VC “Brokers”, “Consultants” and other people who want to raise money for you.

If you are an entrepreneur and you need to raise money, you will inevitably find people who want to help you raise money through their amazing connections and relationships with major investors.  You can decide to deal with these people as you want, but you should be aware of the facts.

First, if they want money in exchange, the transaction is illegal unless they have a series 7 license and I have never come across someone engaged in this activity who has a series 7.  If you ask them about this, they will usually tell you that they are not charging a fee for raising money, but for facilitating an introduction.  My securities lawyer tells me that in the unlikely event that the SEC wants to take notice of the situation, this will not hold up in court.  I say unlikely because the SEC almost never goes after these guys, but that does not make it legal and it does not mean the SEC might change their mind.  When your startup becomes successful want to do an IPO or be acquired by a public company do you want to have an illegal securities transaction looming in your past, even if the chance it will be a problem for you is small?

Now let’s look at the likelihood that these people will be successful for you.  They say they have all these valuable relationships with big-time investors.  If you had these relationships, would you just send them dozens of business plans trying to get them to invest in all sorts of random companies?  Of course not!  If these people really were your friends or associates, they would stop taking your calls after the second or third time you shilled some inappropriate risky investment to them for your own personal gain.  Therefore it is very unlikely that their “connections” are strong at all.  The success rate of these people is often very low, and many people who have tried to sell these services to me I suspect have a 0% success rate.  It is not uncommon for them to request an up front non-refundable fee to cover their expenses!  Sometimes they will also want equity!  Would you pay up front for your dinner if you only had a 10% chance of ever getting it?  I didn’t think so.

I suggest you make real connections with real connected people.  If you really impress one of these people, you might get an introduction to an investor and they will not want you to pay them for it.  They are getting value because they are providing value to their connection by making the introduction.  How do you meet these people?  That is probably a whole other topic.  Happy hunting.

Managing resources in a startup

When it comes to resources, a startup should minimize and control, vs. maximize and own. *

This is one of the most important lessons I learned while earning an MBA in entrepreneurship at Babson.  It minimizes the capital you are required to raise, making fund-raising success more likely, it maximizes return for your investors (pre-money valuation is uncannily linked to how much money you need to raise), and reduces your burn rate, extending the amount of time you have to get through the inevitable problems, changes of direction and surprises that come along the way.

At Motiv, we gained access to the CCI technology through a license with Kansas State University’s Institute for Technology Commercialization.  We thought very carefully about resource management when crafting this agreement – specifically we thought about patents and cash.  A startup needs control of its intellectual property (IP) in order to create value and to have all options open when it comes to an exit, or god forbid, in an orderly wind down to minimize investor losses.  Because of this, we made sure that Motiv is the sole assignee of any new CCI patents that we apply for.  But patents cost a lot of money, and knowing that we will be creating a lot of IP increases the amount of money we need to raise up-front in order fund this essential part of our business.  So how do we get around this?  It turns out that Kansas State understands the need of a startup to control it’s IP, but they also want a financial stake to benefit from these future patents that are derivative of their assets.  We were both happy to include a clause that allows for KSU to reimburse us for patent prosecution costs in exchange for a royalty and a convertible note (a loan that can be converted to equity at a later date).  It’s kind of a back-door, pay-as-you-go funding mechanism.  That’s money we do not have to raise from traditional investors, equity that we do not have to give away until we need it, and it lets us and potential investors know that we have a very solid intellectual property plan that is a major part of our sustainable strategic advantage and a massive barrier to our competitors.

The next example is how we engaged our engineering team and obtained an engine assembly and test facility.  These are by far our largest expenses and therefore the most important to think about carefully.  Our technology was invented at Caterpillar and our Chief Scientist was the inventor at Cat.  For other experimental projects he had worked on, Cat contracted this group of independent engineers to help them, so the relationship was already there, they had excellent relevant experience, and the recommendation of one of the best engine designers in the world.  They also have their own facility.  Traditionally, a company would need to hire all of its engineers, rent a building, finance hundreds of thousands of dollars worth of equipment, and these would become the major fixed costs of the business.  That means those costs are an un-alterable part of your burn rate, or the amount of money you spend every month.  We want, if we can, to make everything a variable cost, so that we can adjust our burn rate to match the changing needs and situations we will run into and make much more efficient use of our cash, and postpone for as long as possible the date that we would flame out, or run out of cash.  So we hired the group as contractors, where we pay them for only the hours they work, and we rent the facility for only the time we make use of it.  This means that when we have a time where we are done testing and designing for a couple months and are focused on business development activities, we can reduce our burn rate to pretty near zero if we need to!

These arrangements for the early-stage structure of our company have given us so much flexibility and freedom from cash worries that it has to be seen as a tremendous advantage for us to reach eventual success.  It also reduces the amount of money we need to raise, allowing us to keep much more of our equity and it raises the potential return for the investors. So many entrepreneurs have a vision of glamor where they have a beautiful facility of their own and a hierarchical structure that is part of their empire-building scheme that the traditional world has trained them to value.  They need to learn that startups are not often glamorous and that ingenuity and innovation are to be valued over empire-building and budget size.

* Timmons, Jeffry. New Venture Creation, Entrepreneurship for the 21st Century. Boston: IRWIN/McGraw-Hill, 1999. Print.