Frequently Asked Questions

Control of a company is vested in the Board of Directors, who sets the policy and direction of the company, furthermore, it is the Board’s responsibility to hire and fire the management team, including the CEO. Many company founders are unwilling to share the control of their companies with outsiders; and because equity investors usually require some representation on the Board, these founders are reluctant to seek and accept outside investors. Frankly, this is an important decision that founders must make very early in the life of their companies. In many cases, the founder can bootstrap the company, that is, use personal funds plus funds raised from partners, friends and family, suppliers and customers to start and operate the company until cash generated from operations can be used to grow the company.

In many cases, however, the capital required to start the company exceeds that which can be raised from friends and family. In other cases, the founder determines that larger amounts of capital will increase the chance of success of the company, by facilitating faster, earlier growth and market penetration. In each of these cases, the founder must get comfortable with the concept of sharing control in the company. The issue of controlling the company is an important decision for consideration by founders as they consider starting companies.

Control of a company is, in fact, vested in the shareholders, who elect the Board of Directors. The shareholders of the company elect the Directors and, depending on local law and the charter and by-laws of the company, a majority of the share ownership of the company can normally elect the majority of the Directors, hence controlling the company. And, in most startup companies the founder/CEO (and/or the founding team) have a majority of the ownership and hence control the Board. So, at the early stages of the company, control is circular question, that is, the Board controls the management team but the founders elect a majority of the Board. Depending on the by-laws of the organization, the shareholder majority generally determines the make-up of the Board and the direction of the company.

100% control of the ownership of the company does, indeed, guarantee independence from interference in the management of a company. It puts the success or failure of the company squarely on the shoulders of the founder.

Bringing in outside investors results in working with those investors but not for those investors. This is an important distinction. By investing monies in your company, these investors are now shareholders (or partners) in the company with the founders. All ownership must share the objectives of building a successful company as well as sharing the objective of harvesting their investment in a reasonable period of time (an exit from the company usually within 5 to 10 years after investment is made).

Entrepreneurs must recognize that investors are not funding their company to help the entrepreneur build the company as fast and as far as the entrepreneur can build it. The investors’ objective is to quickly scale the company to a size and level of profitability that a larger company will be interested in acquiring their company (with or without the entrepreneur at the helm as CEO). Investors are not interested in building a company that the entrepreneur can pass on to heirs or can operate until the entrepreneur’s retirement. Investors are not interested in assisting in growing a company only to have their stock purchased back by the company, so that the entrepreneur can again own 100% of the company. The objective of investing in startup companies is to scale the company quickly and sell the company with huge capital gains for the entrepreneur and investors.

Savvy entrepreneurs quickly acknowledge that building a successful company is different from “building a successful entrepreneur.” While some investors are more patient than others, all investors seek to build a successful company in a reasonable period of time. And, since first time entrepreneurs seldom have the skills to grow a company to sufficient size to justify a highly valuable exit, there will likely come a time when the founding CEO and the investors should agree to hire an experienced CEO to grow the company towards a harvest. Many entrepreneurs resist the transition. By insisting on remaining as CEO, they restrain the growth of the company to the level of growth they can personally manage.

Since it is likely that investors will remain engaged in a successful company until exit, it is important to select investors wisely. Look for investors that bring substantial business acumen and vertical experience into your company. Such investors will understand the problems of growing a company in your business segment and have many contacts in the industry to assist in completing the management team, as well as finding partners and customers. While we equate marriage to a life-long partnership, you will be working closely with investors in building the company for as much as a decade (sometimes more). So, in many ways, selecting investors is much like the process of getting married

Angels are part-time investors. Running a company on a day-to-day basis is not part of their plans. Angels will invest in a company and help grow the company as rapidly as possible. The success will be jointly defined and executed by you, the entrepreneur, with the support of angel investors.

Single angel rounds of investment are in exchange for 20 to 40% ownership in the company. If the company has already demonstrated some success in startup and growth, the first round of investment may purchase less than 20% of the equity. Very seldom does a single angel round of investment result in 50% ownership in the company and hence control of the Board of Directors. Typically, the make-up of the five-Director Board after a seed angel round might be two Directors selected by the entrepreneur, two by the investors and one agreed-upon outsider.

As long as the company is growing according to plan, meeting milestones and not prematurely running out of cash, the investors are likely to provide the assistance requested by the CEO as well as complete financial and milestone oversight at Board meetings. Angels step in when the company is not meeting milestones and especially if the company is unexpectedly running out of cash.

VCs are unlikely to acquire controlling interest in a company in their first round of investment. However, VCs (and many angels) will demand a voice in certain decisions the entrepreneur may address, such as seeking further investment, acquiring another company, pursuing bank debt, etc. In rapidly growing companies which require several large rounds of investment, it is unlikely the entrepreneur will maintain 50% ownership in the company after the second round of investment.

When the company is doing well, VCs also will provide only the agreed upon assistance and guidance to the entrepreneur and the company. VCs, however, are less patient than angels. VCs are full-time investors and usually have much more money invested in each portfolio company than do angels. Consequently, VCs are likely to step in and exert control earlier than are most angels.

An investor’s minority interest generally has some negotiated influence (or control) and some informal control. By reserving some rights for the preferred class of stock in their negotiations as they make their investment, investors can require the CEO and the Board of Directors to get the approval of their preferred class of stock before undertaking certain specific activities, such as obtaining bank financing, making an acquisition, selling the company, etc. So, in this case, a minority interest must approve certain transactions of the company.

Investors always exert substantial influence over subsequent rounds of investment. Prudent subsequent investors, as part of their due diligence, will poll earlier investors for their opinions on the progress of the company and the skills of the management team. New investors usually expect earlier investors to reinvest their pro rata share in subsequent rounds of investment to avoid dilution of ownership of those earlier investors. Reluctance by earlier investors to enthusiastically support the company is always a danger signal to new money.

The CEO is responsible for running the company, at the pleasure of the Board of Directors, who establishes the policy and direction of the organization. So, in theory, the CEO does not report to the Chairman, but to the Board as a whole. In many companies, the CEO and Chairman positions are held by the same person, making the question of control mute. But, the duties and responsibilities of the CEO and Chairman vary substantially from company to company.

The keys to great investor relationships are communications and meeting milestones. Investors thrive on information received regularly that report on the progress of financial and other company objectives. It is suggested that a portion of an early Board meeting be devoted to the specific expectations of each Director regarding communications and a group decision on progress reporting to other investors. Once these communication expectations are defined, the entrepreneur needs to meet those expectations.

There are many sources of capital for startup entrepreneurs, as are outlined below:

Self: Perhaps the most important source of capital is your earnings and savings, Keep your “day job” until the startup company absolutely requires all of your time. The more capital you can provide, the less needs to be acquired elsewhere, allowing you to keep more equity in the company.

The least expensive source of capital is research and development grants from government agencies if available. These funds can often be expended on critical research and product development related to commercialization of the company’s technology. This cash is neither debt (need not be paid back) nor equity (cash in exchange for company ownership).

A critical source of capital to startup entrepreneurs is internally generated cash (bootstrapping), that is, cash from profits in the early sale of products. Cash generation through profitable operations can minimize or eliminate outside investment, maximizing the ownership of the company by the entrepreneur. Entrepreneurs should consider selling equity only when no other sources of capital are available.

Angel investors provide seed and startup investment through an equity investment or a debt instrument that the investors can convert into an equity security later.

VCs also invest a tiny fraction in seed and startup companies. VCs tend to invest at a later stage in company development.

Angels make active investments in companies that will scale. All angel investments are in the high-risk category, angels will only invest in companies that can provide a very high rate of return. Active investments are those in which the business experiences of some of the members of the angel investing group can bring special assistance to the entrepreneur in starting and growing the company. Angels serve as mentors, coaches and Directors to the entrepreneur and the company.

Prior to investing angels want to be able determine if customers buy this product at price sufficient to enable high growth by the startup? Consequently, angels will not usually look at a company until the product development is sufficiently advanced to the point that the product or a prototype of the product has been shown to customers. The angels will then want to talk to those customers to determine if they will buy the product and at what price points.

Investors will generally not invest in technologies, that is, companies formed around interesting technology but for which products have not yet been identified. Initial product release has to be sufficiently complete so that customers can begin to appraise the value of the product before angels will fund the company.

Angels seek to invest in entrepreneurs who are highly-motivated, experienced businesspersons who are capable of making impressive presentations to investors, partners and customers. Integrity is critical – angels do background checks on entrepreneurs before investing. “Highly-motivated” implies a passion for success and “both feet in.” Angels are not interested in funding entrepreneurs who “can always go back to their day jobs” if the going gets tough. Investors seek entrepreneurs with lots of business experience, especially in the business segment of the startup company. 1. Be absolutely truthful in your dealing with investors. 2. Surround yourself with a first-class team, experienced persons who do have the business acumen you lack. 3. Surround yourself with a first-class team of business advisors. 4. Be prepared to step aside after the company has achieved a few milestones and help the investors hire a top-notch CEO for the company. Continue to support the company in a role consummate with your background. Investors expect a substantial return on investment in a reasonable period of time. It is in no one’s best interest (including the entrepreneur’s) that the growth of the company be limited by the skills and experiences of a first-time CEO.

Summary of the characteristics of fundable entrepreneurs

Integrity – Truthfulness and honesty are a must. Angels will check into an entrepreneur’s background. Be truthful from the start.

Interpersonal relationships – Are you a skilled manager? Do your customer, partners, earlier investors and family appreciate your personality? Do you carry yourself well in public (speaking, manners, etc.)?

Coachable – Do you listen? Do you seek the advice and counsel of others? Or, are you a “know it all”?

Passionate and committed – Is this just another activity for you, or is starting this business a self-consuming passion for you? Are you totally committed to the startup venture?

A critical component of the management team is the entrepreneur’s willingness to surround him or herself with the most qualified management team available. Always be willing to hire executives who are smarter and have more experience that you do. Having prior experience with some of the members of your management team is a plus, but is not critical to success. Don’t hire clones of yourself. Develop an experienced, well-balanced team.

Demonstrating the skills to attract highly qualified talent and your willingness to surround yourself with smart businesspersons is absolutely necessary. But, the entire team need not be in place at the time of funding. It is OK to have a few waiting in the wings for the company to be funded and even to tell the investors you need their help in filling a key position or two. It is a benefit to have a team member or two on board (or prepared to join the company). It is critical to make it clear to your investors that you intend to hire the most qualified team available and you would like to involve them in the process of building out the team.

Remain patient, continue writing the business plan or complete product development. Stay the course. Don’t waste time pursuing funding from angels or VCs until the company is fundable. Time is much better spent working on the plan and the product.

“Perishable” opportunities are those which have no value unless commercialized in a limited window of time. Some experts in the new venture marketplace feel that the “first mover advantage,” that is, the first company with a new product for a new application, has a large advantage over companies who enter the market later. Many of the rest of us feel that “first mover” advantage is over-rated, having seen the “first mover” make many mistakes and spend too much money making a market for which the second or third company in the space successfully dominates.

But, some ideas are truly perishable. Suggestions for those with “perishable” ideas are (1) make sure the idea is both scalable and fundable; (2) hurry, with patience; and (3) consider shortcuts to the marketplace, such as development and/or marketing partners.

It is quite shocking and disconcerting to first-time entrepreneurs to learn that neither angels nor VCs will sign a confidentiality agreement (or a non-disclosure agreement) to read the entrepreneur’s precious business plan. This is a serious dilemma. Entrepreneurs have truly confidential information but investors cannot possibly sign several thousand NDAs in their investing lifetime.

Trust – Work with investors whose integrity you can validate. This is actually easier to confirm than you might expect. Most investors value their good names and integrity far too much to ever intentionally steal an idea. There are simply too many good ideas and too many good business plans available to invest in to spend time attempting to steal ideas. Always do “due diligence” on your investors. Make sure they are really persons you would like to partner with in your company.

Non-confidential business plan – As an innovative entrepreneur with a “top secret” venture idea, you must learn to write a non-confidential business plan. Define the “secret sauce” and find a way to write the plan without revealing the confidential materials. And remember, with access made possible by the Internet, there are no secret customer lists and no new business models. Confidential technology is usually covered by patents, and a clever entrepreneur can write the plan around the confidentiality.

Investors do sign NDAs! – If you write a solid plan for a scalable product without revealing the “secret sauce” and an investor finds your plan compelling, he may indeed sign a NDA during the “due diligence” prior to investing. In this case, the investors or a designate may agree to sign a very narrow non-disclosure agreement in order to read and validate the critical claims of a new process patent or the chemical formula for a newly discovered “secret sauce.”

The trick is to write a great non-confidential business plan and then let the investors ask you to reveal the confidential information to them. At that point they will be willing to sign a limited NDA.

Entrepreneurs cannot license their technology to their company and keep ownership of the intellectual property for themselves. Investors will simply not invest in such companies. If you are an entrepreneur/inventor and you own rights to the intellectual property to be utilized by the company, the technology you own related to that venture must be included in your contribution to the company at startup or at least before investors will engage.

Under the limitations I have described above, you may need to protect your truly confidential information from potential investors; however, you do not need to protectconfidential information from your investors. After all, they are your partners. They succeed when you and the company succeed. As long as you have done reasonable background checks on your investors and validated their integrity, you have done all you can to protect yourself.

You will also be surprised to find that very few investors will care about the IP after the investment, except that the company owns it. Investors will primarily be interested in the quality of the company the entrepreneur is building to commercialize the technology, rather than in the technology itself. The exceptions are when ownership of the technology becomes an issue or if the company has difficulty commercializing products utilizing the technology.

If the patent estate is critical to the success of the venture, it is incumbent upon the entrepreneur to secure the best possible team to assist in developing a technology strategy for the company. What technology should be patented? What technology should be protected as trade secrets? What technology should be acquired from others under what payment terms? Management of IP is expensive and most entrepreneurs have little money, so careful planning is necessary to optimize expenditures in designing a highly fundable company.

There is no rule of thumb for managing IP. Get some business advice the best available legal counsel in your particular technology arena.

Patent attorneys are not necessarily the best sources of information on establishing a strategy for your patent estate. If you can find business experts familiar with the technology or market of interest, who are willing to advise the company (for cash or better yet, for a small piece of equity), engage them to develop a strategy and to negotiate licensing arrangements with sources of technology, if appropriate.

The message for entrepreneurs is (1) understand the capital markets and (2) design a funding strategy that matches nicely with those markets.

Scalable companiespropose rapid growth and generally feature products for large niche markets. Entrepreneurs of scalable companies propose sustainable business models for their startup companies that can reasonably be expected to provide a substantial return on investment in five to seven years.

Angels tend to invest smaller amounts in seed/startup and early stage companies, many of which will require multiple investments to achieve positive cash flow through operations.

As a general rule, later stage investments tend be much larger than earlier stage investments. VCs invest in later stage deals.

The startup phase of a high-growth company requires relatively small amounts of funding. But, high-growth startup companies need to raise significant amounts of capital to sustain very high growth over several years. The management teams of these highly scalable companies will soon face a dilemma; how to raise the capital necessary for sustained growth? One option is to raise more money (probably from VCs) to sustain the maximum growth rate. The second is to grow more slowly and organically, that is, using cash generated by the business and later bank debt for growth. This is a complex decision and there is no standard answer. It depends on the nature of the business and the appetites of the founders and early investors.

There are several reasons why a good pre-seed company might not yet be fundable, but may be an excellent candidate for funding at a later date. One likely reason is that the entrepreneur has not yet addressed the critical issues necessary to complete a business plan.

1. The intellectual property (IP) may not yet be under the control of the company.

2. The marketing channels not established.

3. The financials are not yet validated.

4. The product may not be defined sufficiently to interest investors. If product development is insufficient to yet capture customer interest, more work needs to be done prior to approaching angels.

All startup companies can define milestones, the achievement of which will demonstrate progress in starting and growing the company. Each milestonehas to be tangible and measurable. The entrepreneur can demonstrate clearly that each goal has been achieved.

The first task is to establish a list of the dozen or so key measurable milestones for your company. Estimate how much money it will take to achieve each of these milestones. Be conservative. The object of creating the milestone list is to plan when you will need to raise money for your business. The more milestones you can achieve before raising the next round of investment, the more likely you will be able to find investors to fund the company. Use your milestone list and your new knowledge of capital markets to match milestones with your rounds of investment. Select these milestones carefully, because investors will expect you to meet these objectives prior to raising more money.

All angels and VCs put aside “dry powder” (extra cash) for their portfolio of companies because entrepreneurs frequently require multiple rounds of investment to achieve success. Sometimes this additional infusion of cash is planned and sometimes it is not, but to preserve their investment in good companies, all startup investors reserve cash for multiple investment rounds in portfolio companies.Sometimes those second and third rounds of investment are designed to “bridge” the company to VC rounds of investment. simply needs multiple rounds of angel investment to achieve success.

I always advise entrepreneurs against raising money from either angels or VCs, if they can possibly bootstrap the company to positive cash flow. Why sell equity in your new company if you can keep all the ownership for yourself without bringing in outside investors? Raising money is very time-consuming and takes vital time away from the mainstream business. Don’t do it, unless you must.

Put off raising money as long as possible, because the more milestones you can achieve prior to raising angel money, the more valuable the company will be to angels (and the more ownership you will be able to keep). As a general rule of thumb, angels prefer to invest in companies who have completed their product development and have shown the product or a prototype of the product to potential customers. Most angel investors want to talk to customers to validate that the solution offered is, indeed, important to users. Angels will invest at an earlier stage in the company’s development, but will likely demand a greater ownership share of the company for their investment because there is more risk involved in earlier stage investments.

Using a milestone-driven funding plan you will know approximately when you will need to raise more money. Most investors suggest that each round of investment should provide 12-18 months of “runway,” that is, months of operations before you run out of cash. And, knowing that it takes 3-6 months to raise money, a prudent entrepreneur will begin raising cash 12 months before running out of cash. Fund raising is a time-consuming part of the entrepreneur’s job. This is why all investors will suggest that entrepreneurs bootstrap their companies, rather than raising capital from angels and VCs.

If you run out of money, your company goes out of business. Companies that are about to run out of money lose all their investment leverage. Regarding the terms of investment, investors are then in a position of “take it or leave it.” “If we don’t invest, you will go out of business anyway.” Entrepreneurs who run out of cash are forced to give up a much greater percentage of the company versus entrepreneurs who can afford to say no to “bottom feeders” and continue to look for investors who will value the company reasonably.

Winding down a company through the bankruptcy process is painful and time-consuming with little or no return of capital. Early investors, who invested in you and your company, will likely get nothing in return for their investment. Employees will be out of work. Vendors will get pennies on the dollar for the supplies they sold to you on terms. Customers will be disappointed. Since all of your personal assets are tied up in the company, you and your family will be financially strapped.

A down round is a round of investment in a company in which the current valuation of the company is lower than at the time of the previous round of investment. The result of a down round is that earlier investors get “crammed down.” That is, because new investment money came into the company at a lower valuation, the ownership percentage of the earlier investors is substantially reduced.

Some investors believe they can use onerous terms, such as liquidation preferences and anti-dilution provisions to avoid down rounds resulting in a cram down of their ownership. While these investor rights look good on paper, they only tend to drive away subsequent investors may be interested in investing, but want to avoid addressing such sticky issues. The three key issues in avoiding down rounds are:

Negotiate an appropriate low valuation on early rounds in startup companies.

Raise enough money in a seed and startup round of investment to give the company enough runway to meet sufficiently important milestones to then justify a higher valuation for the subsequent fund raising. Raise a little extra cash and reduce spending in the early days to provide a cushion for meeting those critical milestones.

Startup valuation is always based on accomplishments and milestones. Identify goals that will, indeed, increase the value of the company in the eyes of investors and then meet those goals.

Exit strategies describe the planned harvest of the investment in startup companies. This is almost always accomplished by selling all of the shares of the Startup Company to a larger and preferably public company. Not all businesses need an exit strategy.

Angels are investors not lenders, hence they expect more than simply to get paid back with interest by entrepreneurs. The intended exit strategy for angel investments is to liquidate the investment via a sale of the company to a much larger company.

Defining an exit strategy is important for entrepreneurs who are seeking equity investors because those investors will expect the entrepreneur to be able to articulate a well-defined harvest for their investment.

Entrepreneurs must wear two hats, one as a founder/employee and a second as an owner of startup companies. The founder/employee hat dominates the activity of the entrepreneur during the startup and operations of the company. But, the ownership hat is, in fact, more important to the entrepreneur, because a successful exit will have a lasting impact on the entrepreneur and his or her family. Harvesting their ownership position is, in fact, their final and perhaps most important act as entrepreneurs. And, executing the exit strategy is vital to the success of the investors.

An initial public offering of the shares of a private company (or “going public”) is a financing event, not an exit. Going public allows a private company to sell shares in the public markets to generate cash for the company’s growth. It is an expensive and time-consuming process. Very seldom is the company permitted to sell the shares of owners of the private company in the initial offering. The assumption is that the company needs cash for growth, consequently the entrepreneurs and investors shares are neither sold nor made available for public sale by the IPO process.

While an IPO is a financing strategy, it can and often does define the exit strategy for the investors, and can provide for future partial liquidation by the entrepreneur. Assuming the continued success of the company, investors’ and entrepreneurs’ shares can gradually be registered to be sold in public markets over a period of years. Since public companies are often valued somewhat higher than their private counterparts, selling investors’ shares through public markets can eventually be a very attractive exit for entrepreneurs and investors.

Understanding the “trials and tribulations” of being the CEO of a public company should be thoroughly understood by startup entrepreneurs. It has always been more difficult to be the CEO of a public company than that of a private company. Because the officers and Directors of public companies are, by definition, managing an entity owned by public shareholders, the governments have strict financial and management reporting regulations. The jobs of CEOs of public companies are often far removed from innovation, products and customers in today’s highly regulated corporate environment. Unless an entrepreneur knows that he or she can thrive in this environment, striving to take the enterprise public may not be such an attractive accomplishment.

Business plans usually define the exit strategy as either selling the company to a larger company or taking the company public. While these are the two possible options, it is much more likely that the successful startup will be sold than go public.

The expected exit for an angel funded company is to sell the company to a larger public corporation in exchange for either cash or shares of publicly tradable stock of the acquiring company, through merger or acquisition (M&A).

Entrepreneurs should also be aware that selling the startup company to a larger public company is often subject to a market standoff (or lock-up), which precludes owners of newly registered shares from selling for restricted period (usually 180 days). The purpose of the regulations is to avoid a flooding of the market with shares from acquired shareholders on the days immediately following closing and the consequential reduction in share prices resulting from more sellers than buyers making the market.

Investors expect startup entrepreneurs to have anticipated that a thoughtful exit strategy is important to all owners of the company. Simply including a section in the business plan that states that you expect to exit the company in 3-5 years by selling the company or going public is not enough. If the entrepreneur honestly believes an IPO is possible for his or her startup company, it is important to demonstrate why this unlikely exit makes sense for this company.

1. What companies in the same business vertical or using the same business model have recently gone public?

2. Why is it as likely or even more likely that the startup company will enjoy the level of success as the comparable companies?

3. What other companies in the same vertical were unsuccessful in their bid to go public and why does the startup company have a greater chance of success than did they?

If the entrepreneur believes an exit via the sale to a larger public company can reasonably be expected as an exit strategy, the entrepreneur needs to explain why such a company would buy the startup. Define the available target companies and define why each might be interested in buying the startup. Show examples of other strategic acquisitions made by the target companies and compare and contrast the potential of the startup to those comparable acquisitions. Convince the investors that you understand the dynamics of your business vertical and an exit via strategic acquisition is really possible for your company.

There are three types of acquiring companies for startup ventures.

• The first, a strategic acquirer, would consider buying startup companies whose products and customers will allow the acquiring company to grow and succeed faster than the in-house team can grow their business without the acquired venture.

• The second variety of acquirer is a financial buyer. They are looking for a successful company to purchase, planning to use their cash resources and portfolio companies to grow the acquired company very rapidly.

• The third acquirer type is the roll-up specialist. Their objective is to acquire several companies in a related industry to build a much larger, highly successful venture from a set of smaller companies.

Who are these strategic buyers? They understand your product, technology or market. They are suppliers, competitors, customers or co-vendors. Co-vendors supply your customers with products that are complementary to yours. To best define all the targets for your eventual exit strategy, it is important to develop a complete and thorough understanding of your marketplace, including the competitive landscape for your suppliers, your customers and sometimes your customers’ customers. Finally, spend enough time in the appropriate R&D institutions in your vertical to understand the future threats and opportunities in your business segment.

The answer is networking. Go to trade shows. Talk to your customers and your vendors. Talk to your customers’ customers. Look off-shore to see how the competitive landscape differs from local markets. Spend time with the researchers at universities and laboratories to better understand changes in the technology which will impact your success.

From the competitive analysis above, you will be able to identify a rather large list of candidates. You can eliminate (for now) those companies that are small, struggling startup companies who could never afford to acquire your successful venture. You may wish to give a low priority to larger private companies, based on the analysis above. But keep these companies on the list, because they may be acquired by attractive companies in the future.

• You will find some companies whose cultures do not match that of your company. Give these companies a lower priority, but leave them on the list because the situation may change in the next decade.

• Give a high priority to those public companies in your environment that could best benefit from acquiring your new venture in five years or so.

• Try to create a list of multiple candidates to acquire you. Why? All investors know that you will get a better price for selling your company when several large companies compete in an auction for the right to buy your company.

There are two sets of advisors who might help you define your exit strategy: The first is the experts in your business segment, who can help you, define the vertical and how it may change in the next decade. Understanding the competitive landscape is critical to defining potential acquiring companies for your new venture. Where can you find these experts? Consultants will talk to you because they want to cultivate a relationship with you. Your company might be a potential client for them. Vendors will talk to you because you are a possible customer. You potential customers may talk to you, if you flatter them as experts in the competitive landscape.

The second set of experts is those who can help you articulate your exit strategy. If you know angel investors, ask them for advice.

What is a business plan?

General contractors need blueprints. Blueprints are necessary for two reasons; (1) to make sure they do not forget something important and (2) to be able to communicate the plan with others. Entrepreneurs need business plans for the same two reasons. A business plan is a comprehensive review of the venture, covering all aspects of the opportunity. Witha business plan, the entrepreneur can convince partners, investors, employees and others that he or she has a carefully crafted plan for success of the business.

Are there several versions of a business plan?

Because there are a variety of uses and needs for a business plan, at least five versions of the business plan must be prepared. The entrepreneur must be prepared to effortlessly deliver each.

• Full plan: This version must be written first because all others are adaptations of the full plan. It is by reading and studying the complete plan that investors will be able to make a decision to fund your company. It is only after investors have read shorter versions and spoken with the entrepreneur at some length that they will dedicate the time necessary to reading the full business plan.

• Executive Summary: The executive summary is a 2-4 page summary of the business plan, covering the highlights of all aspects of the business. This document is frequently the first introduction that investors and others have to the plan. It must be written after the plan is complete and summarize the full plan.

• Elevator Pitch: The entrepreneur must be able to flawlessly deliver this version of the plan in two minutes or less. The entrepreneur must be able to present this short summation of the product and the market opportunity very quickly. This version must be simple and straight-forward.

• Video Pitch: This version is similar to the elevator pitch, except deliver via a video file. Video pitches are useful when applying online to angel groups or to online investment platforms. Investors are interested in your innovation, the market opportunity for the product and how you plan to attack the competitive environment. Video pitches are usually about two minutes in length.

• PowerPoint Presentation: If the entrepreneur’s elevator pitch or executive summary has attracted the attention of potential investors, he or she may be invited to deliver a verbal presentation. The PPT presentationshould have 10 slides which can be delivered in no more than 20 minutes. Each slide must have a brief description of one aspect of the business in at least 30-size font. The PowerPoint must be delivered in a practiced and articulate manner without reading the slides.

Writing the business plan is a way of thinking through the execution of the business idea and to drill down into the details. All entrepreneurs have a good concept of their product prior to writing a plan, but other phases of the business are much less clearly defined. It is important to understand the sales channels that will be utilized to reach customers. It is critical to develop an appreciation for the amount of funding that will be required to commercialize this product and to develop a sustainable business. Without a complete business plan, the entrepreneur cannot demonstrate he or she has a viable investment opportunity.

Comprehensive plans are vital to successful business partnerships. Clarity of purpose and direction are essential for establishing a lasting partnership. Potential partners need to pour over business plans to make sure they are in agreement on the level of commitment in their relationship which may last a decade or so.

Seldom does the entrepreneur launch a business in a vacuum. Important vendors need to be convinced that the business is viable, sustainable and can grow to a sufficient size to become an important customer to them. Vendors can offer customized sources of raw materials or special payment terms for new entrepreneurs, if they are convinced you are “for real.”

You will be asking key employees to leave their current employers and help you grow the business. It is important that you can concisely explain your business and their important role in its success to them.

Customers need to be convinced that your company is viable and that your product or service resolves an important problem for their companies. Customers must be persuaded that they should make the commitment of time and resources to evaluate and buy your products.

While banks and other lenders may not be important sources of capital at the outset of the business, eventually you will likely choose to use borrowed funds to grow the business (debt is always cheaper capital than is equity). A well-crafted business plan is important to bankers. They are conservative and like to have substantial back-up documentation of their loan portfolios.

Ten slides to describe their investing opportunity.

• Market Need: The single most important part of a business plan. Investors want to know that the product is a “pain killer not a vitamin pill,” that is, your product solves important problems for customers. It is also critical that you explain that yours is a sizeable opportunity and that your business model will accommodate the scale required for success.

• Industry Overview: Provide the investors with a comprehensive review of the industry and marketplace. You need to convince investors that you understand the needs of your customers and the importance of your solution.

• Product Overview: Entrepreneurs tend to make this section of their business plans way too long. The description of the product needs to be concise and is only one of several critical components of the plan.

• Technology (Current & Future): Explain the technology in a concise manner with a focus on your rights to use the technology and your freedom to operate within the space.

• Competition: For every product or service there is an alternative. Develop a comprehensive description of the competitive landscape, present and future, in your plan.

• Barriers to Entry: Describe a complete list of the features and benefits of products in your vertical and explain how your product stacks up against the competition. Make the list comprehensive, even if your product has some shortcomings against the competition. This becomes a “truth test” for investors.

• Strategic Partners and Customers: Describe the partners that will be key to the success of the business. Early, committed customers can, in fact, be strategic partners. Early adopters, especially name-brand players, can be critical to the early success of the business.

• The Team: Describe the background of the players on your team and, if possible, those waiting in the wings. If you have holes in the team, that is OK, at this stage. Describe for investors how you plan to fill those holes.

• Milestones for Growth and Funding: Provide details on the key milestones that you and the investors will use to measure your success. Describe milestones that can be reached with this round of funding and any additional funding that you anticipate might be needed later.

• Use of Funds: Explain how much funding is necessary in this round and to what purposes you will apply those funds. Do not describe the valuation of your company or how much of the ownership of the company you expect to sell for this equity investment. This subject is highly negotiable. Do not paint yourself in a corner with an unreasonably high or low valuation, as you write the business plan. Valuing the business is not a critical ingredient to the business plan.

• Financials: Complete financial projections are a vital part of your plan. Financial projections are required information in deciding how much money you need to raise from investors to achieve positive cash flow in the business. You should develop income statements, balance sheets and cash flow projections on a monthly basis for two years and quarterly projections for the following three years. Most investors would like to see how large you anticipate building the business in five years, and the reasonableness of your projections to get there.

A 20 page plan is probably too short and a 50 page plan too long. Target 20-25 pages in the body of the plan, plus appendices. Detail financials in the appendices and put summary financials are in the body of the report.

Entrepreneurs should write their business plans early. Writing a plan is a time-consuming project, because of the research that entrepreneurs must do to complete the project.

How much cash you need and making sure you do not run out of cash is absolutely paramount to your success of the business. Your investors will have many questions about your financial statements and you need to know what assumptions were made in developing the statements and how to explain the finances of your business.

Build your financial statements from the bottom up. Your investors will want to know who your customers will be and at what price they will be eager to buy your product. Your investors will appreciate quality financials, which will, in fact, lead to good budgeting after the business is launched.

There are many outlines for successful business plans and those outlines change somewhat for different business types

Executive Summary

The executive summary is a 2-4 page summary of the business plan, a stand-alone document that is used as a “teaser” to attract the interest of investors to the investment opportunity. It must very briefly cover all the aspects of the business. This document is used to introduce the venture to investors and to encourage them to begin to engage in the due diligence process of validating the investment opportunity. Write the Executive Summary after you have completed the entire written business plan.


The introduction should detail the value proposition offered by this venture. A company has three major stakeholder groups: customers, employees and shareholders (investors). Introduction answers three key questions:

• How will the business deliver superior value to its customers?

• How will you build a management team and manage a stable, motivated workforce?

• How will you deliver value to investors?

The Opportunity

Here the entrepreneur describes in detail the “addressable market,” that is, the precise market and customers that will purchase the product. The key issues to be described in this section are:

• Describe the total market

• Define the market niche / segment

• Describe the size of the market segment

• Detail the growth rate of the market and the segment, now and in the future

In defining market size and growth rates, used of validated data is important. Investors will seek independent validation of market size and growth rate, so use of quality data is of utmost important.

The Product and the Intellectual Property

This is a choice you need to make, depending on complexity of the technology environment. If the technology is a minor component and easily explained, include IP as part of the product description. If the technology is complex and/or the intellectual property landscape is complex with many apparently overlapping patents and limited room to operate, then separate the sections.

Describe your product in a way that your grandmother will understand it! Investors are not impressed with twenty-page product descriptions.

Investors are interested in understanding the product and also the production of the product and / or delivery of the service. Clearly define

• The manufacturing / service delivery methodology and, in particular, the problems involved in manufacturing the product / delivering the service.

• Is the manufacturing well-defined or is substantial development is necessary to make the product / deliver the service?

• Can this product be outsourced?

• Are there trade secrets and intellectual property involved in the manufacturing process?

• Are raw materials an issue in manufacturing this product?

Some of IP issues are as follows:

• Who owns the technology? If licenses are involved, describe them.

• Describe the intellectual property landscape. Who owns the technology in the environment your business must operate?

• Describe the exclusivity that your patents provide for your business.

• Define your freedom to operate. Will the patents of others impact the advancement of the business?

Barriers to entry (competitive advantage)

• What makes your product unique?

• Describe the features and benefits that differentiate yours from competitive products.

• Does a patent create barriers to entry by your competitors?

• What lead time do you have over the competition?

• Can you extend those patents to lengthen advantage in the marketplace?

• What is the likelihood that well-funded competition could “reverse engineer” your product and introduce a similar product without violating your IP?


Describing the competitive landscape is a critical component of your business plan.

• Who are the major players in this market?

• Describe the strengths and weaknesses of these competitors and their product offerings in this market.

• Describe how you, as a smaller company with lesser resources, will address their strengths in the market.

• If no direct competitors exist prior to the introduction of your product, what are your potential customers doing to satisfy this need?

• If your introduction of this product is highly successful, what reaction do you expect from larger potential competitors?

• How quickly could these potential competitors react and what impact on the market would you expect?

• Often, describing the market today is insufficient. Technology advances and demographic changes alter market direction. Describe how you expect the market to change over the life of your product or products and how you will manage your business to take advantage of these changes over time.


Investors want to make sure you have a good understanding of the selling processes in your industry.

• What are your sales strategies?

• Who are your target clients?

• Will you be focusing on larger clients or smaller users?

• Will that focus change over time?

• What are the unique characteristics of your target accounts?

• What sales channels will you utilize to sell to your target accounts?

• Describe your sales channel options and detail why you have selected specific channels.

• Will you address accounts that are not within your target list? If so, how?

• What are your pricing strategies and what considerations have you made in establishing pricing?

• What compensation schemes have you considered for motivating sales people?

• What tactics do you plan for customer retention?


• What strategies will you use to make your customers aware of your product (and your company) and eager to buy from you?

• How will you find customers or enable them to find you?

• How will you brand your products and strengthen your branding over the life of the business?

• Marketing, in particular advertising, can be very expensive. What marketing techniques will enable you to reach your potential customers without “breaking the bank”?

Management Team

Provide your business background and that of each of your management team. Integrity is critical for investors, so be totally honest in your resumes. If some members of the management team are waiting in the wings, make it possible for investors to do background checks on these team members without, if appropriate, revealing their intentions to current employers. Describe holes in the management team and discuss the skills and experiences needed to complete the team. Describe when you plan to fill these vacancies.Know that investors will plan multiple interviews with you and key team members. This knowledge sometime affects the information you include in bios in the business plan.Keep the biographical information in the body of the plan rather brief, approximately 1/3 of a page. Feel free to add complete biographical information in the appendix.

Funding Required

Complete the financials prior to completing this section. Use the cash flow analysis in the financials (plus a substantial safety margin) to determine how much cash will be required from investors for the company to achieve positive cash flow, enabling the company to grow on its internally generated cash. Then carefully select measurable milestones that can be achieved with specific amounts of funding. Define for investors what can be accomplished with this round and what funding will be required in future rounds. Part of this analysis is to determine to what uses the cash raised in this round will be put. Define, as precisely as possible, the 5-7 categories of expenses to which the funds raised in this round of investment will be applied.

Some companies become profitable but continue to raise money because their growth plans dictate the need for more cash than can be generated from internal cash flow. Rapid growth requires lots of cash. There is no rule of thumb that suggests that investors will only fund companies until they can achieve positive cash flow from operations. This decision depends entirely on the growth rate that the entrepreneur can demonstrate is necessary to develop a highly successful company.

Exit Strategy

Investors expect entrepreneurs to articulate a carefully crafted exit strategy in their business plans. Simply indicating that you expect to exit via an IPO or the acquisition by a larger company is not sufficient. In the case of the more likely M&A exit, the entrepreneur needs to identify candidate acquirers, why these companies might be interested in purchasing the startup company and how the startup company can be positioned to sell at the most attractive return on investment.


Entrepreneurs need to forecast complete income statement, balance sheets and cash flow statements for the first five years of the venture. The financials are expected to be carefully completed with reasonable expectations. Assumptions need to be detailed and, in fact, it is those assumptions that investors really study.Entrepreneurs must realize that the numbers are important and that investors expect entrepreneurs to have a great grasp of the financial metrics necessary to manage the business. If you are unable to assemble reasonable financial statements for a startup company, numbers that you really understand, then you are unlikely to attract the investment needed to start the company.

Entrepreneurs must develop monthly statements for the balance sheet, income statements and cash flow statements for the first two years and then quarterly statements for the same three statements for the next three years, a total of five years of financial statements. These statements should be reasonably detailed; however, only summary statements should be included in the body of the business plan. Include all the detailed statements in the appendices to the plan.


The business plan should be rather easy to read. Excessive detail detracts from the value of the body of the report, because the reader can easily become bogged down with excessive facts and numbers.


Your business plan and executive summary must be non-confidential documents.

Distributing your business plan

When you are introduced to a venture capitalist or angel investor, be ready with your “elevator pitch” or send them your executive summary. Remember: Your full business plan need only be distributed upon demand. You must create interest for your full business plan using other abbreviated versions of the plan.

What is the angel investing process?

The process for closing a deal with an angel organization consists of several steps of increased engagement with the entrepreneur and the company.

These steps are:

• Pre-screening - A quick check to make sure the entrepreneur has supplied all the requested information and that the company meets the criteria for investment of the group.

• Screening - The first look at the company – a spot check to see if angels familiar with the industry might be interested in this deal.

• Due Diligence In depth validation of the business plan and the investment opportunity by a team of investors.

• Term Sheet - Negotiating the terms of the investment deal, including the valuation of the company which determines the percentage of ownership for the investors.

• Investment Meeting - After the due diligence is satisfactorily completed, investors gather at this meeting to consider investment in the company, or, in the case of an angel fund, to vote on investing pooled monies in the company.

What is deal screening?

Screening is the first serious look an angel group will take at an applicant company. The entrepreneur is usually invited to make a 20-minute PowerPoint presentation, followed by a short Q&A period, to a group, which may consist of staffers and experienced members of the angel organization. The meeting will usually be at a site determined by the angel group. The purpose of this meeting is for the angel organization to decide if there is sufficient interest in their group to enter into due diligence with the company and to find a champion among the angel members interested in leading the due diligence on this deal.

What is “due diligence?”

Due diligence is the process of validating the investing opportunity. Here are just a few key points that might be checked on any deal:

• Is the ownership of the intellectual property clearly with the company? Do other patents in the area restrict the freedom to operate of the company?

• Did background checks on the entrepreneur reveal anything untold?

• Is the size of the opportunity compelling?

• Are there lawsuits, violations of regulations or other conflicts that might impede the company?

• Will the customer buy the product?

• Are the financials sufficiently predictive? Is the amount of money the company is attempting to raise sufficient to achieve the necessary milestones?

What is an investment meeting?

The investment meeting, for many angel organizations, is the meeting at which angel members are asked to seriously consider investing in the company. This meeting usually follows the successful completion of due diligence and, in the case of angel networks, agreement by one or two members to invest in the company. The entrepreneur is often introduced by a champion or the lead of the due diligence effort, who can now validate the investment opportunity. The presentation is similar to that of the screening meeting, but the length of the Q&A period may be extended to allow members to get answers to as many of their questions as possible.

Will angels write checks at an investment meeting?

In the case of angel funds, the entrepreneur will be excused and a vote will be taken on investing in the company. Assuming a positive vote and that the term sheet has been successfully and completely negotiated, a check can follow quickly.

How long will it take to get angel money?

From start to finish, it usually takes 3 to 6 months to close an angel investment round. Due diligence takes significant time for both angel networks and angel funds.

When should I get my attorney involved?

First time entrepreneurs should spend time networking and develop a list of the best attorneys in their region for assistance in starting companies in which equity investment is anticipated. Include a candid discussion of fees in your interview. Lawyers familiar with starting companies realize that entrepreneurs do not have a lot of money for legal fees at the outset and many are willing to forgo some or all of their legal fees until the company close its first round of funding. Angels have usually invested in companies before and understand the terms and conditions of the investment. Have a strong team on your side when you begin seeking investors.

Can I expect all the money at once?

Investor have two choices, giving all of the money raised in a round of investment to the entrepreneur at once or parceling the money out to the entrepreneur in “tranches,” that is, giving the entrepreneur the money as milestones are met.

What reports will investors expect?

Ask investor groups what reports they would like and how often they would like them, and then do your best to deliver those reports on time. Provide frequent and complete reports to your investors on a regular basis.

What is “redemption?”

Redemption is the repurchase by the company (or the entrepreneur) of the investment made by angels and venture capitalists after an agreed upon period of time (often five years). This is an intimidating term, because it requires the entrepreneur to buy back the investment (sometimes at a premium) from investors at a later date.While intimidating, this term seldom, if ever, will come into play. Why? Because five years hence, it is unlikely that the entrepreneur will have the resources necessary to repurchase the investor stock as required by this term.

The worst fear of any investor is that the entrepreneur will convert a rapidly growing company into a lifestyle company, that is, the entrepreneur is earning a nice salary and becomes less willing to push hard for growth. In this case, the company is doing OK, but is simply going sideways…not growing, not increasing the value to investors. Redemption is designed to make entrepreneurs uncomfortable and to remain hungry for success. Entrepreneurs who become comfortable will see their investors attempt to invoke the redemption rights and, since the company and the entrepreneur cannot afford to repurchase the investor stock, the investors may, indeed, become 100% owners of the company.

No investor insists on redemption rights because s/he wants to own 100% of the company. The opposite, in fact, is true. The investor wants the entrepreneur constantly striving to grow the company for a successful exit. But, the threat of redemption is necessary to keep some entrepreneurs’ feet to the fire.

What are “anti-dilution rights?”

Anti-dilution rights (or privileges) preclude an investor from seeing his ownership in the company diluted by the sale of shares in the company at a valuation less than the valuation at the time the investor’s funds were invested in the company. There are somewhat complex formulae describing the two basic anti-dilution methodologies.

• Full ratchet anti-dilution – If a subsequent investor is sold one or more shares of stock at a lower price than the price paid by investors with full ratchet rights, the earlier investors are immediately granted an additional number of shares that s/he would have purchased at that price with his or her original investment.

• Weighted average anti-dilution – In this case, depending on the volume of shares sold at the lower price, a proportional number of additional shares are granted the original investor(s). In other words, if only a few shares are sold at a lower price, the original investors are only eligible to receive proportionally more shares based on the extent of their dilution.

What is valuation and why is it important?

• Pre-money valuation – The value of the company at a time immediately before closing a new round of investment in the company. For a company which has not raised any significant money in the past, to what assets are we attempting to assign a value?

• The idea for the business

• The “sweat equity” of the assembled management team

• The proprietary technology driving the business

• Product and/or service development

• Relationships established by the team – with customers and partners

In short, the pre-money valuation represents the value of the opportunity to build a substantial business. What would an independent third party pay for this opportunity, if all owners wanted to sell without taking investment? Probably not much. Investors are paying for passion, commitment and unproven ideas – a high-risk opportunity to build something of value in the future.

• Post-money valuation –Pre-money valuation plus the amount of money invested in this round equals post-money valuation. It is very important that entrepreneurs stipulate whether you are talking about pre or post-money valuation when talking to investors.

It is important to understand that the pre-money valuations of seed and startup companies would be much higher if the odds were greater than about 1 in 10 that invested companies would exceed investors’ and entrepreneurs’ expectations. But, over the decades we have only found that about 10% of fundable startup companies, which are good enough to secure angel financing, actually achieve the kinds of scale to which both investors and entrepreneurs aspire. These statistics, well-understood by investors but not necessarily acknowledged by entrepreneurs, usually explain differences in opinion of pre-money valuation between the two groups.

How are pre-revenue companies valued?

On-going companies are often valued based on multiples of earnings or cash flow. The methodologies generally involve crunching numbers based on financial statements. But, pre-revenue companies have no proven financial statements, only planned financials. We can apply subjective considerations to assist in determining where a fair pre-money valuation is for your company. Investors consider the skills and experiences of the management team, the size of the opportunity, and the strength of the technology portfolio, among other factors.

While this may be surprise to most entrepreneurs, here is a table that describes how some angels attempt to quantify the value of pre-revenue companies:

• Management Team 30%

• Size of Opportunity 25%

• Product/Service and Technology 15%

• Marketing and Sales Channels 10%

• Competitive Environment 10%

• Other factors 10%

Management Team (30%) – The management team is the most important consideration in valuing an early stage enterprise. An experienced CEO will necessarily command a higher valuation for the company. But, a CEO/founder who is clearly capable of achieving certain milestones, such as completing product development and closing the first few sales, and is willing to step aside in favor of an experienced CEO to be hired later is also valuable. It is not critical that the management team be complete, although some key players should be on-board or at least identified and in the wings. What is important is that the founder recognize the key team members that need to be in place and when.Investors bet on an A+ team with a B product idea every time over a B team with an A+ product. Why? Because A+ teams will find A+ products and build a business, while sometimes B teams cannot commercialize A+ products. This is why the quality of the management team so critical to investors.

Size of the Opportunity (25%) – Investors seeks to fund companies that will scale quickly. The importance of this factor in valuing pre-revenue companies demonstrates the criticality of scale to investors.

Product or Service (15%) – Product or service represents such a small piece of the pre-money valuation. And, for high technology companies (with a valuable patent portfolio) this 15% number is low and would be perhaps 20%. In no case would the importance of the product or service exceed that of the management team or the scalability of the company. The product is important, but only as it defines the domination of a large marketplace that the company can achieve.

The Benchmark Method of valuing pre-revenue companies first looks at the average valuation of similar companies in the region in recent transactions. The investor then considers each of the factors listed above for the target company and may conclude that the target company is 20% more valuable than the average comparable company, perhaps due a very strong management team and solid product intellectual property.

How are on-going companies valued?

Often angel investors have an opportunity to invest in small ongoing companies that have uncovered a new, large opportunity and need capital to take advantage of the new business. These cases tend to represent somewhat lower risk investments for angels for two reasons: (1) the founder/CEO has already demonstrated the skills to run at least a smaller business and (2) the company already has revenues and earnings.

Some angels value these opportunities by estimating the value of the ongoing business and then adding to that the valuation of the pre-revenue component of the new business.

Methodologies for valuing ongoing businesses are well-documented. Appraisers of ongoing businesses tend to use multiple methods and then use a weighted average of the results to come up with a final valuation of the ongoing business (or the ongoing component of an angel investment opportunity).

Here are the descriptions of three such methods that might be used in such a weighted average:

• Transactional method – If stock has recently changed hands between independent third parties, the valuation at the time of such transactions is appropriate for consideration.

• Comparable method – By comparing the price/earnings ratios (and other appropriate data) of comparable public companies to the target company, reasonable assumptions of value can be obtained.

• Discounted cash flow – By discounting the cash flow (or earnings) from reasonable projections of future performance (based on past performance), the appraiser can obtain a third important valuation to be averaged with the rest.

How are the CEO and the management team appraised?

In rating the key team members, three sets of criteria are critical:

• Skills and experiences: How many years of experience does each team member have in the role s/he is expected to play? How was each team member rated in these roles by previous employers and employees? How comparable were these roles to the expected roles in the new company? Were these experiences in the same business verticals as the new company?

• Integrity, passion, work ethic: Investors are entrusting large sums of cash with this management team, so integrity is of utmost importance. Background checks focus on integrity. But a passion for the new venture is also important as is the work ethic of each team member. Starting a new company requires huge time commitments by team members. Is this team ready to step up to the plate? Finally, does this team have “both feet in,” that is, fully committed to the success of the venture?

• Prior success in business is an important criterion for measuring team members. Team members with no previous business experience are difficult to evaluate and generally receive low marks.

Why is the size of the opportunity important and how is it determined?

In measuring the size of the opportunity, the key issue for investors is to carefully define the niche. Too many entrepreneurs, in describing the size of the opportunity, show investors the size of the industry as a whole. Another mistake entrepreneurs make is to suggest that the demonstrated market size for their niche is $1 billion and they need only capture 5% to be a $50 million company. That logic is unconvincing. Why should we assume 5% versus 0.05%? Investors want a bottoms-up analysis, that is, we want to know the compelling reasons that specifically-identified customers will purchase how much annually.

How is the intellectual property valued?

Proprietary intellectual property (IP) is an important competitive advantage to entrepreneurs. Investors first want to know that (1) the company actually owns the IP, (2) the IP gives the company a competitive advantage and (3) that the company has room to operate, that is, that competitors have not hemmed in the IP with other patents that limit the operating space of the company.

IP is not usually valued per se. Investors credit the value of the IP into the likelihood that the IP will allow the company to grow more rapidly in market share, because the competition will not be able to respond quickly with “me-too” products.

The competitive advantage provided by strong IP can bring significant value to the company at exit. Once the business model has been proven and value proposition to customers is validated, potential buyers will view strong IP as important differentiation when considering the possible acquisition of your company.

Why doesn’t the product receive more attention in valuation?

The product is a critical ingredient in the success of the business, because it describes the size of the opportunity, competitive advantage, etc. Taken as a whole, these are huge pieces of the valuation. A great management team with an average product has a much greater chance of success than an average team with a great product. Great management teams can innovate and execute. The product is only one piece of the puzzle.

Why is competitive analysis important? What if I have no competitors?

Never tell investors you have no competitors. If your product is going to be used by a customer, those same customers somehow got the problem solved yesterday using some product or technique. That is your competitor today. If you introduce a product today, your potential competitors will know about it tomorrow. Which ones have the capabilities, resources and interest in competing with you in this marketplace? These are your competitors.

Competitive analysis is critical because it provides some answers for investors to the question of what kind of head start you will have in the business vertical and how long that lead will last. Furthermore, this analysis will define which competitors are likely to enter the market with competitive products and when. Well-funded competitors who only have to tweak their products to chase you into a new market are intimidating because they are established in the marketplace with plenty of money and resources.

Why are investors concerned with sales and marketing?

Nobody beats a path to your door to buy your new product. To focus on sales, investors need to know: How customers in this marketplace normally buy their products. Do they buy from direct sales persons or sales representatives or through distributors? Do customers in those different markets buy products via different channels? How will online sales contribute to the success of the company?

Investors need to confirm that entrepreneurs both understand the importance of sales and marketing and have important management team members focused on making sure sales happen.

Why are investors (and entrepreneurs) concerned about dilution?

Dilution is normal for angels and entrepreneurs in companies that need to raise multiple rounds of investment. When the valuation is steadily increasing, the ownership percentage of early investors and the entrepreneur tends to decrease (unless they invest cash along with new investors), but the value of their investment increases because the price per share continues to increase. In some instances, angel will invest in several rounds at higher and higher valuations because they continue to believe in the return on investment opportunity even at higher valuations. But, many angels simply make one or two early investments and allow themselves to be diluted as the valuation and investment increases.

Why is it important to come to an early agreement on valuation?

Contentious negotiations on valuation create hard feelings that can last through the duration of the investment decision making and investment.

What do angel investors expect from entrepreneurs?

Angel investors expect timely information on the financial and non-financial progress of the company. Some of this reporting may be covered in the term sheet for the deal and other investor reporting obligations. After closing the investment round, the entrepreneur meet with investors selected to serve on the Board as members and discuss regular reporting to investors. Quarterly financials (income statement, balance sheet and cash flow statement) be sent to investors with a cover letter describing progress related to non-financial milestones.

What is the makeup of an effective Board?

In general, smaller Boards of Directors are probably better for seed and startup companies. Perhaps the founder/CEO, an angel representative and an agreed upon experienced, outside Director would be appropriate for starting the company. Somewhat more established companies should consider five to seven persons Boards.

Entrepreneurs feel more comfortable when key management partners, such as the CFO or the partner are on the Board, but this can create unnecessary problems down the road. The Board of Directors can provide useful counsel to the CEO/founder in evaluating and managing key members of the management team, but these discussions cannot take place if those team members are also members of the Board of Directors. It is also reasonable to invite key members of the management team to regularly or irregularly attend Board meetings. However, the involvement of management team members should be limited to the “open” portion of the meeting. Only Directors should be present during the “closed” portion of meetings and during these periods, frank discussions of all members of the management team are easily facilitated if only the CEO is present.