Commercial property prices have struggled in many areas over the last few years, and as a result we've seen a few business plans submitted to us with buying a building to house the company as part of the plan. For newcos seeking investment this is usually a show-stopper with professional investors, and is likely to be challenged on a number of grounds.
- First of all, it changes the need for funding. Say one needs a first round of $1m and then $500k to buy a building. If one doesn't buy the building it materially changes the investment needs.
- Secondly, it changes the cashflow model. Investors may want to drip-feed money based on various objectives. They can't do that with a large capital item like a building. If the company survives its first few years then perhaps making a real estate investment to save money over a decade or so might make sense. But hopefully there will be better opportunities in the business to create value.
- Thirdly, it mixes the activity of the business. Tech startups should be applying capital to being tech startups, not property speculation companies. Typically, investors going into a newco at best 1-in-10 chance of getting a big return on their money, even at series A. It is unlikely to fit the investment committee criteria in a big fund: if the fund's capital is designated for early stage, they would want a $1m investment to go into startups, and not half and half into property. Investments like this are rarely capital efficient. Buying a building isn't going to give a "hockey-curve" return in the way that the rest of the business might. In fact, if the business is growing rapidly there are many circumstances under which one might consider selling any company building and investing the money in growing the business instead, for a better return.
- To this end, buying a building looks like a hedge: that the entrepreneur may be worried it won't work and wants a source of rental income to fall back on if it goes wrong. If it goes wrong, however, things won't work that way with the investors.
- Finally, it's worth considering how this might affect an exit from the business. If one has built up $1m of saleable business value and wants to sell out, that extra $500k which was raised and spent on property will increase the transaction price by 50% and not give any extra upside on disposal. It's just a barrier to the entrepreneur getting paid out.
Ultimately, if one has been offered a sweetheart deal on property, it's worth raising any capital separately and in a different vehicle. Tying it up with a newco deal will make investors nervous that it's some sort of mechanism for extracting the funds straight out of the company they're investing in. This is very much like entrepreneurs paying themselves large salaries -- it's only fine when it's their own money!
We're always happy to share thoughts on this at the usual address.
So you've had the idea, done some research, and maybe got an early incarnation of your business running, perhaps even assembling a small team along the way. You need more money to make the business really tick over, and the banks are talking of rates in terms of "LIBOR plus something" or won't lend at all.
What do you need to have together to raise investment? The depends on the investors and the returns you can provide. Angels, early-stage, small funds, VCs, VCT and corporate venture teams all take different angles on investments. Angels can be the best and the worst -- investing after their emotions -- which can make fundraising easier. Watch out for the "Belgian Dentist" on your board: an investor whose only qualification to be involved in the strategic direction of your business is the money they have, rather than experience or connections they have in your field of business.
There's a whole laundry list of things to show. Here's a short checklist:
- Have a team together. Even if they're not involved full-time, show that you are connected with and can involve credible experts to sell or develop your platform. They can sell you. Most importantly: getting someone on board with you who has successfully launched or funded a business is magic.
- Demonstrate a willingness to bootstrap, and understand what a lean, agile business is.
- Present a strong business plan. Future capital expenditure that isn't broken down will confuse and scare investors. Make it easy to read, and cut out the rubbish. Can you do it in no more than five pages? Annotate it in the margin. Some investors read business plans all day, and they'll skim yours however short it is. Make sure they can see the good bits easily.
- Make sure the numbers are all there. Include a P&L for the first few years. Include summary figures up to five years. Show where the workings come from. If your business is converting web traffic into revenue, work the numbers bottom up and top down and see if they match (don't work on a market-share basis: "The market is worth $10bn and we will capture 0.1% of that for $100m", anyone can say that). If you have clear competitors, find out what their numbers are like. If you can't find the numbers online, call the competitors and ask. People like talking about their businesses and will often say more than they should.
- Have diverse revenue streams if you can.
- Demonstrate clearly that the business model is scalable, and back up your claims.
- Don't ever say there are no competitors, or that it will sell itself. Creating an entirely new product and marketing it is expensive, and if you think noone's after you're lunch you've not done your homework.
- Don't talk about "building a brand" unless you're raising millions of dollars or you really know what you're doing. It's not cheap or fast.
- Demonstrate a solid return on investment. Most investments will expect a 10x return on three to five years.
- Have a clear exit plan for your investors.
- Understand why you are building the business. Be clear it's not a lifestyle business. What do you expect in five years time?
- Show that the business is suitable for the current economic climate. Is it a business that will work in the credit crunch? Are there parts you should scale back or put on hold?
- Consider the funding runway you need. If you're asking for £50,000, is that the only capital the business requires? How many rounds of funding will the business expect? Professional investors will ask you this. Have you left enough runway: if the cost of your initial activity doubles, or your revenue is late, will the extra six months it could take for further fundraising run the company into the ground?
- Do you have any intellectual property (IP) in the business? Can you protect what you have with patents or trademarks?
- Build a proof-of-concept or a prototype. This makes funding much easier to obtain. You can really show would-be investors what they're buying into. Understanding somebody else's business is hard, and having a play with a demo product is usually easy. Building a prototype shows that as a founder you can get it together to raise your own seed funding and or executive on delivering the first part of your business. Prototyping also helps as we see most pre-money business change their plans at least three times. Investors will wonder whether you have settled those issues.
- Understand funding types on offer, and how each class of investor is likely to invest. Are you after cash for equity, or convertible debt? Do you know what class of stock you might offer, and how much?
- Make sure the company valuation is sensible. If the investment opportunity appears to be to good to be true, it probably is. And if it's that good, you probably don't need equity funding.
- Don't waste the investor's time, and do your research on them beforehand. A lot of investors talk to each other, and annoying one can be harmful. Don't approach the wrong investors for the wrong sort of funding, and understand what sort of investments they make.
This is by no means a complete list, but we hope it will be useful to many of you. For assistance with your planning, preparation, implementation and funding, please do consider Reincubate.
