[VIDEO] George Deeb Teaches "Fundraising for Startups"

Last week, I had the pleasure of mentoring the 2013 Founder Institute class in Chicago on "Fundraising for Startups".  Here was the video portion of my presentation.


George Deeb Teaches "Fund Raising Tutorial" to Founder Institute Chicago Class from George Deeb on Vimeo.

The matching slide show can be viewed here:  http://www.slideshare.net/redrocketvc/founders-institute-fundraising-22746490.

This presentation addresses the following topics. When is it realistic to raise capital for a brand new company? How should you calculate the amount of money to raise? How should you define the use of proceeds? What materials are required to fundraise? How do you identify and qualify target angel and seed stage investors? How do you find a lead investor? What do investors expect from the company? What are typical investment structures and deal terms for seed-stage financing? How do you negotiate terms?

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[NEWS] 2013 Moxie Awards Winners--Chicago's Best Digital Startups

Last night was the 2nd Annual Moxie Awards presented by Built In Chicago.  Another terrific event put on by Maria Katris, Matt Moog and the Built In Chicago team.

Here were the winners for 2013:

Best Consumer Web Startup:  SpotHero
Best B2B Startup:  Belly
Best Healthcare Startup:  GiveForward
Best Education or Recruitment Startup:  eSpark Learning
Mobile App of the Year:  Branchfire
Best Civic App:  Chicago Bike Guide
Best Boostrapped Startup:  Branchfire
Best Startup Co-Founders:  BrightTag (Marc Kiven, Mike Sands & Eric Lunt)
Best Service Provider:  SurePayroll
Digital Agency of the Year:  Rise Interactive
Mentor of the Year:  Chuck Templeton (Impact Engine)
Investor of the Year:  J.B. Pritzker (New World Ventures)
Tech Woman of the Year:  Shradha Agarwal (Context Media)
CTO of the Year:  Harper Reed (Obama for America)
Best Beard:  Jim Shea
Best Company Culture:  Centro
Best Software Company:  Sprout Social
Best Corporate Digital Innovation:  Guaranteed Rate
Startup of the Year:  Belly
Breakthrough Digital Company of the Year:  Braintree
CEO of the Year:  Mike Sands (BrightTag)

Congratulations to all the winners and the finalist nominees.  You are doing great things for the city of Chicago and the digital tech scene overall.

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Lesson #147: Avoid "The Death Zone" for Venture Capital

Do you have revenues of $5-$10MM and profits under $3MM a year?  Are you a company looking to raise outside capital for the first time?  If you answered yes to both of the preceeding questions, you are about to enter what I call "The Death Zone" for venture capital.  And, as the name suggests, "The Death Zone", much like its namesake in oxygen-starved environments north of 26,000 feet in elevation, can make for a suffocating experience when trying to raise capital.

Why is this "The Death Zone"?  Because businesses of this size have typically grown beyond the size where early-stage venture capitalists like to get involved.  But, have not grown large enough in size to get the later-stage private equity firms excited.

To layer onto the complexity here, venture capital investors are typically looking for very different characteristics than private equity investors, in terms of the types of companies and management teams they are looking to invest in.  Venture capital firms prefer rapid growth even at the expense of profits.  And, private equity firms, much prefer stability in your annual cash flow stream, as they will most likely add a layer of debt to your business (to save them from having to invest additional equity), and therefore, will need a stable and predictable future cash flow stream with which to pay interest and future principal payments on the debt.

That said, there is potential good news for you.  If you are a high-growth tech startup, that still desires fast-growth minded venture capital investors, once you get to $10MM in revenues, you will actually open up a large base of Silicon Valley venture capital firms (each with billions of dollars in capital under management), that won't even look at your business until you get to $10MM in revenues.

So, what does this all mean to you entrepreneurs??  One of a few things: (i) if you are looking for rapid growth capital from typical VC's, make sure you approach those investors well before your business gets to $5MM in revenues; (ii) if your business is already in the $5-$10MM revenue range, just know you will be looking for a "needle in a haystack" investor, and allow extra time to source investors (most likely from atypical sources); and (iii) if your business is over $10MM in revenues, be prepared for: (a) cash-flow driven private equity investors which most likely means slower revenue growth; or (b) you are a tech business looking to continue rapid growth, and will be lucky enough to appeal to the big Silicon Valley venture firms.

So, with this new-found information about the nuances within the financing world, grab your ice axes and crampons, and hopefully you will get to the summit, in the form of a closed financing.

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Lesson #146: Pitfalls Around Earnouts (and Why They Rarely Payout)

Following up on Lesson #145, issues to consider before selling to big companies, I wanted to drill down deeper on earnouts, and potential pitfalls to avoid, as earnouts rarely payout as expected.

First of all, what is an earnout?  An earnout is typically a performance-based payment that has been agreed to be paid to selling shareholders, above and beyond any payments received upfront at closing the deal.   So, for example, let's say a buyer is willing to pay you $1MM upfront at closing, and up to $4MM additional proceeds if your EBITDA exceeds a certain level within one year of closing.  That $4MM part of the deal, is the earnout portion, tied to future performance of the company.

Earnouts typically never pay out they way a selling company is hoping they will, emphasizing the importance of making sure you are 100% content with the upfront proceeds only, in the event the earnout payout ends up being zero.  The reason earnouts rarely payout as planned are numerous, including:  (i) the way it was actually written, which can end up benefitting the buyer; (ii) the buyer is not naturally motivated to have their behavior drive additional proceeds to the seller; (iii) typically, the pace of business post a sale is materially slower than life before the sale; and (iv) unexpected things can happen, that may or may not be in your control.  I will address each of the points below.

The devil is in the detail, in terms of how an earnout gets written.  The first issue is whether it is driven by future revenues (which is in seller's benefit) or future EBITDA (which is in buyer's benefit).  Revenue is 100% clear and clean, but buyer's do not want sellers to load up marketing losses tring to juice up revenues to get a higher payout.  And, on the flipside, sellers should be wary of an EBITDA based earnout, because after they sell the company, there could be a lot of corporate expenses which may be pushed down to your divisional level, that hurts EBITDA and the earnout.

In addition, earnout payment calculations can be manipulated by other things, like making adjustments for any net working capital changes of the company.  And, balance sheet movements are a lot harder to control than income statement movements.  For example, you can't control how fast your vendors pay your accounts receivable owed to you, meaning any inflation in your collection time, could decrease your earnout payment.  Same type of thing around any capital expenditure based adjustments, where any monies you spend on needed asset purchases to drive your growth, could also end up hurting your expected payout.

And, let's face facts, a buyer is typically more than happy to wait a year before investing a lot of their promotion support in your business (which you are most likely hoping for to drive the earnout).  From a buyer's perspective, why pay $5MM for a business, when they can pay $1MM, with no additional earnout payments made.  So, unless you detail otherwise in your agreement, don't expect the buyer to be doing a lot of sales or marketing favors for you doing the earnout period. 

Or worse, protect yourself from the buyer loading up a lot of expenses during the earnout period, which can hurt your payout.  For example, sales & marketing expenses today, which will help long term growth of the buyer, will typically come at a loss during the earnout period until the future revenues are driving for the buyer well after the earnout period has ended (great for them, horrible for you).

And, as mentioned in Lesson #145, when selling to big companies, don't expect the way things operated for your company will be the same after the sale.  Typically, the pace of business will get a lot slower, based on both new corporate tasks required and the slower decision making process of bigger companies.  So, you may not be swimming in a pool of water any longer, you may be swimming in a pool of molasses.  And, any slowdown in pace, could impact your ability to maximize the earnout payout.

Then there is the list of all the unexpected things that could happen during the earnout period, which can hurt the payout.  Perhaps there is a big hit to the economy, like there was around 9/11/01.  Or, some hurricane wipes out your home office in New Orleans.  Or, your salesperson is "cooking his books", to drive more commissions, to only find out the contracts were never real too late in the earnout period to actually make up for the unexpected shortfall.  This last point actually happened to one of my businesses, during its earnout period, costing the shareholders around $3MM of additional proceeds!!

So, as you can see, I am pretty bearish about earnouts.  But, sometimes you have no choice, in order to get your shareholders a reasonable way to acheive their ROI objectives.  So, when you use an earnout structure, make sure: (i) it is "iron clad" in its drafting, so no confusion and no opportunities for the buyer to manipulate the calculation; (ii) negotiate for the buyer to bring full promotional support day one, at no impact to the payout calculation; (iii) make sure you are realistic on what life will be like post the sale, to make you are still happy with the deal with slower growth assumptions; and (iv) make sure the business is largely run as-is until the earnout period is ended, to prevent any unexpected buyer expenses, decisions or process from negatively impacting the earnout.

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Lesson #145: Issues to Consider Before Selling to Big Companies

I was lucky enough to be involved with two startups that were both sold to $1BN revenue businesses:  iExplore was sold to TUI Travel, and MediaRecall was sold to Deluxe.  In both cases, the investors were excited to get an exit and return on their investment, and the founders were excited about joining up with a big company to help accelerate growth.  But, despite the best of intentions of parties on both sides of the transaction, integrating a startup into a big company can present numerous challenges which we will discuss in this lesson.

I think the key challenges revolve around: (i) having realistic expecations of what the big company can really do for you; (ii) handoffs between the people that negotiated the deal and the people integrating your startup into the big company; (iii) the slower speed of making business decisions; (iv) the bureaucracy and procedures of bigger companies; and (v) issues related to any earnout payments that may be paid down the road.  I will tackle each of these points below.

Startups can easily be "romanced" by the idea of getting tied up with a bigger company.  And, for logical reasons.  Big companies typically have bigger budgets to spend on product development and marketing, a bigger base of customer relationships to tap into and a well-known brand name to assist with trust and credibility of your sales efforts.  But, unless specific support is well-documented upfront in the merger or sale agreement, often times, big companies will not bring the dramatic upside the startups are expecting.  There are many reasons for this, mostly stemming from a big company's focus on other more important areas of their business.  So, "seller beware" and make sure you get everything you are hoping for well detailed in writing.

Related to this first point, is the drop-off of focus and support the further you get away from the people that actually negotiated the deal.  Typically the people that negotiated the deal, are not the same people that will implement the deal.  So, your future success is riding on people you have never met before, who may or may not be equally incentivized to see you succeed.  Big companies are full of busy people, typically set up in various fiefdoms internally.  The last thing they need is another project on their list, to help a startup they have never heard of before.  So, where you can, make sure the people who will be implementing your deal, are the same people involved in negotiating the deal, so nothing gets lost in translation in the handoff, as to the importance of the transaction to both parties.  The deal has to be material in scope and equally important to both parties to succeed.

And, for all you fast-paced, A-type personalities that like to make quick decisions and move at lightspeed, get ready to jump into a pool of molasses in comparison.  Big companies just naturally take longer times to make decisions.  They are typically consensus-building organizations that need buy-in from the various stakeholders involved in any project.  So, what used to be a five minute decision stand alone, could easily become a month long process.  So, make sure you are ready for this material shift in culture and personality.

Related to this is the higher level of bureaucracy and procedures that come from being part of a bigger company.  Think about all the budgeting processes that now need to be approved.  Think about all the monthly financial reporting in consistent formats and new systems.  Think about legal having to get involved to approve any new contracts.  Think about HR getting involved in any new hires.  As an example, my CFO at iExplore said he lost 25% of his former startup day, having to deal with all the corporate requirements each month.  So, get ready for these unexpected strains which may create additional needs for your business.

And, the last point relates to earnout payments negotiated in the deal.  Earnouts are any additional monies the selling shareholders may receive from the buyer, based on the future performance of your business post the sale.  These payments can be tied to future revenues, EBITDA or whatever other metrics that are mutually agreed upon.  The problem is, earnouts rarely get paid out.  And, when they do, they are materially lower than expected.  So, don't get romanced by the deal value assuming the earnout will be paid in full; make sure you are happy only with any upfront payments made, assuming no earnout is ever paid down the road.  If not, renegotiate the deal or walk away.  This is a complicated topic, which I more fully address in Lesson #146.

In addition, be sure to re-read Lesson #135 on why big companies struggle with innovation, for additional considerations here.  As merging startups with big companies, is often like trying to merge oil and water, culturally, at the root DNA level.  Just make sure you are clear on what you are really signing up for as an employee of a bigger business.

The most important thing is to make sure both parties are 100% in agreement on: (i) why the deal makes sense to both parties in the first place, and (ii) the execution plan, budget and timeline after closing, to make sure no disappointments by either party post transaction.  As an example, if the big company is simply taking a competitor out of their way, prepare to die on the vine.  Or, if the big company does not provide sales & marketing support for its other businesses, it most likely won't provide much support for your business.  Or, if they do bring support, it may come a year down the road, not the month after the deal, given their pace of doing business.

Please do not read this lesson from the perspective that you should never do a deal with a big company, or that deals with big companies never work.  That is not the intention, as these deals can often work perfectly to plan and expectation.  I just wanted to make sure you were aware of potential pitfalls to avoid.

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