The Private-Capital Survival Guide

Once introductions are made and relationships formed, the same sort of forethought should go into the process of actually raising money. Veteran entrepreneurs and investors agree that the time for a business to raise money is long before it's needed. "Start early," counsels Inatome. "Don't make your first contact when you're desperate -- it's intuitively distasteful to have someone ask you for money when they're desperate." But desperation is more than a lapse of taste, as SRC's Stack points out. It can also be a fatal strategic error. The more urgent an entrepreneur's need for money, the more onerous are the terms a financier can extract in exchange. "I've seen companies tie themselves in knots because they needed money badly," says Stack. "They'll sell 20% of their equity to someone and promise that the stake will never be diluted. Conditions like that can stop a company's growth cold."

Appeals for early-stage financing usually take the form of a presentation to a group of potential investors. Such presentations are crucial moments in the life of a nascent business, and they're worth every bit of energy expended in preparing and delivering them. It's hard to overstate the power of a good presentation. Potential investors remember pitches that anticipate and address their needs and concerns, if only because they are relatively rare. For example, it should go without saying that every presentation should include the idea for the business and a detailed plan for executing it. Yet every angel or private capitalist we spoke to for this article could recall instances of entrepreneurs looking for backing for an idea before they had any clue how they might profit from it.

Presentations should also be delivered in language the audience can understand. Severiens, of Silicon Valley's Band of Angels, complains about engineering types who forget that not everyone is as fluent in technical jargon as they are. "When they're developing their prototype," he says, "these guys spend 25 hours a day underground with other engineers, speaking a kind of shorthand. Then they come up to the surface to make their presentation, and they start talking the way they talk to their buddies, and I swear, you have no idea what they're saying."

As important as the idea and the business plan are, the real product entrepreneurs have to sell, especially in the early stages, is themselves. "First-stage investors are evaluating the jockey, not the horse," says Greenwich Technology's Beninati. "They need to see you're a capable person, and they need to see your work ethic. They need to be sure you're going to devote the intensity and the time to getting those first few victories." They also need to see that the entrepreneur is the sort of person who can be trusted with other people's money. That means being scrupulously honest about even the smallest details. This too should go without saying, but in their eagerness to turn their business dreams into reality, even the most ardent devotees of the truth might be tempted to round off the corners of a few sharp-edged facts or omit a piece of unfavorable data. This temptation, though understandable, must be resisted, counsels SRC's Stack. "One lie, and it's over," he warns. "One bluff, and it's over."

Even well-put-together presentations can founder, however, because of a failure to appreciate a crucial difference between entrepreneurs and investors: Entrepreneurs focus on the potential of an idea; investors focus on its risks. "The key to raising capital is lowering risk, not hyping the upside," says Douglass Tatum, CEO of Tatum CFO Partners and an authority on small-business financing. "The entrepreneurs who say how they'll reduce risk are the ones who get the capital." Of course, investors in growing companies understand that risk is part of the equation, but they want to see evidence that an entrepreneur recognizes the risk factors facing the business and has taken steps to control them. That means devoting a considerable amount of presentation time to addressing questions about market risk, financial risk, and technological risk. Remember, suggests Frank Gwynn, president of Freedom Medical, private capitalists "aren't entrepreneurs, they're numbers people -- they look at risk versus return." And that is how entrepreneurs should frame their business propositions when they make their presentations -- stressing not the dazzling upside but the return investors can reasonably expect, weighed against a limited and carefully defined set of risks.

The most effective way to confront investors' concerns about risk, says Tatum, is to spell out exactly how the business will use the capital and how the capital will enable the business to increase profits, or at least become profitable. It's not enough, he says, to claim that the additional capital is needed for growth, since growth itself is a risk factor. He tells the story of a sandwich-shop franchisee with three stores who was seeking financing to expand to seven stores. Expansion to seven stores required the entrepreneur to add a layer of overhead -- a formal human-resources department, line management -- that absorbed more working capital than the additional stores could generate in revenue. So the sandwich-shop owner instead expanded to 13 stores, Tatum says, giving the business sufficient scale to offset the additional overhead. Had the entrepreneur expanded only to seven stores, he would have merely grown into unprofitability -- perverse as that may sound. "When you bust out of being small," Tatum says, "that's when the problems start."

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