For many technology entrepreneurs, raising venture capital is an important part of their business strategy and may be a goal in and of itself.  As a result, I’m often asked: “What are my chances of being able to raise money from venture capitalists?”

Obviously, I’m not a venture capitalist (we lawyers, don’t pretend to know what exactly a venture capitalist is looking for and what they will require before making an investment).  However, you start to get a fairly decent sense of what a VC won’t fund.  I’ll save that list for another post and another time…

So my general answer to that question about whether or not an entrepreneur could raise VC funds is: it depends. It depends on the team you’ve assembled, the technology itself, the market for your technology, the right timing, and a little bit of luck. And while that may be the case, if you believe Sam Altman, the founder of Loopt, “If you’ve got a good idea, market, and team, raising money won’t be your problem.”

So, what are the odds then?

The truth is, the “it depends” answer isn’t very satisfying to most people. Entrepreneurs want to know their chances.  In a prior post, I wrote about the VC “Fit” Test.  That is one way to gauge if you may be a good fit or not (although, again, lots of subjectivity there).  The other way to gauge interest is to sit down with a few partners at funds and see the reaction (but that means you can get those meetings or are far enough along for them to be truly interested).

So, what about some more data into the chances of an unnamed startup?  Well, anecdotal evidence suggests that between two and three percent of businesses seeking venture capital financing will ever receive institutional funding. The majority of these cases are because venture funding is not the right type of funding for the business (not passing the VC “Fit” Test….). Sean Wise looked further and interviewed a number of venture capitalists to find out where their deal flow came from and the sources of deal flow that had the highest probability of closing. While these are not scientific numbers, these figures should offer some insights into the way VCs see the sources of their deals.

What are the odds of getting a meeting with a VC firm based on:

• an unsolicited business plan submission? Approximately 1 out of 100.
• a solicitation from an unknown agent? Approximately 1 out of 50.
• direct contact from venture fairs, financing forums, and other industry events? Approximately 1 out of 15.
• referral from professionals with fund relationships (accountants, lawyers, and market dealers)? Approximately 1 out of 3.
• referral from current and future investors? Approximately 1 out of 2.
• referral from executives of a portfolio company in the VC’s fund or other stakeholder in the VC’s funds? Nearly 1 out of 1.

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I recently had a terrific conversation with a soon-to-be entrepreneur.  He had pretty much everything set — a unique idea, the right set of skills, co-founders who would bring a nice mix of talent, enthusiasm, connections, etc.  If you asked me, this seemed like a pretty good start to a startup.

Then I asked the question — “So what are you guys doing for startup capital?”

A blank stare came back at me.  “Startup capital?  We don’t need any yet.  Well, I mean we’ll probably do an angel round or something… but we don’t need that for a while.”

Well… you may not think you need startup capital, but odds are nearly every business requires something to startup (more than just sweat equity of the founders).  The question isn’t whether you’ll need it (you will), but is how much (typical range is $15-75K) and where to find it (check the mirror).

What is “startup capital?“

Some people call this seed money; others call it startup capital or initial capital; and still others use terms like founder capital. The short of it is, that this cash represents what you needed that can’t be paid for with your sweat and your time.  Real cash expenses.

Unfortunately, what this promising entrepreneur I’d been speaking with failed to recognize is that it takes money to start a business — really nearly any business, even the most lean, bootstrapped business takes some cash to get it going.  And that isn’t the type money you raise from angels or the like.  This is real startup capital to buy things like office supplies, business cards, software, laptops, test equipment, licenses, paying for a developer or designer, etc.

How much startup capital does a business need?

Obviously, that depends — and it depends on what period of time we are talking about.  If you plan to bootstrap the entire way through, you may be talking one amount or if you are just trying to get setup and have a seed investor or angel investor lined up, then it could just be a month’s worth of startup costs.

Read the full story

On January 20, 2009, America will have a historic day — historic for many different reasons for people around the globe.  Like many of you, I’ve signed up for the CNN-Facebook viewing party (work productivity may hit lows only matched by the first round games of the NCAA men’s basketball tourney on Thursday and Friday).  As much as we can be excited about the inauguration — what comes next may be of real interest.

$1 Trillion Dollars…

Incoming President Barack Obama

And while this date will have substantial cultural significances, the Obama administration has promised a full-frontal attack on kick-starting the economy.  Estimates for the dollar value of the kick-start are huge — between $700 billion and $1 trillion.  (The Democratic House proposal floated a number of $825 billion). Numbers that size are hard to get your brain around… and so for most of us it is simply a number that is supposed to make capital start flowing again, stop the bloodletting of employees and get people excited about our economy again.

But, the reality is the Obama administration is planning substantial programs and tax relief that could reach startups and other technology companies here in Seattle (at least we all certainly hope so.)  Once the speeches end and DC begins to take down the grandstands, you’ll be hearing plenty about the American Recovery and Reinvestment Bill of 2009. The Obama White House believes this bill will create an additional 3 to 4 million jobs, get the credit markets moving, stabilize the housing market, and make transformational changes to our economy — with $275 billion in economic recovery tax cuts and $550 billion in targeted priority investments.

How does a startup get access to $550 billion?

Good question. $550 billion is a big number and, given the slowdowns in the economy, expect a government gold rush.  Many experts have predicted that there will be uptick in activity to solicit government agencies directly, to submit proposals to RFP requests, and to get access to various government loan programs. Whenever the government launches a program or a series of programs of this scope, there is always concern that unless you “know people” your business may never know these potential projects exist.   And, while that may be the case for some projects, in other cases there is a great deal of information available.

The first action for a small business or startup is to familiarize yourself with the government contracting system.  I previously posted some information on various government programs for startups and small businesses — and that should be a helpful place to start out hunting for resources.  The net is full of resources out there — some of which come with a fee and help guiding you through the process.  Others are purely informative.  But the important thing to note is that the process isn’t simple (think about how frustrating you’ve heard it is to submit an iPhone app to the AppStore, and then double or triple it — that could be what you are dealing with here).  So understanding the ins and outs is crucial.  And, if you aren’t a prime candidate for a direct contract with the government, remember that subcontracts can be just as valuable (and perhaps slightly less onerous… but only slightly).

What we don’t know is when these proposed projects from the Obama team will be posted or be available (obviously, until legislation is passed, these new programs won’t be available).  The incoming administration has been clear that the American public can expect heightened accountability for these new dollars — hard to know exactly what that means, but look for more direct oversight, reporting and more “strings” to be attached to the government dollars.

While we wait to see what will get funded and what will get cut in the Congressional process (which could take as little as a couple weeks or much longer depending on how nice everyone plays together), be prepared to hear lots of buzz words about the bill and its components.  In the meantime, if you think your business could be a good fit, figure out the sandbox you’ll need to play in to submit a proposal.

Here are couple sites to look to in order to understand the process:

• Federal Business Opportunities
• Small Business Administration – Office of Government Contracting
• Business Partner Network (source for vendor data for the Federal Government)

There are many more places for you to find education about these projects that should be coming soon.  Remember, the time to submit such proposals can be substantial.

Where will we see these dollars spent and what might ‘trickle down’?

To the extent your business can meet an RFP put out for a government entity, small businesses can and will be given priority for certain deals.  And, to the extent small businesses can’t meet the RFPs on their own, there are opportunities for subcontracting — with Seattle in a prime position to help with key IT, biotech and other resources.

Direct Funds. Let’s begin with the obvious — a substantial amount of that $550 billion is probably not going to ever make its way down to small- or medium-sized technology companies.  But, don’t be fooled — the Federal Government has actually put its money where its mouth is on the issue of promoting small businesses.  In 2006, small firms won $77 billion, or 22.8 percent, of a total of $340 billion in federal government contracts eligible for small business competition.

In addition, some of these funds may be directed to state or other types of organizations who will be responsible for handling the distribution and management of the projects.  Obama and his team are thinking creatively about getting this money into the economy in a hurry — so don’t be surprised to see state governments in action or other sources handling management of the projects.

Subcontracting. Many of the programs and projects will require subcontracts — and oftentimes these subcontracts are terrific opportunities for small businesses.  The SBA has a wealth of information on how priority can be given to small businesses.

Tax Relief and Loan Programs. The Obama administration has spoken about a number of programs designed to lower taxes on certain Americans and direct new low-interest loans.  This is probably one of the areas to expect the most wrangling over the coming weeks and days… but be aware that Obama and his team continue to state that this next amount of money isn’t going to the folks on Wall Street — it is going to Main Street.  Now if we only knew where Main Street was?

Next Post: Specific Spending Proposals in the ARR Bill of 2009

The next post on this subject will look more specifically at the areas the Obama team is targeting in its draft of the American Recovery and Reinvestment Bill of 2009.  In early drafts, the Obama team has laid out the following priorities:

• Clean, Efficient, American Energy
• Transforming our Economy with Science and Technology
• Modernizing Roads, Bridges, Transit and Waterways
• Education for the 21st Century
• Tax Cuts to Make Work Pay and Create Jobs
• Lowering Healthcare Costs
• Helping Workers Hurt by the Economy
• Saving Public Sector Jobs and Protect Vital Services

These all seem like interesting areas and may well have some applicability to Seattle-based businesses.  Even more interesting is that the Obama team has price tags on some specific projects which may help identify opportunities that could shortly be arriving.

I’ll lay out some of the key discussion points for each of these priorities and where money may be available for Seattle startups.  We have some details to help give us some insights.  Obviously, it is all speculative at this point, but it gives us a helpful idea of where to expect this nearly half a trillion dollars to be heading.  And hopefuly, that will make its way to the small businesses and startups… as long as they know where to find it.

Raising money is tough these days. But try asking for money from someone that just saw their portfolio value decline by twenty to forty percent in 2008. Now that is a tough assignment… and what is occurring more often these days as promising startups pitch to individual Angels or Angel associations.

If you plan to reach out to private individuals and contacts, or formal Angel groups, this post has some helpful information – including where to look and how to target your efforts.

We all know 2008 was a tough year for individuals that might be looking to invest in startups. So be aware that adding a risky startup to their portfolio may be hard to stomach for some individual investors. But smart investors know that now offers the opportunity to ‘buy low’ into many very promising startups that are in dire need of important money. Finding the right investor can be a win-win situation for you.

A bit about Angels…

Angel investors represent a crucial piece of the startup infrastructure. According to the Center for Venture Research at the University of New Hampshire and the MIT Entrepreneurship Center, more money is invested annually by angels (approximately $23 billion annually) than venture capital firms (approximately $21.9 billion annually). And so it goes without saying that looking to Angels for startup capital will continue to be crucial, even as money remains tight from other funding sources.

Read the full story

As we begin 2009, many companies are again considering whether or not to begin or restart the fundraising process.  For some technology or life sciences companies, raising venture capital is an important and necessary step in their company’s life cycle.  But, before any company invests the time, energy and effort required to raise venture capital funding, ask yourself the important question…

Is our company a good fit for venture capital?

The harsh reality is, many business plans received by venture capital firms will be immediately rejected because the company is not a good “fit” for that venture fund or for venture capital financing in general. This could mean the company is serving a market that is too small or is a niche market. It could be that the technology has few barriers to entry. Or, it could be a company that will have fairly low gross margins.

But, in many of the cases, it doesn’t mean that the business isn’t a good business.  Rather, it most likely means the business isn’t a good fit for venture capital.

The reasons listed above represent just  a few of the important criteria in the venture capital marketplace.

So how do you know if you are a good fit for venture capital?  At the end of this post is the VC “Fit” Test, a tool I’ve developed that can help companies determine if they are a good fit and should spend the time raising funds now, or should wait for a better point to raise funds.  Use the tool to understand whether your company is ready to focus its fundraising efforts on venture capital.

Read the full story

I’m sure I’m not saying anything surprising when I say that private money is hard to come by right now.  Angels have likely seen their net worth plummet from a declining stock market and decreasing real estate market.  VC money remains tough and not the approach for many startups anyways.  And, of course, you’d be bootstrapping if you could, but you can’t, so that is why you are looking, right?  So where should you look at a time like this?  Well, spend a few minutes digging around to see if you could qualify for any of the various government programs.

There are countless programs out there and going through them all would take forever, but I’ve listed a few valuable links to check out at the end of this post.  But think about SBIR, SBA, NSF, or countless other government acronyms that may offer you an opportunity to find money that isn’t available elsewhere.

One caveat — these programs may not be a good fit if the money needed overnight to keep the lights on or pay employees on Friday.  These applications can be lengthy, require lots of time and phone calls, and be worse than preparing your college applications.  But, remember this — the government continues to aid small businesses and if you are already battening down the hatches riding out the economic storm, now might be the time for some applications and waiting anyways.

A bit of background on a few government programs.

Federal and state governments offer grant, loan and technical assistance programs designed to promote emerging businesses. Competition for these forms of public sector funding is fierce, and the application process is oftentimes quite arduous. Additionally, the funds usually come with burdensome restrictions on what you can do with the money. Nevertheless, some startups effectively use government funds to advance their business development, so these funding sources shouldn’t be completely dismissed.

One quick point to make: the SBA does not make grants to small businesses directly — they are the arm of the federal government that aids small businesses.  SBA grants go to others who actually help deploy that money.  The SBA does provide backing for loans to small businesses — but those are sometimes difficult for some technology businesses.

Many federal agencies participate in the government’s Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs. The SBIR and STTR are funding programs designed to stimulate technological innovation and fulfill the research needs of the federal government. Businesses are required to meet several criteria to be eligible for grants under either program, including U.S. ownership, for-profit status, and restrictions on number of employees. The SBIR and STTR programs differ in two major ways. First, under the SBIR program, the principal investigator listed on the SBIR application must be employed by the small business at the time of the grant and for the duration of the project. Under the STTR program, there is no such employment requirement. Second, unlike the SBIR, the STTR program requires the small business to be engaged in a collaborative relationship with a non-profit research institution located in the U.S. Read the full story

This is an all too common question we get from management/directors of early-stage start-up companies. How should we structure our angel/seed investment.

Typically, this comes down to a choice between two approaches — a bridge (debt) round or a priced (equity) round. So how do you decide between the two?

Many early-stage investors lament the fact that valuations for early-stage business are often unrealistic (or even downright “crazy” to some investors). Deciding to do a “bridge” round removes the requirement to set a valuation on an early-stage business.

How can you determine if a bridge round is appropriate?

• Are you planning to raise additional funds from Venture Capital or other institutional investors?
• Are you planning to raise these funds in six to twelve months?
• Have you received positive inquiries from potential institutional investors?

If you answered ‘yes’ to each of these questions, a bridge round may be appropriate. Ultimately, a bridge round is an effective tool when it is a “bridge” to a later financing event. If you aren’t planning on such an event or are unlikely to reach it, then consider a priced round.

I advise most companies that intend to raise VC financing in the next 12 months to go with the bridge approach. Again, not always, but as a general rule of thumb. If there is less certainty about the likelihood (or even ability) then I say go with a priced round.

Founders will often ask “What do VCs prefer?”  Truthfully, it probably doesn’t matter either way for your future VC.  They are investing in the company based on the business rather than the cap table.  Make sure that if the bridge notes are convertible that they don’t have some crazy opt out provisions or some mechanism where the bridge investor can elect to receive cash rather than convert.  A VC doesn’t want a situation where they suddenly have to pay out a portion of the cash they just invested into your business back to some angel investor or your brother-in-law.  The key for a VC is a clean cap table without any hidden traps or odd structures.

Typical terms vary, but generally speaking we see something like 10-30% warrant coverage on the notes; or a conversion discount to the price of the Series A round also in that range. In each case, these numbers can be higher depending on the risk and stage of the company; or in other cases we see an escalating warrant/discount percentage as time goes on.

This approach saves you from having to worry about dilution until your Series A — and if you don’t reach the Series A round, then you agree to negotiate the equity conversion at that time.

The terms of a bridge loan are somewhat regional, so as a West Coast company you would likely fall somewhere in that space.