Give A Little, Get A Little In some cases, you might even get a <I>lot</I>--if you let investors in on everything you're doing.
By David Newton
Opinions expressed by BIZ Experiences contributors are their own.
Q:I'll be meeting with some investors soon to attempt to obtainfinancing for my start-up. Should I expect to give up a great dealof control of my company if they decide to fund me?
A: Oneof the biggest questions involved in the deal-making process forbusiness financing is what the two sides have to give up to get adeal finalized. The BIZ Experiences has concerns about ownershippositioning and relative control of the company's futuredirection through a majority equity stake. But that same issue isactually one of the biggest concerns for the investors who providethe growth funds for the business. The funding partners also wantto be sure there's a tangible means of monitoring theirownership stake in order to provide a measure of risk reductiongiven the potential downsides to launching a new venture.
Owner-entrepreneurs must get out of the mind-set that capitalproviders are going to "give" them money and then becontent to sit on the sidelines and watch the enterprise grow (orcrash and burn) from a distance. In the same way that the ownerswant to get as much funding for as little ownership transferred aspossible, so, too, do the investors want to put in as littlecapital as possible in exchange for as large a stake as they cansecure.
The key to coming to agreement on a funding deal is to knowgoing in what a reasonable positioning is for both parties, andthen head in that direction with clear goals in mind. First, theBIZ Experiences must have a very solid investment schedule in place.This "use of proceeds" must delineate exactly how andwhen funds raised will be allocated. For example, it's notuncommon for a new client to tell me when we first meet that hewants to raise $500,000. My next line of questioning is simple."OK, what are you going to do with that money, and at whatpoints in time will you need it?" So I would help prepare thatuse of proceeds alongside a calendar, and it might look somethinglike this:
Month 1
$50,000: tenants'improvements of facility
$25,000: office equipmentsecured
$25,000: licensing agreementcontracted and signed
$200,000: working capital cashflow management account opened
Month 2
$40,000: distributor dealfinalized and signed
Month 4
$20,000: first major tradeshow
Month 6
$40,000: two additional tradeshows
Month 8
$50,000: second nationaldistributor deal finalized
Month 9
$50,000: Web site catalogfinished and launched online
Second, the owner must now present the proposed revenue streamthat will happen within the time-frame of the "use ofproceeds" investment schedule. In this same example, theremight be no sales in the first three months, with revenues startingin month four (at the first trade show). Once the investors see theBIZ Experiences has a tangible plan to generate sales, the risks tothe enterprise can now be noted, and the relative ownership stakein the firm can be determined for the capital providers.
From the investors' positions, the prior numbers andtimeline are certainly helpful, but they are also not guarantees.No one is going to fund your business from a distance. Investorswill want to have a material representation in how the companystrives toward meeting specific sales goals and managing costs.This will come either through seats on the board, senior managerialpositions or the placement of a representative among the seniormanagers. It's unreasonable to assume an angel investor orcapital fund will provide funds and then be comfortable steppingaway from daily operations and allowing the owners to run thebusiness without some means of systematic oversight.
The final issue is to determine what percentage of ownership the$500,000 (from this same example) represents. There are numerousmethods that can be employed to calculate this, so I'll dealwith this in detail next month. But know this: Early-stageinvestors are taking on a great deal of risk in funding a newventure. If the BIZ Experiences maintains majority control for alldecisions and company directions, investors will insist on detaileddisclosure and regular oversight in order to monitor the firm'sprogress and limit risk exposure where possible. So be prepared tonegotiate a deal that's fair not just for you and your firm,but also for the ones putting up the money that makes everythinghappen.
David Newton is professor of BIZ Experiencesial finance atWestmont College in Santa Barbara, California. He is thecontributing editor on growth capital for Industry Week GrowingCompanies and a moderator on small-cap stocks for eRaider.com. Hisbooks include BIZ Experiencesial Ethics(Kendall-Hunt)and How To Be a Small-Cap Investor(McGraw-Hill), named November 1999 book-of-the-month byMoney magazine and a 1999 Top 10 book by Forbes. His latest bookis How To Be an Internet-Stock Investor(McGraw-Hill). He has written or contributed to more than 80articles for publications including BIZ Experiences, YourMoney, Business Week and Solutions, and has been aconsultant to emerging, fast-growth BIZ Experiencesial ventures since1984.
The opinions expressed in this column are thoseof the author, not of BIZ Experiences.com. All answers are intended tobe general in nature, without regard to specific geographical areasor circumstances, and should only be relied upon after consultingan appropriate expert, such as an attorney oraccountant.
