Wednesday, April 30, 2008

I Cut The Wrong Deal With An Advisor - Ask the VC

This is a great post from Brad and Jason over at "Ask the VC" (one of the blogs I like). Advisors can be a useful member of the team if they can help you structure your business plan and help prepare your company to be attractive to investors. However, remember, we are investing in YOU, not your advisor. So, outsourcing your fund-raising to an advisor is a non-starter strategy. Advisors should be just that, your advisor, the person next to you willing to give you support.

Advisors do have a role - some companies would never have received funding without the advisor's help. However, an advisor can also poison a deal by demanding unattractive terms. They need to find the sweet spot in the middle to reach the most success.

Unfortunately, the advisor in the post below isn't in the sweet spot:

Saturday, April 12, 2008

How to make your company investor ready

Part of what I like to speak about are interesting technology trends - particularily Cleantech trends. However, other topics of interest for me include suggestions that I can make to potential entrepreneurs. This post is the latter.

We see a lot of variety in the deals we review here in Australia. There are the straightforward deals - smart founder, team of three or four, raised $200k of angel funding, prototype developed and some market traction with introductory customers. We put in money to unlock the full potential of the company and things can really take off. However, just as often we see the "non-straightforward" deals. These might be companies which have been operating on a shoe-string budget for ten years or more, often earning consulting revenue on the side while they try to develop their product. They may have fair amounts of debt, most of it from friends/family who didn't understand that VCs are much more comfortable with angels that hold an equity position, than debt. The company may have a smattering of different products that they have tried over the years, with varying degrees of success. There could be an attractive way forward with a new market opportunity that makes the company attractive for a VC, but given the company's history, there is a lot of baggage to get through.

So, here are my suggestions for making your company as clean as possible before approaching investors (or, at least, before entering final due diligence when the lawyer's bills are running!)

Convert Debt to Equity

One of the things investors have constantly worry about is fraud. Money that immediately leaves the company to repay debt (or to pay advisors, for that matter, if they have excessively high fees - which I would classify, in some cases, to be much more than 4~5%) makes investors very uncomfortable. The reason that the company is valued for what it is by investors is partly due to what the company has accomplished, and partly due to what the company is expected to accomplish. If the company is fully debt financed, especially by the founding members, it says that the founders don't have as strong a vested interest in the company as they would with equity, and are keen to get as much money back as soon as possible, and then participate in the gains of the company. Therefore, expect to have debts paid to founders convert to equity. Debts owed to related parties or third parties may be paid, but in this case, be sure to have clear documentation of the debts prepared to be able to justify these payments. However, if you want to make your company as attractive to investors as possible, raise equity funding from your early stage backers, not debt financing.

Have Accounting Records Clearly Prepared

If your company matches the "straightforward" description that I mentioned above there is likely to be little trading history for the company, and what is there should be simple and easy to understand. However, if you have a longer history of trading (which, arguably is a good thing), then be sure to be able to present clear accounting records documenting the company's history. If it is difficult to verify the company's trading history, if it is difficult to verify the inventory the company claims as an asset, if it is difficult to verify that the company revenues have been what is being claimed, or if it is difficult to understand the company's historic cost structure (and margins) then investors are going to be very uncomfortable. If you have an attractive story, but little documentation to back it up, investors may be interested in supporting your story, but uninterested in supporting a fantasy. Without clear records, some investors won't be interested in taking a risk, based solely on your say-so. Other investors may take the risk on your company, but they will simply discount away anything they are uncomfortable about in the valuation. To have the deal be as attractive as possible to both parties, be sure to keep good records.

Clean Up Complicated Contracts

Have a special agreement with your CTO where the company pays for her car payments? Have an contract with your suppliers where they provide better payment terms in exchange free use of your testing facility? Have you agreed with a distributer to an exclusive licence of your technology over a key geographic region? If you have bizarre agreements or contracts, either within the company, or with external parties, this just further compalicates the deal - either find ways to simplify these agreement, or, again, be able to clearly demonstrate the boundaries of the agreement to the investor - and justify why the agreement was initiated in the first place. This will help calm fears which might come when the investor reviews these agreements in the due diligence, and it will build trust that you are being upfront on the state the business and how it got there.

Remove Conflicts of Interest
Don't try to operate two businesses at once - a consulting business and a high-growth product development business, and argue that you can split your time between two businesses. When investors put their money in, they are backing the founders - and for this they want to be sure that the founders will be focussed on the success of the business. If the investors are worried about your other businesses/committments, they can be uncomfortable about proceeding. If you do have multiple businesses, or subsidaries that are unrelated to the investment that can be conflicted, or even merely distracting, then plan on disengaging yourself from these businesses before proceeding. Structure your responsibilities so that 100% of you commitment is on the new venture, and you will find investors much more interested in backing you.

A key message through all of these points is clarity, transparancy, and accountability. In all cases, show clear documentation, and be able to justify past decisions the company has made, so that the investor feels comfortable that they understand what company they are purchasing, and that they understand what the company needs to do going forward. Without this clarity you may find that the investor feels too concerned about the complicated nature of a deal, and the deal cannot proceed.

This is obviously something both parties want to avoid, so do what you can to make your company as attractive as possible, and you will be in a better position to attract investment!