Raising Capital for a New Venture in a down market
I just heard from a friend of mine. He is out looking to raise capital for a business venture he is starting. Without going into all the niceties of our conversation, we quickly got into a discussion about raising capital and pondered the effects the current economy will have on availability to capital. So I figured I would share some of my views on that here.
Unless you’ve had your head in the sand for the last year, you will know that we have been slipping into one of the worst economic periods of our nations history. So perhaps you may believe that raising capital today will become impossible. I would say it is just the opposite. Sure raising capital was easy during the bubble. All you had to do is put together a 10 page presentation, drop out of Stanford, have one of your professors introduce you to some VCs and voila! You walk away shortly with a 20 million dollar check and you are off to the races. Or at least that was the way it seemed. The fact is the number of investments rose, but so did the field of businesses looking for money. So much so that it was just as difficult to get financed. You had to stand out amongst a larger field of players.
Now… I am not going to say that this ended badly for everyone. However, I would say that this did cause a large amount of funding for very bad ideas. VCs were throwing all their fundamentals out of the window to chase after these deals out of fear of not being able to keep up with their counterparts. The people they raised money from apply huge amounts of pressure to perform, and you cannot perform if you are not even in the game. But there was also a dynamic that occurred that most people didn’t see. The more crazy deals that VC’s got into, the more people came out of the woodwork with more crazy deals.
I can tell you that the number of business plans I was exposed to grew during that period exponentially. I was discarding many more plans than I could ever read and those that I did read all seemed rushed and half baked. But the sheer volume of people that were trying to raise capital was staggering. If anything good came out of the tech bust, it was that things slowed down.
Raising money in a down market can be challenging. But not for the reasons you may think. Most people believe that eventually as the economy suffers, the capital being invested in new ventures eventually dries up. That is in fact not true.
Most investment money comes from people who are trying to balance their portfolios between growth and asset retention. Savy investors will split their portfolios up between various industries, and segments. They will invest in some high risk investments to maximize growth, and some more conservative vehicles to ensure they are able to retain their base level of assets.
However, with most money out there, a long term outlook is necessary. With new ventures, this is almost a given. If I invest 1 million today into a company that is a new venture or start up. I would have to expect that I will not be able to get a return on that investment for quite some time. That and the fact that the new venture will most likely not be dependent on the economy until it is ready to sell or distribute its products will mean that regardless of what the economy is doing today, I need to predict where the economy will be when it will matter. In addition, I will look much more closely at the venture to determine if this is a high flyer or an idea that is built on sound business practices or both.
So think about it this way. If you think you have a good idea for a good business, why not start it today? First off, you will need to have a strong fortitude to handle the risk. I think that is a huge quality in an entrepreneur. In fact, it also is direct proof of the validity of your idea. If your idea is sound and has good business fundamentals, you will survive through downturns in the economy as well as succeed during the good times. In fact, the down economy will prove whether or not your product is necessary. People don’t spend money on things they don’t find necessary when we are in a downturn.
In fact, wise people understand that during a down economy, if you have the war chest to do so, is the best time to invest. During recessions, you see stronger companies buying weaker companies all the time. The reason for this is that they know they are purchasing an undervalued asset. They know with proper management and support that they will be positioned to grow stronger and faster when the economy turns for the better. Its the strong preying on the weak.
So investment dollars are still there. Overall deal flow may be down, it may be longer to get to closure, investors may dig deeper into your plan. But it provides a much stronger test. It allows you to proof your ideas, strengthen your plan, ensure you are making the right choices.
So where do you turn for money in a market like this?
Customers are great. You should always start with your customers. There are two ways to get investment from your customers, sell them your product and or ask them to invest in a joint venture. Large companies invest in joint ventures. They monitor the markets, look for ideas, and seek to be prepared to handle the future. Larger companies will invest in start ups and ideas and joint ventures much like traditional investment sources like VC’s and Institutions. However for them there is the added benefit of those investments not only paying off financially, but also paying off by adding to the value of their ongoing business. It can help them enter into new markets, solve future customer demand, innovate on existing products. The benefit to the entrepreneur is that it proves you can sell to corporate America. You have taken a big first step in validating your idea. You have gotten your first potential reference, access to your end users, and visibility into the real practical problem you are trying to solve. It also helps you later when you seek you next round. Customers who invest in you can be one of the biggest benefits to future fund raising.
Angel investors are another avenue. Since angels are usually individual investors, one of the things you will find is economic downturns weed out the faint of heart in the angel community. Those who are effected by the economy either mentally or financially are probably those you did not want to invest to begin with. They are usually the ones that after they invest are the ones that call every other day to get an update, or look to second guess your ideas, or are constantly asking when they will see a return. During a down economy, the angels that still invest are usually solid people. They are strong enough to weather a storm, they understand that down periods happen, they will hold a longer term view of your business. They will be good planners and advisors. All of which are good attributes.
Institutional players. Many people think that institutions only deal in very large numbers. However, there are many institutions that set aside money to dabble in the early stage of companies. These institutions range from investment trusts for high net worth families to mini funds to pensions unions and the like. What is nice about these investors are that they are very hands off. They expect periodic communication that is done consistently and professionally, but other than that and maybe a few questions now and again, they sit back and watch. They also become a great avenue for introductions to follow on investors once you prove to them you are fulfilling what you said you would in your business plan.
Yes there are other ways to raise capital. Perhaps from my obvious exclusion of VCs you may be wondering what my thoughts are there. I believe that venture capital is tricky and is a subject of its own. Yes it can be a benefit to your company, but only at certain times and for certain reasons. I like to say to new CEO’s that if you feel you need to turn to VCs for money, then you have something wrong with your plan. The reason for this is that if you have a good idea and you can attract investors from other sectors, do so, that way you will be acting in a position of strength if a VC approaches you and not the other way around.
So in summary I guess I would say, down markets may be hard, but a good company that can start and grow and survive during a down market can be one of the best investments there are right now.
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