Crack the Funding Code

Judy Robinett

• Publisher: AMACOM
• Year: 2019
• ISBN:
  9780814439845
• Topic: Commerce
• Subtopic: Activité entrepreneuriale

Crack the Funding Code demystifies the world of angel investing, venture capital, and corporate funding and lays out a strategic pathway for any entrepreneur to secure funding fast.

Lack of funding is one of the biggest reasons small businesses fail. In 2016 in the United States alone, more than 31 percent of small business owners reported that they could not access adequate capital, and the lack of capital prevented them from growing the business/expanding operations, increasing inventory, or financing increased sales.

This book will show you how to find the money, create pitches that attract investors, and then structure fair, ethical deals that will bring them new sources of outside capital and invaluable professional advice. Crack the Funding Code gives you the broader perspective on:

• how funding works,
• how investors think,
• and what they need to hear to put their money where your mouth is.

Every entrepreneur who reads this book will get easy-to-follow deal checklists, a roadmap of where and how to locate the best funding resources and top business mentors for their industry or geographical location, and a step-by-step process to create pitches that make their idea or business irresistible.

I

CRACKING THE CODE OF ENTREPRENEURIAL SUCCESS

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Getting in front of investors takes several steps in preparation before you can expect to find and reach the right investors, meet with these investors, and close any funding.¹

—CHANCE BARNETT, general partner, Decentra Capital

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1

THE FUNDING MINDSET

How to Think Like an Investor

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Learn to raise capital by any means. That’s your primary job as an entrepreneur.

—RICHARD BRANSON

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Imagine that it’s 1491 and you’re Christopher Columbus, looking for your next profitable venture. You notice that all the trade routes from Europe to the lucrative markets in India and China are long and perilous. You believe that if you sail west across the Atlantic Ocean you can find a new, shorter trade route to the Far East—but you need money to build and equip the ships for your voyage. You approach the king of Portugal and then the merchants of Genoa and Venice, but they all turn you down. Finally, you get an audience with Queen Isabella of Spain. You’d been building relationships within the Spanish court since 1485, but this is your last chance to raise the money you need. You walk in and make your pitch for Spain to finance your great venture.

What do you imagine Queen Isabella is thinking as she listens to your proposal? “Let me see if I understand: This guy wants me to give him a lot of money to build three ships to reach the East by sailing west, which, according to every expert, can’t be done. Smart people in Portugal, Genoa, and Venice have already turned him down flat. Why should I be crazy enough to give him money?”

Of course, Queen Isabella was crazy enough, and the Spanish court gave Columbus the modern equivalent of $14,000 to build his ships. Columbus sailed west, “discovered” the New World, and (for good or ill) created the foundation for the great Spanish empire. And because of Columbus’s voyages, during the sixteenth century Spain laid claim to much of North and South America and became a dominant world power.

By the way, it also extracted the equivalent of $1.5 trillion in gold and silver from its American colonies. Not a bad return on a $14,000 investment.

Columbus’s story is a metaphor for what entrepreneurs are doing every day: inventing new or better products or services that solve problems, and then starting businesses to turn those ideas or inventions into reality. The Global Entrepreneurship Monitor estimates that approximately 100 million businesses worldwide—that’s three businesses every second—are launched each year.¹ In 2017 in the United States alone, approximately 540,000 new businesses were started each month.²

But while some legendary enterprises began on a shoestring in a garage or basement, even the “leanest” startup needs capital to open its doors. According to a 2015 study by Intuit, 64 percent of U.S. entrepreneurs started their businesses with investments of less than $10,000.³ That money either comes from the entrepreneur’s personal savings (57 percent of the time) or a combination of personal funds plus investment by family and friends (82 percent of the time).⁴

However, starting a venture isn’t the same as keeping it up and running. The Kauffman Firm Survey (which studies business activities of startup companies) estimates that, on average, it takes a minimum of $80,000 to operate a small business in its first year.⁵ That’s a lot more capital than most people can raise every year, either from personal assets or from friends and family. So like Columbus, at some point many entrepreneurs will need to find outside investment to finance operations.

The good news is that today, a lot of outside money is available to fund great businesses. Consider the following:

• The National Small Business Association reported that 75 percent of small businesses used some kind of financing in 2015–2016. Sources of these funds included loans, credit cards, venture capital, and crowdfunding.⁶

• In 2015 bank loans going to small businesses totaled approximately $600 billion.⁷ That same year, businesses received $593 billion in funds from venture capital (VC) firms, angels, and finance companies other than banks.⁸

• In 2016 “angels” (individuals investing their own money in companies) funded 64,380 entrepreneurial ventures to the tune of $21.3 billion.⁹

• In 2017 VCs invested a total of $84 billion in 7,783 companies—the highest level of investment since the early 2000s.¹⁰

• In 2017 the number of direct investment deals funded by family offices (which manage investments for high-net worth individuals and families) was more than twice the number of deals funded by traditional VC firms.¹¹

• Alternative finance lending (which includes crowdfunding and P2P online lending) is growing rapidly as a resource for businesses. In 2016, $8.8 billion in alternative business funding was raised in the U.S. by 143,344 businesses.¹² U.S.-based companies used equity-based crowdfunding to raise $569.5 million, while revenue/profit-sharing crowdfunding produced $28.5 million.¹³

• In 2017 companies worldwide raised $5.6 billion through initial coin offerings (ICOs), where investors used funds to purchase tokens or digital currency that could then be traded on online exchanges.¹⁴

In some ways, entrepreneurs are in what could be called a “golden age” of fundraising, with the advent of P2P online lending, equity and revenue/profit-sharing crowdfunding, tokenization, and blockchain-based digital currency adding to the healthy numbers for venture capital, family offices, and seed and early-stage angel investing. But while it seems as if the funding landscape is expanding dramatically, the same perennial three questions exist for anyone who needs capital for their business: (1) Where’s the money? (2) How can I gain access to the people and institutions that have it? And (3) what will it take to persuade them to give/loan it to or invest it in my startup?

Unfortunately, entrepreneurs often lack the time, expertise, or knowledge to take on the complex task of finding the funding that can help them reach their goals. As a result, for every startup that becomes the next Airbnb, Amazon, Lyft, or Warby Parker, thousands of other, equally great companies never get the money they need to get off the ground or to keep going. According to Fundable (a business crowdfunding platform), in 2014 less than 1 percent of startups received funding from angel investors, and 0.05 percent by VCs. Banks weren’t much better sources of capital, providing funds for only 1.43 percent of startups.¹⁵

The problem with most startup businesses isn’t their ideas, or even their businesses: it’s that they don’t know where to look or how to present their businesses in a way that “closes the sale” with investors. How can startups find the cash they need to open their doors and keep the business going until they turn a profit? It begins by thinking like Isabella rather than Columbus. Whether you’re going to your community bank for a business loan, pitching a top venture capital or angel investment firm for millions of dollars in exchange for equity, or posting your product or startup idea on a crowdfunding or peer-to-peer (P2P) online lending site, in every situation someone will be evaluating your offer based upon one fundamental question: Will your business make them money? Entrepreneurs must do what they can to access the investors’ mindset so they can meet their needs and convince them to invest.

Cindy Padnos is founder and managing partner of Illuminate Ventures, an early-stage VC, and she remembers when she was an entrepreneur seeking venture capital for her own startup. “A very experienced VC investor corrected me when I said that I was ‘fundraising.’ ‘To be clear,’ he said, ‘I raise funds for investment. You raise capital to build a company.’ Fortunately, I remembered the sound advice I had received to focus on what was actually important and not to argue semantics. This perhaps overly picky investor ended up being incredibly helpful, making introductions that led to our first round of financing.” ¹⁶

One of the core tenets of business is to think like your customers and deliver what they want, rather than what you think they should want. The same principle is true when it comes to your investors. In the same way you conduct market research to help shape your product or service to meet your customers’ needs, you must understand the type of investors you want to reach, and then shape your business proposition to meet those investors’ needs.

The Three Things Entrepreneurs Need to Get Funded

As someone who has spent more than thirty years helping entrepreneurs find and connect with sources of capital, and then guiding them through the process of pitching and closing the deal to get them the money they need, I believe only three things separate entrepreneurs whose ideas and businesses get funded from those who don’t: information, access, and expertise.

Information

Many startup entrepreneurs believe that their only funding options are (a) savings or personal credit, (b) friends and family, or (c) bank loans. But personal savings and credit can run dry long before the business is profitable, and friends and family can be relied upon for only so long (and for a finite amount of money). The next logical resource is a loan from the local bank—if you have the collateral necessary, and if your local bank is still around. (After the Great Recession of 2008–2009, many bank branches that provided loans to small businesses disappeared, and other, larger lending institutions have not picked up the slack.¹⁷) In 2015 a Federal Reserve survey reported that only 38 percent of startups that had been in business for less than five years were approved for loans.¹⁸ And businesses that are able to secure loans are often subjected to strenuous terms and high collateral requirements that can restrain the growth of a struggling enterprise.

Entrepreneurs need information about a wider portfolio of funding sources, such as VCs, micro or seed-stage VCs, angel investors, super angels, angel syndicates, and family offices, to name a few. In addition, recent regulations have opened a new category of lending to entrepreneurs: crowdfunding for businesses, online angel/investor “matchmaking” sites like GUST, and P2P online platforms like Lending Club, Prosper, and Upstart. These sites bypass traditional lending institutions and allow accredited and non-accredited investors to invest directly in businesses. Many municipalities, states, and even large corporations also offer grants to startups (often in conjunction with training programs). Finally, accelerators and incubators provide guidance as well as financial support to help entrepreneurs turn their ideas into viable startups.

Different categories of investors are active at different stages of the funding cycle, and they have specific requirements and guidelines for the kinds of businesses they sponsor. Entrepreneurs need to understand the differences between investors while being able to deliver the universal basics of a solid business plan, a great pitch, and a deal that works for all parties. We will discuss categories of investors, and when in your business development it is best to approach them, in Part II.

Access

The good news is that people with money are always looking for companies with potential for great deals and great returns. Angel investors and VCs need to have a series of deals in various stages of development. When one deal matures and the business either goes public, is sold, or the investors receive a return on investment in some other way, this frees up capita...