Practical Solutions to Business Puzzles

Charles needed $5 million USD to start a new business venture.  Charles exhausted traditional sources for businesses such as friends, family members, banks, and credit cards. Still he didn’t have enough money. In fact, family members, friends, and banks were unwilling to invest in his business idea. Suppose that Charles tries to raise funding from other sources.  How can he work with those other investors?

Angels and venture capitalists often have agents that represent them and screen potential investments for viability and credibility. These agents have fiduciary obligations and the duty to use due diligence in selecting and evaluating potential investments.  

How can one approach this issue in order to maximize the likelihood of receiving funding?  What specific steps can one take?  How can one position oneself to negotiate more effectively and efficiently with potential investors?

Like most things in business, this is simply a negotiation. 

Strategic Sale

Securing funding for a business is, fundamentally, simply a strategic sale.   When one request funding, one is negotiating with firms in the hope that they will ”buy” into one’s idea.  Fundamentally, this is simply selling the idea. 

In order to sell something, it is very helpful to believe in what one is selling with absolute conviction.  In a strategic sale though, one should take it to the next level.  One should test one’s own beliefs and convictions.  It seems to me that strategic selling is always based on trust.  Can trust exist without knowledge? 

Since trust requires knowledge, one needs to decide what knowledge is necessary, obtain the required information, and decide what the information means for one’s own business. 

Let’s think about what this means in the context of seeking funding.  How might one wish to approach the issue?

Requirements and Critical Success Factors

The starting point for any “project” is identifying applicable requirements, parameters, and critical success factors.  What is one trying to accomplish?  One needs to separate all solutions that would achieve the desired result from all other possible answers. 

Specific questions that business owners may find helpful to ask could include:

1. What are we seeking with regard to investors?
2. How much money are we hoping to raise?
3. What is the range of money that we would be satified with?
4. What are the characteristics of the investors that we are hoping to attract?
5. How many investors are we hoping to attract?
6. What are the characteristics of an investor that we do not wish to attract?
7. How many investors will be too many?
8. How many investors would be too few?
9. Describe the ideal investor relationship.
10. What conditions will exist if we are successful in our effort?
11. What parameters must be satisfied with regard to the effort?
12. How will we measure our success?
13. Why is it important to find appropriate investors?

Identifying requirements, parameters, and critical success factors at the beginning of the project can make it easier for business owners to allocate time and other resources efficiently and effectively. 

Let’s look at question 4 in more detail.  What are the characteristics of the investors that the business owner is trying to attract?  This may be impacted by factors such as:

• How many investors one wishes to work with,
• Reporting and processes one wishes to impliment,
• How much control one is willing to give  investors,
• One’s investment in the business,
• One’s interest in building rapport with investors,
• Whether one wants coaching from the investors, and
• How flexible one’s timeline is.

Break it down 

Each of the points listed should be broken down so that one know exactly what one is seeking.  

Tools such as 5 Whys and Appreciation (So What) to help us break the answers down even further.  This is extremely helpful to us when working on massive projects. 

Application of 5 Whys 

Suppose that one were looking at the number of investors that one wished to work with and that one decided that the optimal number of investors was three.  The 5 Why’s approach might be applied as follows:

Q:  Why do we want three investors?

A:  To help us manage investor-related risk.

Q:  Why?

A:  Because we do not want to be too dependent on one investor.

Q:  Why?

A:  If we are too dependent on one investor, we might be adversely impacted by other issues that are occurring in the investor’s business and we would not have an established relationship with other funding sources.

Q:  Why?

A:  The investor might be unable to extend additional funding that could be required for growth and other business activities if it other investments were not meeting its expectations.  By having existing relationships with other funding sources, we might be able to secure funding from the other sources, if it became necessary in the future.

At this point, would one have a pretty good idea of concerns?  If not, one might decide to use Appreciation and replace the “why” in each question with “so what (does that mean for us).”

Application to other questions 

Remember, the other ten questions would be broken down in a similar fashion in order to better define the goals, parameters, and critical success factors. 

The 5 Whys and Appreciation approaches are just two of the tools that one could use to develop a better understanding of each element.  One should evaluate the results to see if the tools add value in any particular situation, or have one “chasing rabbits,” as my friend George used to say.

Research Investors

Just as a supplier should research its customers, so too business owners should research the potential investors.  All investors are not created equal.  Some require more reporting.  Others require more control.  In some cases, the investors want to put their own management teams in place.  Other investors may take a laissez faire approach. 

Take notes as the data is collected.  By taking notes, one creates a resource that can be used when rating and ranking potential investors down the road.  Rating and ranking allows one to decide how to allocate resources most efficiently and effectively.

Business owners like Charles may find it helpful to consider the following questions: 

1. What are the characteristics of investors who would be interested in the project?
2. Why would the investors be interested in the business
3. What are the investors’ objectives?
4. How do the investors’ objectives align with the owners’ objectives?
5. What businesses have the investors funded previously?
6. What criteria do the investors use to identify appropriate projects?
7. How can a potential investment have and add value for the investors under consideration?
8. How can the investment add value for the investors under consideration?
9. What will the investors be concerned about with regard to the investment being contemplated?

Let’s look at the first question, what are the characteristics of investors who would be interested in the project.  In breaking this question down, one might want to consider factors like the following:

How large should the investor be in terms of employees?

Where should the headquarters of the investor be?

How much money should the investor be willing to invest in a business like the one in question?

Does one find it easier to work with firms meeting certain characteristics? If so, what are these characteristics?

The more clearly one identifies one’s ideal investor, the more selective one can be in defining the investors that one wishes to consider.

In discussions with business advisors, one should consider factors like the following.  Ask questions.  Take notes.  Seek clarification.  Think about how each element would impact day to day business operations.  How would each element come into play with regard to annual an quarterly operations?  How will the elements impact one’s cost structure?

Pool of Investors

Which investors - angels, venture capital firms, banks, and investment banks - fund businesses like the one in question?  When seeking funding from investors, it helps to start by identify people and firms that have a history of funding similar projects.  They are more likely to be interested in the project and to be sufficiently experienced in the area to understand the opportunities.

Investors’ Criteria 

What decision criteria do the investors that fund these types of businesses seek in potential investments?  Some investors like start up companies, even though they have higher risk.  Other investors look for businesses that are a little more mature, even though they may have a little lower expected return on investment.

Who are they

Who are each of the investors and how do they operate?  When one accepts funding from a firm, the business accepting funding is creating a situation whereby the business will have to cooperate with the investor.  Some investors may want greater control over the business.  Others may want different levels of reporting. 

Business Alignment 

Are the investors compatible with the approach that the business uses to operate?  If the investors are incompatible with the way in which the business is operated, there is likely to be a lot of conflict.  Conflict is not bad per se.  In some cases, the conflict can be so extreme that the parties are unable to work together effectively.

Recommendations and References

Get recommendations from friends, family, and financial representatives.  One should also talk to similar businesses that have used the investors in the past.

Learn about working with the investors by talking to people who have used the investors under consideration in the past.  Where are issues likely to arise in the relationship with an investor?  How can issues be prevented in advance?  If the issues arise down the road, what steps might be used to resolve the issues?

Always check references.  Questions to ask references include:

1. What factors mattered to you?
2. How did you select _____________?
3. What has worked well in your relationship with _________?
4. If you were a business like ours, what would you consider in screening investors?
5. What might have worked a little better in your relationship with the investor?
6. If you were starting over and were planning to seek investments from ____________________, what would you do differently?  Why?
7. What other investors did you consider?  What was the one deciding factor that led you to choose _________ rather than your other choices?

Expectations 

When businesses use investor money, they have to comply with the investors’ rules.  What are the investors’ rules?  Can one comply with the rules? 

During the discussions with investors, one should ask about each investor’s flexibility.  Some investors may be very precise and others may be extremely flexible.  Either extreme can cause problems for the business trying to select an appropriate investor.

Selection of Investors

In sourcing, there is a saying…  “A bad deal is often worse than no deal.”  That seems to apply to the selection of investors as well. 

Selecting an investor without defining requirements might be a little like buying a service that hasn’t been defined very well.  It might work, but the odds are against it.

Rating and Ranking

The research provides one with a significant amount of data.  One should use this data in rating and ranking the potential investors. 

Rating can be as simple as the investor meets or does not meet one’s criteria on a point.  One may drill down, where appropriate, and rank each potential investor’s alignment on the factors.  Ranking is especially helpful if all of the potential investors meet all of the criteria or none of them meet all of the criteria.

Once the potential investors are rated and ranked, one can allocate time and other resources to the investors that are most closely aligned with one’s own priorities. 

Investors’ Concerns

Let’s think about what investors are likely to care about from a common sense perspective.  Discussions suggest that investors are likely to care about about six things, although the wording and slicing and dicing of issues can vary from one person to the next:

1. How will the money be used?
2. What is the business model?
3. Who will be leading the effort?
4. Are the interests of the firm, the investors, and the customers aligned?
5. How will risks associated with the business be managed?
6. How do the respected returns compare with the returns of other possible investments?

How might the six questions play out in this scenario? Let’s look at that question…

Use of the money

Agents and investors often start with the nature of the project.  Typically, they select project areas that they know and that have greater opportunities than others for them. 

What would happen if business owners try to secure funding from an investor that doesn’t fund a particular type of project?  The presentation could be perfect and the funding would not come through.  If the money will be used primarily in furtherance of a business activity that the investors are interested in, this question is unlikely to be a roadblock.

From a strategic perspective, one should understand the following items in order to select potential investors:

1. What are the characteristics of investors who would be interested in the project?
2. Why would the investors be interested in one’s business?
3. What are the investors’ objectives?
4. How do the investors’ objectives align with one’s own objectives?
5. What businesses have the investors funded previously?
6. What criteria do the investors use to identify appropriate projects?
7. How can a potential investment have and add value for the investors under consideration?
8. How can the business add value for the investors under consideration?
9. What will the investors be concerned about with regard to the business?

Business Model

Investors want to know how the business will make money.  Does the business model in the plan make sense?  Does it appear that the business model can work? Has it worked in other businesses? 

Investors want to understand the following types of questions:

1. What is the vision?
2. What are the goals of the business?
3. What does success look like for the business?
4. How will the business make money?
5. What products and services will the business provide to customers?
6. What is the pricing model?
7. Why will customers purchase the products and services?
8. How do the offerings and approaches compare to the competition’s offering and approach?
9. Who is the competition?
10. What, if any, growth opportunities exist?
11. Which if any customers have already signed up?

It is important to be both self-confident and reasonably optimistic.  (Think about what happens when speaking with someone who is depressed…)  On the other hand, if one is too optimistic or has unrealistic expectations, this can lead one to look at the business with significant skepticism.  Make sure that all assumptions are stated and justified by facts and data.

Business Leaders

Investors consider the leadership of the business in which they are being asked to invest. The leadership individually and collectively should be credible. Credibility is established by factors such as:

1. Prior comparable experience
2. Other experience that may be helpful
3. Results in prior roles
4. Educational background
5. Professionalism of the business plan
6. Professionalism in interactions
7. Poise and self-confidence
8. Business acumen of the team

At both the individual and the team level, would investors expect to see each person on the team involved in such an effort?  Do the individuals know about the product or service being supplied and their subject area?  Can the team members lead others?  Are the team members persuasive advocates for their positions? 

All other things being equal, an investor might want be more inclined to think that a business operated by someone who had operated a similar business in the past had a greater  likelihood of success than a businesses operated by people who had not done so.  Similarity between the businesses could encompass many dimensions - annual revenue, geographic distribution of operations, complexity, customer base, products and services, etc. 

Given a choice, would investors rather fund a team that ”has been there and done that,” rather than a single individual who is seeking funding?  A person who is making an initial foray into a subject area?  Or a team of people that have little experience in the area?

If the team is too small, investors can wonder about the team’s commitment to the effort over the long-term (2 to 10 years).  Beyond size though, investors also want to understand the team dynamics.  Are the team members all committed to the project?  Have the people found ways to recover from the brink of disaster?  If so, this may be a great person to have on the team because the investors will know how the person has reacted to adversity.

Alignment of Interests

When each stakeholder’s self-interest is aligned to support the business’ success, it increases the likelihood of success.  Most of the time, people act in their own self-interest. 

Have you ever seen someone who doesn’t act in accordance with his or her own self-interest?  Were you able to trust the person?   

If the team members’ interests are not aligned, the business is unlikely to be successful and progress is likely to be slow.  Often, the team members’ internal alignment is the result of shared vision, common goals and interests, and financial rewards.

If either the team or the investors have requirements that will not work for the other party, this must be disclosed and resolved.  Otherwise, one is likely to find the issue emerging later.

Suppose that the business is not aligned with its customer.  How do we know this is occurring?  How successful are such businesses?  Talk with potential customers and people who understand the potential customers.  This way, one can find out what some of the target customers are seeking so that the business model can align with their interests.

So, what steps can one take in helping the team align their interests?  Here are a few thoughts:

1. Have each person identify his or her interests
2. Explore what success on the business effort means to each member of the team
3. Take the time to get to know each other, and for each member of the team to get to know the other members of the team
4. Facilitate communication among the team members
5. Help people think through the issues that may arise, and develop contingency plans for the likely issues.  For example, what happens if the business is successful?  What happens if the business is unsuccesful?

Risk Management

Every business has a certain amount of risk.  Even the refusal to take risks presents a risk.  Logically, investors would want to know if the teams running businesses that the investors are funding have identified and planned for major risks. 

There are at least two types of risk.  Some of the risks relate to the business and the business model.  (Precipitation might be a tremendous factor if one is a farmer.  If one owned a different type of business, precipitation might not be a significant factor at all.)   

Other risks are universal.  What are some of the universal risks?

1. Misuse of funds by employees
2. Unmanaged conflict
3. Inflation or underestimating costs
4. Scalability and unexpected rapid growth
5. Slow payment by major customers
6. Customer backing out of major contract
7. Competition
8. Failure

Some might be surprised at the inclusion of item 4, scalability and unexpected rapid growth, on the list above.  Experience indicates that this can quickly exhaust resources.  Additionally, it can cause young businesses to incur major costs that cannot be supported as the business grows.  A third way that this particular risk can be manifested is that customers may be frustrated with a firm’s inability to support their volume and go elsewhere or do without.

Maximizing Returns

There are virtually unlimited investment opportunities open to investors, including the stock markets and bond markets. Many investors have established criteria to decide which businesses represent the best investments for them.  The businesses in which they invest are those that are most closely aligned with the investor’s criteria.

Subject to the investors’ other criteria, investors are likely to be interested in maximizing their return on investment.  As a result, it can be helpful to ask questions such as:

1. What is the rate of return that the investors typically earn for investments of the size and type involved?
2. What rate of return are the investors expecting?
3. Are the investors seeking some type of equity stake in the firm?
4. What is the minimum rate of return that the investors consider acceptable?
5. What is the desired time horizon for the investors to recoup their investments?

Conclusion

These tips are simply common sense tips for positioning oneself to obtain funding.  There may be other tips that can be taken in any particular case.  Always check with your legal and business advisors.  Work with your investors and their representatives.  As is often the case in business, the party with the money usually gets to call the tune. 

What is your experience?  Do these suggestions align with your experience?  Are there other tips that you suggest to people seeking funding?  What steps could one take to implement each of the tips discussed above?