CLOSING THE COMMUNICATIONS GAP WITH INVESTORS
Robert Rea
THE PLUNGE
So your research has finally reached the point where you can see a path to commercialization of a great new technology. You are enthusiastic about confronting the risks and finding investors to share your enthusiasm. You are typically employed in a well-organized large company where you have learned enough about the market and the competition to convince yourself that the time is right to become an entrepreneur.
You
have been successful inside the company in obtaining funding for you projects.
Proposal procedures are well established, and you have staff support for
obtaining market data, forecasting costs and revenues, calculating net present
value based on the corporate cost of capital and submitting your request in the
annual capital budgeting process.
However,
the world of private equity investors is not so well structured. It is filled
with Angels with unstructured personal agendas and hundreds of venture capital
companies. These companies have clearly stated investment policies on their web
sites, but their partners have diverse backgrounds and interests, and they
don’t always follow them. But you remain confident that funding issues can be
handled routinely once an investor learns about the outstanding opportunity that
you are willing to share.
Investors
can be expected to have the opposite view. They learn about many outstanding
opportunities every day. They focus on finding well-structured business models
that provide so much real value to customers that it can be shared to create
substantial wealth for all involved.
STRAINED COMMUNICATIONS
You
quickly learn that you have a communications problem. You can’t understand why
investors are simply not interested in the details of how your technology works
but only in what it does that customers care about. Your communications are also
limited by the lack of a common language. You speak in technical terms –
entropy, caches, C++, morphing structures, photoresist, functional chemical
groups. Investors speak in business terms – value proposition, liquidation
preference, valuation, IRR, time to positive cash flow, exit strategy, product
differentiation.
Here,
investors have the edge. Many of them specialize in focused market segments and
have learned the language well enough to understand most technical concepts. But
technical entrepreneurs often make the mistake of believing that business issues
are just common sense and don’t warrant the time required to dig deeper. In
the end, it’s the business issues that dominate the conversation.
ABSENCE OF SOLID INFORMATION
Even
if there is some initial success in initiating a conversation, there is often
not much to talk about if your business plan does not contain all the
information investors need to continue the conversation. Some typical problems
that irritate investors:
·
Market
data not specific. Investors (and
you) need to know what potential customers are now paying for the function that
you propose to replace, not just the size of the broad market. This level of
detail is rarely available to people outside the industry. Remember, if you
propose to introduce a new, disruptive technology without precedent, the market
size is zero.
Percentages
meaningless. Proposing to
obtain a very small share of a very large market has no meaning.
Specific
customers not identified.
Market segments don’t buy things; people do. They need to be identified
along with compelling reasons to buy.
Customer
value not quantified. How
much cost could be saved or how much market share could be increased?
Incomplete
competitor information.
Spend time with trade journals and the internet looking for competitors. You
need to know more about them than the investor does.
Distinctive
competence not clear.
What’s so special about your stuff? Be specific.
Intellectual
property not solid. Are your
patents easy to work around? Are they configuration-specific or do they
offer broader process protection?
First
to market strategy weak. Investors
have learned their lesson in the dot.com crash. If you have no intellectual
property and the success of your plan depends on being first to market, the
number of potential investors is severely limited.
Inexperienced
CEO. Investors are highly
skeptical of the ability of a technical genius to build a fast-growing high
tech start-up to a $100 million company in five years if they haven’t done
it before…even if they can.
Thin
team. Although not having
everyone on board at the beginning is OK, all of the key people must be
fully committed to the enterprise when the money is available.
Thin
board. The absence of boards
and advisors with lengthy industry experience and broad perspectives makes
investors very nervous.
Too
much R&D. Investors are
willing to take business and market risks, but they’re not very
venturesome when it come to technological uncertainty. Depending on R&D
to produce commercializable results is a job for the government.
No
history in financial plan.
Investors want to know how you have survived so far. Starting financial
projections when you get the money leaves out an important part of the
story.
Time
to positive cash flow too long.
Most investors are willing to hang in there for 18 months, but their numbers
decline quickly after that. They must provide a competitive return to their
investors, and time is a very important factor.
No
analysis of comparables.
Investors paint pictures in their minds of duplicating the recent financial
success of their peers. You can help them along by providing example of
companies like yours beging sold to big companies or going public that
return at least ten times the initial investment in five years.
Investment
request and use of funds not matched with cash flow requirements. How
much money should you ask for? The purpose of equity investment is to cover
the cumulative negative cash flow until the company can sustain itself on
revenue. Do the analysis and ask for a margin to cover the uncertainties in
the assumptions.
Assumptions
not stated. Investors
don’t believe that your financial projections will actually happen.
However, they can decide whether or not to believe the assumptions you used
in making them. The projections are simply the results of the assumptions.
If they are not clearly stated with convincing rationales, you have wasted a
lot of time.
INTANGIBLES
After
you have filled out your business plan, the dance begins in earnest. Research in
the business venturing literature has identified additional factors for success
and failure in getting the money. Success factors include:
Founders
with prior successful start-ups
Ethical,
frugal and skilled people
Technology
and enthusiasm way above the norm
Multiple
investors
Corporate
alliances
An
innovative solution to a difficult, market-driven need
Outstanding
team
Focused
product development effort
Excellent
group of investors and directors
Failure
factors include:
CEO
too abrasive
CEO
too weak
Missionary
market
People
too concerned about their salaries
Conflict
over control
Proprietary
position didn’t hold up
Couldn’t
get together on valuation
Weak
team that didn’t work well together
PUTTING IT ALL TOGETHER
At
this point, you finally know what you have to do.
1.
Don’t waste time by presenting incomplete and unbalanced information.
2.
Make sure your technology offers an innovative and well-protected
solution to a market-driven need.
3.
Make sure your team is credible for carrying out your plan.
4.
Be realistic about your valuation.
5.
Exude cautious enthusiasm.
6. Learn the language of investing.