One of the most prevalent mistakes early stage entrepreneurs make is to totally and completely miscalculate the role of venture capital in their business aspirations.  This reality drove me so batty that I created Venture Capital 101, a document that dispels the myths about venture capital, and provides entrepreneurs with a road map for growing their companies. 

EPrairie contacted me about doing a weekly column -- looks like it will be called VC101.  I've reprinted my first column below.  I'll focus on the topic of venture capital, especially as it relates to early stage entrepreneurs.  I’ll detail what characteristics make companies “venture worthy,” while painfully exposing the mistakes that make VCs run for the hills.  This column will look at current trends in venture capital, profile some Chicago-area companies, and get the inside skinny from Chicago-area investors.

Global Entrepreneur Monitor

Speaking of early stage entrepreneurs and venture capital, the Global Entrepreneur Monitor (GEM) surveyed 37 nations, and reported that some 286 million people in these 37 countries are involved with some sort of entrepreneurial pursuit.   I thought some of the numbers in this report made a compelling case for the difficulty and scarcity of venture capital.  Here’s the link to the report if you’re dying have your eyes gloss over:

According the GEM survey, there are:

* 286 million entrepreneurs (in the 37 surveyed countries)

* 20 million entrepreneurs who think their companies might be venture worthy (in the 37 surveyed countries)

* 12 million entrepreneurs representing 6 million start-ups (US only)

And from the National Venture Capital Association we know there were about 3000 companies in the US that received venture capital during 2002. 

These numbers reminds me of a movie where the freshman class is assembled in the gym.  One of the school administrators says, “look at the person to your left, look at the person to your right, only one of you will be here in 4 years.” 

In a similar vein, I invite early stage entrepreneurs to get to know 8,000 other early stage entrepreneurs.  The odds say only one of you will ever receive venture capital.

The big misconception

Let’s look at some of the biggest misconceptions about venture capitalists: the notion that they are degenerate risk takers, have money to burn, and are willing to take flyers on 100 unproven concepts in order to hit one homerun of Microsoft-esque proportions. 

The reality is that venture capitalists are not degenerate risk takers.   They do not invest in early stage (e.g., pre-revenue) companies.  They do not take risk so much as they manage, mitigate, and frankly, avoid, risk.  Unfortunately, too many entrepreneurs do not know this.  Perhaps these entrepreneurs have bumped their heads and they think they live in Sweden.  They seem to have developed a horrible sense of entitlement.

Sense of entitlement + bitter reality = many wasted steps

A “how to be a better golfer” joke made the Internet rounds a few years ago.  The number one suggestion was, “if you want to be a better golfer, go back and start at an earlier age.”  There’s a similar lesson for many entrepreneurs trying to raise funds in the difficult post 9/11 market: “If you want to get venture capital funding, go back and be a better entrepreneur.”

The bitter reality aspirant entrepreneurs need to face is that venture capitalists are returning money to their limited partners.  While venture capital deals are graded on a very steep curve, being the best of a subpar group will not yield investment.  If the choice is investing in lesser companies or returning money to investors, venture capitalists choose the latter.  Many entrepreneurs, especially in the boom time of the late 1990’s, developed a sense of entitlement where they thought if they came up with a novel enough idea, venture capitalists would fund them, sight unseen.  The truth is venture capitalists did not operate this way in the 90’s, and they certainly do not operate this way in 2003.  It is safe to assume they will not operate this way in 2010, 2020 or at any other time in the future.

An entrepreneur who dives into the world of venture capital armed only with a misguided and unprepared sense of entitlement will meet with bitter reality, resulting in wasted steps, for both the entrepreneur and the venture capitalist.

GolfServ

Speaking of golf and realistic entrepreneurs, let’s look at a recent Chicago success story…in the making.  GolfServ, which manages the content for over 200 golf related websites, recently raised $1 million from a group of local angels, including Bill Weaver and Steve Miller.  On a recent Sunday afternoon, Mike Lazerow, CEO of GolfServ, joined my foursome at Pine Meadow Golf Club.  While watching Mike consistently (and annoyingly) hit fairway after fairway, we discussed GolfServ as well as some of his philosophies. 

Mike is an experienced business builder who knows the ups and downs of entrepreneurship.  While still in college, Mike started University Wire, which eventually merged with Student Advantage.  The company, trading under the symbol STAD, went public in June 1999 at about $8 per share.  Over the next 6 months STAD rode the NASDAQ wave, eventually peaking at almost $30 per share (or almost $300, adjusted for splits) in December 1999.  All good things end, and STAD has come back down to earth, and despite almost $60 million in revenue, the stock languishes in penny stock territory, and currently trades over the counter.

Having seen the ups and downs of entrepreneurship, Mike is imbued with a healthy sense of reality.  He knows GolfServ’s current business model, which is heavily dependent on ad sales, is not a “venture worthy” deal.  A revenue model driven by ad sales is heavily dependent upon hiring more and more people who can only be expected to produce at a certain level.  It is difficult to get higher and higher levels of production from each person because there is a finite amount of time in every day, every week, every month.  People can only make so many calls in a given workday.  There is little or no scale in this model, and as such, VCs tend to avoid these kinds of deals.

Mike knows this, and he isn’t planning to look for venture capital.  Instead, in what should be lesson #1 for all entrepreneurs, he is concentrating on building a business.  Mike the realist knows GolfServ’s current revenue potential might be a $10 million a year business.  Nothing a VC would consider, but not bad for a privately held company.  Let’s face facts: the CEO of a profitable $10 million a year company will live a very nice lifestyle, there’s nothing wrong with this goal. 

Telling, there’s more to GolfServ’s story than an ad driven business.  In February 2003, GolfServ introduced an on-line subscription service, and in June, the company will unveil various enhancements.  For $30 per year, golfers will be able to keep their handicaps on-line.  GolfServ current has about 10,000 paying members, and hopes to have 40,000 by year-end. 

This model becomes the type of thing that scales, and VCs find interesting.  Do the math: according to Mike there are about 26 million golfers in the US.  For every one million golfers who sign up for the service, GolfServ will generate upwards of $30 million in revenue.  Instead of relying on advertising sales, GolfServ will utilize what I call the “customers sitting in their underwear buying things at 3 am” business model.  Any revenue generated from ad sales will be gravy on top of a very dynamic (and profitable) business.  Smart.  

“Do one thing well”

After watching Mike hit a couple of 50-foot putts to within “gimme” distance (for pars), we talked a little about some of the other things he does well.  Not surprisingly, Mike is a big proponent of the “do one thing well” philosophy.  GolfServ isn’t trying to be all things to all people.  The company GolfServ is focused on one thing: being the preeminent on-line resource for golf.  As Mike says, “we want to be the Yahoo of golf.”

My VC101 columns were published on ePrairie.com and written in the wake of Venture Capital 101, a self published ebook about venture capital.  Send me an email, bill@billsnow.com

Online investment news sources seem to be flooded lately with articles aimed at determining whether or not a deal is venture worthy. And, more often than not, these articles tend to focus on those opportunities that are not ready for funding. On a more optimistic note, I felt it would be beneficial for our readers to provide some tips on how entrepreneurs can be prepared, should they receive that long-awaited call back from a VC, investor, agent or investment banker.

1. Do Your Homework

Before you send out your plan out, narrow your search to logical investors. Raising capital is not necessarily a numbers game; it’s a quality game. Learn what recent deals a VC firm has invested in, and make sure your investment matches the criteria of targeted VCs. 

Because most VCs will not review plans “tossed over the transom,” you need to utilize every connection you have. Attend as many industry events as possible, and if warranted, engage top-tier legal and accounting firms, as they are often conduits for venture firms. Hiring an agent to assist with your capital raise is often a good idea, as the fee charged (usually under 10 percent) is well worth the doors the agent can open. If you feel these fees are excessive, keep in mind that IPO underwriters are usually paid seven to eight percent. It is merely the cost of doing business.

2. Know Who Has a Copy of Your Plan

If you do not immediately recall the name of the investor or VC firm you’ve sent your plan to, this often means you are sending the plan to everyone. This will give investors the impression that you are not serious about your proposal and that you are hoping the quantity of your business plan submissions will make up for the lack of quality in your preparedness. It won’t.

3. Provide Direct Answers to Direct Questions

A frustrating and infuriating situation is dealing with someone who cannot, or will not, answer direct questions with direct answers. Entrepreneurs are often so excited to receive a call back that they inadvertently leap 10 steps ahead and try to answer questions before they are asked -- often at the expense of not answering the original question. Learn to listen carefully and provide precise and full answers. 

Failure to provide direct answers may also give the investor the impression that the entrepreneur is hiding something. Your answers should be a reflection of your current business situation -- not what you hope your business will look like in one, three or six months. A projection is an estimation, and everyone knows projections are not worth much. Actual results are gold, and these results will be the basis for the valuation of your company. To commingle these separate worlds means you risk confusing and insulting a potential investor. 

If you tell a VC that this year’s sales will be $2 million, this should mean you’ve already booked $2 million, or that you have a reasonable expectation of achieving those numbers.  For example, a reasonable expectation of achieving those numbers would mean you’ve booked $1 million in sales for the first six months of the year, and you have a strong sales pipeline with more than $1 million in pending sales. It is unreasonable to say you will generate $2 million this year if you’ve only booked $100,000 through the first nine months of the year. Do not blur the distinction between talking to sales targets and actually booking sales. Provide accurate and honest answers, and do not embellish your results.

4. Memorize Your Deal Facts

During the call back, you should be prepared to answer the following questions -- clearly, concisely and comprehensively. Commit your answers to memory and rehearse them often. The answers to these questions should roll off your tongue in a very fluid and natural manner. 

What is the value proposition for the investor?

What makes your deal different?

Who are your competitors and why are you better? Why are you going to win?

·         What is your revenue model and what is your current revenue run rate?

·         What events will positively or negatively impact revenue?

·         How does the current business/political environment affect your business? Will your opportunity benefit, suffer or experience no real impact? And, why?

·         What is the ROI for your customers?

·         How do your customers measure the results of your product?

·         What is your sales cycle? What is the length of time from identifying customers to receiving a signed contact?

·         What is the average cost per unit?

·         Where does this funding round get you? (Breakeven, cash flow positive, etc.)

·         What were your sales last year?

·         What are this year’s sales?

·         How much money has been invested?

·         Who are your investors?

·         What is your burn rate?

If you cannot provide direct and simple answers (i.e., three sentences or less) to each of these questions, you still have some homework to do. Beyond rote memorization, you need to make sure your answers sound natural, not “canned.”  Investors are not going to be patient or give you the benefit of the doubt. Failure to provide direct and complete answers means you are unprepared, and your deal is not venture worthy. 

Special thanks to Jerry Hug, vice president, Redwood Partners, New York City, and Michel Feldman, partner, D’Ancona, Chicago, for helping with the preparation of this article. 

I wrote this column during another life…when I worked for Vcapital.  Send me an email, bill@billsnow.com

Never mind the pessimists...it's a great time to start a business!

Let’s take a quick scan of some of the thoughts, ideas, and observations being permeated in the media and in networking circles: Things look bad, dark, dour, and downright awful.  The economy is slow.  Unemployment is climbing.  High paying IT jobs are going to India and China.  The stock market is down.  IPOs are almost non-existent.  The venture capital industry is one fifth (or is it one sixth?) the size it was in 2000. VCs are not investing.   There’s too much ambiguity in the world: Al Qaida still scares me, the Iraq situation is still going on, we now have a situation in Liberia, and to top it off, Madonna is thinking about making another movie!  By golly!  It’s never been worse!  What an awful time to be an entrepreneur!

Actually, it sounds like a great time to start a business.

I admit it; I have a strong counter intuitive streak in me.  I’m often drawn to people and ideas that run contrary to what the New York Times, MTV, and the network news tell us.  This counter-intuitiveness reared its head in early June at the MIT forum, where I watched a few VCs and entrepreneurs discuss the state of private equity.  One of the panelists mentioned that there is no correlation between companies being started in boom times and long-term success.  Apple and Microsoft got their starts and rose to prominence in the late 70’s and early 80’s, hardly a go-go economic time.  For every eBay, there are dozens, if not hundreds, of failed on-line-dotcom-B2B-ASPs that were launched in the late 90’s, widely considered to be a go-go boom time.

In other words, whether the general economic climate is fraught with optimism or pessimism, entrepreneurs go about their business of building businesses.  I am convinced that somewhere in the current pessimistic morass lurks another Bill Gates, Steve Jobs, or Larry Ellison, silently going about his (or her) work in optimistically paranoid anonymity. 

Optimism vs. Pessimism

Yes, I said, “optimistically paranoid anonymity.”  Another MIT panelist essentially noted that entrepreneurs and VCs are two sides of the same coin: they are both optimists.  Entrepreneurs tend to be paranoid optimists (“This is the greatest thing in the world, it’ll make me a billionaire…will you sign this NDA?”), while VCs tend to be skeptical optimists (“I hope this new deal is all that the entrepreneur claims…but I doubt it.”)

This paranoid-skeptical continuum is important to note, because 1) you have to avoid mixing these sundry parts and winding up with a skeptical pessimist, and 2) both entrepreneurs and VCs are cut from the same cloth: they are both optimists at heart.  But optimism can only get you so far.  There comes a time when you have to move beyond theories and talk about concrete steps to building a business.  With this in mind, let’s look at a few resources that should be known to every Chicago area entrepreneur.  Given my love of paradigms and accounting, I’m going to utilize the cash flow statement to make my points.

How entrepreneurs can build businesses using Bill’s Cash Flow Paradigm

Much like Gus Portokalos, the father in “My Big Fat Greek Wedding” who bores friends and family members with his line, “say any word, and I'll tell you how the root of that word is Greek,” I bore friends and family members with my line, “describe any situation, and I’ll tell you how it relates to a cash flow statement.”  Need to know why your kids are such potty-mouthed punks, or why the dog messes in the house?  I’m sure I relate it to the cash flow statement.

For this column’s purposes, let’s stick with entrepreneurial matters.  Entrepreneurs should look at every service provider, advice giver, hanger on, government agency, funding source, family member, etc., and think of how each of these different parties relates to the cash flow statement. 

Investing section

I know it sounds tantalizingly close, but the investing section does not refer to how much someone is investing in the company.  Instead, this section details how a company is investing in itself, that is, where is the company spending money?  OK, I know I’m blurring the lines here a little bit, because spending money on IT services, legal work, accounting, etc., technically doesn’t show up in the investing section of the cash flow statement, but for our purposes, let’s lump all outflows of money into one section. 

Here’s the rub: Any time you talk to an IT sales person, a consultant, an accountant, a lawyer, and so on, this is the section of the cash flow statement you should think about.  With the exception of the Cisco equipment reseller I invited to my last networking event, every service provider will jump at any chance to meet people and laugh at their lame jokes.  Service providers are looking to take your money, which means they will give you the time of day and return your phone calls. 

Is this bad?  Of course not.  Service providers of all stripes play an extremely important role in the development of any company.  But entrepreneurs, especially early stage entrepreneurs, should limit the time they spend with service providers.  You can’t spend money until you have money, therefore early stage entrepreneurs should focus on obtaining money, and that leads us to the next two sections.

Financing section

This section refers to how money is raised, either by selling stock or issuing debt.  Unfortunately, for many entrepreneurs, this is the only section that they pay attention to.  For too many entrepreneurs, the financing section takes on a life of its own, and becomes an end instead of a means to end.  Instead of raising capital to help build a business, many entrepreneurs only spend time chasing money.  They never actually build a business. 

If you want to play VC lottery and toss your business plan willy-nilly over every transom, here is Yahoo’s comprehensive listing of VC firms.  I don’t recommend this path, but for brave and foolish, there it is.

A better method of raising capital is to focus on the resources that can help you at the right time.  For the very early stage entrepreneur (e.g., idea stage or pre-incorporation) these resources are usually: 1) their own money, 2) friends and family.  One institution that will make “pre-seed” investments is the Illinois Technology Enterprise Center (ITEC).  The state of Illinois is in the process of opening a number of these facilities across the state, the first one is located in Evanston.  In addition to providing funds, ITEC can help guide early stage entrepreneurs through the labyrinth that we call capitalism. 

Once a company is established, the entrepreneur may look to angels or early stage venture funds for the next round of financing.  Some of the notables in the Chicago area include the Illinois Coalition, Northern Illinois Angels, Prairie Angels, and Arch Development Partners.

While raising money is important, don’t let it become your job.  Much like my advice about limiting time spent with service providers, entrepreneurs should actually limit their time with investors.  That’s right!  You heard me correctly.  Instead of making raising money a full time job, entrepreneurs should make something else their main focus.  This “something else” is found on the operating section of the cash flow statement, and in a nutshell you can call it SELLING.

Operating section

The operating section of the cash flow statement refers to how much money the company earns (or losses) due to the actual operations of the business.  Forget about the money raised from selling stock or issuing debt.  Those are short-term solutions, and raising money should never be confused for the main operations of a company.  Can a company fund itself strictly from its operations?  This should be the A #1 lesson taught in all college classes (even English Lit classes), and this be the A #1 goal of every entrepreneur. 

To this end, the Chicago area is fortunate to have a great resource.  One of the numerous goals of the Chicagoland Entrepreneurial Center is to help early stage companies make connections (and sales) with Fortune 500 companies.   For companies with interesting technology that is ready to go to market, I would think a phone call into the Entrepreneurial Center would be a must. 

Basic decorum

Lastly, there are a couple of resources that all Chicago area entrepreneurs should utilize.  Basic decorum is often a sorely missing piece of the early stage entrepreneur’s repertoire.  Both the Midwest Entrepreneurs’ Forum and Arch Development Partners run periodic meetings where entrepreneurs get the chance to present their business plans to a live audience.   The feedback, which is often delivered as a well needed kick in the pants, is just the thing all entrepreneurs need to hear. 

20 years from now

Instead of whining about the current state of the economy and the lack of VC interest, the next generation of Microsofts and Apples are out there selling.  They are solving problems and focusing more on their operating cash flow and less on their financing cash flow.  In 20 years, it will be interesting to look back on the ambiguity and vagaries of these recent years, and marvel that such successful companies were born from such “troubled” times. I’ll bet a number of these companies will be here in Chicago.  In fact, I’ll guarantee it.

My VC101 columns were published on ePrairie.com and written in the wake of Venture Capital 101, a self published ebook about venture capital.  Send me an email, bill@billsnow.com

Raising venture capital is a difficult proposition in any economic climate. But, with the slowdown of the economy and the uncertainty of a post-September 11 world, entrepreneurs currently face more daunting challenges than ever.

To be attractive to possible venture capitalist investment, it is generally accepted that a company must have: 1) a strong management team, 2) impressive technology, 3) a compelling story, 4) existing and scalable sales channels and 5) a previous investment. VCs rarely invest in pure startups in today’s economic climate.

Privately held Sonic Telecom of Chantilly, VA is an international provider of “bandwidth of demand.”  In other words, Sonic offers video conferencing and TV content distribution products. For those of you unfamiliar with Sonic Telecom, if you watch Jay Leno or Tom Brokaw, you are watching these programs (and many others) through Sonic Telecom’s broadband network. This company is a prime example of successful fundraising in a difficult climate.

Find the Right Investors at the Right Time

Despite the impressive resumes of its founders (upper management at various telecommunications companies), Sonic did not go to VCs with a mere business plan; they put up $300,000 of their own money to start the company. Then, angels who previously invested in other telecommunications deals were brought in to finance the second round. Finally, traditional venture capitalists and strategic investors, including Broadwing (NYSE: BRW), General DataComm (NYSE: GDC), MasTec, Inc. (NYSE: MTZ), HSBC (NYSE: HBC) and Saudi Cable, were brought in to finance the third round. 

Have a Hook -- Build Assets and Solve Problems

Sonic’s asset is its network for transmitting broadcast quality digital video through broadband “pipes.” Satellite transmission has a number of limitations: The technology behind the broadcast is analog, bandwidth is limited and sending a signal 23,000 miles into space (and back to earth), even at the speed of sound, results in a slight lag. 

Sonic’s product boasts an all-digital network that provides more bandwidth and, because of shorter broadcast distances, almost completely eliminates lag. Sonic further differentiates itself by charging “by the byte.” In other words, pricing is not fixed; clients only pay for what they use. 

Close Deals, Book Sales

Sonic is able to differentiate itself from many other capital seekers because Sonic has actual, paying customers. In addition to the Leno and Brokaw shows, other Sonic clients include ABC, CNN, CBS, Fox News, Univision, Lifetime and RTL-TV (Germany). If you watched the Democratic or Republican national conventions on Fox last year, you watched them with the help of Sonic’s network.

Compile a World-Class Management Team

The biographies of Sonic’s management team read like a who’s who of industry experts. As a press release explains: “The company’s senior management has extensive experience in telecommunications, having held senior positions in engineering and marketing with MCI, WorldCom (NASDAQ: WCOM), Sprint, (NYSE: FON), Perot Systems (NYSE: PER) and EDS (NYSE: EDS).”  Sonic’s Board of Directors also includes former congressman Joe Kennedy and former Reagan advisor Art Laffer.  

Persistence, Doggedness and Reality

And guess what? Despite all of these impressive accomplishments, Sonic still faced hurdles with its capital raising. With slowing markets, Sonic needed to obtain a $3.5 million convertible bridge loan from past investors to tide it over until the funding round was closed. In July, the round was completed when Saudi Cable invested the last $7 million in a $25 million round. 

Conclusion

Sonic Telecom obviously has a leg up on its competition -- a world-class management team, a scalable product, existing sales and a product that solves a real market need. Sonic’s president and CEO, Todd Ruelle, probably said it best in a recent article: “Specialization fosters success in a competitive environment. Even in today's market, investors appreciate companies that deliver a clear benefit to customers.”

Special thanks to Sonic Telecom co-founder, Santiago Testa, for his assistance with this piece.

I wrote this column during another life…when I worked for Vcapital.  Send me an email, bill@billsnow.com

In today's investment climate, the onus is on the entrepreneur to understand market conditions, to figure out what investors want, and to realistically present their companies. In other words, entrepreneurs must mitigate as much investor risk as possible. For example, take a look at these recent statistics:

·         Venture capitalists are returning money to their limited partners instead of making investments in low quality deals (“Some Venture Capitalists Are Finding It May Be Better to Be Out Than Down,” Wall Street Journal, November 14, 2001.)

·         Less than one percent of venture money went to seed stage companies in the third quarter of 2001. (“Q3 MoneyTree Report 2001,” PriceWaterhouseCoopers.)

·         In 2001 it has taken much more time for companies to close rounds. On November 1, John Kirks from Venture Economics reported, “In today's market conditions, private financings are generally taking longer. Many venture capital firms are advising their portfolio companies that they should enter into a private placement effort braced for a six-month process at a minimum.”

Factor in the virtual shut down of the IPO market and the recent pronouncement that the US economy has been in a recession since March 2001, and we are left with a difficult time to raise money. While the usual venture capital mantra of management team, defensible technology, scaleable sales and proven model are still applicable to today’s capital seekers, entrepreneurs who otherwise have venture-quality deals may unwittingly scuttle their opportunities by proffering financials that break accounting rules or use faulty and unrealistic assumptions. 

While accounting minutia often makes people’s eyes glaze over, there are a number of accounting-based sins that I have recently witnessed -- mistakes that are often “red flags” for investors. 

Understand the Cash Flow Statement

I recently spoke with an entrepreneur who obviously didn't understand the difference between operating cash flow and financing cash flow. He thought selling a product and selling stock were the same -- he booked both as revenue.   Even though this entrepreneur previously raised a few million dollars in a series A round and the company was generating millions of dollars in annual sales, I ended the conversation because of this basic flaw. I was left wondering what other “holes” were in his business skills.

Here’s a quick review of the cash flow statement:

The balance sheet is a snapshot of a company’s assets and liabilities. The income statement shows the profit or loss for a particular period of time. The cash flow statement shows the relationship between the two statements, and it is presented in three parts: Operating, Financing, and Investing.  Operating cash flow is the amount of cash generated from the operations of the business (e.g., selling your product). Financing cash flow shows the inflow or out flow of money due to fund raising (e.g., selling stock). Investing cash flow shows the inflow or outflow of money due to purchase of assets used to run and build the business (e.g. buying a warehouse).

Possess a strong balance sheet before seeking money

Given the fact that closing funding rounds if taking up to six months, companies should have sufficient cash on hand to weather the lengthy process.  While there are always exceptions, companies that are “running on fumes” or worse, have missed recent payrolls, may not have enough strength to attract venture money – they may not be existence in 6 months.  The best time to raise money is when you have money. 

Proper Use of Goodwill

A few months ago I dealt with an entrepreneur who’s balance sheet listed $18 million in goodwill. Curiously, her five-year projections failed to amortize this intangible asset, and nowhere in her plan could I find mention of an acquisition. The entrepreneur was unable to explain the goodwill entry until she conference called her CPA, who told me the goodwill amount was a “plug-and-chug” number created at the behest of the entrepreneur. The entrepreneur’s goal was to create a higher valuation for her company. This situation was “red flag” for a couple of reasons:

1. The entrepreneur failed to demonstrate an understanding of basic accounting.

2. She was unprepared to answer questions pertaining to the plan she “wrote.” 

Realistic Paid-In Capital

Achieving large sales usually involves a large investment -- plans that forecast sales of $2 billion in year five, with only $3 million of paid in capital, are highly unlikely. Relying on retained earnings to fuel this kind of growth will likely lead to severe cash crunches, some of the reasons include (but are not limited to): 

·         Receivables will be collected slower than expected

·         Not every employee will be a “keeper,” which reduces sales and increases costs

·         More equipment will be demanded than planned (and will probably cost more than forecasted)

·         Litigation that often accompanies large companies

·         Changes in the economy

Avoid the Ambiguity of “Current-Year Revenue”

In their zealousness and optimism, entrepreneurs often create unintended confusion with regard to the current year’s sales figure. Last year’s sales are fact, and next year’s sales are projection. The current year is actually a combination of existing sales and forecasted sales. A current-year revenue figure of $2 million that is dependent upon the company closing a $2 million sale on December 31 will be a red flag to potential investors. For this reason, it is often advisable to state the current year’s revenue in terms of the run rate -- the most recent month’s sales multiplied by 12. 

Solutions -- Demand Brutal Honesty

Raising capital is never an easy process, and entrepreneurs need to remember to do everything possible to mitigate investor risk.  The fact VCs are returning money instead of investing it should be a siren call to entrepreneurs.  Entrepreneurs need

Using the right partners at the right time can help an entrepreneur mitigate these risks. In addition to finding quality legal, accounting and marketing providers, insist that your advisors provide brutal honesty when reviewing your plan. If you work with an accountant who bends GAAP rules for your appeasement, investors will probably see this as a warning that there are more problems in your plan, management skills and/or business operations.

I wrote this column during another life…when I worked for Vcapital.  Send me an email, bill@billsnow.com