Raising Capital

Get the Money You Need to Grow Your Business

 Raising Capital

Author: Andrew J. Sherman
Pub Date: April 2012
Print Edition: $34.95
Print ISBN: 9780814439012
Page Count: 464
Format: Paper or Softback
Edition: Third Edition
e-Book ISBN: 9780814417041

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Chapter 1


Strategies and Trends

After more than three decades of being an entrepreneur, serving as a legal and

strategic advisor to entrepreneurs and growing companies, and speaking and

writing on entrepreneurial fi nance, I have found one recurring theme running

through all these businesses: Capital is the lifeblood of a growing business.

In an environment in which cash is king, no entrepreneur I have ever met

or worked with seems to have enough of it. The irony is that the creativity

that entrepreneurs typically show when they are starting and building their

businesses seems to fall apart when it comes to the business planning and

capital-formation process. Most entrepreneurs start their search for capital

without really understanding the process and, to paraphrase the old country

song, waste a lot of time and resources “lookin’ for love [money] in all the

wrong places.”

Not only is capital the lifeblood of a growing business, but it is also the

lifeblood of our economy. When its fl ow stalls, our progress stalls. And when

small and entrepreneurial companies cannot gain access to capital at affordable

costs, we all suffer. According to recent Small Business Administration

(SBA) statistics, smaller companies make up 99.7 percent of all employer fi rms,

pay 44 percent of total U.S. payroll, and have generated 64 percent of net

new jobs over the past 15 years. When small companies do not have the access

to the resources they need in order to grow, our nation cannot grow. If

entrepreneurial leaders are too concerned with what new crisis, burdensome

regulation, budget defi cit, tax hike, or economic downturn may await them to

make any new hiring, growth, or capital investment decisions, we are destined

to be in a perpetual recession. Healthy credit and equity markets are vital to

our country’s ability to foster and commercialize innovation, penetrate new

markets, seize new opportunities, create new jobs, offer raises and promotions,

and compete on a global basis. The economic downturn of 2007 to 2009 put a

dent in everyone’s pocketbook, but for smaller and entrepreneurial companies,

it robbed them of the critical fuel that they needed to keep the engines of the

economy moving forward. Payrolls were slashed, creativity was halted, inventories

were reduced, capital investment decisions were delayed, and motivation

in the workforce was virtually nonexistent.

I wrote Raising Capital to help entrepreneurs and their advisors navigate

the often murky waters of entrepreneurial fi nance and explore all of the traditional

and nontraditional sources of capital that may be available to a growing

business. I’m assuming that you, the reader, are the entrepreneur—the owner

of a business that’s looking for new money. So, wherever possible, I’ll address

you directly, as if you were a client sitting across the desk from me. My goal

is to provide you with pragmatic guidance based on years of experience and a

view from the trenches so that you’ll end up with a thorough understanding

of how and where companies at various growth stages are successfully raising

capital. This will include traditional sources of capital, such as “angels” and

private placements; the narrower options of venture capital and initial public

offerings; and the more aggressive and newer alternatives such as joint ventures,

vendor fi nancing, and raising capital via the Internet. The more likely

the option, as demonstrated by the Capital-Formation “Reality Check” Strategic

Pyramid in Figure 1-1, the more time I’ll devote to it. Look at the fi gure as an

outline—it’ll make more sense as you read further.

Figure 1-1. The Capital-Formation “Reality Check” Strategic Pyramid.

1. Your own money and other resources (credit cards, home equity loans,

savings, 401(k) loans, and so on). This is a necessary precursor for most

venture investors. (Why should we give you money if you’re not taking a


2. The money and other resources of your family, friends, key employees,

and other such people. This is based on trust and relationships.

3. Small Business Administration loans, microloans, or general small-business

commercial lending. This is very common, but it requires collateral (something

that is tough to provide in intangible-driven businesses).

4. Angels (wealthy families, cashed-out entrepreneurs, and other such people).

These can be found by networking or by computer. You need to

separate smaller angels from superangels. This is a rapidly growing sector

of the venture-investment market.

5. Bands of angels that are already assembled. These include syndicates,

investor groups, private investor networks, pledge funds, and so on. Find

out what’s out there in your region and get busy networking.

6. Private placement memoranda (PPM) under Regulation D. This involves

groups of angels that you assemble. You need to understand federal and/

or state securities laws, have a good hit list, and know the needs of your

targeted group.

7. Larger-scale commercial loans. To get these, you’ll need a track record, a

good loan proposal, a banking relationship, and some collateral.

8. Informal venture capital (VC). This includes strategic alliances, Fortune

1000 corporate venture capital, global investors, and so on. These investors

are synergy-driven; they are more patient and more strategic. Make

sure you get what was promised.

9. Early-stage venture capital or seed capital funds. These make up a small

portion (less than 15 percent) of all VC funds. It is a very competitive, very

focused niche—the investors are typically more patient and have less aggressive

return on investment (ROI) needs.

10. Institutional venture capital market. This is usually second- or third-round

money. You’ll need a track record or to be in a very hot industry. These

investors see hundreds of deals and make only a handful each year.

11. Big-time venture capital. Large-scale institutional VC deals (fourth- or

fi fth-round level—for a pre-IPO or merger and acquisition deal).

12. Initial public offerings (IPOs). The grand prize of capital formation.

Understanding the Natural Tension Between Investor and


Virtually all capital-formation strategies (or, simply put, ways of raising money)

revolve around balancing four critical factors: risk, reward, control, and capital.

You and your sources of venture funds will each have your own ideas as to

how these factors should be weighted and balanced, as shown in Figure 1-2.

Once a meeting of the minds takes place on these key elements, you’ll be able

to do the deal.

Risk. The venture investors want to mitigate their risk, which you can do

with a strong management team, a well-written business plan, and the

leadership to execute the plan.

Reward. Each type of venture investor may want a different reward. Your

objective is to preserve your right to a signifi cant share of the growth in

your company’s value and any subsequent proceeds from the sale or public

offering of your business.

Figure 1-2. Balancing Competing Interests in a Financial Transaction.


(Meeting of the



Maximum capital/valuation

Avoid dilution/control

Affordable cost of capital


Growth in the value of the business

Additional rounds of $ at more

favorable valuations

Mutually beneficial exit strategy


Maximum return

Mitigate risk/downside protection

Input on future and growth of the


Control. It’s often said that the art of venture investing is “structuring the

deal to have 20 percent of the equity with 80 percent of the control.” But

control is an elusive goal that’s often overemphasized by entrepreneurs.

Venture investors have many tools to help them exercise control and mitigate

risk, depending on their philosophy and their lawyers’ creativity. Only

you can dictate which levels and types of controls may be acceptable. Remember

that higher-risk deals are likely to come with higher degrees of


Capital. Negotiations with venture investors often focus on how much

capital will be provided, when it will be provided, what types of securities

will be purchased and at what valuation, what special rights will attach to

the securities, and what mandatory returns will be built into the securities.

You need to think about how much capital you really need, when you really

need it, and whether there are any alternative ways of obtaining these


Another way to look at how these four components must be balanced is to

consider the natural tension between investors and entrepreneurs in arriving at

a mutually acceptable deal structure.

Virtually all equity and convertible-debt deals, regardless of the source of

capital or stage of the company’s growth, require a balancing of this risk/reward/

control/capital matrix. The better prepared you are by fully understanding this

process and determining how to balance these four factors, the more likely it is

that you will strike a balance that meets your needs and objectives.

Throughout this book, I’ll discuss the key characteristics that all investors

look for before they commit their capital. Regardless of the state of the economy

or what industries may be in or out of favor at any given time, there are certain

key components of a company that must be in place and be demonstrated to

the prospective source of capital in a clear and concise manner.

These components (discussed in later chapters) include a focused and

realistic business plan (which is based on a viable, defensible business and

revenue model); a strong and balanced management team that has an impressive

individual and group track record; wide and deep targeted markets that

are rich with customers who want and need (and can afford) the company’s

products and services; and some sustainable competitive advantage that can be

supported by real barriers to entry, particularly barriers that are created by proprietary

products or brands owned exclusively by the company. Finally, there

should be some sizzle to go with the steak; this may include excited and loyal

customers and employees, favorable media coverage, nervous competitors who

are genuinely concerned that you may be changing the industry, and a clearly

defi ned exit strategy that allows your investors to be rewarded within a reasonable

period of time for taking the risks of investment.

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