Raising Capital - Risk Disclosure

When raising capital, the law requires that you disclose to a prospective investor all material information regarding your business.   Without this disclosure, the prospective investor is not prepared to evaluate your offering and make a decision to invest or to walk away.

From an investor perspective, although you are required to disclose everything that may cause your business to succeed or fail, most investors are only concerned about failure.

Failure, in this context, has many meanings and many levels.

Obviously, you should disclose anything that may cause your business to fail:

  • You or a key member of your team die, are permanently disabled, or are temporarily disabled for long enough

  • You fail to complete development of your technology

  • You fail to make a product or service

  • No one buys your product or service

Aside from these majors, you should also include that you fail to raise your capital goal.  This is just a starting list, don’t stop here.

If, you have made any projections with regard to sales, revenues or profits, failure is not measured just in terms of your business, but also in failure to achieve your projections.  This lowers the level of threats that you need to disclose.

In addition, failure to disclose something can also get you in trouble.  You are accountable not just for what you say, but anything you should have said.  Fraud by omission.  Be complete.  Be thorough.

Simply listing the risk is not enough.  You have to explain how it may negatively impact your business and the extent of that impact.

By this time, you may be thinking that you are going to scare away all of your investor candidates.  You may be right.  The less sophisticated the investor candidate, the more likely that they will walk away.  More experienced investors will listen to what you say and draw their own conclusions.  In any event, it is better to have an investor candidate say no than to try to explain later why you left something out.

Failure to disclose a risk is important.  It constitutes securities fraud.  This makes you, as a principal in your business, personally liable for any harm that occurs.  You cannot shield yourself behind the structure of your business.  An investor may sue you personally in addition to your business.  Depending upon which securities laws have been violated, you may be liable for treble damages and attorneys’ fees after returning the investor’s money.

To avoid this problem, be objective in assessing the challenges that your business will face.  This is where having a management team is helpful.  Create a competition for the person who creates the most complete list of possible risks.  In the event that all your team has ‘drunk the Kool-Aid’ and is giddy with the prospects of your business, go to someone outside your business.  Hire one or more advisors or put together a group of experienced entrepreneurs.  Ask them to tell you everything that can go wrong.  This may take a while.  You may be surprised and entertained.  Write it down. Compare it against your list.  Upgrade your disclosures and put them in writing.  Include them in your offering memorandum or your investment contract.

 

No Problem with Access to Capital?

I occasionally hear a community leader, thought leader or government official state that there is no shortage of capital.  Some will also add statements that all good businesses get funded.  When I hear these statements I struggle to reconcile them with my own personal knowledge of the startup industry in Colorado.  But, I can’t.

Here is one example that was published on the Internet.  “There’s a perception out there that small business lending is difficult to obtain and on a decline.  The reality couldn’t be further from that,” stated Patrick MacKrell, President of the New York Business Development Center in a newsletter dated July 16, 2013.  Although he acknowledged that certain types of business, particularly retail, always have trouble obtaining capital, he concluded, “The truth is that credit-worthy, well-managed and well-operated businesses have absolutely no problem with access to capital.”   

I have tried to understand what could lead a person like this to make a statement that is so obviously wrong.  Wrong at several levels and in different manners. 

Business lending did decline.  How could it not?  New federal regulations imposed upon banks stricter lending guidelines and higher capitalization requirements. 

To say that a credit-worthy business can obtain credit means no more than saying a hungry person cannot obtain food.  The fact a business obtained credit is the definition of credit-worthy. 

However, when banks, angel investors and venture capitalists change their funding criteria, all businesses that no longer meet those criteria are no longer investment worthy.  Who is worthy and who is not investment worthy is, and always will be, based upon the criteria of the capital source.  When those criteria change and the percentage of the businesses that meet the criteria changes from 50% to 5%, then there is an access to capital problem.  Or more accurately, there is a worse access to capital problem. 

The fact is that any effort, project or campaign to improve access to capital by startups and small businesses must deal with opinions publicized by people who are in positions of authority with access to the press who will deny and misdirect public opinion in their own self-interest. 

Whenever a person makes a statement that “access to capital is not a problem”, please challenge that person to provide evidence in support of their position.  Specifically, they should be asked if access to capital is a problem for startups, minority businesses, businesses in distressed economic regions, or businesses that historically have low profit margins. 

Just because mature, middle-market businesses clearly have more capital options, doesn’t mean that they are unconstrained by capital markets and that they are unable to realize their full potential for growth and job generation.  Even a business well positioned to obtain capital may expend a substantially greater amount of time and money in gaining that capital and may pay a higher price for the capital.

Our capital markets remain focused on large businesses and our securities regulatory structure makes it prohibitive for nearly all of the investment banking industry to make money servicing small businesses.  Opinions vary, but the lower dollar limit is between $250,000 and $10 million: a floor where investment bankers and broker/dealers cannot make any money raising money for a small business. 

Raising money in amounts below this floor is the greater challenge, but not the whole challenge.

Alternative funding may address the problem of access to capital in part.  However, without established networks of communications between sources of capital at the local, state and national level, the capital that these sources can deploy will remain limited.

Crowfunding still presents the promise of substantial improvement for small dollar capital markets.  Multistate (federal) accredited investor only crowdfunding is starting to surge.  Meanwhile, many states are now legislating intrastate crowdfunding while the SEC seems unable or unwilling to set rules for non-accredited investors to participate.

At the local level, Capital Communities may coordinate interaction between businesses, investors and intermediaries to reduce the time and cost of obtaining capital and improving the probability of a successful funding.  This movement of money from Wall Street to Main Street is part of the Buy Local agenda.

There is no simple solution.  But, there is a problem.

Raising Capital - Components of an Executive Summary

In raising capital, it is good practice to summarize the offering in a single page document – an executive summary.

It is correctly assumed that a prospective investor will have limited time and will prefer to familiarize themselves with the business opportunity before expending time in reading an entire offering memorandum.

So, what goes into an Executive Summary?

Just enough information to intrigue the prospective investor into wanting more information.  There is no document that can be so beautifully drafted and presented that the investor will immediately pull out their check book and write a check.  But it is easy to create a document that is boring, inconsistent and/or incomplete that it will bring consideration of your opportunity to a quick halt.

Tell your story.  You have a product or service that creates a benefit for your customers.  You have a business model that will generate a profit from selling your product or service. You have a management team that can execute a strategy to realize the opportunity.  You need to say this much and no more.  Your ability to tell your story concisely reflects your understanding of your business and generates credibility.

If you are so early in the start of your business that you cannot tell an entire story, you need to state the point where you are in your business launch and the next steps you intend to take to achieve critical milestones until you have a whole story.  Don’t fudge your status.  You will only generate temporary interest and then experience embarrassment when you can’t answer investor questions.  Then the investor will walk away.

Don’t share any information that may be considered a trade secret or treated as confidential. 

One page is enough, but I sometimes will use two pages with lots of illustrations/pictures/graphics that can tell a richer story in a manner that is more quickly and deeply understood.  Try telling your story with just images.  Then fill in words as needed.

Just because you have one page, don’t feel compelled to squeeze as many words as possible within a small space.  This looks like a bad slide in a presentation with too many words.  Confusing.  Rambling.  Too be ignored.

State how much capital you need and how you will spend it.  Do not use descriptions that read like the names of ledger accounts.  State what milestones you will accomplish and how achievement of the milestones improves the probability of success.

State what the investor will get for their investment in terms of percentage of ownership of your business or the revenue/profits from the project.  A simple statement as to quantity of shares or units received does not give the investor a feel for the impact of their investment.

Don’t assume that the reader of an Executive Summary is a CEO, trained in investing, market savvy or an engineer/scientist.  Use language that can be understood by someone with a high school education.  Don’t use buzz words, slang, acronyms, or words of art.  If you must use a technical term, provide a short definition.

Provide contact information so that the investor candidate can easily obtain more information or schedule a meeting. 

Obviously, there is substantially more information that an investor will need and want in order to make an investment.  And, there may be even more information that must be disclosed to meet regulatory requirements.  But, that is for a later time – the second or third meeting, or the demonstration, or a question and answer session.  All of this other information should be included in your investor package and ready to be provided when the investor asks for it.

Raising Capital - Getting an Introduction to an Investor

You have just identified what looks like the perfect investor.  The problem is that you don’t know him or her and you would benefit from an introduction.

So, how do you get an introduction that will present you best and start a dialogue leading to a relationship leading to an investment?

The introduction should be made by someone that knows you and the investor.  The introduction can come from a mutual friend, a business associate, a professor, a former boss, or other person who is held in some esteem.  The introduction serves as an endorsement of you as an individual.  It places an obligation upon the investor to hear you out and not reject your opportunity out of hand.  Even if the investor does not invest, this may lead to a referral to another investor.

The introduction should be made with knowledge of your investment opportunity.  It isn’t required, but the goal is to place you in the most favorable position.  This calls for an introduction that also includes a favorable statement about your business.  The strongest possible introduction would take the form of a recommendation – even a mandate – to invest.

The introduction can be strengthened if the person making the introduction holds a position with your business.  This may be as an officer, director or advisor.  In this way, the investor is actually making an investment in the person they know.  In effect, you are standing in their shadow while accepting money from the investor. 

A word of caution.  An introduction by a wealthy person that is not matched with an investment by that person is a problem.  The question is raised why the person making the introduction hasn’t made an investment.  Even if unspoken, the question will need to be answered with an acceptable answer.

If the person to make the introduction is not obvious, they may be identified with some research.  A background search on the investor may reveal a common employer, hobby or activity, charity, sports team or other platform for an introduction.  Within this framework, a person may be found who you know who also knows the investor. 

Capital Goals for 2015

If you intend to raise capital in 2015, your first step is to set your capital goals.

Most business people pick a dollar amount and consider the job of setting their capital goal to be complete.    For example, raise $100,000. Job done.

However, the gross amount of money raised fails to take into account the cost of raising the money.  For example $25,000: lawyers fees, broker/dealers commissions, finders fees, printed offering materials, multiple dinners and cocktails with investor prospects, and travel.  This leaves a net capital raise of $75,000. Only the bottom line counts.

If the goal was to raise a net of $100,000, then the goal has not been reached.

On the other hand, I have seen lots of businesses focus on the net capital raise, but ignore the price of the capital.  Price is the amount of interest paid on a loan or the amount of future profits given up in the form of equity.    

Attaining a capital goal cannot be attained at the cost of the future.  Investors should be paid no more than necessary to obtain their investment.  This includes not selling equity when debt financing is available – getting money at the lowest price.

So, setting a capital goal means also includes minimizing the money expended in raising capital and obtaining the capital at the lowest price.  This requires development of a capital campaign – a plan for raising capital that has budgets, timetables and responsibility allocations like any ordinary business plan.  It also requires an understanding of the capital industry to know all of the appropriate sources of capital and the types of available capital transactions from each source.

Yes, it is more work.  But a higher success rate and a lower cost of money today and tomorrow justify the greater work.

Set your goals.  Make them happen.

What is Capital Coaching?

I am introducing a new service I am calling Capital Coach.

What is a Capital Coach?  Well, the short answer is that it's just like a business coach, except it's limited to issues and activities in raising capital.

The long answer is obviously longer.  All businesses use capital in the conduct of their operations.  Many, if not most, businesses have a need for capital that exceeds what they have.  They can obtain the capital they need by earning it or by raising it. 

I help raise capital for businesses and projects of charities and government agencies.  When I coach, my clients raise the money and I support them with advice, mentoring, analysis, networking, introductions and instruction. 

Even if you have raised capital before, unless you are raising capital using the same type of transaction from the same capital source, you may benefit from coaching. 

Most people are familiar with loans and equity investments from banks, angels and VC's.  These options represent only a small percentage of available options that may not be available or if available are too expensive.  I can show a client alternatives and select the source of capital and type of transaction that will best match their business strategy.

Raising capital has been described as a 'contact sport' - to find a qualified investor requires a seemingly endless list of contacts.  I have been working in the capital industry for 35 years and I am a Director of the Colorado Capital Congress where I am working with other civic leaders to improve the capital eco-system for Colorado.  My network is large and I can make introductions.

I have found the biggest challenge to raising capital is knowledge.  How does one get ready to receive capital? How does one tell their story?  To whom should their story be told?  How does one price their business?  How does one structure and negotiate a deal?  All questions that need to be answered.  I teach methods, techniques and processes for designing, developing and conducting a capital campaign.

Finally, a cash investment is not the only way to obtain capital.  Money can be obtained through grants for research (monetizing the startup), from an exchange of products/services (barter), or from negotiating with vendors or distributors (strategic partnerships), or selling off a secondary market application (licensing).  All of these activities get the job done in securing the resources needed to start and grow a business.  My broad experience in technology commercialization and product development has shown me many ways to obtain capital that are not found in any books.

So, the goal of capital coaching is to obtain needed capital.  Anything and everything that needs to be done to attain this goal may be a topic of capital coaching.