In early 2005,
Jay Bhatti and a business school friend, venture capitalist Jaideep Singh, hit on the idea of building a people-oriented search engine. To compete against behemoths like
, they spoke to some 40 venture capitalists and investors to raise the needed funds for Spock.com.
It took some smooth-talking, serious number crunching and a bone-deep belief in their vision to pull it off. But about a year later, they've raised $10 million for a beta test. Here are some things they and investing experts say to keep in mind when wooing the money people:
Do Your Homework
Write up a business plan yourself. You've heard this piece of advice a lot, and there's a reason for it. It not only helps you figure out how you'll differ from the competition, it also helps you determine how much funding you'll need. More importantly, you'll know how to defend your financial request. Because, says Bhatti, investors like venture capitalists will push back and question every line item. If you're not able to explain your rationale, then investors may question your understanding of the market and your model.
Some investors will even make you project into the future. Bhatti and Singh had to figure out where their business could be in five years, from the revenue source to the acquisition cost per user. "We had to create a ridiculously complex financial model based on nothing but assumptions," says Bhatti. "I didn't even know what our first month would be once we got funding. But this all was to make the VC comfortable that we could be a huge business in five years."
Mine Those Connections
After you've hit up friends and family for money, consider your local bank. A prior relationship with a bank may persuade that lending institution to take a risk on you. "When it's not a clear approve or decline decision, if a customer has a good established relationship with the bank, he or she has a better chance of getting approved than someone with no relationship," says Mark Hogan, president of small business banking for
Bank of America
The investing world can be a small one. Don't be willing to talk to every Tom, Dick or Harry with a checkbook. Target investors who you think will not only understand your vision but also be comfortable to work with. After all, the relationship can be a long one, and the road to success will be arduous.
But Be Realistic
Most start-ups will, frankly, be funded by friends and family. An institution like Bank of America is only interested in investing in a company that's been around for at least two years, says Hogan. "What we look for are businesses that have established their niche or target market, have made entrance into that market and found success in delivering their product to that market."
Venture capitalists can be even pickier. David Stern of Clearstone Venture Partners says VC companies like his are only interested in opportunities "that can produce a sizeable return." Adds Stern, who is also a blogger (davidlstern.com), "A business that would grow 15% per year and be cash-flow positive might be a great investment for an angel investor that is happy with a three-times return on their investment. We're shooting for something much larger." For Clearstone, we're talking
Don't be too eager to sign away the company in the hopes of getting that investment. It's your vision, your company. Not to mention, things can change in a start-up overnight. You need to retain enough equity to make the necessary decisions to keep on track. You may also need to keep some of the equity to lure the most qualified employees. According to Bhatti, it's standard practice in Silicon Valley to set aside 20% equity for employees. That strategy helped them recruit engineers with years of experience building search engines. Still, says Bhatti, "at the end of the day, the VCs will own 50% of the company. We're lucky, we have the right VCs working with us."
Timing Is Everything
Once you've written up the business plan and put together a list of investors you want to go after, take a hard look and see if you are indeed in a position to be attractive to investors. Stern says he often tells entrepreneurs to come back "when you've created some value that we all can reward you as an entrepreneur for. Build a prototype. Hire an A+ rock CTO. Put your own money into the company. Get a key strategic partner that is locked in. Get your first 100 users on the Internet and glean some data from their use ... anything that shows some progress and shows your commitment to an endeavor."
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Lan Nguyen is a freelance writer based in New York City. She has written for the New York Daily News, The Wall Street Journal, Worth magazine and Star magazine.