Monday, January 17, 2011

Financing: 8 Considerations for Taking Other People's Money

Institutional Limited Partners Association (ILPA)Image via Wikipedia
Congratulations, you now have the proceeds from your financing efforts and survived the financing gauntlet.  You feel relieved and relaxed, but in reality that’s when the work and the pressure starts. Now, for the first time, you really have a boss, or several bosses, and often very demanding ones at that. Having participated in several venture capital fund meetings for Sprint's Pension Fund and helping small and start-up businesses develop business plans for venture capital financing, I've had a chance to see this in action from both sides.

Angel and venture capital investors rarely just give a small business or a start-up cash, and stand back to wait for you to spend it the way you want. First of all, they are generally experienced in your own domain, so they have strong views on what it takes to succeed.  Secondly, they likely didn’t give all the money up front, but made part of it contingent on meeting some measurable milestones. Your start-up is now part of a portfolio that is expecting high risk adjusted returns.  Here are a few of the ways you should expect to be monitored by your investors:

  1. One or more seats on the Board. Maybe you had an informal Advisory Board before, but now you have a formal Board of Directors. This means you shouldn’t expect to make any strategic decisions without their approval. You should now plan for formal presentations to the board, with communications in between. Key business decisions that could be immediately executed after reaching agreement between you and another party now need additional approvals.
  2. Manage to documented milestones. A normal part of a funding agreement is a set of accomplishments, with dates, that you are expected to achieve in order to remain in good standing and qualify for remaining cash distributions. These covenants can be either financial like cash flow, operating profit, etc. or operational such as customer counts, transaction volumes, etc.  Treat them as management objectives that will get you fired if you don’t perform. You will also need processes to routinely track and predict these measures and be able to explain variances.
  3. Visits from key investors. Both angel investors and venture capital partners like to make personal visits to your facility or a regular basis, sometimes unannounced, to see how the business is running. You should expect to personally host these visits, and openly answer any questions or concerns that are raised. Do not delegate these visits.  You always should be able to speak to your key measurements.
  4. Number of  contacts from you. Every investor expects to be contacted and updated proactively on key decisions or issues. A quick way to lose investor confidence is to always wait for the investor to call, or inversely to call the investor for every minor decision. It is a balancing act that needs to be managed.
  5. Access to operational information. All investors have information rights which are detailed in your contracts. They generally expect you to share key operational data, such as the sales pipeline, developmental efforts, vendor discussions, and quality issues, at any time. Don’t keep secrets from your investors.
  6. Extra focus on cash flow. Remember, it’s their cash, so treat it like gold. Because you now have money in the bank, now is not the time to upgrade to Class A office space, or travel around the world first-class on company business. Pinching pennies and bootstrapping like you did in the early days is still the only approach.
  7. You are now graded.  Also realize that you are now being "graded" compared to other companies in their portfolio. It is to your advantage to keep track of how your company performance compares to others in the investor’s portfolio. You may think you are doing well, but if your numbers put you at the bottom of the ranking, you may need to decide that taking more risk is better than the risk of being cut from the source of financing.  On the other end of the spectrum, if you are one of the top performers, a venture capitalist may encourage you to take big risks and swing for a home run, even when a base hit or double would be a smarter move from your perspective.
  8. You have more paperwork.  You will now have firm dates to turn in financial and planning information that your processes must now meet and they will likely vary from the ones you used.  Comparison to your documented milestones is key.

You no longer have full control, and you don’t need any surprises, just like the investor doesn’t want any.  The simple fact is that your whole world as an entrepreneur changes when you take someone’s else’s money. Do it with your eyes open.

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