what slice of my company are investors going to take? Right? Here's the expectations and here's a really easy way to think about rates of return If you take $10 and it grows to be $30,000 in three years. What's the return? 44%. The time value of money changes that calculation If you take the same $10,000 investment in your company And again it grows to be worth $30,000. That's awesome. Three times of your money, The return drops to 38%. The longer your cash is put away for achieving this same valuation jump, the rate of return falls. So remember our sweet spots that investors are looking for no less than certainly 30%. They'll always say they want 40, 50. you know, bigger bigger multiples. But the average investor, especially at the angel level, is not looking for secret number two. Quite often, somebody will say, Oh invest in my business and I'll make sure you have a return of like 15%. That's better than what you can get from a CD. It doesn't really, it's not enough for them to risk...
losing all of their money. But this is a good guide for early stage privately held businesses in America. But look at your own money. If you've invested $10, or five, you know the numbers don't change too much, right? This is a good guide of what you need to accomplish in building the value of your business over time. This works for a small store, main street, store, a restaurant, a website. Whatever you want to build the value of is possible. And these are your driving numbers for return. Another easy way. I usually point to this because I don't like to flood people with lots of numbers. Here's another way You make four times your money in four years Or 10 times ceremony in seven years. Is that something you can remember right down and turn to. It's not a bad guide. So if your company is growing in value at all progressive rate, remember we're going to give you a long time to do it. You should not feel under the gun to do it in six months now it's possible. But overall, if your business is growing in value, it's good to continue to communicate that growing value to your investors. Here's another way to look at it. Usually people say, what's the chunk? What's the percentage? So let's address it in a very different way. Let's say there's a $2 million dollar investment going into your company venture, inc We know they roughly want a minimum of 30 to 40 return on their invested capital. If the value of the business grows over six years, that's a lot of time to build up a company For a return. If your company now is worth 20 million in order for them to have achieved That 30-40 return, they will have to own 48 of your business. The bigger the value that your company grows to be worth, the smaller the equity stake they need to be happy campers. Okay, Five good reasons to pursue investors. I started out earlier saying, I am the cheerleader for raising equity. Don't rule it out why? Obviously, if the deal doesn't work, if your company doesn't work or if it doesn't grow to be worth necessarily that Uber big value, you personally do not have to pay back the investors unless there is fraud involved. But that's not us right. You don't have to pledge collateral, so you don't have to put up savings accounts, pledge your home, do other things to back the investors investment in you. So in terms of your own personal risk and reward, that's lower risk in some circumstances, think getting the same amount through debt. You know, there's a time and a place for both. But if you don't have a if you don't have any money and you have a big idea, let's face it, you're dealing with investors. It's better though than not pursuing your dream at all. And let's suppose your company is not what I call debt worthy yet. It's a very early stage. You may involved lenders a lot in the future, but where you are right now, if that's close to you, even after you go through all the different types of lending resources that we went through in prior sections, right? These are good reasons to pursue investors. Other advantages of equity investors. They love working with entrepreneurs. They get their joy out of your success in terms of their temperament. They are very different than lenders lenders like steady growth. They don't like too much risk. But investors, in terms of their mentality and temperament, they are a very good fit for entrepreneurs because you are already thinking big, you are already willing to explore new possibilities and shake things up. Investors love that. They embrace it. So can you get along with investors? I hear over and over again from VCS as well as investors. There are some of their best friends turn out to be people they invest in and they admire and respect what entrepreneurs do. It's one thing that VCS can do. They're not as creative as you. The other thing that equity investors, especially at the seed and early stage level, they do believe part of their workday is not just writing a check to you, but helping you achieve, connecting you to more customers, connecting you to professionals who specialize in something that you may need. At that moment they cast a very wide net, a professional and customer resources and let's face it, once their caches in, they are there to help you connect more dots and quite frankly, when things are not going well, I think the worst mistake entrepreneurs make is they don't raise their hand and say something's going wrong. Let's all work together. What ideas do you have because sometimes, you know five heads better than one, especially if you're going through the strain and the stress of it, you're not going to be doing your best thinking, let's bring in the team and work through solutions. And that's the mindset of entrepreneurs, N. V. C. S. So sometimes there is that fine line and I appreciate what control means. And we're going to talk about how to maintain control of your business coming up. But involvement, collaboration is different than losing control. And sometimes investors respect you more when you're willing to collaborate and when you're willing to say, I don't know the answer to this. All right, I have to make a very big qualification here when start up entrepreneurs come to me and say, Well, I only want this type of investor who will buy five of my company. Give me a $5 million dollar check. Is it impossible for me to get that done? And I'm gonna say no, it's not impossible. But the more expectations that are kind of out of this world expectations that you have, it's probably gonna take you longer to find that needle in a haystack. I will never say it's impossible. And you may come across an investor who is just not that smart about how they deploy their cash. I call those investors unsophisticated. The types of investors I'm talking about today are the ones that are most prevalent and most likely to write checks faster, anywhere in the United States. I call these sophisticated investors and you don't want to take money in from the other than friends and family from people who've never invested in other companies before. Mhm. We're matching, we're shopping. You need to know if you want to find your investors and get them to say yes, part of your own education is appreciating what they value today, but because investors want their money back and are entitled to get their money back there. Also thinking about what will boost the value of your business that will enable them to get their money back tomorrow. So it's really a two part problem that we're addressing here. They're closely related but not the same. So when you say, what are investors looking for to write the check today? Got a list, but at the same time this is in the back of their minds. They may not spend time talking to you about it that much. The execution is on their minds as the one audience member brought to attention. They're not going to ask these questions. But if you and your business plan or you're talking points, don't address this at all, there is a good chance those investors may lose interest. You need both. You need to answer both in your meetings, in your presentations and how you drive your business. So priorities. As I said, they want their money back. Notice how that's number one on my list of what investors want. They want it back and they want a big chunk of your company, especially at the earliest stages. So if you're going to investors and you talk about borrowing from them and you would think people wouldn't do that. They do. I've heard it too often. Well no, I just want, you know, your money and I'll pay you back And I'll pay you 10 interest. 15%ages. That's more than you would get, you know, in a cd. That's bad matching. You've already turned them off. They may invest in something that we're going to get into later in a later segment in convertible debt that turns into a big chunk of your company. But overall they are not out for interest, measly interest. It's a bad fit. If you bring up that language, they will walk away. They'll smile and walk away and they want a deal. We talk in deal if you want to buy a pair of shoes and you get a deal on it, what does that mean? You buy at a discount, some little discount and it's all negotiable. They don't want to over pay day one. So if you are already in your mind thinking um, that you've got an asset and you want investors to come in at a higher value than that asset is worth, you're putting yourself out of the game in some way, investors must believe. And these are very qualitative terms that they are getting a good deal. What do we look for in the characteristics of the founder? We want you working really hard. Um, we want you engaged, we want to inspire you without putting too many restrictions on you. Uh, the last thing we will do despite what everybody thinks is put such onerous deal terms on you, especially at the start that you don't think you can make big money when you lose the motivation to work hard for that big reward. That is trouble for the investors. Real trouble. We want you engaged in loving life. There will be hard days. But that's the attitude we also want. And this is my phrase. We want a boss, not a baker. If you are the founder and all your about is just let me sit in front of my computer and write code. Maybe we'll invest in you, but you may not be the right person to run the business. So we want you as the boss of the business. We want you ready and able to make hard decisions. You have to hire and fire the slug, even if it's your best friend were higher, we're investing in you what you want. You do want to be the boss of your own business. But that means you must embrace responsibility for everything that goes on in the company without finger pointing. You're accountable and you care about cash. We are looking for people who know how to read a financial statement. You don't have to be a CPA, but If we are giving you $1 million 500,000, we have to, we are putting a lot of trust in you not to go on a trip to Vegas and spend the money. We want you to be great investors of their cash. So going into meetings and say, well, I'm not really good at numbers, but I'm a great coder and I expect to run the business and I have heard that before. Um, you're not ready for prime time. So exuding those characteristics and taking a responsible approach and when you make a mistake own up to it. We already appreciate that, especially at the seed level There's trial and error going on and a lot of times the product or the website may change dramatically from the first year to the 5th year because you're going to learn more about customers and what they want and markets change. So going in with a flexible attitude, a willingness to solve problems, not bury problems is what we love. That is a capable boss, not the baker who is in love with the cupcakes. You have to be willing to change your product to match customers and these are issues of control. We're not giving money to you to do what you want to do. We're giving you money to do things that customers want and are willing to pay for. That is the divide on what the definition of control is. Okay. Changing investment analysis at the start up stage, we have to guess we have to place bets so much. Everybody wants to get an exact number from me that I can't give them. What percentage of the business will they own for this? It's not that way. It's a qualitative decision making process. Why if you don't have customers yet and revenues and a lot of expenses, there's no P. N. L. For me to look at. So I'm looking at vague issues, I'm looking at us, we're gonna be diving into market demand, other indicators that customers will be around. When you get your product together, you have to convince them and be willing to play ball and present a qualitative case of why invest in me. As your business progresses, decisions from investors become much easier. 10 years from now when you have 30 different locations up and down the West Coast for your educational services. All I'm gonna do is show me your balance. Give me your balance sheet, your P and L. And your projections. I don't even necessarily need to meet you and I can get a good sense of whether or not I want to invest in you because the numbers drive investment decisions more than then at the start up stage. All right attributes to integrate into your growth strategy. Remember I was talking about things that are guaranteed to boost the value of your business. Here's my list. I'm giving you actually seven. We're going to really focus on four. Why did these attributes matter from the investor perspective, which is also you because I know you've all put or will put money into your own business. These attributes matter because every single one of them reduces the risk of investment. Check check, check those seven if you have those things as elements of your business and you can say with competence that they are part of where you're going less chance of going out of business. Plus at the same time they maximize upside how cool is that? You're tackling investors to worst fears as well as where they will finally get that reward maximize upside limit downside. So let's dive into them. Growing market demand. You were asked, I'm going to put you on the spot. You were asked about what's the growing market demand for your business. But is listening carefully. You answered it in terms of marketing expenditures. So subtle distinction in terminology, you started saying we spend our money on marketing and advertising, blah blah blah blah blah. But investors care about something different, especially at the start up stage. So hard to explain market. So you're gonna look at my blob I found over time with my students, this is the best way to explain what investors are thinking about when they ask questions about market demand. Why do they insist on saying and wanting to see in your executive summary? Some evidence that there are people out there, customers who want to buy what you make or deliver and keep buying more and more of it. If the market, the appetite for your product or service is expanding, it means there's room for everybody. Like a rising tide lifts all boats that everybody can play ball and get some customers and not go out of business. It sort of looks like this. Here's your venture, the market is growing. We love markets that are growing by 10 or more, especially at the seed level, when we really don't know if you'll be able to get a customer. One thing that reduces our risk, if there is a growing appetite where all of a sudden people are now eating pizza every single day where goblin and pizza, it means more pizza makers and pizzas outlets can make a living less risk more upside. We also know in growing markets eventually there will be consolidation, as we say, where different competitors will gobble up and it could be you, that's the big gobbler where you decide, hey, we're going to grow by making acquisitions, which doesn't scare investors at all. A lot of ways to grab customers and sometimes acquiring another business with you at the lead down the road is one way to continue to build that market share. What's a shrinking market. What's it look like? What makes us run a shrinking market is when we're bumping up against everybody. There are too many competitors all selling the same thing In my neighborhood. There are six frozen yogurt stance or little outlets. The branding is so terrible. I can't tell the difference between one or the other. The marketplace is too small for six in a little town in the Seattle area. Bad, bad, bad, bad, bad. What happens when there are too many competitors fighting over the same customers, prices go down coupons? I hate coupons, I hate investing in companies when I hear coupons, I think, Oh, they are discounting the value of what they're selling. Day one. Oh my gosh. Which means your profit margins shrink. Who wants to invest in that? It's too risky. So if we see you are going into a marketplace with shrinking customer demand, you had better come up with a different presentation to prove how actually you're changing the market in a very different way. This is # one. If your seed early stage business, we will ask about this, you're going to need to come up with some stats regionally locally, nationally, internationally and why the customers are growing. If you can't get stats, you're gonna need to convince us that customers want what you are going to sell. Customers want it. When you hear, tell us about your market demand, we're asking about customer demand. Don't answer it as marketing expenses. Do you see the subtle distinction here? This is so important if you don't have a lot going for your business, but you can nail this we're keeping were paying attention. This is my favorite. I get sentimental about my gross profit margins companies with high gross profit margins higher than their competitors are going to be bought for a premium. Most people, most entrepreneurs will say to me when they're doing their projections, especially if they've got products company, What net income number should I show Susan, I don't care. I'm happy. If you can tell me a story where your gross profit margins or services profit margins at the top line beats or exceeds your competitors. Hi, gross profit margins survive recessions. They don't go out of business as easily as low gross profit margin companies. If you are starting a software business and you say your gross profit margins Or 20 or 30%,, your business plan is dead on arrival at any venture capital fund in America. Why why should we invest at the bottom of the the industry? We know, you know, look at Microsoft, look at google, look at publicly traded software companies. Where are their gross profit Margins, 60, 70 80%. You better show us a company. If you're in software up there, if you are an advertising agency, find out what the gross profit margin are for your industry competitors. You don't have to have the highest gross profit margin. Day one. But your success over time over those seven years is to carefully steadily improve your gross profit margin. So you have the industry leading gross profit margins. If you deliver that to me, I will buy your business at a premium all day long, You can do this, it doesn't have to be day one. I also want you sophisticated. I'm scared if I ask you a few questions about industry, gross profit margins, notice again, I'm not talking about net income margins and you are clueless. You don't know if you don't know what the industry standard, what is great performance in your industry versus bad performance? Do you think I want to invest in you? That's item number two, everybody can deliver this. You don't have to be very sophisticated. It's just, here's the metric we've got Gross profit divided by your revenues. In this case it's a 60 gross profit margin. That's all the math. All right. Some patents have tremendous value. Some patents are a complete waste of time and money. Not all patents have value. What's the difference? I like patents when they really do something And the nature of patents are the claims in the patent. If those claims block out your competitors, I'm gonna give you a lot of check marks of value. I don't think you necessarily must file a patent to get funding. We will look at the quality of the patent application. So right then and there. If you're thinking of filing a patent, do not do it yourself. And I would say drill down a shameless plug. Chapter seven of start on purpose is all about patents, trademarks and copyrights and what builds the value and what investors are attracted to. But in summary, there is a very new law. It's only about a year old were in the United States patent law changed. If you go to online articles or read books that were published over two years ago, all the advice you will read will be wrong in the United States to get a pattern. It goes out to he or she who files first, Not, who invented 1st. So now it is a fast dash To the Uspto file 1st wins. That's big. So the pressure is on. You have a choice of filing a provisional or non provisional application. One is a placeholder and you better get your act together to finish it up in a period of time. But we will look at both. Don't mislead us and say I filed a patent application and mislead us into thinking you have done the whole thing when you've only filed a provisional starter pattern. I get that often and it annoys me because it's already a signal that this person is not black and white about telling the truth. We love patents that can generate licensing revenues cash coming out of that pattern. We're gonna look at trademarks. So often, investors or entrepreneurs will present companies have the domain name. The product name may have even started to package the product and never checked to see if they have federal trademark clearance. It's the kiss of Death. Suppose somebody else is already there in your product or service classification for your brand name. Guess what you have to do. Probably start all over. But we have the impression that g this is a very simple action step. We want you to be the boss of your own destiny. Do your homework, make sure you have federal trademark clearance in the product and service categories that you want. If you go to start on purpose, you can see those trademark classic vacations. If you go to uspto dot gov for free, you can put your product or service or your brand name company name into their tools and check and see if somebody already else is operating in your product or service classifications. Don't send us an executive summary until you've gotten your act together on these issues. It is a very common reason for us to reject you out front outright. And what do you think you're negotiating power is going to be when some of the basics are not done.
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Susan Schreter is a veteran of the venture finance community with expertise in the life cycle of financing companies from startup to sale. She is an MBA-level educator, expert on the factors that influence startup success or failure, and popular