Tactical Plan for Raising Money From Private Investors
(twelfth of a series)
The first step in attracting any potential investor is to address the risk of the opportunity, as perceived by the investor. Venture capitalists do this by conducting due diligence, a structured, possibly lengthy and costly, process whereby they attempt to confirm the business proposition and the people who are proposing it.
In the private investor arena, full blown due diligence of this type is rare. Most often, the substitute for due diligence is Affiliation Risk Reduction. In essence, itÕs a process of getting new investors to commit to an investment because of the investors who have already committed.
The metaphors I can use to illustrate this point are many, so IÕll try a few:
And for the cynics among you,
The key point is that most private investors will never be able to understand your business, or your ability to run it. If they had to make an investment decision in isolation, it would most likely be negative. Recognizing that, your job is to secure a surrogate whose judgment that private investor will be willing to accept as an endorsement to both.
Last week we closed with a method to categorize potential investors into different groups. This week weÕll look at how you can use that insight to favorably impact your fund raising efforts.
This is the second best group, but may be the first one you address. Like the prior group, their endorsement of the business is meaningful, but their personal relationship with you may bring this personÕs objectivity into question. Still, someone from this group may prove to be an ideal conduit to someone in the first category.
This group is not perceived to have independent credibility. They should be actively solicited only after investors in the first two categories are moving in the right direction.
If you do the preceding correctly, this group of investors will be anxious to get in on your ÒhotÓ deal.
Think about how this has changed the dynamics! If you went after this group first, as many first-time entrepreneurs do, you would face tremendous resistance and likely rejection. They donÕt know you. They donÕt know the business. Your proposal is extremely risky.
With the approach suggested in this column, though, the fact that others with independent credibility have endorsed the deal reduces the perceived risk. The fact that the deal is getting further commitments reduces the risk. The fear that the deal will be fully subscribed, and the investor might be prevented from participating, may induce a quicker decision!
When you decide to launch fund raising, you need to have a game plan plotted out in advance.
WARNING: I am not an attorney. Some of what IÕm about to write could violate securities laws if not done correctly. Make sure your attorney is aware of what you are doing.
How much money do you hope to raise? What terms are acceptable to you (subject of a future column)? When would you like to close the deal? Are you prepared to devote the necessary time and energy? Have you assembled and prioritized a potential investor list?
Have you prepared the necessary collateral that you will need to support your fund raising efforts?
Create some positive buzz about your business through formal and informal channels. Perhaps share your one-pager (see above) with selected individuals as an update to what the company has accomplished and where it intends to go. DO NOT solicit any investment interest at this point. ThatÕs practical as well as legal advice.
Your goal at this point is to get an investment commitment from 1-to-3 individuals whose credibility is likely to get others to invest. If you were seeking $500,000 total, you would like to get commitments in the range of $75,000 - $125,000 at this stage of the fund raising process.
From your list of potential investors, identify the 10-15 that fall into the two primary categories of people who know the business, whether they know you or not. Of these, who are the 6-10 that it is the collective judgment of you and your advisors that could invest and are likely to respond favorably to your pitch? Determine how you can get to each. If youÕve done the job right, youÕre likely to be only 2 introductions away from these people (in the context of Six Degrees of Separation).
With the core commitment in place, expand your reach to the next circle of potential investors. Up until this point, these people have expressed ÒinterestÓ in your company and a potential investment, but havenÕt committed to invest, and really havenÕt had anything to commit to until this time.
Prudent application of time, energy and pressure, should get the commitments to your deal to the 40-60% level.
With the apparent momentum of the deal, and with a closing day in sight, you will have three powerful tools at your disposal by this time. You have a deal, so the fence sitters now have something to look at about which they can make a decision. You have a closing date, so they need to make the decision within that time frame. You have a dwindling amount of investment available, and with a Òfirst come, first servedÓ posture on accepting investment, there is pressure on the potential investor to decide sooner rather than later.
Next week weÕll look at various deal structures that might be used with angel investors.
Frank Demmler is Associate Teaching Professor of Entrepreneurship at the Donald H. Jones Center for Entrepreneurship at the Tepper School of Business at Carnegie Mellon University. Previously he was president & CEO of the Future Fund, general partner of the Pittsburgh Seed Fund, co-founder & investment advisor to the Western Pennsylvania Adventure Capital Fund, as well as vice president, venture development, for The Enterprise Corporation of Pittsburgh.