The Money’s in the Bank Once the Money’s in the Bank: Back-up Plans

By: Janis Machala, Managing Partner, Paladin Partners janism@paladinpartners.com I recently have had conversations with several entrepreneurs who were scrambling for investment for payroll, commitments made to vendors, or who thought they’d have a paycheck and lo and behold “it’s not going to happen this month.” This reminds me of other conversations over the past 20 years when a VC check didn’t arrive to close a round because something odd happened at the 11th hour that spooked the partner on the deal or a VC signed a term sheet without having done due diligence ahead of the term sheet and the founders were star struck over who the VC was versus what their process was and how solid was that term sheet really. What all this has led me to is two things: 1) Hope is not a strategy 2) The money’s not in the bank and can’t be spent until the money’s in the bank. I have seen too many entrepreneurs believe wholeheartedly in an angel syndicate or a venture firm and not have a back-up plan should that deal not happen. The latest case is a family office investing $1.5M into a company. A tornado hit the region where the FO Leader lived and then a family member got very sick right after that. Needless to say, that person’s focus is not on you and your company but on their shelter and family member (rightfully so). In this situation there were other family offices interested in the deal but the founder put a hold on these since this was the “sure near term one.” There’s never a sure one. Stuff happens, life happens, interest wanes. And there’s bad luck in business just as there’s good luck. When it comes to financing I have not seen very many good luck scenarios versus bad luck scenarios. That’s because you need the money far more than the investor needs to invest in your company. Always remember that. That’s why I always recommend managing investor fundraising exactly as you manage enterprise sales with all being worked but with a different probability of close for each investor. Keep as many balls juggling and moving forward as you can (oh, yes, and run your business too!) until you actually have money in the bank. And by the way, don’t accrue debt thinking you will pay that back after funding closes. Investors are not putting money in to cover the past investments but are investing in the future. How many entrepreneurs have not made a payroll, have not paid the IRS or the state tax liability on payroll, have liquidated their 401K to cover payments thinking they’d just put that money back when sales or investors come through, or have foregone any funds for their own living expenses only to find that their credit now sucks and they’re paying interest only on their credit cards and not able to refinance their high priced mortgage never mind putting their 401K funds back in place. It’s a slippery slope and one that can ruin personal relationships and founder partnerships. Again, hope is NOT a strategy. When you liquidate that 401K just assume that money will never get put back. I have seen a founder do the smart thing and arrange a line of credit secured against an asset (their home is the most typical) before they’re in trouble since interest rates are quite low on these and it’s easier to have $100K or $200K lined up before you quit your job as a line of defense against a missed payroll or a sliding fundraising date. By the way, ask your VC for a bridge loan-that’s often a good way of testing their intent versus their using the “no shop” time-frame to see if they really want to do the deal with you. If you’re an investor, be open with the entrepreneur where you’re really at with respect to funding and any snafus or issues you’re personally dealing with that might affect timing of your investment. Being honest about your probability of doing a deal will win you lots of friends in the greater entrepreneurial community. A “fast no” is much better than a “slow maybe, let’s see how you evolve.”  It’s a small town so telling an entrepreneur how long you take in your due diligence, that you have 3 issues you want to see addressed, or that you want someone else to lead the round that you like to follow will pay you back in many ways re: word of mouth from entrepreneurs recommended investors and other angels who like doing deals with you.

Key Marketing Metrics in Startup Projections

Guest article by Bryan Brewer of FundingQuest

After hearing more than a thousand investor pitches in the last 12 years, one thing I’ve noticed is the frequent omission of two key marketing metrics: Customer Lifetime Value (CLV) and Customer Acquisition Cost (CAC). I’ve even had startup clients argue that determining these metrics was not a useful exercise!

In my opinion, both of these metrics are key to evaluating the efficiency of the company’s marketing efforts. I think some of the confusion arises from the valid point that assessing either of these metrics alone may not be very meaningful. For example, if Company A is making single sales of low-priced items, the average CLV might be less than $50. On the other hand, if Company B is selling a $30/month SaaS subscription with an average customer tenure of 30 months, the result is a CLV of $900. Or Company C, selling a complex piece of medical equipment with disposable test items, might have a CLV of $10,000 or more. Taken alone, any particular CLV does not give an indication of the company’s prospects for success.

A better approach might be to consider the CLV as it compares to other companies in the same space. If other businesses similar to Company C in the above example have an average CLV of $50,000 or more, then an investor may rightly wonder if Company C will survive in that market.

The best approach to making sense of these metrics is to calculate the ratio of the Customer Lifetime Value to the Customer Acquisition Cost. If a startup sells products at higher prices, then it can afford to spend more money to acquire customers. Conversely, a company with a low CLV needs to find a very low cost way to acquire customers in order to be profitable.

The ratio of CLV to CAC is what I call the “Marketing Efficiency Factor.” For Company B in the example above, a CAC of $150 results in a healthy Marketing Efficiency Factor of 6 ($900 divided by $150). However, if it turns out that Company B needs to spend $450 to acquire a customer, then its factor drops to 2 – a position which doesn’t leave much margin for overhead and profit.

Marketing Efficiency Factor is one of numerous metrics on which you can rate your startup in my recently released Minimum Fundable Company® Test, available for free at www.mfctest.com. The test covers 20 multiple choice questions in the areas of Startup Viability, Business Model, Market Strategy, Management, and The Deal. I suggest that a company needs to score at least 50% in all five areas in order to be considered “investor-ready.” In my experience, if a company is deficient on one or more of these areas, the story told in the investor pitch will simply not hold together, and thus will not hold the attention of investors.

Minimum Fundable Company is a registered trademark of Funding Quest, LLC.

Board of Directors and/or Board of Advisors

By: Janis Machala, Paladin Partners, janism@paladinpartners.com

Since this newsletter goes to angels and entrepreneurs I thought it would be interesting to discuss start-up boards. Who should be on a board of directors? Is an advisory board a good thing?  How to use advisors effectively? I’m sharing a great piece by Steve Blank (who also has a link in his piece from Brad Feld).

People often tell me they are advising several companies but when I ask what they’re doing as part of this role it’s usually coffee once and a while with the founders.  That’s expensive equity and cost of coffee for founders. I also know from recruiting board members for the board of directors and advisory board members that every one of those individuals needs to be led and not left to figure out how to be useful. Also, don’t recruit so many advisors that you can’t possible use them to maximum effect. More advisory board names in your executive summary or on your website is not growing your value as a company or adding to your legitimacy as an inexperienced team.

I often recommend an advisory board to founders: 1) it’s great practice for learning how to lead senior executives; 2) it’s a great try out for potential board of director candidates; 3) leading an advisory board is great at preparing the CEO to chair a board of directors; 4) reaching the right industry players who can open doors to the C-Suite for B2B companies is a valuable use of a modest amount of equity; and 5) your advisory board is there for the CEO/Founders while the board of directors is there for the company (big distinction).

I’m in Brad Feld’s camp about building your board early. As soon as you take in any outside investment it’s good business practice to have outsider(s) on your board. It prepares the founder(s) in leading a board before the “big gun VCs” join the board at your venture financing stage. The outsider(s) have hopefully been a CEO and lived in your shoes. Just because someone writes a check to invest as an angel or a seed VC does not automatically provide a right to a board seat. Boards where founders are 2-3 of the board seats, a waste of critical founder talent on the wrong things. The CEO should be on the board but there’s little value to other founders being on the BofD since their equity ownership will provide sway on critical issues such as financing terms, addition of shares, hiring/firing CEO, etc. It is typical that the other founders who want to be on the board think it’s a big deal but that’s their egos talking.

I am often surprised at how little thought goes into board of directors and advisory board composition. The people you keep company with in these roles can add enormous value to your company or be a “pain in the you know what” if they are not a cultural or capabilities fit. Treat each of these roles and recruits with the same care you use to pick your cofounder or your executive team members.

Check out the new Office Hours!

Woohoo, more mentors at Seattle Angel are offering Office Hours. Ryan Porter has an incredible background as an engineer and has now been investing in young companies through the Seattle Angel Conference and the Seattle Angel Fund for the last couple of years. This is a great opportunity to meet with a young angel investor with a wealth of experience and perspective to share about building businesses, getting an investment, and designing world class software.

Join Ryan Porter on Monday at SURF Incubator!

How do you sign up? Register here.