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How to Best Finance a Start-Up

If location, location, location is the key to success for a retailer, the key to success for a start-up is money, money, money. The experience of many entrepreneurs shows that even the most technologically exciting company with a fantastic team and management, will make little progress, let alone be a success for its founders, if it has failed to organize sufficient financing at the critical moment. This is a sad truth, or a happy one, depending on which side of the banknote you are.

The good news about money, is in contrast to technology, is that you are dealing with a problem that everyone has faced rather than one that no one has been able to solve before you. You do not have to wait for inspiration in a dream or in the shower, in contrast to the technological solution, money is definitely out there. The only question is how to get it.

Four experts in fundraising from different sources met to support the winners of the “Globes”-Bank Hapoalim (TASE: POLI) smartup2 competition in their search for financing: Eran Barkat is a partner in BRM Capital and a partners in the 8200 EISP accelerator program; Yossi Moldawsky, a joint general manager of Moldowsky Group a diamond company that also owns micro-fund and the incubator Plus Ventures and Explore.Dream.Discover.; Gil Brandes, a partner and head of the high tech practice at the Naschitz Brandes Amir law firm, who serves as chairman on behalf on investor and entrepreneurs. Brandes is also involved with 8200 EISP, Explore.Dream.Discover., and the Nielsen Innovate incubator, which is advising the smartup2 winners.

Who to ask, and for how much

“The prominent trend in current fundraising is personal money,” says Brandes. “I am now seeing more people prepared to draw on their savings or take loans, and fewer people relying on friends and family as investors. After 20 years of active and accelerating entrepreneurship in Israel, people are ready to risk their own money.”

After personal savings, it is possible to approach incubators, accelerators, or Chief Scientist programs, such as Tnufa, which provides NIS 100,000 to very early stage ventures, and various binational programs. “Something that is mentioned, but I see little of, is crowdfunding,” says Brandes. It isn’t very attractive for a real start-up because you have to recruit a great many people to raise money and that is almost a mission impossible.”

After utilizing these sources, most entrepreneurs naturally think about venture capital funds, but this is not always suitable at this stage. “It’s very important to adapt the approach to the stage and kind of company,” says Moldowsky. “If you come to an incubator or seed fund like ours with a request for $3 million, we won’t look at you because the investment is too big for us. If you go to Barkat with a proposal to raise $750,000, he probably won’t look at you because the investment is too small for him.”

How do you decide how much money the company needs? “The company should think what it will need until the next financing round, and to achieve that it must show progress and reach targets on what we call ‘key performance indicators’ or KPI,” says Barkat. “I classify them in four categories: financial targets, such as, ‘I want to reach $1 million in sales.’; marketing targets, such as, ‘I want two big customers and four small ones’; human resources targets, such as ‘I want to hire a professional CEO and have 30 employees’; and technology targets, such as, ‘The product’s next generation will have the following feature.”

The targets chosen should be presentable to the investors of the next stage, so there is a likelihood that they will invest in the company. Keeping a safety cushion is common practice, because you always need more than you think. “With the amounts raised at us, I suggest a safety cushion of 50%; in other words, if you need $500,000, ask for $750,000,” says Moldowsky. Barkat adds, “A reasonable margin at the amounts we provide is 15-20%. If you want to raise $3 million, ask for $3.5 million.”

The experts suggest presenting a detailed business plan that includes reaching these targets and the next financing round, and to outline the company’s vision more amorphously, because investors are quite indifferent to Excel tables that show rapid linear growth with infinite potential. They have not seen a start-up act in this way (not even Check Point Software Technologies Ltd. (Nasdaq: CHKP) BRM’s amazing investment, which closed a $500,000 seed round for half of the company.

How to reach investors

How do you create opportunities to meet these investors? “I suggest to first approach investors you can contact directly, via their website or a mutual acquaintance, because every investor likes to feel that he is unique and special, and that you’ve come specially to him,” says Moldowsky. “There is also the option of making contact through a mediator. If a familiar and trusted person calls an investor and tells him to pay attention to a particular start-up because it’s very interesting and especially suited for him that will definitely get his attention. In contrast, there are mediators who send the same email to all their contact persons. That’s a legitimate way to spread the news, but its disadvantage is that if you personally approach the investor later, he’ll say, ‘They approached everyone and failed to raise money. What’s going on?”

“Many angels have already developed a very organized filtering system,” says Brandes. “For example, Guy Gamzu’s website has a request form to make contact. If the request is interesting, there will be a 15-minute interview via Skype, not because that’s cool, but because its saves him and the entrepreneur time. Today, even if I tell him about a company I saw, he might tell me, ‘Tell them to contact me through the website.’ In contrast, it is now very hard for a new company to get a meeting with a venture capital fund, and a mediator might not be able to help.”

When the relevant investors have been found and a contact strategy has been established, “it’s best to work in parallel and not in sequence,” says Moldowsky. In other words, don’t wait for a rejection from one investor before approaching the next; approach them all more or less simultaneously. “In this way, you get the picture of what the market is offering you all at once. If they are fighting over you, you can bargain. If there is little interest, you should take what you can get.”

“If you nonetheless arrange your approaches sequentially, you should not first contact the most desirable fund, but the less well known or less relevant fund to get feedback from it that you can immediately apply in your presentation and be better when facing the fund you really want.”

It’s important in this context to note that one fund’s feedback is not necessarily relevant to another fund, which has different tastes, goals, and investors. An angel investor might have completely different tastes. For this and many other reasons, it is very important to do your homework. Get to thoroughly know the party you’re talking with. It’s easy to know from the website about each investor, his portfolio, media interviews, and exactly what he is seeking. As for the person you’re meeting with, find out his background, if it’s in technology or finance, because that will probably determine the focus of his questions.

A letter to an investor should be 1-3 pages long, with a presentation either appended or kept back for the interview.

Meeting the investors

“The presentation to investors should start with the important question, ‘What is this,’” says Barkat. It’s important to realize that when presenting to an investor, in contrast to a customer, that your competition is not against rivals in the market, but against every other start-up that he sees.”

Moldowsky concurs, saying, “Start with the most impressive thing. If you have an amazing team with experience, start with the team. If you have breakthrough technology, start with the technology and explain why it will capture the market. If the market potential is huge and you’re in a good position to exploit it, explain this.” He adds that if there is a product or even a product mock-up, it’s better to explicitly present it than to use only a video. “It’s important to be honest and open with investors. If there is a problem, don’t whitewash it. If there is competition, present it, even if you’re not sure that it is direct competition. That is better than the investor discovering the competition later, when you’re not around to explain that it really isn’t a competitor.”

“There are also filtering questions,” says Barkat. “For example, a venture capital fund might ask you if you would sell the company for $30 million? A venture capital fund wants to know that you’re synchronized with its own interests to build a big company. If the entrepreneur begins to stumble over these questions that’s a problem.”

“In general, every investor must know that the company is synchronized with its interests,” agrees Moldowsky. “All in all, I am investing money in his vision and then I’ll make money on it. He is building the company, he is planning its future, he is the company’s face in the next financing rounds. When I put my money on him, I must know to the best of my ability that he is working in a way that will benefit me.”

The opposite is also true. “It is important to choose an investor who will not prevent you from moving forward,” cautions Brandes. “For example, I was presented a company in which one of the early-stage angels fought too much to prevent dilution. He even opposed the allotment of employee options. Such an investor can torpedo subsequent deals, and it’s important to know this in advance.”

“After the meeting, we don’t forget you, especially those we’re interested in,” says Moldowsky. “We try to call back everyone within a reasonable time, but if we didn’t call back for some reason, you can understand the answer. There are entrepreneurs, and I’m not exaggerating, who call five times a day. If we’re deliberating that is liable to result in rejection, because in the end, we’re talking about a relationship.” He adds, however, to recommend sending the entrepreneur an e-mail immediately after the meeting.

Barkat estimates the chances of a start-up obtaining investment from a venture capital fund at 0.5-0.7% per interview. The numbers are depressing, but someone will get the investment and it definitely won’t be the person who despairs from the figure Signing the contract

BRM Capital and Moldowsky Group have completely different attitudes towards agreements. BRM has a single fixed agreement that it is the end of the negotiations as far as it is concerned. “We concluded that this was the agreement that is the best for all the parties. We get good feedback from the entrepreneurs,” says Barkat. The only things not predetermined are the amount of the investment and the company value.

Conversely, Moldowsky is proud that his company creates a completely different deal with each company on the basis of the two parties’ needs, and that no deal is the same as another.

As for valuation, Brandes says, “If this is a cash-hungry company, say a semiconductor company, a reasonable valuation is important so that down the road, the entrepreneur won’t be diluted to a faction of a percent in the many subsequent financing rounds. If we’re talking about an app, the amount raised is more important than the valuation, because a single round can be enough to bring the company to much better shape in which it can raise a substantial amount at good terms.”

Brandes adds, “A seed investor will not try to give the entrepreneur the feeling that he is the owner and he won’t try to take control, but will seek a 20-30% stake.” Without control, investors will not cause the entrepreneur to leave the company, unless they team up with one of the other founders. That’s rare, but it does happen, he says.

Brandes says that there are terms in an agreement that might discomfort the entrepreneur, but there is a reason for them. For example, venture capital fund which say that they will take a substantial number of shares from a departing entrepreneur. “It sounds awful, but the fund cannot allow itself to invest in you, just to see you leave and found another venture after a year in the knowledge that that the fund will continue to promote a company in which you own 30%.”

Other conditions that an entrepreneur must grant the investor is the first right to buy shares and to veto a sale if the investor does not see the exit himself. “This angers someone doing this for the first time, and it’s sometimes infuriating, but the question is whether you have a better offer.”

Published by Globes [online], Israel business news – www.globes-online.com – on July 13, 2014

By Gali Weinreb

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