Accredited Investors
It's important to understand that you can sell stock only to accredited investors. An accredited investor is presumed, by the SEC (Securities Exchange Commission) to be sophisticated enough of an investor to purchase high-risk stock in startup companies. The SEC's test for an accredited investor is that it is someone with either:
* A net worth of $1 million or,
* Income of at least $300K for each of the past 2 years
One loophole: an officer of your company is assumed to be an accredited investor for the purposes of purchasing stock in your company. So if you want to sell Aunt Maude stock, and she doesn't otherwise qualify as an accredited investor, you could make her an officer of the corporation (but it's not really a recommend tactic.)
Equity vs. Debt
When you're a startup that hasn't received any funding and doesn't have much if any revenue, it's unlikely that you'll be able to get much financing in the form of debut. The typical bank won't touch you. But there are some important exceptions.
You may be able to finance furniture, computers, and other equipment through a leasing company. They buy it and lease it back to you. That beats writing the check up-front.
Another debut option is the convertible note. Often, when getting investment from angels, it's best to take their money in return for a note which converts to stock as soon as a significant funding event takes place with one or more venture capital firms. The advantage of a convertible note is that it puts-off the need to determine a valuation of your company until later. When a VC decides to invest, the VC will decide on the valuation. The angel's note then converts to stock at the same price as the VC gets. Since the angel is investing earlier than the VC, the angel is actually taking on more risk than the VC. Because of this, the convertible note often includes "warrants" giving angel the right to purchase additional shares. That basically provides a "kicker" for the angel, compensating the angel for taking on higher risk. Your accountant or lawyer can fill in the details.
It's a Sales Process
Convincing people to invest in you company is a sales process. This is good practice for the stage when you sell a product or service to customers, because the principles are the same.
The "prospects" in this case are not users of your product or service; they are either venture capitalists or angels (high net worth individuals who invest in high-risk startup ventures).
There are, of course, many books written on sales. But to keep things simple, a sales process requires that you:
* Generate awareness (that's called Marketing)
* Develop the right sales tools
* Qualify your customers so you don't waste time on unqualified prospects
* Understand your customers needs before you the first meeting
* Get the first meeting
* Generate enough interest to get the second meeting
Generate Awareness
If a prospect (in this case an investor) has heard about your company before (somehow, in some way) then the odds of them agreeing to meet with you are much greater. That's where marketing comes in (and introductions, which are covered in "Getting the First Meeting".)
Start a "Friends of <your company>" distribution list. Start sending regular (perhaps monthly) email updates to that list. Every time you connect with a prospective investor (or someone who might know prospective investors) add them to your distribution list. This is a simple method of generating awareness.
Public Relations (PR) is another route to awareness. There are times when it makes sense to be in stealth mode. But consider the idea of doing press releases when you have significant accomplishments. These can also be mentioned in your regular update email to "friends".
Sales Tools
You need sales tools that are appropriate to the target audience. By sales tools, we primarily mean:
* Your business plan
* Your investor presentation
* Your "industry expert" references
* Your customer references
* Your strategic partner references
"Appropriate" means that you need to remember that most investors are business oriented (i.e., Return on Investment oriented) and are not that technical. So if, for example, your presentation is a technical discussion of how wonderful your product is, it probably will not be that effective in generating investments. The investor presentation (and the business plan) are discussed in more detail later in the Roadmap.
Yes, you do need references. If you can get credible references (customers, industry experts, strategic partners, etc.) then your odds of getting funding are significantly increased.
Customer (Investor) Qualification
You wouldn't (we hope) waste time selling a product to a person who clearly didn't need or want it. The same goes for investors. Whether they are Venture Capitalists of Angels, the questions include:
* Are they interested in investing in the market or the technology that you a
addressing?
* Have they made any investments that relate to your market?
* Have they made any investments in Oregon?
* Have they made any investments at all recently, or have they gone quiet?
VCs these days have web sites that generally provide some insight as to what market segments they target and what actual investments they've made. You're hit-rate will be higher if you focus on investors that have invested and want to invest in your space. So do the web research. In the case of angels, you'll have to network to ask-around about people who are interested in your space.
Qualification continues when you get the first meeting. Ask questions.
* How large is their current fund?
* Is there still room in the fund for new investments, or is it largely
committed? (Investors must allocate a significant part of their
fund for the follow-on rounds that their portfolio companies require,
so if their fund is mostly spent, the rest is probably already allocated
to existing investments.)
* How does their process work for evaluating investments?
(Understand what steps they go through, and how long it typically takes.)
Develop and Manage your Investor "Sales Funnel"
Like any sales process, as you learn about (and qualify) prospective investors, you'll want to add them to your sales funnel and begin to work them through the sales process (e.g., do your homework, find a way to get an introduction, send them the business plan executive summary, ask for the first meeting, etc.)
Be Prepared
Before going in to present to a venture firm, be sure to do your homework . You'll have significantly more credibility if you are familiar with their investment strategy and existing portfolio companies when you go in to the presentation.
Dress professionally. You want to make a good impression!
Follow Up
After meeting with a prospective investor, don't sit around waiting for the phone to ring. Follow up. A thank-you note or email is good. And ask to take the next step. (Of course, you'll know the next step, because you asked them about their process when you met with them...)
Syndicates
There are advantages in having multiple investors (a syndicate). If nothing else, it means you have "more checkbooks around the table" for future rounds. There is an interesting article on the Miller Nash web site that suggests that a strong syndicate increases your odds of success (Why Syndicates Matter).