Technology entrepreneurs often have great ideas, but are short of a critical resource: the money to bring their product or service to market.
Creating a business that can grow organically or taking an existing small business to the next level is expensive.
But unless you’re taking straight debt financing, from a bank, for example, there’s more to a business partnership than just money. But how does a startup find potential partners? And how do they know they’re the right fit?
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Calling all Angels
Often, the initial funding for a startup comes from friends and family – “love money,” as Scott MacCannell, president and director of York Angel Investors Inc., calls it.
“Angel investment is really what gets these early companies going,” MacCannell says. The next step up the ladder is the angel investment group — experienced angel investors who apply a lot of criteria to potential investments, using their collective wisdom to determine whether risk of a business with a good upside can be managed, MacCannell says.
“These are the people who have done what the entrepreneur is trying to do, MacCannell says. And it only starts with the money. They’re coaches, sounding boards, and co-managers, too. A simple debt partner “is not going to ride with you on a key presentation.”
Tough economic times are giving angel investment a higher profile, as venture capital companies tighten purse strings and angel groups fill the void in the lower end of that market. But still, “this whole angel business is unknown to many people,” MacCannell says.
And they can be difficult to find.
Individual angel investors don’t tend to advertize, though the groups can be located on the Internet. And the National Angel Capital Organization organizes national and regional conferences, where pre-screened entrepreneurs get a chance to present to representatives of angel groups.
Now you’ve connected with potential partners. How do you get the right fit?
Deal from a position of strength
Have options. You don’t want to be in a position where you have to do a deal; you want to be in a position where you want to do a deal, says Bill Snider, chief financial officer of Blue Cat Networks. The Toronto-based Internet protocol address management (IPAM) company has been through two rounds of financing since its self-financed launch in 2001.
For BlueCat’s 2006 and 2009 rounds of financing, the company had a proven product, proven market and proven organic growth. But there are other ways to create that position of strength.
“You have to believe in your ability to succeed,” says Snider. Back that up with a complete, fleshed-out strategic plan, not just cash-flow projections. Who are you hiring? When and why? Does that match up with your spending projections?
Often, revenue projections and market share estimates are too aggressive, says Kashif Hassan, a serial entrepreneur who’s been on both sides of the negotiation table.
And on the flipside, entrepreneurs often underestimate the costs of bringing a product to market, he says.
“It’s not just about technology,” Hassan says.
Your package should reflect an understanding of the customer and the pain point you’re solving, the size of the market, and the competition for your customer’s dollar.
Angels are looking for “disruptive technologies, something that’s really a breakthrough,” says MacCannell. They’re also looking for intellectual property (IP) that is patented or has patents pending, and to make sure ownership of that IP is owned in-house – it can act as security for the investment if the business doesn’t pan out.
Throughout the negotiation process, “if you’re an individual who needs to win on every point of the deal, you won’t get much done,” says Snider. Know which elements of the deal are critical, and which are simply nice-to-haves.
“Pick your battles,” says Hassan, who founded Wysdom Technologies Inc. and now serves as chairman and CEO of Ooober Inc., a mobile software company. The biggest friction point will probably be valuation; entrepreneurs have to be flexible. Make sure one side doesn’t dominate the board seats, and that your rights to the business when it comes time to sell are clearly spelled out.
It’s not just about valuation
Interestingly, Bridgescale didn’t offer the highest valuation for its stake in BlueCat.
“It was about who we wanted to work with at the end of the day,” Snider says. “It’s all about fit. It’s about wanting to have them at the boardroom table with you.”
It’s important to approach partners that can add value to the company, Snider says. Bridgescale, for example, introduced BlueCat to some key strategic hires from its worldwide network of contacts.
“There’s the know-how and the know-who,” as MacCannell puts it.
According to Hassan, there are the money investors who just want a piece of the company, and the active investors who want a more hands-on approach. If the investor has experience in your market, you’d be foolish not to leverage that. If they’re new to that market and want to be hands-on, though, “they might become more cumbersome than anything else.”
Do your diligence
When negotiating the 2009 financing deal with Bridgescale Partners, “it was just as much us interviewing them as them interviewing us,” Snider says. Talk to other companies and ask what doors your potential partner opened for them. Test-drive the Rolodex. Can they get you into deals you couldn’t yourself? “Prove their network,” Snider says.
Be open and honest
“It’s key throughout the process to be open and honest,” says Snider. Trying to cover up the warts can backfire. An eleventh-hour discovery that you’ve tried to hide a flaw can kill the deal.
“As soon as you’re going out to get someone’s money, you’re entering a partnership,” Hassan says. It’s better off in the long term if both sides are upfront. “Everybody’s got issues.”
Be honest about the challenges; investors don’t expect you to have all the answers. “The more they know about the business, the more they can help it,” Hassan says.