Capital is the lifeblood of a growing business. In an environment of global recession where cash is king, no growing company I have ever met or worked with seems to have enough capital. One irony is that the creativity that company leaders typically show in starting and building their businesses seems to fall apart when it comes to the capital-formation process. Most companies start their search without really understanding the process.
Virtually all capital-formation strategies revolve around balancing four critical factors: risk, reward, control and capital. You and your source of investment will each have ideas as to how these factors should be weighted and balanced. Once all parties have agreed on these key elements, you’ll be able to move forward with the deal.
Risk: The venture investors want to mitigate their risk, which you can do with a strong management team, a well-written business plan, and the leadership to execute the plan.
Reward: Each type of venture investor may want a different reward. Your objective is to preserve your right to a significant share of the growth in your company’s value, as well as any subsequent proceeds from the sale or public offering of your business.
Control: It’s often said that the art of venture investing is structuring the deal to have 20 percent of the equity with 80 percent of the control. But control is an elusive goal that’s often overplayed by growing companies. Venture investors have many tools to help them exercise control and mitigate risk, depending on philosophy and their lawyers’ creativity. Only you can dictate which levels and types of controls may be acceptable. Remember that higher-risk deals are likely to come with higher degrees of control.
Capital: Negotiations with the venture investor often focus on how much capital will be provided, when it will be provided, what types of securities will be purchased, and at what valuation, what special rights will attach to the securities, and what mandatory returns will be built into the securities. You must think about how much capital you really need, when you really need it, and whether there are any alternative ways of obtaining these resources.
Another way to look at how these four components must be balanced is to consider the natural tension between investors and growing companies in arriving at a mutually acceptable deal structure.
There are certain key characteristics that all investors look for before committing their capital. Regardless of the economy or what industry may be in or out of favor at any given time, key components of a company must be in place and demonstrated to the prospective source of capital in a clear and concise manner. These components include: a focused and realistic business plan (which is based on a viable, defensible business and revenue model); a strong and balanced management team that has an impressive individual and group track record; wide and deep targeted markets that are rich with customers who want and need (and can afford) the company’s products and services; and some sustainable competitive advantage, which can be supported by real barriers to entry, particularly those created by proprietary products or brands owned exclusively by the company.
Finally, you should expect some sizzle to go with the steak. That may include excited and loyal customers and employees, favorable media coverage, nervous competitors who are genuinely concerned that you may be changing the industry, and a clearly defined exit strategy that allows your investors to be rewarded for taking the risks of investment within a reasonable period of time.
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This content may have been developed with IBM funding. Regardless, this work represents the view of the author and does not necessarily represent the view of IBM. Although the content may utilize publicly available material from various sources, including IBM, it does not necessarily reflect the positions of such sources on the issues addressed in this content.