By George Deeb Of all the consulting inquiries I get at
Red Rocket, fundraising is by far the biggest need of these startups. And the problem is, not all startups are venture-backable, for a variety of reasons, which we will discuss in this post.
It's imperative to ask: Is my industry appealing to venture investors? Is my business appealing to venture investors? And, if so, how can I attract capital for my business?
First of all, angel investors and venture-capital firms invest in a wide variety of industries (e.g., technology, digital media, CPG, retail, real estate, health care, life sciences, manufacturing). So, before reaching out to any investors, make sure your industry is clearly in their sweet spot and skill set. That said, there are certain industries that have a LOT more start-up activity than others. As a rule, businesses that heavily invest in real estate, inventory or other capital risk are materially less desirable than simple technology businesses. So, bad news if you are a start-up restaurant, retailer, REIT or manufacturing business. Good news if you are a dot.com, software or technology business.
The reason for this investor bias is the extra levels of risk that get added to your startup. Business start-up risk is bad enough, with only one in 10 startups succeeding. But, when you layer on real estate location risks, long-term leases or merchandising inventory risks, it becomes a much bigger pill for the startup investors to swallow, unless they have deep expertise in that space.
But even if your industry is in one of the more active venture markets, there are still numerous hurdles in assessing your specific business. Are you B2C focused or B2B focused? Are you a sales driven or marketing driven company? Do you need $1 million or $25 million to succeed? Do you have one-time revenues or a recurring revenue model? Are you the first mover in your market or entering a highly competitive space? Is your technology patentable or not? Is your business easily and cheaply scalable, or does it have heavy overhead investment along the way? Are you serving a $1 billion market, or a $100 million market? Is my forecasted ROI going to be a 10x return or 3x return? Is it a first time CEO, or an established veteran? How deep is the management team? Has there been proof of concept, with revenues or site traffic to date? So, as you can see, lots of hurdles to get over to get investors' attention for your business.
Now, let's assume you are one of the lucky five or 10 in 200 who has a venture-backable business. How do you typically phase in investment? You can't simply show up at a big Silicon Valley venture firm with your piece of paper idea and say, "Cut me a $10 million check." Investors are typically segmented by life-cycle stage of the business: Angel investors or friends and family typically get a business off the ground from a piece of paper to a working prototype; Series A venture capitalists will put in $1 million to $5 million after there has been a preliminary proof of concept, based on revenues, pipeline, site traffic or some other metric; and Series B venture capitalists will put in $10 million to $50 million to hit the accelerator after the model is finely tuned and scaling. So, when you are approaching the investment community, make sure you have thoroughly researched not only their industry focus, but their stage of business focus as well.
Once the term sheets start flowing in, how do you ultimately decide who to move forward with? At the end of the day, you need to follow your gut. Who is going to be the best partner for my business, bringing a Rolodex of relationships to the table? Who is going to be the most pleasant to work with around the board table, especially when things start to go wrong (as they always do)? Who has the deepest pockets to invest additional monies in follow-on rounds? Who is giving me the best valuation? Whose term sheets are more or less onerous than others in terms of liquidation preferences and antidilution rachets? So, hopefully, what you are hearing is, not all venture capital is the same shade of green, and it is important you do your homework upfront, to avoid misery down the road. And, if you are not clear you are making a good decision on your own, ask an adviser to help you.
But, overriding all of this, if you can figure out a way to fund your business, with no outside capital, that is the preferred model. It preserves the founder's 100% control of the company's equity, board control and and timing of a sale (or not), at terms 100% satisfactory to the founder. Don't get romanced by the idea of raising venture capital, because it certainly has its strings attached, given the reasons above. But, if you think you have the next big idea at the scale of a Google, Facebook or Groupon, the venture community will be your best partners, having funded several of those similar businesses and navigated the various pitfalls along the way.
In the words of my old boss at CSFB . . . "Happy Hunting!"
George Deeb is a managing partner at
Red Rocket Ventures, a Chicago-based startup consulting and fundraising firm with expertise in advising Internet-related businesses. More of George's startup lessons can be read at
"101 Startup Lessons - An Entrepreneur's Handbook."George's posts appear on Crain's blog for Chicago entrepreneurs on Fridays.
Follow George on Twitter at
@georgedeeb.
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Small businesses have grown used to shopping among insurers for the best prices and plans. Brokers say it may be time to stop the annual game of musical chairs and consider other ways to manage health care needs. Here are three outside-the-box ideas -- part of the Employer's Guide to Health Reform published in this week's Crain's: 1. TRY A “DEFINED CONTRIBUTION” MODEL. Does that phrase sound familiar? About a decade ago, many retirement systems began switching from defined-benefit plans (pensions) to a defined-contribution system, in which employers contribute to the money employees invest in their 401(k) accounts, putting employees in charge.
Under a defined contribution model in the health care world, small-business owners give their employees a set amount of money to spend on a plan of their choice.
The federally mandated insurance exchange expected to go live in 2014 may offer small-business employees another version of a defined-contribution plan.
“I think (defined contribution) is something small businesses should be examining,” says Tim Tracy, vice-president of insurance brokerage Gerard B. Tracy Associates Inc. of Fairfield, Conn.
2. GIVE AN HMO A SECOND LOOK. HMOs were supposed to save the world about 20 years ago—but they fizzled because people didn't want to give up the freedom to go to any doctor they wanted at any time. Now that medical care has become so expensive, freedom is a secondary issue for many and HMOs are making a comeback. Most of the big insurers operating in the small group market offer an HMO, which is often the least expensive plan in their array.
“I've been selling a lot of those HMOs because of the price,” says Jim Cosares, principal at Jimco Associates Inc., a New York insurance brokerage.
3. CONSIDER A PEO. Professional employer organizations have continued to grow during the recession. For a percentage of your payroll, PEOs will become your workers' official employer—taking on all responsibility for payroll taxes and insurance, among other things.
Because they can negotiate as a large business with insurers, PEOs can sometimes get lower prices or better deals on health care coverage. Brokers and benefits consultants warn small-business owners to compare carefully the total price for a PEO to what they currently pay. But for some small companies, losing the headache of back-office administration is worth almost any price.
For more smart ideas on shopping for employee health insurance now, check out
the Focus section in this week's Crain's.
