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THE ACRONYM REFERS TO the Latin phrase quod erat demonstrandum, which translates roughly into that which has to be proven. Sometimes you see it at the end of a mathematical or philosophical proof as a statement that the matter has been proven.
The reason it is mentioned here is because the phrase appears in a useful blog entry from Bill Gurley, a general partner at a West Coast Venture firm that helped fund Twitter, Uber, Snapchat and others. The blog is entitled In Defense of the Deck. It's worth a read. The entry presents the venture investor's view on why it is important to prepare and accompany your fund raising proposal with a convincing slide presentation that provides the Q.E.D. that the company's opportunity is significant and its plan is solid. It also mentions one scenario when you may want to avoid using a deck with a potential investor. The argument for the deck revolves around a number or factors, First, there is value in working with your team to create a coherent presentation of your company's value proposition and plan for succeeding. It also enables entrepreneurs to present their proposition in an organized fashion that builds to a conclusion that appeals to investors. Also, decks make it possible in ways conversation cannot to present the important numerical piece of the business and its important metrics. From Bill Gurley's perspective, the presentation deck enables entrepreneurs "to walk the listener through an argument as to why this is going to be an amazing business." A good deck and presentation "will gradually transport the listener to the desired conclusion – this will be a great investment.” Check it out at http://abovethecrowd.com/2015/07/07/in-defense-of-the-deck/. REFLECTIONS ON A CONVERSATION earlier today with a very knowledgeable friend, lawyer and entrepreneur. He's got an early, development stage company he is putting together and beginning to explore how best to go about fundraising. At this point he is exploring how best to present his venture to investors.
Crowdfunding was an option he wanted to explore but we quickly put that aside because of the amount of funds needed and the requirements of classical non-accredited investor crowdfunding - relatively small investments, numerous investors, a total funding limitation too small for this company, and ongoing reporting requirements. Even if you could raise enough money, would you really want scores of unaccredited investors to deal and communicate with in an early stage technology company? We both thought not. From my perspective, this type of crowdfunding is not suited for early stage technology companies. Funding for a dry cleaning establishment perhaps, but even there I would want to explore other alternatives first. The more interesting part of the JOBS Act that created crowdfunding for the masses was something largely overlooked by the press. Buried in the Act's provisions was an enabling amendment to Regulation D that governs private fundraising. The amendment authorized private companies to make public solicitations in exempted accredited investor fundraisings for the first time if they met a higher standard of vetting the accredited nature of their investors. The result of this has been the proliferation of new "crowdfunding" web sites that provide a method for conducting a non-accredited investor offering but also, and more importantly, aggregate pools of fully vetted (under the new Reg D rules) accredited investors that can invest without the dollar limitations of a non-accredited crowdfunding offering. If you are looking to raise more than $1.0 million, this opens the prospect of presenting to a pool of vetted accredited investors who might invest $50,000, $100,000 or more each to give the company a small pool of more sophisticated investors with higher average net worths. This may or may not make sense for my friend. Time and the viability of other potential fundraising pathways will tell whether this or another path makes most sense when it is time to raise serious amounts of money. The image is from the hall of tapestries at the Vatican Museum. Copyright 2015 by Clinton Richardson. IF YOU EVER HAVE SECOND THOUGHTS about engaging good and separate counsel when raising capital, consider the following real world case involving a biotech entrepreneur who found an experienced venture fund to finance his fledgling business.
The investor committed to provide $4.0 million for which the investor would receive 51% of the company’s stock and the right to elect two of the company’s three directors. The entrepreneur would fill the other spot on the board. Troubles started at the closing when the investor announced that he wanted to stage his investment. Instead of putting in the $4.0 million as provided in his term sheet, the investor instead would provide $2.0 million at closing and a second $2.0 million in one year. The only requirement to receive the second $2.0 million was the passage of time. Without viable alternatives (or independent legal counsel to advise him about risks or ways to mitigate those risks), the entrepreneur acquiesced. Twelve months later when the second $2.0 million came due, the investor had cooled to the company and refused to provide the second $2.0 million. Notwithstanding the investor’s legally binding and unconditional funding obligation, the entrepreneur's options were limited. Cash was tight and there were no alternative investors. With the investor unwilling to fund, the company had little prospect of attracting a new investor. Suing the investor to force funding was problematic. A lawsuit would be expensive and time consuming. Even a favorable result would come too late to save the company from financial ruin. Not only that, the investor threatened to use its majority position on the board and as the 51% shareholder to liquidate the company if the entrepreneur tried forced it to put in the second $2.0 million. The investor had purchased a preferred security with his original investment that entitled it to take the first $2.0 million of new investment back in a liquidation before the inventor saw a penny. Did the investor violate its contractual obligations? Absolutely. But the investor had more on his mind than his duty to the company. He also had duties to his investors and was convinced that putting in the $2.0 million would result in losses to his investors. The entrepreneur contributed to his own woes as well. Having no lawyer of his own at the initial fundraising and then using the investor's lawyer to advise him later, the entrepreneur missed fundamental issues that exacerbated his situation. For example, when the investor reduced his initial investment by half, the entrepreneur should have insisted that the investor take half of the stock originally promised and reduce his board representation until the deferred portion of the investment was received. He could have also negotiated for a penalties that would have made it more costly for the investor to renege on his promise to fund in one year. Using the investor’s counsel for his company lawyer after the closing was also a mistake. Owing duties to both parties likely prevented counsel from proactively advising the entrepreneur about the risks inherent in his deal structure. When the issue did surface, counsel resigned the company account but continued to represent the investor, further complicating matters for the company and the investor. How did it end? The entrepreneur eventually engaged qualified counsel to advise him. But the damage was done. After much back and forth with the entrepreneur's new and independent counsel, the investor agreed to sell the entrepreneur all of the investor’s stock in the company for $1 plus a waiver of the entrepreneur’s rights as a shareholder to sue the investor for failing to provide the funding. Not having the time or money to sue the investor in any event, the entrepreneur took this settlement in hopes of raising money from new sources. It was small comfort though. The company's prospects were badly damaged and likely funding sources, if they could be found at all, were sure to value the company below its valuation in the first round. The entrepreneur and his company were free to move forward but the cost of that freedom was high. For more on this topic, check out the entry on Real World Conflicts in Fundraising in Richardson's Growth Company Guide 5.0 - Investors, Deal Structures, Legal Strategies at www.growco.com. Image by imagerymajestic courtesy of freedigitalphotos.net. OR, THE WORST WAY TO SELL STOCK IN YOUR COMPANY. In 1969, Mel Brooks won the Oscar for best screen play for his irreverent and outrageously funny movie The Producers. An unscrupulous producer and his mild mannered accountant team up to profit from raising more money than they need to produce a play on Broadway. For their scheme to work they need only to produce a total flop of a play that will leave the investors expecting no return. Then, they can keep the extra they raised for the play. The producer targets little old ladies, selling them each a fixed percentage in the profits of the play. When they open their musical - Springtime for Hitler (the "mother load" of sure flops) - the initial audience reaction is horror and disgust, raising the expectation of a quick profit from a total flop and early closing. But something unexpected happens and the play becomes a great success, dooming the producer and his accountant to financial ruin. So, what's the reason for the producer's impending doom? After all, a successful play should generate plenty of profits to share with investors.
The answer is in their fundraising process. The producer sold percentage interests in his play instead of selling fixed units of ownership. Expecting a flop, he sold percentage interests adding up to more than 100% meaning for every dollar of profit they would owe more than a dollar to their investors. For the entrepreneur, selling percentage interests instead of ownership units can be just as dangerous. The effects are more subtle - unless, of course, you sell more than 100% of the company - but can be very damaging to a company's prospects. The process makes it harder to raise more money. This is because it protects the percentage investor from dilution in future rounds at the expense of other shareholders, which usually includes management and the founders. This means, literally that the company has less ownership to sell in later rounds. It also means future investors will be disproportionately diluted in rounds after they invest. This is not something most thoughtful investors will agree to. It also makes it harder for management to retain enough ownership interest to motivate themselves or attract needed talent. This can put an expanding company with growing cash needs in a crunch. The company's success, like the producer's play, can spell the doom of the venture. Not because the company has to pay out more than it makes to investors but because the ability to raise needed investment to fund growth is impaired by a capital structure modeled on The Producers. The cure is to sell the investor who wants to by X% a number of ownership interests that equal X% of the company at the time of the sale. But when the sale is a percentage of the company that won't change when more ownership is sold, the company has mortgaged its future to raise current cash. Remember, Mel Brooks is not your venture investor and selling percentage interests in isn't a good idea even if Will Farrel and Uma Thurman are promoting your product. Sell units of ownership instead of percentages. Image and video clip from promotional photos for the movie The Producers. THE SCIENCE OF HEALTH ENGAGEMENT and behavior design is confirming some common sense notions that have application to successful business development. Check out the work of Stanford's health design professor Kyra Bobinet, MD, MPH who specializes in the field. In a recent (and short article) in Experience Life magazine, (January/February 2016,)
Dr. Bobinet advises that "setting ambitious behavior-change goals often backfires, diminishing our chances for success in the future." To understand why "setting outcome specific goals may not be the best way to approach making important changes in our lives," Dr. Bobinet discusses how two high performing individuals approached the task of losing weight in a weight-loss study she conducted. The first individual set specific, measurable, achievable, realistic and time-bound goals and promptly set about counting calories, excluding junk food and exercising. She succeeded but later gained it all back. The second participant and self-proclaimed sugar addict adopted a more process oriented approach. First, he moved the vending machine that provided the doughnuts and other high calorie snacks he craved to the other side of his building. He set goals and created a spreadsheet to figure out how wean himself off sugar. He succeeded and kept the weight off. Dr. Bobinet explains that an area of the brain called the habenula records our failures. When we fail it inhibits our motivation to try again by suppressing dopamine-releasing neurons. When we measure our goals in terms of success or failure, this suppression can keep us stuck on square one. Another physiological function that can also inhibit success of outcome-oriented goals is something called implicit memory. When your have harsh goals, like getting up at 5 a.m. to jog, implicit memory of the discomfort of those goals can encourage you to stop the unpleasant behavior. This is what likely kept our first participant from keeping off the weight. So, what does this say about business building? We know setting ambitious goals is a touchstone to success in an entrepreneurial company. And failure is a staple in any new business as it charts a new path to a new development or offering. Dr. Bobinet's research suggests you can improve your odds of success by keeping our focus on your process for achieving your goals. When you get stuck try other approaches and enjoy the problem solving process as you proceed. And, from one who has witness many entrepreneurial successes and failures, remember that failure to some extent is inevitable. Remember that it is part of the process and be flexible and creative in your approach. Many venture investors can give your story after story of the company team that failed because of their single minded focus on one approach and stories, too, of the many teams they backed who changed course dramatically and succeeded because their process included an intense attention to market and competitive changes. As Dr. Bobinet would say, there is more power in the process than in the specific goal and greater chance of sustained success when your focus is on process. Note: The article referred to is in the January/February issue of Experience Life Magazine. Dr. Bobinet is also author of Well Designed Life: 10 Lessons in Brain Science & Design Thinking for a Mindful, Healthy, & Purposeful Life. Image by Hywards courtesy of freedigitalphotos.net. KNOWING SOMETHING ABOUT VENTURE venture capital fund managers can help you plan your venture fundraising campaign. It can also help you negotiate and work more constructively with investors in your business.
Consider the following factors that influence the average venture capital fund manager:
There is more about this topic in Richardson's Growth Company Guide 5.0 but even this partial list provides some insight into your potential venture fund investor and future board member. A few observations pop out from this partial list. Do your homework and screen the funds you can as best as you can. Do they invest in your market or your stage of investment? Do they have money or are they in fundraising mode? And, have you prepared a convincing deck and a worthy written plan to back it up? Think about how can you tailor your approach to stand out among the many who apply? Do you know someone who can make and introduction and increase their interest in considering your company? Image from Roswell, NM. Copyright Clinton Richardson. Think about it. They fly in looking for prospects. They hover around their candidates. They probe. They question. They challenge.
And then most of the time they fly off. Most of the time, you are not in their sweet spot. You need more sales or profit. Your team is incomplete. You are a milestone short of where you need to be. Or, your financial reporting is insufficient. But once in a blue moon they swoop in and stay. They offer money. Lots of money. They have contacts and experience. You celebrate. But then come the terms and conditions. Their expectations are high. They want a lot of stock and their own special kind of stock. They don't want control but certain important things will require their consent. And then there are the rights they want. Odd sounding things like preemptive rights, first refusal rights, tag along rights, co-sale rights and anti-dilution rights. And, they want a seat on your board so they can monitor your progress and ask more questions. Regular financial reports with comparisons and detail will be required. There interest is genuine. Their presence will be a new constant in your life. So, what makes them this way? To protect yourself and benefit from their presence you need to get into their mind. You need to think like a VC. More about that in our next post. Image copyright Clinton Richardson. Taken at the Roswell, NM, museum. HOLLYWOOD GETS IT RIGHT with the release of Joy starring Jennifer Lawrence. The film has been described as the "wild true story of Joy Mangano and her Italian-American family across four generations centered on the girl who becomes the woman who founds a business dynasty by inventing the Miracle Mop."
For someone who has worked with entrepreneurs for decades, much of the movie rang true. Achieving entrepreneurial success is messy, demanding work that is full of hazards and advice. Consider the following scenes from the movie:
Joy prevails again. By this time, she and her business have the kind of qualified professional advisers her business could have used earlier on. INNOVATE, RAISE MONEY, EXPAND AND FLIP. The mantra of many modern entrepreneur. It's the classic venture capital method and dream that draws the best and the brightest to entrepreneurship. It's how many have built wealth through creativity, hard work and the leverage of OPM - other people's money.
But, what about the rest of the business world? How, for example, do you sustain a business for generations, innovating to stave off inevitable challenges and motivating family and in-laws to approach a centuries old business with entrepreneurial fervor? And, are there lessons to be learned by the entrepreneur from these successful and ageless success stories. Here are some interesting ideas from our recommended reading segment, a recent article in the Wall Street Journal entitled How to Keep a Family Business Alive for Generations. Check it out. |
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