Tuesday, April 8, 2008

Startups: Primer on Raising Capital

By Chris Benjamin of Chris Benjamin Consulting LLC (www.chrisdbenjamin.com)

Two questions I hear often – “how much money should I try and raise” and “how easy will it be”. There’s no set answer to either, and it depends on a myriad of factors.

How much money should I try and raise?

It is a difficult question indeed. You are the brains behind the operation, and have images of where you are going to take your new venture. It all starts to add up though. Hiring good people, renting a space, keeping your site search engine optimized, marketing – quickly you have some hurdles to tackle, and the number one issue is money.

A good starting point is your business plan & financial forecast. If you haven’t done these, stop right here. You’ve jumped a few steps, and worrying about funding isn’t a high priority yet. If you have these done, become very familiar with the numbers.

How do they shake out? Things to consider are:

When do you start making a profit?

How long can you sustain the business before needing money?

What are you going to need money for? Funding operations, capital expenditures, launching? Other?

A few examples:

Company A is a manufacturing startup. They will sell online, and not have a storefront. They plan to rent a warehouse and invest heavily in capital equipment. They need money up front, because without the warehouse & equipment, there’s nothing to sell. It is an all or nothing situation.

Company A needs money, and for a specific purpose. Besides funding the capital, they need to think about the ramp up transition. Covering operational costs for a period of time until the revenues of the company can sustain the cash flow.

Company B is a dot.com service company. They run a resource online, and revenues come from ad revenue & affiliate revenue. They have a site up, receive a small amount of traffic, and are steadily growing. They have received lots of positive feedback, but need money to really market the company properly.

Company B is already operational, but needs the capital injection to get them to the next level. This one is a bit tougher. What amount is the right amount? Coming up with a solid list of the operational expenses and where the money will be spent is important. It’s a bit less tangible than Company A. You could spend $250K in Marketing, or $1 Million. How do you decide? It’s your company, come up with a justifiable plan.

How easy will it be?

Raising capital is not a scientific process. Nor is it the same process for all levels of funding. The general categories & where you should look are:

Under $100K

  • Friends & Family
  • Credit Cards
  • Home Equity Loan
  • Sell Assets
  • Borrow Against your 401K

$100K - $1 million

  • Angel Investors
  • Commercial Lenders
  • Small Business Association (SBA)

$1 million +

  • Venture Capital
  • Investment Banks
  • IPO
  • M&A

All of these warrant a lengthy discussion about the pros & cons, and if they are right for your specific situation. Just know there are options, ones beyond this list as well. Determining what level you are at, and then how to go about raising the funding is a process.

So how difficult is the process? Well, depends on your definition. Certainly no one will be coming to you handing you money. Time is your friend, and the more money you want, the longer it will take. It makes sense: if you lent a friend a $1, you’d just do it. But to lend them $1,000, you’d want to know they can pay you back.

If you are in the Under $100K category, it should be a somewhat simple process. A home equity loan takes about a week to get, as does borrowing against your $401K. Credit cards are of course not recommended, but many an entrepreneur have gone that route and funded their startup.

When you get into investors, they will be taking a position in your company. So at this point you are giving up a bit of ownership, but for a capital injection. This process can span a month to several, and includes:

  • Finding the investors
  • Due Diligence process
  • Filing with SEC
  • Funding

So how easy is all this? Well, it’s more a test of patience and being able to take rejection than anything. No one will ever be as passionate about your new company as you, so when someone says “no thank you”, it can be a tough blow. Finding the right investor is key, and from there it becomes a natural flow of moving through the due diligence.

In summary, decide how much funding you really need, within that range decide what method you want to look for capital, and begin the hunt. Keep your chin up, preserver, and if your idea is great, the money will be attracted to you once people know about you.

Monday, April 7, 2008

Startups: Why You Don’t Need A Full Time Controller

By Chris Benjamin of Chris Benjamin Consulting LLC www.chrisdbenjamin.com

It seems like a natural progression. The founders have taken the company to the point where it’s really time to get serious about the financial side of the house. Thoughts of going public are starting to brew. It’s time to start managing the capital in place more effectively, and prepare for a pre-IPO round of funding. The obvious next step: hire a controller. Well, that’s typically the route startups go, but it’s not in your best interest.

It seems like a good idea, hire a full time controller. Why would you NOT want a full time, devoted professional to guide your growing venture? Well, there are good reasons.

1. You need 20 hours, not 40+ per week of time
The biggest fallacy I see in startups was that everyone has to work 80 hour weeks. The reality is some people thrive on that environment, while others quickly lose productivity. Not only that, in the first few years of operation, there is only so much a controller can accomplish. Once the budget & forecast are set, the reporting standardized, the audit completed, the accounting system up graded, there isn’t that much left to do other than routine accounting. The better mix of staff would be a part time bookkeeper who can increase to full time, and a part time controller who can increase to full time. Taking the job and splitting it into 2 part time jobs is a terrific strategy. Otherwise the controller job does become an 80 hour job, because they are doing routine accounting, and then doing the entire CFO work. A sure fire way to make someone not interested in their position.

By using a consultant, you gain flexibility. If you need 80 hours in one week of CFO time for a special project, you got it. The person isn’t burdened with routine accounting. If the next week you need 10 hours, then you get 10 hours. There is also the added benefit that hourly paid professionals typically work harder. They are there to do a job, and they are being paid to create specific deliverables.

2. Cost Savings
Startup’s have the tightest purse strings of any venture. Typically limited resources are available, with many demands for those resources. Trying to spread your limited capital to all areas without ignoring any one is a challenge when trying to make the wisest decisions, in a changing unknown environment.

Payroll with inevitably be your largest ongoing expense. Adding head count before the right time can be a large burden. Hiring just the right person costs money in itself. The job posting, the interviews, the investment in computer equipment, desks, and time of other employees to train alone can add up quick. One startup estimated it cost approximately $8,000 to add a new employee.

From a mathematical perspective, compare the 2 situations:

A full time CFO/Controller would make at a minimum $100,000 per year. Benefits and payroll taxes typically end up being 20-25% of the salary, ending with a number somewhere around $120,000 per year. Also remember this is the lowest potential cost, you won’t find many quality CFO’s for $100K a year.

Instead if you used a $75/hour consultant 20 hours a week on average the first year, that translates into 1,000 hours and $75,000 for the year. The company saves a substantial amount of money, enough to hire a full time bookkeeper if need be, and have the contract CFO focus exclusively on important issues.

3. Limited Candidates with the Experience Needed for a Full Time Position
Startup companies have different needs than a public company. Startups thrive on creative, energetic people with fresh ideas. Finding a seasoned pro that still has the entrepreneurial zest is a difficult proposition. While someone with 20 years of experience brings an unbeatable background, they tend to have difficulty adapting to the startup atmosphere. Creating 5 year plans, waterfall reports, adjusting quickly to strategy change aren’t engrained in someone with big corporate America thinking. 5 years from now is when you need that person.

Hiring a consultant, you are hiring a person who does this for a career. Working with startup companies is their passion, and they have exposure to several. A controller/CFO in a startup is focused on the numbers and how to make tweaks to operations to help improve. Working with the board of directors who is typically made up of venture capitalists, whose money you are spending by the day, is a different skill than a board of directors meeting for a public company.

4. Conclusion
To conclude, is this the case for every company? Of course not. At the same time, it should not be assumed that every company needs to hire on full time staff and then work them senseless with tasks that are better handled by an administrative person, solely for the purpose of getting your 40+ hours out of them. Using an outside contractor until it makes sense to bring on full time staff is a very effective method of managing the largest expense to a company, bringing on experience you most likely wouldn’t find in a more expensive full time person.