planning, Starting a Business, Venture Capital, , , ,

It’s an obvious question. And if you’re looking for startup investors you’d better be able to answer it well, and quickly too. No wandering eyes. No doubt. If you’re doing a pitch, have a slide for it. And be specific.

I liked this from Ben Yoskovitz’s Instigator Blog on Use of Funds:

…most descriptions of “use of funds” are incredibly generic and standard, typically involving the following: hire key personnel, product development, sales & marketing. Hhhm…the phrase, “No shit Sherlock…” comes to mind.

And on the other hand, there’s this about that, from Perfecting Your Pitch, by Guy Kawasaki’s Garage.com Ventures:

It should be clear from your financials what your capital requirements will be. On this slide you should outline how you plan to take in funding—how big each round will be, and the timing of each—and map the funding against your key near-term and medium-term milestones. You should also include your key achievements to date. These milestones should tie to the key metrics in your financial projections, and they should provide a clear, crisp picture of your product introduction and market expansion roadmap. In essence, this is your operating plan for the funds you are raising. Do not spend time presenting a “use of funds” table. Investors want to see measures of accomplishment, not measures of activity.

So go figure. There are two opposite points of view from two good sources.

I’m amazed, meanwhile, how often I see people pitch startups to investors without having a good answer to that question. I expect an instant answer, without hesitation, and if it’s a slide deck there should be a slide.

And that doesn’t mean that anybody necessarily believes what you say. It’s all educated guessing. But details add credibility. And if you can’t answer that question, what do you think your audience is thinking?

There is a standard way to calculate starting costs.

  1. Make a list of the stuff you need to purchase before you start. Include expenses like early salaries, cleaning up the location, developing the website, packaging if relevant, prototypes … it’s a collection of educated guesses, of course. It’s just guessing, but how can you not do it?
  2. Do your projected first year cash flow. Estimate sales, costs, expenses, and payment lags from business customers, your own lags paying your vendors, plus what you need in inventory. If this isn’t a cash deficit, recalculate. In real startups it almost always is.
  3. Add those startup costs with the deficit spending, and that’s what you need from investors.
  4. Reality check: if that calculated amount is way too much, investors will laugh at you, go back and change your plan. Spend less. Look for the startup sweet spot.
  5. Double reality check: if you can spend less, maybe you can do it without investors. There are other ways to get money. But even in that case, don’t you want to have a good idea of what it takes?
  6. Triple reality check: if you’ve got a high-end high-tech startup, looking for serious angel or VC investors, give them a break and show spending the money on things that make for growth, excitement, virality, sizzle. If you don’t know what that is, rethink your plan.

(Image: mgkaya/istockphoto.com)

10 Good Reasons Not to Seek Investors For Your Startup

Angel investment, Starting a Business,

Sure, maybe you need the money. Maybe that’s what your business plan says. But seriously: Do you really want to have investors involved in your dream startup?

I’ve said it before: bootstrapping is underrated. I get frequent emails from people asking how they can get investment for their new startup, and I’ve admitted to being a member of an angel investor group. But let’s not forget, while we’re thinking about it, these 10 good reasons not to seek investors for your startup.

  1. It’s almost impossible to get investment for your very first startup. If you don’t have startup experience, get somebody on your team who does. Chris Dixon said it best: either you’ve started a company or you haven’t. And if you haven’t, and nobody in your team has either, that makes it very hard.
  2. You are selling ownership. Investors write checks to own a serious portion of your business. I admit that’s patently obvious, but you should see the emails I get in which people think of investors as if they were some sort of public agency. Once you get investment, you don’t own your entire company.
  3. Investors are bosses. You are not your own person when you have investors; you’re part of a team. You can’t decide everything by yourself. Politics matter. Investor relations matter. If you screw up, you do it in front of other people, and it hurts those people.
  4. Valuation is critical to them and you. Simply put, valuation means the price. If you want to give only 10 percent of your company to investors who pay $100,000, you’re saying your company is worth $1 million. And so on. Simple math, but wow, not so simple negotiation.
  5. Investors don’t make money until there’s a liquidity event. That’s why we always talk about exit strategies. You can be the world’s happiest, healthiest, most cash-independent company, but your investors won’t be happy until you get them cash back. The win is getting money back out of the company. Some big company stock buyers like dividends. Startup investors don’t.
  6. If it’s not scalable, forget it. The real growth opportunities are scalable. It used to be products only, but now there are some scalable services, like web services, for example. But if doubling your sales means doubling your headcount (that’s called a body shop), then investors aren’t going to be interested.
  7. If it’s not defensible, it’s tough going at best. Not that I trust patents as a defense, but trade secrets, momentum, a combination of trade secrets and patents, plus a good intellectual property defense budget … if anybody can do it, then investors aren’t interested. (Of course, what would I know, I thought Starbucks was a bad idea because I thought that was too easy to copy … there are always exceptions.)
  8. Investors aren’t generic. Some become collaborative partners and even mentors, some are nagging insensitive critics. Some are trojan horses. Some help, some don’t. (Hint: choose carefully which investors you approach.)
  9. Just getting financed doesn’t mean diddly. For an example of what I mean read this piece from the New York Times. You haven’t won the race when you get that check.
  10. Investors sometimes take your company from you. Well-known strategy consultant Sramana Mitra has a couple of eloquent minutes on that them in this two-minute video. She seems to be talking about India, but she’s well known in the Silicon Valley, and what she says applies perfectly well here.

Why The Bank Won’t Finance Your Business Plan

Advice, Business Financing, Starting a Business, , ,

Over the years I’ve received hundreds of emails from entrepreneurs complaining about banks not lending them money on their business plans. I just got another one this morning, and when I searched this blog I couldn’t find a post to cite as an answer. So here it is, today:

Banks can’t lend you money on your business plan. It’s against the law. They’re supposed to protect their depositors’ money by demanding collateral, credit history, and low risk. And startups are high risk.

Bankers are good and bad, smart and not-so-smart, liberal and conservative. Sure, some just follow rules and fill forms; but I’ve known some smart innovative bankers. Just as an example, one of the senior officers of a local bank is also a fellow member of the Willamette Angel Conference, meaning that he invests his own money in startups – his own money, not the bank’s money.

Banking laws have discouraged banks from investing in your startup since the Great Depression of the 1930s, when lots of banks went under. You have to have some assets – like your house equity – and you have to risk losing them. And if your credit rating is bad, that’s your fault and not the bank’s, but it does make it harder for the bank to lend you money. And that means that you can lose your house.

Yes, there are exceptions to these rules. For example, The U.S. Small Business Administration (SBA) can guarantee portions of a commercial loan so you don’t have to. For that, ask your bank; those loans are managed by commercial banks.

And yesterday I posted 5 non-traditional ways to get startup money, on this blog. None of those involve traditional bank loans.

(image: mmaxer/Shutterstock)

5 Non-Traditional Ways to Get Startup Money

Angel investment, Business Financing, Starting a Business, , , , ,

So you want to start that company but you don’t have enough of your own money to do it. Most people think you either borrow the money or find investors, but neither of these are always possible.  You won’t get investment if your company isn’t investible.  And banks can’t lend you money on faith, you need a credit rating and some collateral. But there are some other ways to get that startup money.

  1. The absolute best startup financing is prepaid sales. Get a company that knows and trusts you to prepay services, or product development. Give one or more key customers an attractive discount for betting on you early. When I started on my own I sold a year’s worth of consulting, in advance, to the consulting company I was leaving; I accepted only half a year’s money, but it worked. It got me started. Later  I got large buyers to prepay software development in order to influence the product features they wanted. I know it’s hard, but it happens.
  2. Innovative non-traditional borrowing. Even though banks can’t lend you money if you don’t qualify, other people – angel investors, for example – can lend you money if they want to take a risk on you that way. Usually they’ll do it only for additional benefits to compensate for additional risks. That could be a high interest rate, or an “equity kicker” (a small percentage of ownership that they keep even after the debt is paid), or some portion of the debt that converts to equity (ownership). Look into convertible debt and warrants.  Fred Wilson had a very good post yesterday on Venture Debt, which isn’t usually applied to startups, but still, an interesting option.
  3. Percent of revenue, or royalties. This worked beautifully for me in the middle 1990s when I needed professional programming to help turn my business plan templates into Windows applications. I found a company that would work for a small fixed fee per month plus a small percentage of future revenue. Just last year I helped a friend find a fair way to pay a co-author without sharing ownership in her startup. She and her co-author were both happy with a long-term royalty arrangement.
  4. Do-now pay later. Offer somebody a contract for services paying a bare minimum now and then twice as much later on, as a balloon payment or a series of payments. Say you get a consultant to help you with your business plan and she’d normally want $5,000, but you offer her $10,000 if she can take it in 10 monthly payments starting on the third month. It can happen.
  5. Lease equipment. Leasing works best when a new business depends on relatively big equipment purchases: the trailer truck, the espresso machine, the dry cleaning equipment, for example. If you can qualify for the lease contract, you turn that big purchase into a long series of monthly purchases.

Bombarding Investors With Your Deal Is a Terrible Idea

Angel investment, Starting a Business, , ,

Subtitle: The deals chase the money. The money doesn’t chase the deals.

Two days ago in Angels vs. VCs on Business Pitches I said our angel investment group looks at all submissions.

That confused my friend Anthony Richardson, who followed up yesterday with this question:

Should an early stage company bombard every online submission under the sun ? It has always been my advice to clients to tell them that it was a complete waste of time, and if I may be honest here; I was fairly surprised to see that you thought differently.

Anthony, I completely agree with what you’ve been telling your clients. An early stage company should definitely not bombard every online submission under the sun. That is, exactly as you suggest, a complete waste of time.

(Aside: misunderstandings are always the writer’s fault, never the reader’s.)

My reference to submissions was very specific. We use angelsoft.net, which is free to entrepreneurs and angel investors, and is used by about 400 other angel investors.

We would never consider investing in a company without getting to know the people personally. Our review process first narrows them down to about a dozen or so, using mainly the executive summaries. From there we break into teams, visit their offices, talk to their customers, and study their business plans (the buzzword is due diligence) before we make our decision.

I like angelsoft.net because it’s practical, it works, it collects and manages the information, and it’s free for both sides of the table. And several hundred angel groups use it like we do. It’s free for entrepreneurs and angel investors.

But submitting to us through angelsoft.net is not just submitting online. While it may be possible to use it to submit to lots of groups, that won’t work. Almost every group that uses it has its specific criteria. For example, our group looks only at Oregon companies. We’ve made a couple of exceptions for companies in Southern Washington wanting to move, but neither of them won.

Angelsoft.net does allow what it calls “bulk” submissions, meaning subsmissions to multiple groups. We don’t look at them unless they’re in Oregon. I doubt that other groups look at submissions outside their criteria either.

I’ve been watching online business plan posting sites since I finished the first Business Plan Pro in 1995. My company owns one of them, secureplan.com, but only as a convenience to our software users. It lets them post a plan online instead of printing it. Investors don’t browse it; they need an owner’s specific login information for each plan they see. And we don’t charge for it.

Seriously: real investors don’t browse the web business plan posting sites.

Those sites that charge you money to get listed where investors will find you? Assume that’s a complete waste of time and money. No, I don’t know them all. Things do change. In 15 years I’ve heard of one single deal that started with an online listing. I’ve heard serious investors have concerns about deal flow, but that doesn’t mean they’re browsing business plan posting sites.

If you’re serious about getting investment, do it right. Choose your targets very carefully. Look for close matches between what you have and what they want. Shotgun scattering will never work.

Angels vs. VCs on Business Pitches

Angel investment, Business Financing, Starting a Business, Venture Capital,

Over the weekend I caught Business Insider’s Five VCs Explain What They REALLY Think About Your Pitches. It’s a great post, gathering points together from discussions with several high-end VCs. If you’re looking at venture capital, read it. Business Insider

Part of what they said reminded me that angel investors and VCs have a lot in common. For example, these important points:

  • Keep it short.
  • Avoid buzzwords.
  • Answer questions quickly without getting defensive.
  • Be a good storyteller.
  • Know the people you’re pitching.
  • Don’t forget the financial info.

I’m pretty sure all of the 30+ investors in my local angel investor group would agree with every one of those. I particularly like the three about answering questions, telling stories, and not to forget the financial info. Those three are critical.

Some of the other points, however, remind me of the differences between VCs and angels. For example, the VCs say introductions matter:

The person introducing the entrepreneur is a big deal — if [the VC quoted] doesn’t trust the referral, he won’t even take the meeting.

Our group, in contrast to this, looks into every submission we get. Introductions aren’t required. Some of them don’t get past a quick read of the executive summary, but I think most angel groups are similar. We’re going to read the executive summaries, at the very least. And we invite submissions. Every plan submitted before March 31 is considered for our May investment. Some are not considered very long — like less than five minutes — but still. Introductions don’t matter. The plan does.

Two other points probably depend on the group, the particular angel investor, and the moment. The VCs said:

  • Think big or don’t bother.
  • Forget saving the world.

I don’t think those points are as true for angels as for VCs.VCs are investing other people’s money, mostly institutional money, and they’re paid to do that well. Professionally. Angels, on the other hand, are investing their own money. Maybe that makes a difference. It does to me. Angels invest smaller amounts, generally, and at an earlier stage, generally. Maybe that’s why sometimes we’ll consider a not-so-big deal, and sometimes saving the world, or not, makes a favorable difference.

That’s my opinion, anyway.