Up and Running:

Adeo Ressi says entrepreneurship is getting a lot harder.

“Compared to when I started my first company, in 1994, things for the entrepreneur founders have gotten exponentially worse. There’s steadily more regulation, less liquidity, more difficult labor situation; things are always getting harder.”

“When I was a newbie in 1994 it was complicated, stressful and difficult. But it was significantly easier than it is today. The only reason that I could easily start a seventh and eighth company recently was that I have 15 years of experience starting and running companies under my belt. If I were like at ground zero, in today’s market, I couldn’t do what I’ve done.”

Ressi should know. As you probably already gathered from the quote here, he’s been around this block a few times. I posted about his newest venture, The Founder Institute, on my Planning Startups Stories blog last month. And he is the founder of theFunded.com, a site where entrepreneurs can review investors.

“Honestly, I think more and more, these days, the entrepreneurs get a raw deal. They are victims of a lot of predatory and exploitation behavior. A lot of this is on the part of investors, taking advantage of their position with founders looking for capital. But it’s not just them. It’s the whole gamut of service providers, regulations and so on.”

In what feels like ironic understatement, he says TheFunded.com “has tried to address some of the problems of the predatory and exploitative things that happen when founders are seeking capital.”

He goes on quickly, though, to point out that schools aren’t teaching entrepreneurship well. Legal regulations keep pouring on new obligations and the life of a would-be funder gets tougher. Reflecting on The Founder Institute, which offers a three-month educational program backed by some big names in startups, he says:

“If we could eliminate all the headaches that modern bureaucratic layering adds to start a company, and allow these founders to focus on the core business challenge, the likelihood of success increases dramatically.”

And this is not about the depression. At least, not specifically. Asked whether that was the reason for starting his new institute, he told me:

“Why now? Well, now is the only time to do it. When things are good, help isn’t all that helpful. When things are bad, the ability to do something like this can have a bigger impact. Hopefully we can help people get companies off the ground that wouldn’t make it otherwise. And everybody knows that what really drives this economy is small business and entrepreneurship.”

So there’s a point of view for you. I hope he’s wrong, that things aren’t harder–at least not in the long term–but then, what do you think?

Many people in the audience were surprised last Thursday when the Willamette Angel Conference announced CenterSpace Software had won the investment decision. It wasn’t the biggest, the newest or the oldest of the ventures entered. It had the lowest projected growth rate of the five finalists and the lowest projected sales for three to five years from now.

I was one of the 19 people who voted Thursday. And I was one of 25 people whose money was at stake. Although CenterSpace wasn’t my first choice, I’m happy with the outcome.

It isn’t always about the biggest market and the highest sales projection. Sometimes investors are also influenced by comfort levels on intangibles, such as being able to dominate a small market, developing very strong positions in new technology and long-term consistent management.

CenterSpace is a software business focused on add-on math products sold to programmers.

I posted New Entrepreneurial Seal of Approval earlier today on Planning Startups Stories, my main blog.

It’s about The Funded Founder Institute, a four-month, $450 program to run selected entrepreneurs (including, by the way, wanna-be entrepreneurs) through weekly sessions with mentors and experts, ending with a certification that should smooth the path to investment.

This is just starting, but it looks like a great opportunity. Adeo Ressi, the founder, has a great track record in startups–with VC funding and successful exits–and what he’s after is getting a few people a better chance at a more level playing field. Learn the ropes before you get in too deep.

If you can’t hack the $450, he’s got a number of Microsoft BizSpark scholarships to offer, too.

So if this sounds at all interesting to you, apply now. Applications close May 9. The application costs $50. The window is closing for this first run.

I think this is likely to be a really interesting opportunity.

Adeo promises that selection will be reasonable. He wants a broad group of potential founders. And they won’t necessarily all be headed for venture capital, not even necessarily for angel investment or even any investment. There’s even some language on the main site inviting bootstrapping startups as well.

Also, he says he doesn’t want just sophisticated, experienced startup people. He’s also looking for people without experience who want to learn.

Do you have a start-ups group where you live? I think it’s a pretty good idea. I’ve watched how three interested people got one going where I live, I’m seeing it working now, and it’s definitely a good thing.

Specific example: Yesterday around 5 p.m. I went over to a local hotel where we had our Eugene (Ore.) Smart-ups group meeting. There was some milling around, then some welcoming, a talk about an upcoming local angel investor contest with $150K to the winner, then a panel discussion on bootstrapping–with two people who are up and running as bootstrapped ventures–a presentation on basic financials and then, at the end, two five-minute elevator speeches chosen from business cards drawn out of a hat.

While this may be of specific interest to you if you’re in the lower Willamette Valley area of Eugene and Corvallis in Oregon, I post it here because you might want to look at your own local groups.

If you don’t have one, start one.  What’s interesting to me is that Smart-ups is the kind of thing you could do in a lot of different places. Here’s how they did it here in Eugene:

1. Smart-ups was started a couple of years ago by a small group of people who missed having a start-ups organization where they could get together every two or three months and hear experts, watch presentations, share experiences and keep up with what’s going on in the local area.
2. They connected with the local chamber of commerce, which has been a strong supporter, by talking to the chamber leaders. The chamber has helped them organize meetings, offered online registration, speakers and organizational help.
3. They set up a group name and a website. They started talking about what kind of events they could do.
4. They connected with the local Small Business Development Center by talking to the SBDC leaders. The SBDC has become a supporter in a number of ways.
5. They started with events, which they called “pub talks,” including some start-up presentations, workshops, etc.
6. Then they connected it to a statewide entrepreneurs network and a statewide software association, by talking to the leaders of those groups.
7. By now they have connections to both the University of Oregon and Oregon State faculties (one in Eugene, the other in Corvallis).

Last night they had a full room at the local hotel, maybe 150 or more people, and a good program. So Smart-ups is up and running, the local area is better off, the organizers are proud, and people are looking forward to the next event.

I get asked frequently what’s the deal with friends and family, as in funding your startup with people who aren’t sophisticated investors as defined by securities and exchange laws. What that means, in a nutshell, is that it can be illegal to take money in exchange for stock from someone who doesn’t have the income or net worth as defined by the government as the minimum that makes that person a “sophisticated investor.”

I was browsing for an explanation of why not, yesterday, when I came up with this one: The Trouble with Raising Money from Non-Accredited Investors on The Startup Lawyer. That looks to me like a very good summary.

I woke up to the real world today after a great Thursday-Saturday stint judging the Rice University Business Plan Contest. If you want to read about a very strong field of new ventures, I posted about that on my main blog today. 

I thought I’d add a note here about an interesting talk I had Saturday night, at the banquet celebration at the end of the contest, with Rudy Garza of G-51 Capital Management, about angel investors getting organized. Groups of angel investors in Texas are working together, he said. He mentioned the Central Texas Angel Network, the Houston Angel Network, and others; few of them familiar to me, but then I’m not from Texas. I’ve been on several judging panels with Rudy. He’s a smart, knowledgeable professional.

What he saw was a trend towards more organized deal flow and information sharing between angel groups working at earlier stages, and professional venture capital firms picking up the successful angel-financed startups as they take off. This isn’t a new idea, by any means; it just seems to be gaining popularity because when it works well, everybody wins.

It certainly happens often enough: the Web startups get routed through the angel groups to get going, create the prototypes, get the first bounce of users and traffic. The angels who put in the first few hundred thousand do it as convertible debt that converts to equity at the same ownership rate as the first venture investors, but discounted because they were there first.

As the ventures move up the scale from angel level to venture capital, they get seasoning and mentoring from the angel investors. The professional VCs get deal flow from the angel groups, as their deals evolve and mature into venture investment candidates.

I’ve seen signs of the same thing in my home state, where several Oregon-based angel groups are now linked together and sharing contacts and information.

One of the catalysts, as far as I can tell, is the emergence of angelsoft.net, whose website offers free services to angels and entrepreneurs, and paid services to VCs. It has information and posting for the angel groups and entrepreneurs, messaging and file sharing, so it helps the groups and the startups get organized, find each other, and share information.

(Note: this is posted here with permission from Bplans.com, where it originally appeared.)

Last night we were talking about getting angel investment and valuation, which is one of, if not the, most important points in the discussion. Valuation is essentially price.

Say you want to bring in $150,000 from an angel investor. The immediate question from the investor will be something like: “at what valuation?” Sometimes that’s called “pre-money valuation,” because the instant the deal happens the valuation will change into post-money valuation, which is always higher–because your company just got some new cash.

Your answer sets your deal equivalent of an asking price. If you say $500,000, then you’re offering the investor 30 percent of your company for $150,000. If you say $300,000, you’re offering 50 percent. If you say $1 million, then you’re only offering 15 percent.

Which leads to the question:

So how do I know? How do I set valuation appropriately? What is that based on? Is it some multiple of sales or intellectual property or what?

And that’s a good question, and very hard to answer. Sure, you want some compromise between what you want to give as a percent of ownership in your company and what investors would want to buy. Investors will simply say no if it’s not an attractive offer. But that’s still very vague.

• In the case of an existing business with some history, you do have some formulas you can use. For a great site on that business interpretation of valuation I suggest bizequity.com, the Zillow.com equivalent for small business.
• When we’re talking about startups, however, you don’t have history and you can’t really apply formulas based on sales, revenue or even intellectual property (although that could be more relevant).

So here’s my concrete suggestion:

1. Calculate starting costs. That’s two lists, the expenses you have to incur and the assets you have to have at the starting point–except cash. Leave that blank for a bit.  Add those all–except for cash assets–to the starting costs, to get an amount, a number in dollars.  Click here for a lot more on that. So for example, in the illustration here, that would be about $40,000. Yes, I know it says $38,750, but this is just an estimated guess; always round up. You never guess just right.
2. Calculate cash flow through the lean period at the beginning, before your sales cover your costs.  Make a good guess at how much money you need to cover the deficit spending to get you to an operational, month-by-month break-even level of cash. That’s where the cash requirement number in the illustration came from: it seemed like this company would need about $400,000 to survive from startup to break-even. You can’t see much in the chart below, because it’s small, but it shows a projected 12 months of cash flow (in blue) with a minimum balance, a deficit (in red), of about $400,000.
3. That gives you a number. In this case, it’s $400,000. That’s what your cash flow shows you you’ll need to get to cash-flow break-even. In the last two months, the cash flow is positive, so the negative balance starts shrinking. With that estimate as a best guess, you go back into your startup costs calculation and add in the cash required. It’s $400,000. You can see what that does to the startup costs worksheet in the next illustration here.
4. Having done that, you now know that you need about $500,000 from investors (again, technically it’s $458,750, but you’re using best-guess estimates, so round up.) Set that as the amount of investment you’re seeking. Then–and here it gets hard, to be sure–you need to decide how much of your company you’re going to offer to an investor in exchange for that $500,000.
5. Get some help here if you can. Ask somebody with experience in startups, or dealing with angel investors, or both. Ask an attorney you can trust, who should also be somebody with experience. The thing is, how much of your company you offer to investors is about a compromise between what you’d like–none, free money–and what will entice the investors to write checks. At this point a lot depends on your overall business offering, the cards your company brings to the table. Investors want as high a return as possible, with as little risk, but in relation to return. How experienced is your team? How defensible is your product? How rich is the market? All these factors determine what kind of a deal will be acceptable to investors.
   • Let’s say, in this case, you’re new at startups, you have very little track record, and you want to attract an active angel investor as a partner. So maybe you set your initial valuation at $750K, meaning you’re offering to give away 2/3 of your ownership to get the money you need. You’re being realistic about what will attract an investor. You’d better really, really like that investor, because he or she will essentially own your company. But this is a hypothetical case and, without a lot of experience and defensibility, that may be the best you can do.
   • Or maybe you’ve got better cards to play: You’ve got a team with startup experience and a defensible new product, with some intellectual property, and it looks like an attractive market. That makes you able to set a stronger valuation, and maybe–we hope–still make it an attractive offer to investors. So maybe you say you’re valuing it at $1.5 million. You’re offering investors one third of your company for $500K.

So there’s a quick and (I hope) simple summary of how you set the initial (pre-money) valuation when you want to attract investment.

Dennis Lankes of startupslive.tv commented on my recent post, asking me this:

You work with startups and talk to investors all the time. What is it that really catches people’s eye and attention at a pitch? What are the questions the investors want to hear answered? Can you help me out?

Sure.

That seems like a reasonable question. What’s really fun is to start by thinking about what you’d want, if you were to invest money in a startup. You’d want a big payoff later for money invested now. You’d want as little risk as possible, in a very risky business, for as high a payoff as possible.  Right?

Yeah, for sure, but how do you get there? That’s the end point. So here’s a list:

1. Potential growth.

Usually that means products rather than services. You can sell more products by making more and ramping up–which we like to call scalability. It’s about leverage. If you sell boxes, not hours, you can sell more boxes without having to bring on proportionately more people. The investor makes money when the successful startup goes liquid. Liquidity comes from either IPO–not likely these days–or getting acquired by some other company. That doesn’t happen without growth.

Services, in general, are harder to grow than products because there’s not as much leverage. But that’s not true for all services. Web services, for example, can be very attractive to investors. As a quick test of whether a service might be interesting, ask yourself how many people you have to add to double the volume. With a lot of services–say business plan writing, for example, or graphic artistry or limo services, you have to double the people to double the volume. Investors call that a “body shop,” and they don’t like it as much.

Another major concept that’s wrapped into potential growth is the product/market fit. I like this phrase, which I saw first in a post by Marc Andreessen, “The Only Thing That Matters”, because it absorbs both benefits and market size. You don’t separate those two concepts.

This basic concept flows into many facets, such as positioning, defensibility, potential market, proprietary technology–all those factors that generate potential growth.

2. Potential Payoff in 3 to 5 Years

They call that an exit. It means a way out. And just like prisons, investments without any way out are very confining. Investors want an exit strategy.

Entrepreneurs take note: Investors don’t want to hold a share in your happy and healthy company that lasts forever and never creates liquidity. How would you like to put money into somebody else’s company and never see it produce any money for you? That’s why they call it investing.

If you have that dream about building your own company and turning it into a lifestyle business, then passing it on to your children, be aware that this scenario is an investor’s nightmare. You’re happy, so you don’t want to go liquid.

You can pretty much assume that a professional investor or sophisticated angel investor is looking to get at least $10 back for every dollar invested, and preferably $20, $50 or $100, and in three to five years’ time. Investing in startups is a risky endeavor.

As an aside, I’m amazed at how often entrepreneurs take this as some sort of character flaw on the part of the investors. Why do they want so much return? What’s wrong with them? The reason is that they know that startups are very risky. Lots of them fail. So investors want to hit big with the winners to pay for all the losers.

3. Reassurance on Risk

Investors know this is risky business. Nobody’s pretending you can produce a new business without risk. There are, however, factors that reduce the risk, keep it at a minimum level. For example:

• A good team: Founders they can believe in. People who know the industry, people with product development and market expertise. The best proof of intellectual property, better even than patents, is credible founders.
• Startup experience: Sorry, I know this is tough for first-time startup people, but having been through the process at least once before makes people on the management team much more credible.
• Defensibility: Might be patents, might be know-how, might be first-mover advantage, proprietary technology or maybe something else. Investors don’t want to see a good idea that serves the world only to point competitors in that direction.

I can’t say I like its title, but the post called “Earth to Venture Capitalists: Are You Out There?” on the American Express OPEN forum is a good reminder that there is some money available for new investments. And you might, if you need investment to get your startup going, just have to look harder.

Though it’s tougher for small businesses to come up with financing today than it was even a year ago, there are more resources to help locate capital that is available, says Wharton management professor Gary Dushnitsky, who studies entrepreneurs. And, he says, there are more opportunities for entrepreneurs to network with industry veterans and learn about previously unknown funding sources.

That’s posted there by knowledge@wharton.

It recommends several specific sources:

• Your Encore,
• youngStartup Ventures, and
• the National Venture Capital Association.

Don’t forget as well to ask your local SBDC or chamber of commerce about local angel investors as well.

An angel investor is someone who loves to take a lot of risk, who (it is hoped) has a lot of industry expertise, who invests $50,000 or $100,000 in raw startups. This was recorded at a conference last month. It’s a good review of angel investment from two experts.

Although I’ve got the video embedded here–I hope you can see it–you might be better off if you click this link to go to the source site. This is the first segment of a longer talk, and the rest is just as good.

This is from Stanford’s entrepreneurship conference last month. It’s available at the Stanford program’s ecorner video site.

Are you a student or recent graduate building a business around a new technology or invention? Take a look at the National College Inventors & Innovators Alliance (NCIIA) at nciia.org. Pay special attention to NCIIA’s 2009 Venture Well program, because it’s about finding mentors and money.

It’s also about doing some good. Specifically:

“…designed to provide venture development and seed investment to emerging university entrepreneurs creating scalable, market-oriented solutions to social and environmental problems.”

This program kicked off last Friday and is focused on a March 21, 2009, event called the Forum in Washington, D.C. Teams will be invited to connect with investors and advisors.

Here’s more detail:

Venture Well is now taking applications from student teams. All selected teams will be eligible for investment by the NCIIA and will receive training and ongoing support from Venture Well advisors as well as NCIIA’s nationally recognized Invention to Venture (I2V) mentoring program.

Interested teams must apply to the NCIIA by December 19, 2008, at www.venturewell.org.

Venture Well focuses on low-cost and highly scalable solutions for both Western and “Bottom of the Pyramid” consumers in fields of health, wellness and the environment.

Myths about angels. No, I don’t mean the ones from heaven, just the ones who supposedly invest in your business. I’m talking about a new book by Scott Shane, Fool’s Gold?, about the myths of angel investment. And in this case, myths matter.

Kelly Spors interviewed Shane in The Wall Street Journal last week, and came up with an interesting summary:

Myth #1: Angel investors are like VCs, they just invest less. Prof. Shane finds angel investors are far more varied in their investments than venture capitalists. While VCs tend to focus almost exclusively on high-growth industries like technology, angels will invest in everything from the local dry cleaners to a restaurant. They tend to stick with industries they are familiar with. Plus, they are far more hands-off than VCs. Most angels spend less than an hour a week with the companies they invest in. And fewer than 5 percent of businesses that receive angel money go on to get VC money.

Several interesting points in this one. I’ve always thought of angels as a lot like VCs. I’m also surprised by that last point, the 5 percent one. I would have guessed that figure to be a lot higher.

Myth #2: Most angel investing is done by organized groups. Groups only account for 500 to 600 each year, he says, and only 2 percent of all angel investment dollars come from organized groups or networks of angels.

Myth #3: Angels are wealthy and savvy investors. Prof. Shane notes that only 21 percent of angels meet the Securities and Exchange Commission’s requirements for being an “accredited investor”–or an individual making $250,000 annually or more, or a couple making $350,000 or more (or net worth of more than $1 million). What’s more, the majority of angels don’t end up making money on their investments, and only 2 percent of businesses they invest in eventually become IPOs. And only 15 percent of angels do “extensive” research on the sectors of the businesses they fund.

This one is hard for me because I thought it was illegal to take an investment from somebody who doesn’t qualify as an accredited investor, according to the SEC.

And even more important than that, however, is that angels don’t make money on their investments, and don’t research their investments, either. Wow. I’m surprised.

Myth #4: Angels frequently invest $50,000 or $100,000 in businesses, sometimes up to $500,000 or $1 million. The median angel investment is around $10,000, Prof. Shane finds.

This is another surprise to me. I generally go with the idea that investing a little bit takes as much legal red tape as investing a lot.

Myth #5: Many people invest in businesses of people they barely knew beforehand. Of all informal business investments, 92 percent are made by friends and family. Few are made by an angel who isn’t one of those.

In this area I like being surprised, so I pass this on to you, and I’m looking forward to getting the book. Shane, a professor of entrepreneurship at Case Western, has done several other important books for entrepreneurs. This new book, intriguingly titled Fool’s Gold?, is due out next month. I very much liked and recommend Shane’s last book (Illusions of Entrepreneurship), too.

Independent Street : Five Common Myths of Angel Investing