How do you solve the 'Finding Nemo' conundrum?
For most entrepreneurs, the search for capital can sometimes be a mix of a witch-hunt and searching for Yamashita’s treasure. A bit of a goose chase and loads of calculated behavior. The treasure hunter is the entrepreneur who is not part of a larger conglomerate, is not publicly listed, and runs a small- or medium-sized enterprise (SME). Without the backing of a large company with a strong balance sheet, or access to capital markets, most SMEs can find themselves stuck. Breakups may be hard, but rejection is usually what adds character to a person. The same can be said about the conservative bank’s rigorous credit process. It does not fit the borrowing profiles of SMEs and the lack of a venture capital market in the Philippines leave little option for SMEs to raise equity financing. Once rejected, the entrepreneur can either go to the valley of Forget It or to the highway of Let’s Go Get It.
For most entrepreneurs, the chances of selling ice to the Eskimos may well be higher than getting a prospective investor to write that check. Check out Dragons Den, a reality TV show that features the trials and tribulations start-up entrepreneurs face raising money. While it can indeed be a painful process, it is also a deeply rewarding one if you are successful. As the adage goes: No pain, no gain.
The importance of being well funded and having access to capital to pursue opportunities are critical to your success as an entrepreneur. For your chosen career, money does unfortunately make the world go ‘round. Love just ain’t enough. The fact that 90 percent of startups close before their first year anniversary, and most of this is due to insufficient capital, really stack the odds against you. However, it’s always more fun being the exception than the rule anyway. For example my first Internet startup in Boston right after college folded after just the cursed one-year litmus test. This, however, did not deter me from doing it all over again. In entrepreneurship I guess you have to be both a lover and a fighter. I dreamed up all sorts of ideas — from BPO to gaming ventures — that have received some financial acclaim. Investors and lenders tend to be quite risk averse, however, and rightly so. That risk they fear is — yes — you. It is therefore important to understand the challenges you are facing in order to meet those challenges head-on and hopefully succeed in filling your piggy bank.
There’s nothing like empirical experience to master the lending game. Let every Shylock be your steppingstone.
1. Be prepared. Investors expect good, clean presentations and materials. Be sure you have the necessary materials which you can share with investors every step of the process. Typically these are: investment teaser (executive summary), company profile, investor presentation (covering business model, products and services, forecast, etc), full business plan, data room or data archive (containing all legal contracts, customer contracts, and other confidential information). More importantly, investors expect you to know the business inside/out. Explaining the materials should be second nature. This is cultivated through study, practice and deep involvement with the operating nature of the business. Bring out your inner teacher’s pet.
2. Target market. The kind of business you have and the stage of its development will determine the profile of investor you can typically attract. The stages can be seen as startup, early stage, growth, and maturity (or steady state).
Angel investors are either high net worth individuals or individual investors who don’t mind parking a bit of their savings in a startup venture. Angel investors are normally a source of equity funding for startup and early stage companies. Access to, or relationship with, potential angel investors is key. A budding entrepreneur can normally gain access to this exclusive network through the following referrals: successful entrepreneurs, business school professors, relatives, and business associations (like YPO, YEO, Rotary). A proper introduction or referral is absolutely key. While I don’t dissuade people from doing cold calls, realize the failure rate for cold calling is quite high and it really isn’t the best way to reach out to people in general. Most importantly, do not try Facebooking them.
The other kinds are corporate investors and professional equity investors. Due to the underdeveloped nature of the venture capital and private equity sector in the Philippines, most of the prospective third-party institutional investors are linked to investment arms of much larger companies or conglomerates. These investment arms shy away from risk. A business must demonstrate a profitable track record, stability and ability to grow the business further if capital were made available. It is important for entrepreneurs to target investors that see a “strategic value” in your business. This strategic value will serve as an impetus for the investment arm to invest, given the strategic synergy with the core business of their parent or affiliate. Successful deals in recent history include Globe’s investment in G-Cash, SSS in Phoenix Gas Station, GMA7 in X-play, and PLDT’s acquisition of Chikka, to name a few.
Other capital sources for entrepreneurs include customers and suppliers. These can be structured either as supply financing, or upfront payment (deposits) against sales. On the extreme side, a large customer or large supplier may also be willing to invest in your operation. Luck has its way even when you’re dealt the short straw.
3. Everyone wants a good deal. Given that the odds are stacked against you, be prepared to offer investors a good deal. I am not saying you should give away the company to the first John (or Juan). You should also know when to walk out of the room. But don’t feel shortchanged because you are not able to retain your desired ownership level (dilution) after the fundraising effort. The important thing is you are able to raise the needed capital to expand, and you are able to maintain your role in the company in driving it towards the next level. Be a big thinker! Many entrepreneurs fall into the trap of falling in love with their businesses or overvaluing their enterprise. More often than not, a realistic and objective third-party opinion can help ensure that you are going to market with a realistic and reasonable valuation. Given the risky nature of investing in startups, investors are willing to tolerate that risk if they are given a very good deal. Eventually, as you build your track record as an entrepreneur and you have a string of successes behind you, your ability to raise money on much better terms will happen. In fact, at that point, investors will likely offer you money as they believe in your ability and success as an entrepreneur. The business itself sometimes becomes secondary. You become the product that they invest in.
4. Structuring the deal. There are many ways to cut the cake. You can structure an investment either as a straight equity investment (cash for shares), investment into preferred shares (non-voting but first crack on dividends), debt (loan), convertible debt (a favorite for many investors who want to hedge), or other hybrid structures. The structure is the method in which the investor will provide capital and normally a function of their investment strategy. As the invested, you need to study your financial and cash flows and make sure your business plan can accommodate their investment structure. For most entrepreneurs, the overriding need for cash is so great that they are likely to accommodate whatever structure is being imposed by the investor. It’s a sad reality but cash talks, and everything else walks.
5. The importance of reputation. People have a natural bias towards the familiar. In the risk-filled world of investing, investors normally like to park their funds in safe or familiar places... hardly the profile of a startup business. When investors do decide to take on a riskier investment, they normally weigh very heavily on the reputation of the entrepreneur and feedback from various referral points (bankers, suppliers, customers). Raising money with a good reputation is already challenging, but with a bad reputation it becomes nearly impossible. No one wants to be in bed with a snake oil salesman.
Budding entrepreneurs should blossom with fragrant reputations. One can only afford to have the stink of infamy when one has reached the top (that is if you are top honcho Gordon Gecko)!
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Any questions? Please e-mail me at egtheplayer@gmail.com.
