Johnson: I would lean toward putting more equity on the balance sheet. But capital can be a vice as well as a virtue. One of the benefits of bootstrapping is that you learn the necessity of making trade-offs. Many companies don't appreciate the need for trade-offs if their access to capital is too liberal.
Morgan: Get out of resale fast. To the extent that pass-through sales hold down your percentage of after-tax income, they position you lower on the valuation scale than a business that does a higher percentage. You may have to sell through as many as five channels -- direct, VAR [value-added reseller], telemarketing, retail, franchisees. That's expensive but not unmanageable.
Johnson: The company should stay with its annuity kind of strategy, building relationships with major clients and delivering an expanding family of products that meet their needs for both present and future applications. That's a competitive position that's enviable. Over time it will yield increasing gross margins, very much the opposite of the reseller business. The annuity kind of business -- the idea that you have a "franchise" with large accounts that you can sell to again and again -- will be much more appealing to investors.
Morgan: Companies often do things when they need money and then later live to regret the fine print. Fortunately, you have the opposite problem -- an embarrassment of riches. You should look at financing like any other strategic item in your business plan. The hard part about formulating financial strategies is that it causes you to read the end of the novel before it's written. You'll see those salespeople you have to hire, that distribution channel you still have to build, some competitor raising $30 million, and you'll think, Do we want to face this by ourselves?
Platt: You should get capital to beef up your marketing and sales. And a high percentage of your income is from one source, so you need to broaden your customer base. If you try to raise financing strictly as a service business, it'll be difficult. The most value you will get for this company is through product -- but a standardized product that someone picks out of a catalog, not one you have to keep customizing.
Founders: We could do with $2 million, but good venture firms won't talk about deals under $5 million. And they don't seem to be interested in paying more than one times revenues.
Johnson: In the venture stage, valuation is more of an art than it is a formula. It isn't just, Go out there and get the money. Were you to wait a few years and your product strategy to become more solidly established, there's no doubt you'd get a better valuation. However, you can use the business advice and capital an experienced investor can bring you now. The best investor isn't always the one who gives your company the highest valuation. A good venture investor wants to be compensated for the time, experience, and credibility he or she brings to you, as well as the money. On the other hand, a corporate investor often is willing to pay a higher valuation than traditional venture investors will if a company fits into its strategic plan. I'm negative on deals in which only a corporation invests. I will always steer a company toward having a mix of venture capital and corporate partners, so the corporation doesn't have the attitude that the company is a captive subsidiary.
Morgan: Venture capitalists aren't apt to be as rigid as they first present themselves. It would come down to negotiation. Don't try the shotgun approach, though. Venture capitalists don't want to feel part of a massive shopping trip; some will turn you down on that basis alone.
Platt: Do you even need a venture capitalist? No. But as well as sound advice and input, you'll need access to capital markets and additional sources of investment, and you get those needs answered by a relationship with a venture capitalist. A good venture capitalist, however; a mediocre venture capitalist can be incredibly destructive.
Morgan: You are clearly between late-stage venture capital and what is known as a mezzanine round -- deals for companies that aren't seen as start-ups. You avoided a seed round, and you avoided that always-predictable second venture deal to get to first-customer ship. What is your true value? Package software companies have to earn their quarter every quarter they live. Such companies -- that is, companies that have risk in the top line -- sell at about half their growth rates. At the other end are companies that have most of their revenues already booked when the doors open every quarter -- recurring revenues that are simply being accrued, such as from subscriptions. Their multiple is often 100% of their growth rate, because the perception is, there's little risk associated with their earnings.
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On Founders' Exit:
'Go IPO -- But Not Yet'
Founders: We want to have fun with what we're doing, and we also want to have wealth. Our wives keep asking, When are we going to take something out of this thing? We tell them, If we run a successful company, we'll make a very nice cash income just through salary and bonuses. Because here's what scares us: A company we watch brought in investors who brought in a new president. The board had one founder as chairman, the new president, and the two investors. Its first action was to fire the founders.
Johnson: You don't control a company just because you own a majority of shares. Performance is the way you control a company. The important kind of control comes from the business's succeeding and your managing it. I've worked with public companies where the president owned only 2% of the stock, yet there was no issue that he absolutely controlled the company.
Morgan: Your danger is going out with a whimper, not a bang. You could easily have a machine that affords all of you an ample living on your W-2, or you could get liquid soon at a decent price and be very happy. If sales plateau, ITI will become a nice little company with a nice little growth rate that investors simply won't be interested in. Is that good enough? I'm not telling you it's not, but you also have the opportunity to hit a home run here. Whether you get taken out in a transaction in which someone buys this company, or you sell a portion in the public market and thereby drive liquidity over time, you could drive it the same way and pay out all the money to the partners every year if you choose. Don't assume you couldn't go public because of that history, that you'd have to operate as a profitable entity for years before anyone would believe you. Wall Street will understand the differential between the reported bottom line and the actual.
