Equity plus sales is often the best funding

Part Nine: funding a startup

So, here we are nine articles down the track and back where we started with “Show me the money”. Why? Because at the end of the day it’s the start and finish of everything.

It’s our oxygen supply that we need to build our valuable business and it ultimately controls everything we do.

We have seen how a valuable company is a profitable company and we have seen how we need to find a market then build a team and a product. Each of these steps will require (from one source or another) money.

The dream is that along with customers beating a path to your door, a gaggle of benevolent venture capitalists (VC) will come, offering you the money you need to support your new lifestyle. Unfortunately, it mostly doesn’t work out this way. So lets look at a few ways that may work out.

The first thing to do is to make sales. As well as proving that a market exists this, as a handy by-product, should also generate cash. Cash is a better predictor of future success than your mother’s opinion. So, the faster you can generate sales the faster you can build profits and the less you will have to spend.

When it comes to building a team, equity can be a useful ally. You need the very best team you can find. A poor choice here may well be fatal. But it’s also likely you won’t have the funds to pay someone who is really good, say at sales, what they are worth. However, you can offer them equity to compensate.

External investors are a typical source of funds for a start up, but not normally VC’s. A realistic alternative are angel investors. These are people willing to invest relatively small amounts into early hi-tech businesses. But remember the failure rate.

They also know that it’s very high and they will want to be compensated for that risk accordingly.

Debt is a possibility, but difficult in New Zealand. Bank debt funded over debtors has been common in other jurisdictions, but debt here is usually only advanced over bricks and mortar assets.

An often overlooked source of funding are customers, especially competitors. In many cases a mature company will not be able to innovate as well as a young company.

So you find a cash poor start up with a great product and a cash rich competitor with a poor product.

You can probably see where I am going with this and I have concluded funding like this on a number of occasions. Rarely do the two companies wind up competing directly and the revenue gained from this approach is a very useful source of funds to build a profitable company.

Just bear in mind, as with the example on heart transplants, this is the “what to do” not “how to do it”. You do not want to even think about drawing up legal agreements yourself. This is an area where you need professional advice to avoid a disastrous learning experience.

How should you arrange funding then, well clearly a mixture of equity and sales is the best. Whilst everyone’s circumstances will be different, some general rules of thumb and benchmarks exist. When you are building your team (executive, board, advisory board etc) you will need to draw on all these skills to formulate the best mix for your circumstances.

However, please bear in mind running out of money is like running out of oxygen. It will result mostly in sudden death. In order to win the game you have to first of all stay in the game.

Now for a couple of closing thoughts before I hand the final column, part 10, to others whose opinions and advice I respect immensely.

Building a hi-tech business is a very risky proposition.

It’s not for the faint of heart. It’s not likely to be a business you will leave to your children and, like selling fish, it’s not something that improves with age.

That said, building scalable and valuable hi-tech businesses can create tremendous value.

As a country we will need a lot more of these businesses in the future, if we are to provide a better standard of living for our children. They can also be tremendous fun and offer huge opportunities for personal growth.

Unfortunately, the track record in turning clever product ideas into valuable businesses is not great.

More worryingly, I often see businesses that failed due to self-inflicted own goals. This is a tragedy for all involved, entrepreneur, staff, customers, suppliers and financiers.

Sometimes a lot of good comes from the process. In my experience, an entrepreneur who fails and then gets up and tries again is a lot wiser second time around and a lot more likely to succeed. Unfortunately, this learning comes at a horrendous and avoidable cost, both financial and personal, to those directly involved and the consequent collateral damage to those around them.

If there is one thought I would like to leave in your mind after having read this series, it would be to focus carefully on your objective and listen carefully to any advice offered, especially the advice that at first blush seems counter intuititive and offered by someone who has been there and done that before.

If your objective is to build a valuable business, and I hope it will be, for each issue you face simply ask yourself which alternative takes me closer to that objective.

Ultimately, you are embarking on a marathon and a war. You may lose the odd battle along the way, providing you win the war. You don’t want to focus just on winning battles so that at the end of the day you have still lost the war.

In the final article you can read the views of the best people I could find, offering you gems of wisdom drawn from their experience. At the time of writing this article, I have had the first dozen back and they are very good. I am sure you will enjoy reading them. They have come so far from serial entrepreneurs, VC’s, a PR expert and an Honorary Consul General who are all willing to offer advice to help you on your way.

Good luck on your journey and godspeed. Our children’s future and our economic future as a nation are riding on your shoulders! No pressure.

O’Hara is chairman of Clarity Commerce a publicly listed software company based in England. He is also an independent director of Tait Electronics in Christchurch and Tekron International in Wellington. contact him at www.johnohara.co.nz

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