FUND-RAISING FATALITIES

by Bruce Woodry

Of the 800,000 or so new businesses formed each year, only a tiny fraction are successful in raising capital.  For instance, last year there were about 700 initial public offering (IPOs), a sizable number, but not when compared to the number of start-ups.  According to the securities and exchange commission (SEC ), about 10,000 Regulation D  forms are filed each year.  Lately, venture capital has been very fashionable, but it is not an option for over 90 percent of all small companies. From all combined sources, the number of companies that are unsuccessful in raising capital are greatly outweighed those that are. 

As an investment bank, we see more business plans in one month than most operating company presidents see in their career.   By experience and necessity, we have developed a screening process which eliminates the potential fundraising failures before we commit our investment of time, energy, money and opportunity cost.  Simply put, there are too many fine deals that go unfunded to get entangled in a transaction that is doomed to failure.

Here are some of the lessons that we=ve learned that make companies unable to raise the required capital.

1. No "walking-around" money.  Companies that can't afford the expenses of a deal almost never raise the capital.  These "walking-around"expenses include legal, accounting, promotion and travel costs that are part of every fundraising effort.  For an initial public offering, these expenses may exceed $300,000, and for small private placements may exceed $50,000.  When the dust settles, expenses may be in the 15-18% of the total capital raised for small transaction sizes.  Companies that don't have this "walking around" money to get see them through the fundraising process will simply not be in the game. Most investment bankers are unwilling to assume both the risk of their professional fees and out-of-pocket expenses for your transaction.

 2.  Going to the market with a half finished transaction.  Deals move quite quickly once taken to the market, and if the details are not worked out ahead of time, the pace of the transaction slows, investors become disinterested, and a project fails.  At that point, it's almost impossible to go back to investors previously contacted.  Also, if a company tries to raise its own money and fails, it is unlikely that they will get an investment banker to finish the deal.  "If it's somebody else's failure," says Woodry, "no one will want to fix it because it's just easier to find clean deal to work on."  If the idea has sufficient merit to continue, a whole new approach and elimination of all previous efforts is generally required.

3. Over shopping the deal. In virtually every area of the country, there's a limited number of early stage investors.  Repetitive calls, presenting it to investors who may have conflicts with others and the like are hidden land mines. Investors like exclusivity and to be the first one in on a good deal, so investments promoted too widely, such as through advertisements or over the Internet, could potentially be a turn off.  Also, the wider a company distributes its business plan, the more likely it is to find its way into the hands of competitors. So if you have trade secrets, guard them carefully

4.  Lack of full disclosure. There's no escaping exposing your skeletons to investors.  If you fail to address prior problems, SEC violations, threaten litigation and gloss over competitive products or disregard of market barriers, etc., you're asking for trouble.  Not only will they show up in the investor's due diligence process, but at a minimum your credibility will be shot, or worse yet, you may be in for protracted litigation.  When we find a client has misled us or been dishonest, we drop them immediately.

5.  Improper valuation.  Everyone wants to get the most value for their idea.  However, raising capital requires that you compete against all other forms of investment opportunities from which a potential investor could choose.  We've found that people with unrealistic expectations not only fail to achieve them, but are likely not to secure any investment at all.  If you hold out for the highest possible value, you become an un-fundable deal.

6. Inadequate financial reporting. One key area where entrepreneurs often fail is either inadequate financial reporting of past results, or overly optimistic pro forma projections of future performance.  If we are presented an income statement, balance sheet and cash flow statements in spreadsheet format, we are highly suspicious, since without the validation of an external source, either a CPA or investment banker, the numbers are suspect.

7.  Unrealistic operational pro-formas. A fatal flaw with financials is an overly optimistic revenue projection, a profit and loss statement which shows a profit, which upon further scrutiny indicates a loss, or an overly aggressive time table.  This occurs through write-downs, deferral of research and development expenses until product launch, inappropriate assumptions regarding receivables, un-collectibles, production yields, etc. are a clear indication of either naive or poor management.

8.  Inadequate management team for the task at hand. We encounter numerous companies which are capable of explosive growth, but don't have a management team in place to assure that commercial objectives are met.  For instance, one plan  we reviewed indicated growth from startup to $60,000,000 in four years, yet no one on management team had ever managed a company, hired any employees, etc. or experienced this level of growth.

9.  "Closet case" management. Many times, the company doesn't have warts, but the founders and senior management do.  When raising capital, personalities play a big role, perhaps a disproportionate one. The reason is that with equity capital, the investor owns a piece of the company, and so we are really talking about a partnership. While some people are good managers, they are not saleable to the public because all of things like personality flaws, poor social skills, a dry or no personality, lack of fashion sense, poor hygiene, or a know-it-all attitude.

10.  Poor historical performance. If the company or the management team has produced poorly in the past, it's an indication they will perform poorly in the future.  Don't ask an investor to place their money with under performing management when their prior attempts have failed.  Also, projecting growth while turning in poor performance will immediately kill the deal.  The message is: make your numbers!  

11.  Lack of understanding of how to sell and market the product. We have seen an endless supply off technologically innovative products, where the entrepreneur has no idea how to get it to market and make profit!  Since after the initial product design a majority of money allocated to selling and promoting the product, usually in a ratio of three to ten times that of the initial product development, this area requires close scrutiny from investors and rightfully so.  Also, with an inexperienced sales and marketing team, there are often "barriers to entry" which cause setbacks and  prevent the timely and effective market penetration.

12.   Low investor returns and lack of a planned and exit strategy.  As mentioned before, fundraising is competing for risk capital based on relative risk/reward merit against the available universe of investments.  Many companies have not thoroughly thought through the investment from the investors perspective.  They offer non-competitive returns or do not plan a means for the investor to get their risk capital back.  Since private company stock is not readily salable, special attention must be given to providing the liquidity required.