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When seeking investment, preparation is everything


In part four of our series on the capital raising cultures in Australia and the US, San Francisco-based Steve Anderson explores how Australian and New Zealand entrepreneurs can best prepare for securing local investors.

Also in this series:
Part 1 – Funding in the US – Holy Grail or Holy Hell
Part 2 – The benefits of Australian VCs and US VCs
Part 3 – Five must-sees before Australian VCs will invest

There is no better place to begin capital raising for Australian and New Zealand entrepreneurs than in their home country.

Seed capital for venture capitalists in Australia has historically consisted of government money that attracted funding from the private sector.

The intent was, and continues to be, to encourage and, therefore, capture the benefits of the inventiveness and energy of its citizens rather than forcing them to seek success overseas. Unfortunately, the Commercial Ready Grant Scheme was withdrawn and that has caused a shortfall in available capital.

The venture capital industries in both Australia and New Zealand are faced with a conundrum. They are restricted in the cash available to do new deals because they need to conserve funds to support portfolio companies. That has been compounded by the global recession. (Economic signs are improving in some places, but my suggestions here are designed to be equally relevant in good times or bad.)

Given this rather dismal current environment, what are the best steps to take for entrepreneurs with a gnawing ambition and a killer product or service?

Fundamentals, Fundamentals, Fundamentals

Like the real estate adage “Location, Location, Location”, the entrepreneur seeking capital for the first time, and every time thereafter, must engage in fundamentals.

Fundamentals of what? The fundamentals that have been used successfully by the founders of all those companies that succeeded.

There are four classic stages of a fledgling business: Concept Stage, Seed Stage, Product Development Stage and Market Development Stage. These are not set in stone, but have been sufficiently documented to rely on as a map.

Idea to Concept

This occurs in the first few months when one, two or more people gather together to flesh out the details of a new technology or service, and the business model. Where will the revenue come from? (The answer is never simply “the customer”.) This group of founders, or discoverers, shoulder the cost of this stage themselves. The primary product of this stage is a brief business plan (ten pages or less) that serves as road map and concept clarification that everyone agrees to. This is the first test of the concept because the plan must answer fundamental questions:

  • What is unique about this product/service that addresses a severe customer pain level so well that they will have to buy it?
  • What is the size of the market? (How many customers are there for this product or service globally?)

Take a break here in thinking and planning from being in the box (traditional business models) to the challenging, but increasingly common request to think “outside the box”. Within the traditional context of building a business, who would have considered the concept of a “freemium” created by a New York venture capitalist? How can revenue be generated if the product is given away for free?

How can we fund this?

This is the “seed capital” stage. This is where the concept grows from just a concept to a company and product or service. It takes money, and it most commonly comes from the founders, their friends and family, angel investors and, in some flush capital periods, from venture capitalists.

Each of these investors needs to know what the business plan is for X Pty Ltd, with specific milestones of what will be accomplished in how many weeks or months, and how much cash it is going to take to get these milestone steps completed. The Stage II Business Plan is more complete than the Concept Stage Business Plan because the founders have learned a lot more about their business.

The highest hurdle is addressing and then articulating the concept product or service in terms of customer benefits. Why must they need this product or service compared to their other options?

The business plan at this stage is more sophisticated and detailed than the Phase I plan. Someone in the organisation has to be able to verbally articulate in convincing terms, without hesitation, why this is a high-quality investment.

In preparation, do the following:

  • Define the assumptions made by describing the customer’s needs, but also in the financial plan.
  • Describe in detail potential customer applications and the benefits the customer gains.
  • Create a quality description of the marketplace in terms of size, geographic distribution and characteristics, including how the product or service is going to be delivered to the customer.
  • Identify target customers for beta testing of your product or service and the reason for their selection.
  • Outline your current management team and their background as it is relevant to the business.
  • Develop a financial projection that primarily describes the application of the investor’s funds in detail.
  • Describe the milestones that the business will accomplish during the next 12 months. These should mirror the financial projections.

Putting planning into reality

This is where the rubber starts hitting the road. The company is now using hard cash provided by the investors, and every hour counts. The faster and better this stage is executed, while spending every cent as though it is the last cent, the more likely the business will succeed.

Somehow, the motivation to save cash in product development creates a ferociously creative environment that in most cases places the cash where it does the most good and establishes a business culture that will always benefit the company and its investors. At the end of this stage, the company will have to have a product or service ready for customer purchase and use.

Product and service development is a dangerous period because team members can become distracted away from the focus on the original product. Specifically, keep the process and the product or service focused. Milestones of each of these stages will need to be reported to the investors.

The quality of the product and meeting the milestones is a direct reflection of the quality of the team. Document this product or service development professionally so that it can be replicated effectively is important to the business, and will be very important to the next stage of investment. Your best investors now and in the future will understand the importance of this stage.

Putting reality into the marketplace

It is in the crucible of the marketplace where all the work begins to pay off… or not.

Beta testing provides valuable feedback for the reality stage. However, there is a danger that additional customer requirements will suddenly arise when you enter the market. Given the strong desire for customer acceptance – and associated revenue – this can cause significant chaos and company division.

It is vitally important to keep focused and measure the sales and marketing results, within the financial plan. Every variation needs to be scrutinised to determine whether it is an anomaly or a significant indicator. Trust your preparation to this point, but be careful not to follow your plan off the cliff.

Setting the stage for next investment

About six months into the reality in the marketplace is the time to make another assessment of the business and the business model, adjust the business and the financial plan to reflect what has been learnt and begin setting the stage of the next investment phase.

It is also a time to assess whether the current team has the ability to take the company forward. The latter is very difficult for the founders. They may be among those that cannot take the company to the next step, and it is also difficult for them to accept the fact that people who dug into the business during the toughest days may not have the ability to continue to contribute. Some people are just better in early-stage companies. Some are only good at middle stage companies. And some can only function well in later-stage companies. It is just the reality of growth businesses.

Selecting venture capitalists

The crux of success is selecting the best financial partner. Venture capitalists come in many different forms, and it is very important that a company selects an investment partner at this stage that provides more than the capital. A venture capital firm that has invested steadily and successfully in early-stage mining companies is probably not going to be a useful and supportive investor in high technology or consumer products or internet services.

For investors, as with managers and entrepreneurs, experience counts.

Steve Anderson started as a journalist, working first at The New York Times and the next 30 years interpreting business to investors. He is now Managing Partner, Marquis Advisory Group (San Francisco and Sydney).

Photo: PDR