Are you ready to raise funds? Need investors to take your business to the next level? Before you raise the first dollar of other people’s money, it is important to understand certain key elements of the process and tools used. It is also important to understand that the process of raising funds has certain steps, practices, and expectations that companies desiring funding find are “musts” to acquire investors. While “any good idea can get funded” it takes less time and effort to get those funds, if you know what the people with the money expect you to do to get their attention, make the request, and prove to them you are the people they want to do business with.
The Term Sheet
You know what you want to offer potential investors, so you provide an outline of all the legal and financial terms of the deal; this is known as the “term sheet.” It quantifies in numbers, and in qualified language, the value of the deal being proposed. The term sheet is essentially the summary of the contemplated deal and serves as a template for the complex legal documents to be subsequently drawn up if both sides agree to the terms as outlined.
The term sheet is in most fund-raising processes an opening gambit for discussion and negotiations. Getting to the term sheet is a milestone that many organizations do not achieve, so understanding the fund-raising process and its participants is critical. You don’t lead with the term sheet; hopefully you close with one.
The Fund-raising Process: You Gotta Shop “A Round”
Funding your business usually begins with your own funds and that of the other founders. You usually tap into other sources of funds too like credit cards, credit lines, and personally guaranteed loans and lines of credit. You may also have a round of funding from friends, family, and others—the (excuse the term) “dumb money” that required only (and it may have been tough) you going to ask for the money as an investment or a loan. Then comes the true “OPM” rounds: OTHER PEOPLE’S MONEY!
Asking for OPM from people you don’t know requires something more. It requires information. Oh, and it will usually require you to do some things that may have been (and probably were) overlooked earlier in your fundraising process…that is taking care of the legalities related to making securities offerings. Whether it is raising funds within state boundaries (requiring knowledge of state regulations) or across state lines (which adds in Federal regulations, not to mention possibly the Securities and Exchange Commission), raising funds and issuing securities documents is regulated by a government agency, so one of the earliest steps is to understand which regulations you need to comply with and how to comply. Now back to the shopping “a round” …
Meet the Investors
Who do you want to raise funds from? There are various types of individual and groups of investors, e.g., angels, venture capital groups, institutions. The type of investor, the amount of funds being raised, the stage of the business and product development, and many other factors impact who and when you will be approaching someone to raise funds. Typically, the funding sequence is usually angels, venture, institutions, and then some other sources.
Individual investors are categorized accredited or unaccredited. An accredited investor meets the following definition under Regulation D of the Securities Act of 1933:
- Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his purchase exceeds $1,000,000;
- Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;
Individuals who do not meet this definition are unaccredited investors and are generally viewed as higher risk as a funding source.
Accredited investors are often referred to as “angels,” because they are early-stage investors often willing to take a higher degree of risk in investing. They also are expecting upside rewards for this assumption of risk. Angels may act alone in their investment analysis and investment, making them “lone wolf” investors. Other angels may work in conjunction with other accredited investors for analysis participating in angel forums or investing in conjunction with other angels as a group.
Next in the funding sequence usually are the venture capital funds. These professional investors are organized investment groups that consist of capital raised from a host of sources individuals, organizations, and businesses. They have a more formalized process for screening, evaluating, and investing decisions. They will also have a higher standard of due diligence for making the investment decision. (In simplest terms, due diligence is the process of evaluating the information presented and the underlying business, e.g., financial, technology, of the investment target.)
Institutional investors are organizations that pool funds from organizations that include banks, insurance companies, retirement or pension funds, hedge funds and mutual funds. Institutional investors act as highly specialized investors on behalf of others and arguably have the most intensive due diligence processes and investment standards.
Perfect Pitch and Proper Timing
Now you have a general idea of the category of your potential audience, but what do they want to know about you business? The need for detail and the degree of formality to the pitch will vary with the investor type. A lone wolf angel may be comfortable with a basic business plan and an informal meeting. He/she may not expect to see a formal term sheet. On the other end of the spectrum is the institutional investor who will usually expect a more formal offering instrument (e.g., private placement memorandums, term sheets). By understanding what your target investor group wants to see and being prepared for that standard of due diligence, you save yourself time and the effort. It doesn’t do you any good to make a pitch to deaf ears. If you aren’t prepared with the right answers, documents, and with your financials and concepts (business, product, and technology) in order, don’t knock on the door. It won’t open, or if you manage to get your foot in the door, it will be painful to have it slammed in your face … even if it is done all so politely.
Give your potential investors the answers they need. Demonstrate that you have a firm grasp of not only your business and how your technology or product works, but also how and against whom you will compete. Have realistic projections and expectations of the market and how/when you will make money. Know what and how much money it will take to get to market. Know what the team needs to do and who the team needs to be. Spell out a compelling story, weave a winning scenario, and know the obstacles and how you will overcome them. Pitch and get to first base. Show you know how to get to second, and what it will take to make to third and all the way home! Show investors the money and they’ll pull out the checkbook.