The average entrepreneur fails to raise capital for their start-up or early stage company for any one of the following 15 reasons:
- The entrepreneur does not properly assess his/her personal capital contact—e.g., investor—environment in the beginning stages, in order to tailor the securities offering to meet that particular market demand, i.e. doesn’t do his or her research.
We suggest you and your management team “test the waters” by contacting only potential investors with whom you have pre-existing relationships. These would include pre-existing “personal & professional” contacts to see if they might be interested in your idea, investing in company and if they have investment funds available, before attempting a capital raise.
- The entrepreneur spends too much time, money, and effort soliciting the wrong sources of capital.
At any stage of your company’s existence, we suggest you only negotiate from a “relative position of strength.” In other words, ensure that any prospective investor, who you approach with your company’s securities offering, needs the deal more than you need that particular individual’s capital investment. In the beginning stages of your Company’s existence, you are working from a relative position of weakness when approaching strangers (i.e., venture capitalists, angels or investment-banking firms) and a relative position of strength when approaching personal and professional contacts that already know and trust in your ability to get the job done. You should consider professional sources of capital only when your Company grows and expands through internally generated revenue…and only to the degree that you maintain a relative position of strength.
- The entrepreneur seeks too much or too little capital for the company (or project) during the first round.
Your five-year operational plan should be geared toward raising the minimum amount of capital necessary for each step, in a series of subsequent financing rounds or securities offerings, but not so little that investors don’t take you seriously. There is an optimal capitalization amount that you can discover within the Corporate Engineering Conservatory™, but suffice it to say that $500,000 to $1,000,000 is normally an appropriate amount for seed capital followed by a $5,000,000 to $10,000,000 round of development capital for most operating companies. This strategy accomplishes two very important and strategic objectives: first, it increases the probability of obtaining the desired amount of capital. Second, it allows you to maintain the maximum amount of equity ownership and voting control.
- The entrepreneur puts the proverbial “cart before the horse,” by failing to start the capital-raising effort early enough in the company’s existence.
More often than not, entrepreneurs spend considerable time building their company or developing their project—i.e., intellectual property—with little or no capital, when they should be concentrating on raising capital for future development. It is better to raise capital in the beginning stages, especially when you have your initial personal capital to do it right rather than waiting until you run out of capital.
- The entrepreneur does not have enough personal capital committed to the project.
Most investors want to hear that you have your own money in the deal—i.e., “skin in the game” as the term goes. If you personally do not have considerable capital to contribute, one way to mitigate a possible objection is arranging for your management team to sign personal guarantees for debt financing or bank loans—if the company is bankable—or have friends and family members finance the deal. Somehow, you need to show investors that you have far more to lose than they do, if your Company fails.
- The entrepreneur does not communicate a clear strategy or “game plan” for the use of proceeds of the capital raised.
This is solved when conducting a securities-offering to raise capital, as you must provide a detailed, GAAP compliant Sources and Uses statement as your required Estimated Use of Proceeds disclosure when conducting a securities offering. This is mandatory for Regulation D compliance (all subsections of this exemption from SEC registration), as well as all registered offerings.
- The entrepreneur does not provide an estimated Internal Rate of Return (IRR) or Return of Investment (ROI) analysis for potential investors.
Most investors are already well aware of the possible downside, which is a 100% loss of their investment in your Company. That’s simple math. However, most investors want to know what their potential rate of return on investment (ROI) will be if things work out as planned. Rarely are these estimated ROI figures provided—i.e., an Internal Rate of Return analysis—in most business plans or securities-offering documents. If, on the rare occasion, the IRR & ROI figures are provided, the pro forma financial projections most often are not GAAP compliant, subjecting the estimated IRRs to gross errors. GAAP compliancy is a mandatory requirement if you are including pro forma financial projections in for your company’s securities-offering documents.
- The entrepreneur does not provide a forward position on liquidation rights for investors…in case of business failure.
It’s wise to show investors that if your company fails, they come first on asset rights, or at least ahead of you and your company’s founders, in the event of bankruptcy and forced liquidation of assets, even though the assets may not be worth very much. The assets may grow in value mitigating financial risk over time as the original financial structure with lien rights would still be intact until the securities are payed off or redeemed. This is easily done with hybrid securities, such as; convertible notes, convertible bonds, and or convertible preferred equity.
- The entrepreneur attempts to collect a capital investment from an investor, using only a business plan.
Using a business plan to attract individual investor capital rarely works and if done incorrectly, it can be very dangerous, as it may be in violation of US securities laws. This happens more often than you may think. You may ask, “But what are the consequences?” The consequences are far too numerous to mention, but suffice it to say you would have to refund the money to your investors (at a minimum), pay fees and fines, and most likely the entrepreneur would be prohibited from using securities to capitalize any company, as a principal, for a period of five years.
- The entrepreneur does not assure or guarantee an exit strategy for the investor.
Although an IPO or an outright sale of the company (or its assets) may be a nice approach to an exit strategy, it certainly cannot be guaranteed or even remotely assured in most cases. Therefore, this approach is largely unrealistic and real investors know it. A structure must be put in place that allows investors to get their investment principal back—in a relatively short period of time with a strong probability of occurrence—while enjoying some upside potential over a longer period, if they so choose. This is easily done with hybrid securities, such as; convertible notes, convertible bonds, and or convertible preferred equity. Convertible notes work best or callable preferred equity as a close second choice. The exit strategy of the investment is the most important aspect for the investor, and it can easily be guaranteed due to the nature of the security that matures, such as; convertible notes or convertible bonds. Although a Call Protection Date ending in 4 or 5 years is not an assurance of investment principal return, with proper illustrations in GAAP compliant pro forma financial projections, one can pose the Call being exercised with the pay-off of convertible preferred equity at the end of the Call Protection Date.
Essentially, for any company, there are no guarantees on an effective exit strategy as a whole, so we use hybrid securities that enable an investor to exit from the investment without the need for an entire sale of the company.
- The entrepreneur does not have a solid management team.
If you have yet to build your management team, do what you can to put together a contingent management team, if you have not already done so. In the securities-offering document, include the relevant biographies and designated responsibilities for each management-team member that has signed and dated and executive compensation agreement. This can be a bit of a catch 22. If the arrangement of your management team is contingent upon financing, it is wise to ensure it with signed contingent-commitments letters from each potential management team member before you include their backgrounds, biographies, and responsibility statements in a securities offering document.
Otherwise, it could be construed as securities fraud in a securities-offering document—a very bad thing, indeed.
- The entrepreneur requires too large of a minimum initial investment per investor.
Consider allowing as many investors as possible into the deal, with relatively small amounts of capital per investor, without going to extremes. In most cases, it may be better to have 100 investors in your deal with a $5,000 investment per investor (totaling a $500,000 equity raise) than it is to have 5 investors in at $100,000 each. The reasoning for this is most investors can “take a flier”—e.g., risk a small amount of their investment portfolio—with a small amount of money. An additional benefit to this tactic is that rarely will an investor constantly bother you over a $5,000 or $10,000 investment, whereas a $100,000 investment may necessitate attending to constant inquiries, concerns or further unwanted investor involvement in your Company. In addition, today you can now have many more investors in your deal, with relatively small investment amounts, before you must report to the SEC as a publicly traded company. A provision within the JOBS Act of 2012 allows you to have up to 2,000 investors (plus the number acquired under Section 4(a)(6)-Regulation Crowdfunding) in your Company’s securities offering before you are required to become an SEC-reporting company. Previously, it was only 500 investors participating in your securities offering before you would be required to become an SEC-reporting company—so there is some relief here. Becoming as SEC-reporting company comes with many compliance issues that can become too burdensome and grossly cost prohibitive for most small companies, so it is best to stay under the two-thousand-investor limitation or delay the reporting process as long as possible.
- The entrepreneur does not allow ample time for raising capital.
Like most business objectives, raising capital may take longer and cost more than you originally thought—no matter how you go about it. We advise our portfolio companies to plan on a minimum of six months to one year, depending on the following: the amount of capital sought; the history and general nature of their company; as well as the number of potential pre-existing-investor contacts of the company’s management team. I have yet to meet an entrepreneur who did not need all the capital they are seeking…“yesterday.” Almost all entrepreneurs state that if they “don’t have the money to act now, the opportunity will be lost.” Well, that’s life…and as an investor—if you approached us in that manner—we would run. Do yourself a favor; do not bind yourself or your Company to “an opportunity.” That is not a reliable plan for business rather a speculation in outcomes…and real investors do not speculate—they invest for the long haul, meaning 5 to 7 years. In addition, many factors can affect the timing of a capital-raising effort, so plan on a longer time horizon than a shorter one.
- The entrepreneur does not have enough seed capital dedicated to the capital-raising effort.
Like any type of product launch, it takes promotional dollars to raise capital effectively. You need seed capital to promote the attainment of your development capital. If you do not have seed capital, raise it through a seed-capital securities offering, first. The seed capital is riskier by design, so the structure of a first- or second-lien debt position with a two- or three-year maturity should mitigate some of that risk…and, therefore, attract seed capital.
- The entrepreneur does not have the proper corporate governance in place.
It’s all about the legal and accounting paperwork that normally an attorney and CPA should be handling, but most entrepreneurs put it off or handle it themselves—incorrectly.
The vast majority of the entrepreneurs who contact us either: 1) want us to invest; or 2) want us to find investors who will fund their company or business project. We have two VC Funds specially created to fund start-ups and early stage companies. We also have many relationships with institutional investors who will have an interest in providing funding…when your Company is ready. However, for most start-up and early stage companies, it is futile to make an attempt at raising substantial amounts of capital from institutional, professional or even passive investors, until you’ve properly mitigated all risks through proper corporate engineering. Most entrepreneurs do not want to face this fact, and they continue to “bang their heads against the wall.” If you want to get serious and be ready to approach any investor, we have created the Corporate Engineering Conservatory™ as the utility for delivery.