Paul Graham of Y Combinator fame recently posted on his website an extraordinarily comprehensive and useful essay regarding startup fundraising. You can it in its entirety here.

While he is specifically writing to an audience of startup entrepreneurs, his thoughts are well suited for anyone who is faced with the task of raising capital for their business.  I heartily recommend that you invest the 30 minutes or so that it will take you to read Paul’s essay in its entirety.  Then read it 2 – 3 more times to be sure that you give it an opportunity to soak in.

In this post I’d like to focus on his comments on valuation, and the objectives of a capital raise.

“Founders who raise money at high valuations tend to be unduly proud of it. … This is stupid, because fundraising is not the test that matters.  The real test is revenue. … Being proud of how well you did at fundraising is like being proud of your college grades.

“Not only is fundraising not the test that matters, valuation is not even the thing to optimize about fundraising.  The number one thing that you want from … fundraising is to get the money you need, so you can get back to focusing on the real test, the success of your company.  Number two is good investors.  Valuation is at best third.”

Amen, Paul.  As a startup CEO, you are responsible for setting the company vision and driving growth.  Raising capital may be a necessary part of the plan (more on that at a later date), but the capital is simply a tool that you need.  If you need to raise money, get it done and get on with execution of the plan.

Give Paul’s entire essay a read.  It’s probably the best investment of time that you will make today.

In December 2012 I read a blog post by Brad Feld regarding the importance of choosing cultural fit over competence when hiring in a small company.  His argument is that competence can improve over time, but cultural fit does not.  That post can be found here.

His thesis absolutely resonated with me.  I retweeted it, and forwarded to a couple of friends who I believed to be in situations where this was particularly applicable.

Then I went and completely disregarded it when hiring for my company.

The result is predictable.  The employee left of her own accord after two months because of the lack of cultural fit, and I’m back where I started less the time and money devoted to her training.

Heed my words, friends.  Cultural fit over technical competence when a compromise on one or the other must be made.  Additionally, practicing what you preach isn’t a bad idea.

I was recently speaking with someone about the changes that have taken place in the Charlotte start-up community since I moved here in early 2010.  The progress has been substantial, and I’m truly excited about the entrepreneurial environment that has developed in our city.

 

Here is how I saw things in 2010, and how I see them today.

 

April 2010:

 

• The city was still in a period of aftershocks from the global banking crisis.  Confidence was shaken, and people seemed more focused on not losing money than on making money.
• Terry Cox was a lone ranger on the early stage landscape, banging the drum on behalf of Charlotte entrepreneurs.
• A handful of angel investor forums existed, but their activity seemed to be more about networking than about funding early stage ventures.
• There was no identified early stage success story serving as an example of what was possible in Charlotte.

April 2013:

• The Charlotte Venture Challenge and NC Idea grant competitions are in full swing.  More important than the funds that they provide, these programs put entrepreneurs through the process of articulating their ideas in a structured format, give them invaluable feedback on their ventures, connect them with mentors, and provide them with exposure
• There have been five Charlotte Startup Weekend events, during which entrepreneurs are given an opportunity to pitch and hone their ideas.
• With the launch of Packard Place and the Ben Craig Center there are locations at which entrepreneurs can find others for collaboration (and consolation, when appropriate).
• There are numerous Meetup groups, giving entrepreneurs an opportunity to connect with others in their areas of interest.
• CRTEC is providing a structured forum for interaction between area technology executives, and scholarship funds for students in the UNCC College of Computing and Informatics.
• Successful exits have occurred (Peak 10, Yap), providing Charlotte entrepreneurs and investors with evidence that it can happen here.
• The guys at Detailed Block have given a voice to the startup community via their blog.
• Terry Cox is still banging her drum!
• And, if you needed more evidence that huge strides have been made, the Southeast Venture Conference came to Charlotte in 2013.

While Charlotte’s startup community may not yet rival Silicon Valley, Boston, Austin, or even RTP, there is something good happening here and I’m really happy to be a part of it.

Many entrepreneurs have the impression that they need to have a fully-developed business plan document before they can approach a potential investor or lender.  The reality is that few if any sources of capital have an interest in reading 40 pages about your venture.

The following library of items will have you well prepared for the process of engaging and carrying on a productive discussion with the investment community:

– Executive Summary (2 – 3 pages in length, the purpose of this document is to give you something to provide as an e-mail attachment or handout in hopes of getting a 60 minute meeting to fully describe your business.)

– Slide Deck (Prepare two versions of this.  The first is designed for use in meeting where you are the presenter.  Keep the verbiage brief so that the audience is listening to you instead of reading slides.  The second needs to be more descriptive, and will be used in situations where someone asks “Do you have a slide deck that you can send to me?”  Because you will not be there to present these slides they need to do a more complete job of telling the story, thus the need for more words.

– Expanded Executive Summary (8 – 15 pages in length, this is for someone who wants to read more about your business after reading the Executive Summary or having met with you.  Think about this as taking the place of the full business plan, and designed to be read in 15 minutes rather than an hour.)

Don’t hesitate to write a more expanded business plan if you believe that it will help you organize your thoughts and/or provide you with value as a management tool, but you will rarely encounter a situation where such a document is necessary in order to satisfy a potential investor’s desire for information about your business.

What is a “fair” valuation?  (Greg Brown, March 15, 2013)

I am often asked questions related to the valuation of early stage companies. These typically come from an entrepreneur who is trying to understand what a “fair” valuation would be for a capital raise from angel investors.

The answer is really simple. Like it or not the valuation of a start up to early stage venture is subjective rather than objective. The investor(s) want to receive what they consider to be a meaningful but not controlling interest in your venture. This will be based upon emotion and perception rather than a discounted cash flow analysis.

Of course, as an entrepreneur you need to and will paint the picture of the lavish returns that the investor will receive when the hockey stick takes place and the business is delivering huge profits. As you are doing this keep in mind that every deal that the investor is considering has projections that look more or less like yours, so these spreadsheets are somewhat meaningless.

If the amount of money being raised is going to allow your company to accomplish something meaningful (get product to market, significantly expand, etc.), you should probably be prepared to give those who provide the capital something in the 15% – 30% range in exchange for the needed fuel. Those aren’t hard and fast figures, but it’s a reasonable ballpark for you to be thinking about as you consider your options.

A related but slightly different topic is the over-emphasized impact of dilution, but I’ll save that for another day and another blog post.

Co-founders often plan to put in sweat equity into their start-up for 6 months or so, after which they foresee being able to compensate themselves out of revenues or outside funding.  Everyone loves the plan, quits their jobs with Big Corp, and gets to work on the big idea. Equity is divided equally, and unconditionally, because this is going to work.

Then reality hits.  The 6 month mark passes … then 7 … then 8 … and the revenues and/or outside funding have not yet materialized.  Bank accounts dwindle, spouses get nervous, and eventually one of the co-founders is forced to significantly cut their time commitment to the start-up in order to pursue a more regular paycheck.  The departing co-founder is apologetic, wishes the others well, and says “well, I’ll see you at the next shareholder meeting.”

Understandably, the co-founders who are still grinding away trying to make the start-up work are not pleased when they realize that their equity stakes are no greater than that of the party who is no longer eating ramen noodles with them. How could this have been avoided?

In many cases the departing co-founder does the “right thing,” and voluntarily gives up some of their equity.  However, this does not always occur and when it does not there are a lot of hard feelings and disillusioned entrepreneurs.

I am believer that there should be some sort of vesting mechanism on sweat-equity based founder shares, for example vesting over three years, to ensure that those who continue to man the ship have the largest stakes in the venture.  While planning for less than unconditional success isn’t fun, addressing this issue at inception is much easier than the emotional and destructive debates that often occur when co-founders part ways.

What is this about?  (Greg Brown, March 7, 2013)

My intention is to write about a variety of topics of interest to entrepreneurs, some of which will be somewhat general in nature (e.g. – valuation), and others which will be based upon events and observations related to the Charlotte entrepreneurial community.  Hopefully there will be enough of each to keep everyone interested, which is of course the point.

Thanks in advance for your interest.  I’m looking forward to getting started and seeing where this goes.