Ways to Raise Capital

Entrepreneurs are ripe in the San Diego Region basking in the golden sun of inspiration. In the beginning days most entrepreneurs are idea rich and cash poor. If ideas are worth a half a cent of inspiration, then the other half of a penny is sweat.  Yes, sweat, the good old fashioned variety that comes from hard work living the American Dream.

Most entrepreneurs begin their toil on sweat equity without pay, chasing the dream of an idea on the cutting edge of tomorrow.

How do you take a vision and make something out of nothing?

Every good entrepreneur needs passion; the fire that drives them to see the world differently than it exists now. And most important of all they need capital.

Whether you are at the startup, development, growth or expansion stage you need to know how to raise capital. Money is your lifeblood. Without it you can’t go forward and grow your business. Knowing how to raise capital is a skill set all business people need to know even if they’re a sexy tech firm, perceived as the apple in a VC’s eye, or a run-of-the-mill Mom and Pop business.

What do entrepreneurs do at the startup, development, growth and expansion stages to raise capital?

Understand that raising capital is a constant game.  It can be frustrating at times. More investors and banks will say no than yes. It’s like anything else in sales if you throw enough darts something will stick.

Entrepreneurs need to keep the momentum, build the excitement whether they’re at a business dinner or a networking function. The quest for capital is continuous. Like Patrick Henry, CEO of Entropic Communications says, “If you’re a CEO of a small company… if you’re not raising capital, you’re always raising capital.” It’s synonymous with being an entrepreneur, that constant need to get people motivated about the vision and to show value in the business is paramount.

Start up phase:

Your best bet for funding at the startup phase is to be a proven entrepreneur. Investors like betting on past successes and giving credits to those who’ve succeeded before.

Without a history of prior successes it can be hard to break in the market and get funding. Peter Kostello of VMix recommends to all entrepreneurs, “Don’t be discouraged, most investors will say no. Believe in what you’re doing and move on.”
Often the cause for no is nothing you can address, for instance the answer could be there is too much competition in your marketplace. This is an area out of your control. Recognize when a no provides key insight like “we need more feedback on team members with experience in a particular area. “

What can you do to prepare for the VCs?

Build a strong team, have a CEO with passion to get investors excited and willing to believe in the company’s vision.   Investors put tremendous credence in the team. There’s a conventional saying that reflects just how important the team is, “Better to invest in the A team with a B plan than the other way around."

Investors want valuation before they deploy their dollars. What this means is they need information about the market, its potential size, projections for success and a competitive edge. If it’s a tech company the valuation needs to also show how it represents a differentiated technology – not something that tomorrow someone can copy.

Startup funding successes:

Peter Kostello of VMix says, ”Most people say we’ll build a better mouse trap and we’ve done it – now let’s figure out how to make money.” The key to get funding is a combination of the vision, the plan and the people to back it up.

In VMix ’ case they created a picture of their vision, how they’re creating an Internet presence like Myspace where artists can use video to connect with their audience whether it’s a teenage girl who creates a multi-media music video or a media company who wants to engage an audience. Making this picture clear to the VCs became the VMix mission, but they didn’t neglect the analytical…the numbers.

They put together a projection with numbers for two years and included a spread sheet for seven independent variables to track the business plan. This represents the important part of valuation that VC’s require; they need to know where the vision is going and how the company is going to be profitable.

The other track – self funding the startup phase

Paws for Thought chose to self fund their business instead of going the VC route. With money borrowed money from family Joe Foster, purchased vacuum forming tools and contracted with a company to shape the dog tub and launch his product.

Raising capital during the development phase

In the development phase the pendulum of funding shifts from initial investors banking on the entrepreneur and business model to funding based on the company’s progress and milestones with customers and revenue. In Akonix’ case they raised capital after they built version one of their product and achieved customer acceptance.

Funding During the Growth Phase

Raising capital at this stage is to further the growth of the company. This means showing investors that you are continuing to build upon prior successes in the development phase, while also expanding your customer base and the revenue stream.  A big part of the success at funding this level is attributable to having investors in at the earlier stage. Patrick Henry of Entropic Communications says, “If you can get the big name VCs (Redpoint VC, Mission Ventures, CMEA) on board early, then you can get them in at series C (growth phase). “

Now that the company has customers and revenue (assets) there is another funding option available and that is borrowing money from banks. Money borrowed from banks is debt, not equity. VCs on the other hand come in and invest in the company to own a part of it (equity).

There is also another niche of investors known as Venture Debt. These are investors willing to take more risks on lending money than traditional banks. The money still comes from VCs only it’s in the form of debt rather than equity.  Like a loan it must be repaid, as opposed to a traditional equity investment in which you sell a portion of your company.

Raising Capital During the Expansion Phase

By this stage the business has customers, demand for the product, considerable market share, but in order to grow further capital investment is needed.

Paws for Thoughts reached this expansion phase after five years. The business did reasonably well primarily selling their Booster Bath TM for $300/piece through the Internet and catalogues, but They recognized limitations in the price point and design of the tubs.

In 2002 they looked into injection molding (couple hundred thousand dollar investment) which would produce the tubs and reduce costs of production considerably, enabling them to reach a wider customer base with a lower price point.

The banks refused to lend the company money for this tooling equipment. Undeterred, CEO Joe Foster funded it himself by taking out a second mortgage on his house. In both 2004 and 2005 Paws for Thoughts doubled yearly sales figures and cut delivery costs by nearly half. Without the tooling equipment the business wouldn’t have been able to grow to this level.

Now in 2006 Paws for Thoughts’ working capital needs have again increased.  It’s a question of whether to continue to self-finance their growth or bring in outside investors. Michael Sick summarizes the dilemma that Paws for Thought faces, which is typical of many new business ventures, “It’s a Catch 22. Do we go in debt to grow? The advantage of having VC investors is you can grow quicker.”

Side Bar: Resources

Peter Kostello
VMix  
http://www.VMix .com/aboutUs.php

Mission Ventures
Leo Speigal
11455 El Camino Real, Suite 450
San Diego, CA 92130
Phone: 858. 350. 2100
Fax: 858. 350. 2101
http://www.missionventures.com
contact@missionventures.com

Akonix
Peter Shaw
600 B Street 18th Floor
San Diego Ca 92101
Phone: 619 814 2300
Fax:  619 814 2360
http://www.akonix.com/company/contact.asp
info@akonix.com

Entropic Communications
Patrick Henry
9276 Scranton Road, Suite 200
San Diego, CA 92121
Phone: 858-625-3200
Fax: 858-546-2409
http://www.entropic.com
Email: info@entropic.com

Paws For Thought
Joe Foster
Paws for Thought
2163 Cumbre Place
San Diego, CA 92020
Phone: 1-888-494-4004
Phone: 619 448-8828
Fax 619 596-8137
http://www.dogbath.com

Michael Sick
12534 Caminito Mira Del Mar
San Diego, CA 92130
m41mike@aol.com
858 509-8930
858 342-0998 cell
M41Mike@aol.com

Seed Investors:

Band of Angels
275 Middlefield Road
Menlo Park, CA 94025
http://www.bandangels.com/contact/index.php
contact@bandangels.com
Tech Coast Angels
http://www.techcoastangels.com

Revolution Ventures
11682 El Camino Real, Suite 100
San Diego, CA  92130
Phone: 858 450-2842
Fax: 877 881-9192
http://www.revolutionventures.com/contact.html
kelly@revolutionventures.com

VC oriented networking associations:

CONNECT
8950 Villa La Jolla Drive, Suite A124
La Jolla, California  92037
Phone: (858) 964-1300
Fax: (858) 964-1301
http://www.connect.org

SD Venture Group
PO.BOX 9357
SAN DIEGO, CA 92169  
PHONE: 858.550.6100
FAX: 858.558.8750
http://www.sdvg.org
INFO@SDVG.ORG

Sidebar Terms:
VC: Venture Capitalist
Seed investor: Venture capitalists who invests in startup companies.
Series: A, B, C – Applies to rounds of funding such as: startup, development and growth.

Equity: A term applied when investors give money in exchange for owning a percentage of the business.

Debt: In the context of this article is it money that is borrowed and must be paid back.

Side Bar: Financial climate in San Diego

First half of 2006 $529M
Breakdown of the industries :
Biotech 32.9% of funding 2Q
Medical Devices/Equip 22.43%
Semiconductor 16.59%

Source: Price Waterhouse – NDCA – National Venture Capital Association from their Money Tree Report published on a quarterly basis.