Strategies for Raising Capital
Last month (see my October 2006 column) I introduced the concept of using a "parsing strategy" -- identifying a series of specific milestones or events that could significantly increase business valuation, and raising only the amount necessary to reach the next milestone -- essentially allowing you to bring in equity investors without giving away the store. This month we'll take a closer look at the factors to consider when contemplating a parsing strategy.
In the broadest sense, when you parse a financing, you divide the total amount of money that you will need to accomplish your ultimate goal into a number of smaller, discrete portions that will be needed at different times. You maximize the benefits of parsing by identifying specific milestones or events that cause a significant increase (appreciation) in the valuation of the business and correlate rounds of financing to those events. These are natural "breakpoints" for financing. Rounds of financing occurring after the "breakpoints" typically cost you less than earlier rounds. What sort of events am I talking about? Examples include proof of concept, completion of a prototype of your product or technology, filing a patent application (or better yet, obtaining a patent grant), completion of product development, completion of market research, a product launch, a major contract or customers, or filling out the management team.
The securities law may also factor into the timing of successive rounds of financing. If sufficient time passes between rounds, breaking the financing into smaller amounts may permit you to take advantage of certain exemptions from some of the more onerous obligations (such as the registration requirement) imposed by the securities law.
The affect of asking for the smaller amounts on the potential sources of other people's money (OPM) available to you also must be considered. How do the smaller amounts fit with the range of investments made by your potential sources of OPM? Smaller amounts may take you "beneath the radar screen" of your potential sources of OPM (venture capitalists), but may make other sources (family and friends, angels) available to you.
As valuable as a parsing strategy may be, however, it is not appropriate in every instance.
- If sources of OPM are available to immediately fund the entire amount and the price of the money is not too egregious, you may want to go for it. Sometimes you simply have to strike while the iron is hot. Do you remember the saying about a bird in hand versus those in the bush? Before you opt to break the financing out into rounds, you should feel relatively confident that the sources of OPM still be there when you are ready for later rounds of financing.
- Will you have the necessary lead times to raise the funds in separate rounds of financing? Will you be able to have the money in hand when you need it? Will your ability to move your business forward be hindered by not getting the financing in on a timely basis? Of course, you can sometimes arrange it so that when you reach a milestone, you will already have a commitment from an investor for funding of the next milestone. If not, you must be able to survive during the time it takes to raise the funds. Is it feasible to deal with this problem through a contingency fund or reserve? Certainly. It's called planning ahead!
- How much will the process of raising the money in separate rounds (as opposed to a single round) cost in terms of time, effort, and money (e.g., fees for professional services). Consider whether the savings are great enough to make parsing worthwhile. Just like it doesn't make good use of your time and efforts to drive across town to save pennies on the gallon of gas, it may not make economic sense to parse your financing. Will your time and effort be better spent on growing the business, than finding the money in different rounds?
- Occasionally there is an advantage to being associated with a single particular source of financing. Perhaps your source is someone or some company that has particular credibility or "fame" in your industry, and the association with that source of OPM may give you standing in the eyes of people in your industry, the media, the public, or even other sources of OPM. Or, perhaps a single, larger funding may cement a relationship that will facilitate future fundings. In those cases, it may not make much sense to parse out financing to others.
In any event, parsing is a powerful tool, but it should be employed as part of a carefully planned financing strategy.