Get Funded! A Definitive Guide to Seeking the Right Funding, at the Right Time, from the Right Source. Copyright 2010 by Naeem Zafar

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2 Get Funded! A Definitive Guide to Seeking the Right Funding, at the Right Time, from the Right Source Copyright 2010 by Naeem Zafar All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without written permission from the author. Disclaimer: the content of this book consists of the author s opinions and should not be considered legal advice. Published by: Five Mountain Press Cupertino, California USA info@fivemountainpress.com ISBN 13: ISBN 10: Printed in the United States of America

3 At UC Berkeley we encounter some of the best and brightest would be entrepreneurs. But no matter how great the opportunity they all face the same challenge how to get funded. They may be great engineers or scientists but this has not prepared them for communicating their ideas In the post dot com world a world where success requires the blending of all available financing sources. In this volume Naeem Zafar has done the hard work of digesting and shining a light on the pathways and methods of dealing with today s complex institutional and informal financing resources. Success comes to those who are prepared and this volume can help prepare those brave enough to take the plunge. It can be a true life saver. JEROME S. ENGEL Founder and Faculty Director, Lester Center for Entrepreneurship & Innovation Adjunct Professor, Haas School of Business University of California, Berkeley

4 Table of Contents Why I Wrote This Book 4 How to Use This Book 6 Three Main Sections 7 section I: Know Your Options 9 Chapter 1: The Entrepreneur s Sources of Funding 11 Types of Investors 11 Six Funding Stages for Your Company 12 Bootstrapping 13 FFF: Friends, Family & Fools 15 Government Grants and Loans 16 The Next Stage: Professional Investors 17 Seed-Stage Investors 17 Early-Stage to Mid-Stage Venture Capitalists (VCs) 18 Late-Stage Options 19 Strategic Investors 19 Summary 19 Chapter 2: The Investors Profiles 21 Friends & Family 22 Angel Investors 24 Why Angels Invest 24 Venture Capitalists (VCs) 25 Banks 26 Venture Debt 27 Strategic Investors 29 Chapter 3: The Secret World of Venture Capitalists 31 Where Do VCs Get Their Money? 32 The VC Model 33 How Do VCs Make Money? 33 Limited Partners (LPs) 35 How VCs Invest the LPs Money 36 Discover a VC Fund s Focus 37 The Anatomy of a VC Firm 38 What are Your Odds of Being Funded by a VC? 40

5 Get Funded! The Profile of a VC 41 Inside Structure of a VC Firm 42 EIR Programs 43 How VCs Evaluate a Company 43 Syndication 44 Chapter 4: Investors Motivations and Your Funding Strategy 46 Why Angel Investors Invest 46 Why VCs Invest 46 VCs Investment Criteria 48 VC Firm Size and Tiers 48 Why Do Strategic Investors Invest? 49 Your Investment Strategy 50 section II: Prepare Yourself for Seeking Funding 51 Chapter 5: How to Get Investor-Ready: A Must-Do Checklist 53 Market Validation and the Unmet Need 55 Market Traction Proof Point 55 Target Customers and Market Size 56 Competitive Landscape 57 Business Model 57 Financial Assumptions 58 Sensitivity Analysis and What if Scenarios 59 Key Performance Indicators (KPIs) and Financial Projections 59 The Team 61 Chapter 6: Approaching and Engaging Investors 63 The Art of Networking 64 Presenting Your Company to the VCs 65 What Is in an Executive Summary? 66 VC Meeting & Presentation Preparation 67 Tips for Presenting to Investors 69 Presentation Style 70 Slide Zero 71 Section III: The Funding Process 72 Chapter 7: The 12-Step Process of Getting Funded 74 The Process 75 Get Referred 77 What Do You Need to Send Investors? 77 Fine Tune Your Message 78

6 Get Funded! Approach Investors in Stages 79 You, Under Scrutiny 80 The Due Diligence Phase 81 Term Sheet 84 How Do You Know You Are Seeing Interest from VCs? 85 The Closing 86 Chapter 8: A Primer on Term Sheets 87 Common vs. Preferred Shares 88 Stages of Funding 88 Valuation 89 Aim for an Up Round 90 The Down Round 90 Exit Math: Who Gets What in an Exit Scenario 91 Liquidation Preferences 92 Governance 93 Founder s Treatment 94 Termination With Cause 95 Constructive Termination 95 Change in Control 96 How to Negotiate a Term Sheet 97 Chapter 9: Post-funding Priorities 99 Running Your Company 99 Extend Your Lifeline! 99 Board Relationship and Management 100 How Often to Approach Board Members 101 Running Board Meetings 101 Chapter 10: What If You Don t Get Funded? 102 Are You Doomed? 103 Alternatives 104 Technology or Company Sale 105 Chapter 11: Final Advice 106 Appendices 108 Example of an Executive Summary Template 109 Resources for Entrepreneurs 110 List of VCs 111 List of Angel Investors 117 Naeem Zafar 119

7 Why I Wrote This Book It was the last Friday of the month and Jacob was getting his hair cut again, a routine that he had kept for the last seven years. During the normal process of filling his barber in on his life between shampoo and trim, Jacob ended up talking with him about how a bunch of people myself included were giving up our day jobs to start a new company. As it turned out, this barber also cut the hair of Dean Scheff, the CEO of CPT Corporation. CPT Corporation was a pioneer in the word processing business that had gone public. (Mind you, this was in 1985 and there was no Microsoft Word yet.) Dean, himself, was an entrepreneur and understood what it takes to start and grow a company. This useful connection resulted in Dean and Jacob meeting. A few weeks later, CPT Corporation invested $500,000 in seed capital, and our company, XCAT, was started for the purpose of making a specialized computer that was expected to accelerate scientific computation by six orders of magnitude. We had connected with the right investor at the right time and had sought the right funding. This funding allowed our company to develop our first prototype and get our first customer. The VC money followed. In this book I will outline all that I have learned about getting startups funded as an entrepreneur, as an investor, and as an educator on this topic. Most entrepreneurs think they need to meet an investor as soon as they have an idea, but this is the wrong way to go about it. Before you meet with investors, you must become investor ready. What does this mean, how does one become investor-ready, and who are these investors? In this book, I will answer these questions and more. Funding is the one thing that is foremost on the mind of almost every entrepreneur. In reality, it should not be one s focus, but it is. Instead, there are many other things that should be the focus of your attention: knowing your ideal target market; creating a product that you know provides solutions for your customers, based on research you ve done with the customers themselves;

8 Get Funded! Why I Wrote This Book putting the right team in place; and preparing an executable plan. Once you have accomplished all of these things, the funding will come to you. I know, having been there myself, that this is NOT how a first-time entrepreneur thinks, however. Instead, he or she thinks, I could conquer all aspects of starting a new venture IF ONLY I had access to funds! I hope this book will enlighten entrepreneurs on all aspects of funding, including when to seek it, from whom to seek it, and how to find it. This process is often a mystery to entrepreneurs, so they approach investors, or people who look like investors, ill prepared and at the wrong time. Worst of all, they don t understand the reasoning or mindset of the investors they approach. As a result, a lot of time and effort is wasted, frustration sets in, and many good ideas are lost. It is my intention to help educate you on the proper process of attaining funding for your startup business. I want you to become very informed so you will seek the right funding, from the right source, at the right time. When you do that, you will be much more likely to get the funding you need! I have been an entrepreneur almost all my life and have raised tens of millions of dollars from venture capitalists, angel investors, strategic investors, and bank financing, as well as from friends and family. When one is seeking funds, each of these sources requires a different mindset. My intention in this book is to demystify these processes, so you can successfully navigate the choppy waters of funding.

9 How to Use This Book Every company, at each stage in its life, will need capital to grow; every entrepreneur has to learn how to deal with fundraising for his or her startup company; and at each stage of a company s development, its money-raising options change. There are different opportunities available to a startup for raising money. In Chapter 2, we will look at the different kinds of investors out there. I will teach you how to determine which type you should approach, based primarily on which stage of growth your company is in. Then, I will show you how to approach investors in a way that maximizes your chance of success. The chart below represents a typical cash balance of a startup business. You need to be clear about this diagram, which reveals a lot more than you may think. It tells an investor how much cash you will need in order to turn the corner on profitability, how long it will take you to become profitable, and what the outcome will be a few years down the road in terms of revenue and profits. This information provides the investor with a basis for making a decision to invest in your venture. Suppose this chart shows your company s income. It is negative at the start of the business, showing how much cash you will burn before you turn cash flow positive (1), how long it will be before you turn it positive, and what your run rate (how much will you be making per month that your revenue exceeds your expenses) will be when you turn that corner? These three items should be on the tip of your tongue.

10 Three Main Sections I have organized this book into three main sections based on the three key stages of getting funding for your company. First, you have to know your options for getting funded, then, how one prepares himself or herself for seeking funding, and finally, what the actual process of getting the funding involves. Section I: Know Your Options Section I deals with understanding funding options. There are many different sources of funding, and it is vital that you understand these various types of investors and their mindsets. Why do they invest? What do they look for in potential investments (since each investor type has a different set of criteria)? And where can you find these investors? In any endeavor of life, the best thing you can do to ensure success is educate yourself. This is especially true when you are seeking funding for your startup company. You need to know the following things about your potential investors: Who are these investors? What forms and shapes do they come in (angel investors, angel groups, venture capitalists, or strategic investors)? Why should they be interested in you? What data do they look for for making an investment decision? What gets them excited? How can you get introduced to the right investors? How should you approach them? What should you say when you meet with them? There may be scores of questions, including the ones above, floating through your mind. In this section, I try to answer most of them in the most logical order.

11 Get Funded! Three Main Sections Section II: Prepare Yourself for Seeking Funding Section II deals with you, the entrepreneur, and how you can get investor ready. It s essential that you understand the proper method and timing for approaching investors. I strongly suggest that you do not approach investors until you are truly ready to do so. Each investor type requires different preparation. We will discuss these types of preparation in detail in this section. Section III: The Funding Process Section III deals with the process getting funded. How do you negotiate with these investors? What is negotiable and what is not? What happens if you do get funded, and what is expected of you? Even more importantly, what happens if you do not get the right funding? Not every company is ready to seek funding from every source available, and each stage of company growth dictates its best choice of investment. So, given where your company is, what options do you really have? In this book, I am summarizing my 25 years of being an entrepreneur. I ve spent years raising money, and I ve hung out with investors and venture capitalists. I ve advised hundreds of entrepreneurs and helped them raise millions of dollars. My experience gives me some knowledge and perspective that you should find useful. (You can find out more about my experience by looking at my bio at the end of the book.) My style is direct and no-nonsense. I will tell you exactly what I know and believe about getting funded. But I don t want you to think that there is only one way to get money. There are actually hundreds of ways! Even if you don t follow all of my suggestions, you will find knowledge in this e-book that will help you do a better job raising money and dealing with investors.

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