The Old-New Economy: Are the Rules of Engagement All That Different for Raising Early Stage Capital

A question posed to me this week by the CFO of one of our technology clients, caused me to think back to the pre-bubble, everything-is-getting-funded go-go days of no due diligence and mysterious pre-money valuations - when everyone was a venture capitalist and mezzanine rounds were the thing. He asked me how emerging growth companies in seeking angel or early-stage venture financing have shifted their approach to potential investors from their approach in the pre-bubble days.

Let's face it, in this regional market (and in others as well) it has never been easy to raise private equity capital. That was true 24 months ago, and it is even more true today. That's not to say the environment, the terms, the valuations, the timing, the effort, the size of rounds or a whole host of other things have not changed. They have. But the fundamental profile of attractive investment opportunities are the same and, although the climate is different, the strategies that early-stage companies can utilize to increase their chances at getting funding today are not much different from what they were 24 months ago.

The following are a few observations on some of the basic principles that are key for engaging early-stage money sources:

It is going to take more time than you expect.

Getting a deal done in any environment always takes longer than you expect. In the current environment this fact is compounded, maybe exponentially. Start early and well before you have a crisis funding need. Being on or below empty reduces your leverage and exposes you to bad deals and bad terms with little or no alternatives.

Sell more than technology.

Tell potential investors in plain English how the business is going to make them money. Do not overly focus on the technology. The technology is not the business itself.

Create scarcity.

Leverage your contacts and advisors to find a lead or a significant investor who will advocate for your company. Try to create an appropriate environment that puts demand-side pressure on your deal.

Be flexible.

Stay focused, but keep your options open. Talk to potential investors even if they do not want to lead. Look for and pursue strategic alternatives, grant sources, governmental sources and other alternative funding sources.

Seek experienced input, but follow what makes sense to you.

Seek input and advice from sources you trust. But do not be paralyzed by conflicting advice. Synthesize those opinions with your own judgment. Rarely is there only one path to get someplace.

Listen to the feedback given by potential funding sources.

Good VCs and serial angels give feedback, even if they do not invest. Press for their feedback. Listen to what they say. Incorporate the advice if it makes sense.

Believe in your story, but keep it simple.

Know your story. Be prepared to defend it and your team against the rigors of professional inquiries. Expect to be challenged on your plan and its underpinnings. Know what is in your business plan and why it is there. Make yourself and your plan creditable and believable by building on solid, supportable assumptions. Articulate clearly the business strategy when pitching your plan. Techno-babble only creates confusion and misunderstandings, and inspires suspicion in the eyes of investors.

Address your weaknesses.

Do not hide your major flaws. Tell folks what keeps you up at night and why and how you're going to fix these issues. If you don't, your potential investors will find the weaknesses. It is better to turn these issues into "overcomeable" challenges than credibility problems.

Valuation isn't the only term.

All pre-monies are not the same. Valuation is important, but other terms impact the deal tremendously. Participation features, multiples on liquidation preferences, compounding dividends and onerous protective provisions (to name a few) not only establish the rules of the game, but the payoff. In addition, the intangibles and quality many investors can bring to the table will not have a value on the term sheet, but you should considered that with the financial terms of the deal.

Keep things organized, take care of the details and keep the structure as simple as possible.

Keep your house in order. Due diligence reviews vary, but investors do not like surprises. Avoid issues that arise from a lack of attention to detail (e.g., take care of IP and follow the securities laws). Keep your capital structure simple, unless there is a very good reason to complicate it.

Entrepreneurs, serial angel investors, bankers, VCs, technology lawyers and accountants all have short memories. Most of us gauge the world by our last deal. Pre-bubble deals seem very different than current ones. And in many ways they are. However, at the end of today, investors are looking for the same things (namely returns, value and risk reduction) they were two years ago. And emerging growth companies are looking for capital, support, guidance, a decent relationship and a home run. After all, investors are investors and entrepreneurs are entrepreneurs. And though over time the environment may change and dynamic may shift, the basic rules of engagement do not.