Chapter 4 – Be Prepared for the Deal
In previous chapter we found out how you should prepare yourself for presenting your idea to anyone and what makes some pitches stand out from others. Previous chapter gave us a good idea what you need to do (or not do) to make your pitch perfect.
In current chapter we will talk about setting your goals and developing your business idea. We talk about SWOT analysis to evaluate the strengths, weaknesses, opportunities and strengths of your company. However, perhaps the most important part is about the negotiations with investors, how does business valuation work, how do investors do the screening and due diligence and what are the different types of financing – so everything you need to know to be prepared for the deal with investors.
MAIN OUTCOMES OF CHAPTER 4:
What should be carefully avoided when fundraising?
- Don’t spend more than you need to reach your goals.
- Don’t use up marketing budgets up front. They will use up your investment in no time.
- Don’t exaggerate the power of your numbers. Be sincere and transparent.
- Don’t raise a round just for the sake of it. If you don’t need it yet, wait until you do.
Business valuation - a process used to determine what a business is worth.
Traditional business valuation methods:
- The Scorecard Method - Each factor affecting the business’ worth shall receive a percentage score within a predefined range, the sum of which equals to 100%.
- Venture Capital Method (e.g. needs $0.5M to organic growth)
- Berkus Method (e.g. for $20M potential in 5 years)
- Risk Factor Summation Method (another score based method, the score range -2 to +2.)
However, in reality this often does not work, and what works is:
- Subjective clauses. There are often fixed-price equity rounds, which means a specific percentage of equity for a specific amount of capital.
- Discounted Cash Flow Analysis. This is the most thorough way to valuate a company. There are two ways to valuate a company using the DCF approach: the Adjusted Present Value (APV) method and the Weighted Average Cost of Capital (WACC) Method. Both methods require calculation of the free cash flows (FCF) of a company and the net present value (NPV) of these FCFs.
Comparison of types of financing
| Benefits | Risks | Timing |
| Self-funding | You don’t have to relinquish any control in your company. | There is no safety net for you. | Any time |
| Friends and family | Funding is usually obtainable quickly and flexible terms. | Pressure to succeed can strain personal relationships. | Any time |
| Loans or lines of credit | Relatively quick and you do not have to give up equity. | Difficult at early stage unless you have personal collateral at risk. You will still owe the money, whether the company succeeds or not. | Any stage; very early difficult |
| Angel investors | Access to angels network and know-how. More flexible than VCs. | You may have to give up some degree of control over your company. | Ideal when starting. Try to start low |
| Venture capital | Large sums of money; brings credibility; access to network and expertise | They want to see a return on their investment and may steer the business in a direction that you don’t agree with. | Later stages, more than $1M |
| Strategic partnership | Investor believes in product; access to know-how, equipment, marketing | You may get locked into an unfavourable partnership; may be strict terms. | Any stage, some experience required |
In the next chapter “Chapter 5 – Now What? Working with an Angel?” learn about lean methodology, progress monitoring and problem solving. We also learn how to use step-by-step decision-making process and how to communicate effectively. Last but not least, we learn how to measure performance.
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