The startup entrepreneur has plenty of anxiety and frustration to deal with when trying to figure out how to raise capital or what that process entails. It’s the number one question aspiring entrepreneurs ask me. There are many experts who have written entire articles/blogs on each of the steps outlined below. I wanted to show the basic process that an entrepreneur should be prepared for when embarking on a capital-raising journey. It is by no means the only path, nor is it simple. But it’s a start.
Step #1. Create an effective one-page executive summary. This summary should outline the facts about your venture and serve as an overall summary of your business. This document will be used to capture the potential investor’s interest. I know it is really difficult to tell your story in one page. Keep it to one page. If the potential investor is interested, you’ll hear back. It is also the first step toward getting a “warm introduction.” I like the format used for TechLaunch’s BullPen application, available at http://www.techlaunch.com/wp-content/uploads/Executive-Summary-Template-1.doc. A similar summary is used by other angel investors or angel groups.
Step #2. Create a 60-second elevator pitch that describes your business concisely. The business description in your executive summary is a great start. Avoid vague descriptions and comments like “we are the next Google or Uber.” Instead, an analogy such as “we are like Amazon, but focused on pet food” puts your business model into perspective. Avoid acronyms. Not every investor you speak to is as familiar with your business or industry as you are. The most frequent investor question, after an elevator pitch is, ”So what do you actually do, or what problem are you solving?” A well-crafted elevator pitch can open doors or lead to referrals; or, when done badly, it can kill the opportunity. Your elevator pitch can also be used as your intro to a presentation after you briefly introduce yourself.
Step #3. Create an investor pitch deck that describes the business opportunity to a potential investor. It can also be used as your overall business plan. A majority of angel investors would rather have a pitch deck in lieu of a business plan document. Your pitch deck can be used as a stand-alone description of your business, but it will mainly be used to tell your story to potential investors. It most likely will have the same information as a written business plan. If an investor(s) is interested in your business, they most likely will ask you to return for a more in-depth follow-up F2F meeting or conference call. It’s the start of an informal “due diligence” process. Keep in mind that investors have great memories, although they may have some gray hair. My template of guidelines can be found online at http://www.techlaunch.com/wp-content/uploads/Sample-Pitch-Deck.pdf. The template is a general guide to what information should be in a pitch deck. You’ll need to be creative in telling your compelling story. Please stay away from videos and other artistic creations that would detract from your business story. Early-stage investors don’t care how artistic you are. We care about your ability to execute your plan and your knowledge of the market. Be prepared to adjust your pitch to either a 3- or 5- or 10-minute pitch. Make your deck scalable.
Step #4. Get a “warm referral” to a potential investor. An attorney or accountant or business adviser or friend can refer you to a potential investor. A “cold application” puts you in line with all the other folks looking for funding. A “warm referral” will more likely put you on top of the pile. It will not guarantee an investment, but it will catch attention. The referring person will most likely know what the investor wants to see first … just an executive summary or also a pitch deck. The executive summary is usually sufficient to generate interest, and then an email intro or pitch deck is requested.
Step #5. Presenting to a potential investor. You’ll be making lots of presentations before generating interest. Take as many opportunities as you can to practice your pitch. Learn from each pitch. Ask for feedback and listen to it. All criticism should be taken as constructive. Keep in mind that the Shark Tank show is just that … a show. There are very few investors who want to steal your business or intellectual property. Most investors are looking to learn from you. You need to know more about your business and market then they do. Also, keep in mind that they have probably walked the same path and felt your pain. They are sympathetic to your journey, but expect you to weather the ups and downs. Perform your own due diligence on the investor or group of investors before accepting any funding. They will become your partners.
Step #6. investor due diligence (DD). If potential investors are interested, they’ll start by asking informal questions about your business model, financials, personal referrals and customer referrals. They’ll follow that by going into a due diligence process that does a much deeper dive into the business. At this point of your discussions, you can probably ask the potential investor(s) to sign a non-disclosure agreement (NDA). During the due diligence phase, be prepared to provide detailed information on categories such as your management team, employment agreements, capitalization table, corporate structure, financial information, material agreements, intellectual property, customer information and references, and pending litigations. Keep in mind that whatever information you generate can be used for your next DD activities, or at least you can keep it handy for the next round of capital raising. There is, in most cases, a next round. This DD phase may take 30–60 days to wrap up if the investors decide to continue. I have seen plenty of deals go south due to a lack of or delayed DD activity, or as a result of negative information. Be as cooperative and responsive as possible.
Step #7. Term sheet (TS). This document basically outlines the understanding between the entrepreneur and the investor. In most cases, you can find templates or samples on the internet. It is not the legal document that will “close” the deal or get you that check. This one- to three-page document spells out things such as the amount of the capital raised; estimated closing date, or when you can anticipate receiving the funds; the type of investment (such as equity or convertible note); the pre-money valuation of the company; whether an equity round will be preferred or common shares and associated preferences; if it is a convertible note round, what the cap is on the note, due date, interest and conversion preferences; the composition of the board of directors; how the investment will be used (use of funds); what the no-shop exclusivity is for the deal until the close; what activities or funding thresholds are imposed that require board or shareholders’ approval; and what the anti-dilution rights are, if any.
Step #8. Legal documentation to close. This is where you’ll definitely need a knowledgeable attorney (who has worked with startups, done closing docs and knows how to protect you) to generate the legal documentation to close the deal. In some cases, you may feel more comfortable getting an attorney involved earlier in the process, perhaps in crafting the term sheet.
Depending on the type of deal (equity or convertible note) the entrepreneur and investor have agreed to, the amount of paper work can vary tremendously. With a convertible note, financing the paper work can be as simple as finding a SAFE (Simple Agreement for Future Equity) template online. A typical SAFE agreement can be found at SAFE: Valuation Cap and Discount. This SAFE financing document was primarily used by Y Combinator to make initial investments easy and less costly. In any case, SAFEs or the more formal convertible promissory notes can be used when startups and investors can’t agree on a valuation of the business. The determination of the value of the company is deferred to the next round of financing, which most likely will be an equity round. More information on SAFE financing can be found at Y Startup Documents. The SAFE or note usually includes a 10%–20% discount in the next round, a cap on the valuation, conversion rights, an interest rate, note payback date, minimum raise on the next round (qualified round) and the consequences if the note is not payed back on time or the next round of financing does not occur. The meaning of all these terms can be found online or provided to you by your business adviser or coach. The biggest advantage of doing SAFE or convertible promissory note financing is that it saves legal costs, and startups can close and use the funding as soon as the documents are signed by both parties and the check is received.
The alternative to a SAFE or note financing is the equity or priced round. This type of financing is more costly and time consuming and, more importantly, the funding cannot be used until a minimum has been raised and a formal “close” has occurred. In a priced or equity round, the value of the company is predetermined based on various factors such as revenue, intellectual property, product status, knowledge of the team, market size, customer traction, etc. In a startup or seed-stage company, it is very difficult to determine the valuation of the company, so most startups and investors go with a note of some kind. If the company and the investors can agree upon a valuation (aka post-money valuation) and on the type of stock that will be issued to the investor, an equity round will be possible. The advantage of a priced or equity round is that the entrepreneur can require that the stock be the same as those of the founders, meaning that the investors do not have any special preferences over the founders. The questions of common vs. preferred shares or voting vs. non-voting shares and anti-dilution rights are topics for another discussion and various books.
Step #9. The close. So, you have gotten this far and you’re ready to spend the money you have worked so hard to get. Keep in mind that the investor has worked hard for his or her money, too. And now that you have one or several partners to deal with on a weekly, monthly or annual basis, you must be ready to put up with their scrutiny and desire for updates and financial reports. Don’t fret, most investors take a hands-off approach. They do their due diligence and basically invest in the team that can best execute a project. Be prepared to issue quarterly progress reports, including management-generated financial statements. Communications is key to keeping your investors happy. Surprises like “I’m running out of money at the end of this month” are the worst. Most investors expect that you’ll eventually need more money. Hopefully, you have chosen investors who have “dry powder” to invest in the next round. If you have made significant progress, expect the next round to be an “up round,” meaning that the valuation of the company has gone up. If you have made little to no progress, and you are looking to raise additional funding, expect the next time to be either a “down round” or a “flat round.” You get the message.
Final words of wisdom: Spend that money as if it were yours and as though you might not get another dollar for a while. Meaning, spend it wisely. Spend it as if you were bootstrapping, and only when you have to. Lean on your investors for advice, referrals and connections. It’s good to have high expectations of your team, but always treat them with respect and compassion. Remember, the board of directors is responsible to the shareholders (especially the minority shareholders), while a board of advisers is responsible to the CEO. Choose both wisely.
Enjoy the journey for the journey’s sake, and not for the pot of gold at the end of the rainbow.
A wise and younger friend reminded me to “forget the mistake but remember the lesson.”
About Mario M. Casabona
Mario Casabona is an entrepreneur and an active angel investor. In 2006, he founded Casabona Ventures, investing in over 25 seed and early-stage companies. In 2011, he founded TechLaunch (Kinnelon), which is committed to identifying early-stage tech ventures and nurturing them by mentoring, coaching, and providing access to resources and capital. To date, TechLaunch has supported over 50 tech companies and mentored over 100 budding entrepreneurs; it has over 150 mentors in its network.
Casabona is chairman emeritus and an active board member of both the Jumpstart NJ Angel Network and Research & Development Council of New Jersey. In 1982, he founded and continued as chairman of Electro-Radiation Inc. (ERI), which was acquired by Honeywell Aerospace in 2004. ERI was a developer of radar, navigation and communications equipment for the national and international defense industries. He received the U.S. Small Business Administration Tibbett’s Award for his contributions in technology, and was listed as one of the top five most influential persons in New Jersey technology by The Star-Ledger. In 2014 he was named New Jersey Immigrant Entrepreneur of the Year. He was twice recognized by the New Jersey Tech Council, in 2013 as the recipient of their Legend of Technology Award and in 2010 as their Financier of the Year. He currently serves on the boards of various businesses and nonprofit organizations. He is often quoted in mainstream media and trade outlets, and enjoys being a frequent guest speaker and panelist at university and professional events.
Mario is an electrical engineer, and is named in 12 national and international patents in the field of satellite-based navigation and communications. He lives in Morris County, enjoys mentoring, launching new ventures, vacationing and spending casual time with family and friends at his Catskills log home.