Welcome to The Capital MatchPointTM “ Where Business Meets Capital.”

Our eBook, How to Raise Money for Your Business: 75 Years of Raising Capital: How we did it and what you need to know, contains easy to read vignettes of information on a wide range of topics in a conversational format taken from years of trial and error and now we’ll share these experiences with you! As the principals of NuQuest, Inc., and owners and developers of The Capital MatchPointTM web portal, we have over 75 years of experience in entrepreneurship, corporate finance and I’ve personally started a public company from scratch and exited at a multiple of profitably. We’ve been principals of Wall Street brokerage firms, have demonstrable investment banking backgrounds, we’ve come up through the ranks of Fortune 500 companies and are serial entrepreneurs in our own right raising millions of dollars from the private and public sectors.

We welcome you to use this eBook for its intended purposes…you’ll find a video section to almost every topic. Click on the links and take the video tutorial with the NuQuest, Inc. / The Capital MatchPoint’sTM principals presenting in layman’s terms with a big touch of professional advice on the topics you need to be a success.

Is your company further down the road, more mature and looking to raise further rounds of financing? Do you find that running your company and having to locate capital and position it to do so is a three headed monster? We can help…our AVSTM Consulting Platform may be the answer. Our winning Assessment, Valuation and Structure consulting model will help you get “investor ready” for the Capital MatchPointTM investment corps.

Let us share our vast experience with you in what I’m sure you’ll find to be a compelling, insightful and above all, useful tool in your search to make your company the best it can be, how to position it for funding and above all, how to locate it!

Regards,

R.K. (Ken) Honeyman

President, CEO NuQuest Inc.

1

How to Raise Money for Your Business: 75 Years of Raising Capital- How we did it and

what you need to know…

By R. K. (Ken) Honeyman

Dave Dambro &

Mark N. Bass

© 2009 by NuQuest, Inc. and The Capital Matchpoint™. All rights reserved.

2

TABLE OF CONTENTS

PART I .........................................................4 The Basics of Capital Formation1. ................................................................ 4 Need Capital To Start Your Business?2. ............ 5 True Cost of Raising Money…Are You Really Ready for This?3. ........................................................................................... 6 Stages of Financing4. .................................. 8 50 of the Worst Business Mistakes You Can Make5. ........................................... 12 Raising Capital: Prepare a Cogent Business Plan6. ................................ 13 Elements of A Good Business Plan For Capital Funding7. ................ 14 The Most Valuable Secrets to Raising Capital…Use These!8. ............................. 18 Top Eight Tips On Raising Angel Financing Today 9. ......... 20 Raising Capital – Create a Business Plan: Another 10 Point Process!10. ................................. 21 The 3-Minute Review: What Are Investors Looking For?11. .......................................................... 23 How do I Raise Capital in this Economy?12. ......... 24 Should I Seek the Assistance of Professionals when Raising Capital?13. ........................................................... 25 Which is Best: Debt or Equity Funding?14. ....................... 26 When Seeking Capital, How Much Money Should Be Raised?

PART II ......................................... 28 Practical Advice…Putting it All Together15. ....................... 28 What Not to Tell the Investors When Seeking Capital Funding16. ........................................... 29 What TO Tell the Investor When Seeking Funding17. .............. 31 Investors Perception of Your Team When Seeking Capital Funding18. .......................................... 33 Know the Investor When Seeking Capital Funding19. ........................... 34 Negotiations with Investors when Seeking Capital Funding20. ............ 36 What Does It Mean If Turned Down When Seeking Capital Funding?

PART III ................................................... 37 The Financials: Make or Break Time21. .......................... 37 Business Plans and Pro-Forma Financial Statements22. ....................................................... 39 Complete Set of Financial Statements23. ............ 40 Debt Financing vs. Equity Financing…Which is Best for Us?24. ..................................... 41 Income Statement and Investor’s Interpretation25. ........... 42 Cost Categories – Cost of Goods Sold (COGS) and Overhead26. ..................................................................................................... 43 Gross Margin27. ............................................. 44 Balance Sheet and Investors Interpretation28. ........................... 45 Statement of Cash Flow and Investors Interpretation29. ............................. 47 EBITDA – What does it mean? Why is it important?30. ........................................................................................................... 48 Burn Rate31. ..................................................... 49 Ratio Analysis of Financial Information32. .................................................................................. 50 Price to Earnings Ratio33. ..................................................................................... 51 Return on Investment34. ...................................................................................... 52 Valuation and Pricing35. ........................ 53 Investor Considerations When Valuing Your Company36. .................................. 55 Considerations When Negotiating with Investors37. ............ 56 Financial Statements That Will Stand up to Investor Scrutiny38. ...................................................................................................... 58 Term SheetsSummary .................................................................................................................... 59

3

PART I The Basics of Capital Formation

1. Need Capital To Start Your Business?

The investors at the Capital MatchPoint want to see a number of things, but the thing that they want to see the most is the business plan. Your business plan creates so many opportunities for you, not only as a funding source, but as a road map for your own success.

So, you started a new business. I say congratulations to that, but you have to create a written business plan which is actually the next logical step in that process. Smart entrepreneurs plan, not because accountants and financial people tell them to, but because they understand it increases their chances for success.

There are successful people out there who have flown by the seat of their pants, and they probably succeeded despite a lack of a written business plan. But how much better would they have been if they would of had one that really made a lot of good sense?

I tell the entrepreneurs that come to our site, look, business plans are used for two main reasons. You can plan for the future, create a road map, or establish your business credentials so you can get funding for yourself and use that as a really good tool to hand off to an investor when they want to see what you're all about.

The guts of your business plan are so important. So, if you're just starting out in business, your written business plan can help organize every thought. It can put everything into context. A well-established business, on

4

the other hand, trying to grow can use the business plan as a modeling tool to examine various options before committing to any particular one. Your business plan should be treated as the most important document you’ll ever produce, you’ll need it and so will investors…

2. True Cost of Raising Money…Are You Really Ready for

This? One expense that entrepreneurs almost always overlook is the cost of raising money. Most feel it will only cost their time and that of their key managers. Granted, it will cost at least this amount and then some, make that a lot. Consider the following….. Do you know how to write a good business plan? Most entrepreneurs know that they need a business plan but lack the time or skill-set or both to write one that is thoughtful and complete. Generally speaking, a good business plan takes at least a month to write from scratch, longer if your business is larger or more complex. Having this work done will cost from $5,000 to upwards of $30,000 depending on the amount of work involved. Advisors – are you a one man or woman show? Or, does you management collectively have the competencies necessary to raise capital and formulate the tactics necessary for your business plans success. If not, you may want to consider retaining advisors. The successful entrepreneur is on who recognizes their own strengths and weaknesses and surrounds themselves with people whose strengths and weaknesses are complimentary. Advisors will generally want to paid in cash for a short term introductory period. That way, they have something in exchange for their time if the relationship doesn’t work out. Going forward, you can most likely work-out a cash and stock compensation plan. At any rate, you should plan on

5

spending $7,500 - $10,000 for advisors over a three month period depending on how many you hire and the demands your company puts on their time. Marketing your business – Think of the countless color copies of your business plan that you will be mailing to potential investors. Also, consider how much it will cost you in travel to present to investor groups and the fees associated with presenting at investor forums. For a six to twelve month process you should count on $15,000 on the low expense, short time frame end and up as time goes on an expenses go up. Legal and accounting fees – Unless you’re an attorney and your partner is a CPA these fees are unavoidable. You’ll spend money organizing your company and setting up the correct legal and financial structure. And, if you have intellectual property to protect you’ll want to do that up front in way of patents, trademarks or copyrights before going forward. It’s hard to say how much you will spend because it is so dependent upon individual situations. But, you should plan on spending at least $5,000 or substantially more if there is intellectual property to protect. All in all, for a process taking six months to a year you should anticipate spending upwards of $30,000 on the low end. 3. Stages of Financing We have the opportunity to meet a lot of entrepreneurs at different funding stages in their life cycle. One thing that I’ve found is that it is important that you communicate to investors which stage you’re in and, if possible, how many rounds of funding you anticipate before exit. You can bet the investor will form their own opinions, but it is important that you, as an entrepreneur, give this serious consideration and show the investor that you have done so. It will go a long way in establishing credibility. Let’s talk briefly about the different stages of financing.

6

Think of investment needs as a time line with milestones highlighted at different points, much like you would see in a history book. The first stage of funding, called seed funding is at or very near the beginning of the time line. This is when money is spent on activities such as technical development, market research or in securing intellectual property rights. Basically, it is money spent evaluating potential viability and preparing for the commencement of operations. Many times this money comes from the entrepreneur’s own personal savings or from investments from family or close friends. Institutional investors such as venture capital firms or angel investors usually see this stage of development as too risky. The next stage of investment comes when the company needs money to get operations off the ground. This is known as start-up financing. The start-up financing stage is usually characterized by the business’ first revenues that fall short of supporting positive cash flow, hence the need for a capital infusion to fund operations until revenues are sufficient to sustain operations on their own. Sometimes start-up financing is dubbed series A financing, referring to the first outside capital brought into the company. Once the business is on firm footing, there will come a time when more money is needed to support continue growth. This money may be used for things such as refining marketing efforts, hiring additional management and staff or new product launches. This round of financing is called second round or series B financing. Sometimes companies have a seed round of funding followed by series A and series B rounds of funding then proceed to a sale or public offering. The last stage of financing with the general purpose of preparing the company for a profitable sale of IPO is called mezzanine financing. Mezzanine financing is generally some combination of debt and equity than can lower a company’s overall cost of capital. Funding stages can take on many different forms depending on the business and market in which it participates. At some point when cash flow is positive companies may elect to take on a revolving line of credit backed by working capital, to support operations or some companies may choose to move on to subsequent rounds of series C and D financing before exit. Whatever your funding strategy, remember that each stage will require a valuation of your company and that too much funding will lead to dilution of the founder’s stake.

7

3. 50 of the Worst Business Mistakes You Can Make

While starting a business can be advantageous and quite prosperous for a great number of people, there are a variety of business mistakes that new entrepreneurs can make. Some of these common business mistakes are repairable, while others are truly detrimental to the health of a company and can spell certain death. Here are the top 50 most common business mistakes, divided into five primary categories as they apply to business.

A. Planning Errors

1. No Sound Business Idea: Without a sound idea, how will you develop your business plan? Without a plan, how will you develop a successful business idea?

2. No Business Plan: Your business plan is the core of your business. Without a solid business plan, there is no way that you will ever be able to turn your business into a successful operation.

3. No Market Research: Market research will determine the viability for your product or brand. If you don’t know your market do you really know your business?

4. Poor Timing: There is a right time to start a new business, and a wrong time. If you roll out your business when the market is not ready for it, you may fail before you ever even get off the ground.

5. Poor Location: Location is everything for many businesses. Choosing your location is one of the most important decisions that you make when planning a business.

6. Poor Choice of Suppliers: The quality of the products and supplies that you offer is vital to the success of your business.

7. Underestimating the Competition: Every business and every concept has competition. If you do not recognize it, you are missing something important. Identify your competition before you launch your business.

8. Choosing the Wrong Type of Business: Sole proprietorship, partnership, LLC? Choosing the right business form is vital.

8

9. Failing to Seek Advice: It is important that you turn to successful people for advice in the planning process of your business; otherwise you will not be successful.

10. No Financial Preparedness: Simply put: If you’re not financially ready to launch your business, prepare to crash and burn.

B. Personality Problems

1. Not Mentally Strong: A certain attitude is required of successful entrepreneurs. Do you have what it takes to lead rather than to be lead?

2. Inability to Analyze: Successful entrepreneurs need an analytical spirit. Can you be analytical and even a little bit critical in order to guarantee business success?

3. Inability to Self Critique: As a business owner, you need to be willing to self critique. A business owner who is not critical of his or her self is an unsuccessful one.

4. Lack of Desire: You have to be passionate about your industry, niche or business in order to succeed. Do you lack desire for your business? Then you are destined to fail.

5. Low Motivation: Just like desire, motivation is critical for business success. If you are lacking motivation, perhaps you are in the wrong business. Get motivated or get another job.

6. Over Confidence in Expansion: While expanding may be a necessary part of business, if you become over confident in your ability to expand, your business will surely flop.

7. Making Rash Assumptions: If you walk into your business making assumptions, you will have trouble acting on real information.

8. Failing to Take Responsibility: When you are an entrepreneur, you have to accept responsibility for failures in your business; you cannot simply shirk them off onto someone else’s shoulders.

9. Procrastination: If you procrastinate, or are lazy, or otherwise simply cannot get things done, you are NOT suited for entrepreneurship.

10. Overzealousness: Your business will not go from 0 to 60 on day one. You need to be prepared for a slow battle, and shoot for “slow and steady” business growth.

9

C. Financial Mistakes

1. Not Having Enough Savings: Finances are obviously a large part of owning and operating a business. If you are not prepared financially, you will sink.

2. Poor Credit Rating: You will run across situations where loans and other assistance is required, but if your credit is destroyed, your business too will fall apart.

3. Overspending: Overspending without any thinking or researching can have a serious negative impact on your financials.

4. Poor Budgeting: Budgeting is a vital part of running a business smoothly, so make sure yours is good! Poor budgeting will prevent you from getting a handle on your finances.

5. Unrealistic Targets: If your financial targets are unrealistically high and you continue not to meet them, your business will never succeed.

6. No Organization: When it comes to financials, organizing is absolutely vital. Keep yourself organized and keep your financials in order and you will succeed.

7. Dishonesty: To yourself or to your employees, dishonesty can destroy the financial standing of a business.

8. Taxes: Pay your taxes as often as you can. Work out a basic plan, stick to it and always be honest about your taxes if you want to prosper.

9. Deductions: If you want to save money every year, do your deductions right and get some money back each year.

10. Set Goals: Your business needs to have clear cut goals if you want to climb from the red to the black.

D. Advertising Blunders

1. Misuse of PPC Ads: Using Pay Per Click, (PPC), correctly is an art. Master PPC advertising or your business will initially languish until you build organic traffic.

2. Poorly Performing Offline Ad Inventory: If your ads are performing poorly, you are throwing good money after bad.

3. Poor Word of Mouth: Word of mouth is actually a powerful marketing tool. What are you doing to spread the name of your business?

10

4. Choosing the Wrong Advertising Medium: Advertising is everything. Choose the right medium or your business may flop. Hard.

5. Overspending in Advertising: Stick to a budget when you pay for advertising. Do not go over your budget no matter what.

6. No Tracking: If you can’t track advertising progress, you’re doing something really wrong.

7. Poor Branding: Is your brand memorable? If not, you’re doing something terribly wrong.

8. Bad Name: Your name is half of your branding. Can your customers remember your name?

9. No Business Cards: Carry business cards at all time and be prepared to pass them out at all times.

10. Poor Business Cards: Forget cheap business cards. Buy nice, legible and attractive cards.

E. Networking & Human Resources

1. Insularity: Detaching yourself from the people around you is an excellent way to destroy your business.

2. Unwillingness to Talk & Share With Competitors: Networking is a powerful part of business. If you fail to network effectively, you will surely crash and burn.

3. Poor recruits: Pay close attention to who you recruit and hire. Look for employees that will stay for the long term.

4. Badmouthing Competitors: You don’t have to like your competitors, but you do have to cooperate with them.

5. No Benefits: Offering benefits to your staff is the best way to keep them around. If you don’t offer any incentives, they will go on to bigger and better things.

6. Staying Informed: Stay informed with what is current in your industry, or your competitors may pass you by.

7. Keep Things Fair: Keep things fair with your competitors. Don’t steal ideas or products. Respect one another even if you are competing.

8. Cold Calling: Cold calling is not the answer to networking. Meet your contacts in person first.

9. Getting too personal: Getting to know your networking contacts is a great way to spread the good word, but getting too personal can be a deal killer.

11

10. Drinking at social events: Just because there is alcohol where you’re networking, that does not mean that you should drink! Stay sober.

5. Raising Capital: Prepare a Cogent Business Plan

Now you know what NOT to do!! So you’ve answered those breathless questions with a high degree of certainty and you’re ready for the next step. Let’s go...what next?

A lot of people come in to the Capital Match Point offices with a game plan. It's not so much a business plan. It's a game plan. Our investors want to see your business plan.

You’ll have to create a business plan as your next logical step in this whole evolution. Smart entrepreneurs plan not because their accountants tell them or because their financial people say it's a must.

Sure, there are successful business owners out there who had no business plan, and they stumbled along and certainly made some money for themselves, and that's great. But I will tell you that 98% of people that walk in our doors have to have a very cogent business plan. You have to plan for your future. You need to create a road map for your success. What do you really want to get out of your business plan? It may help establish your business credentials for financing purposes.

So, if you're just starting out in business, the business plan is going to help you

organize every piece of the puzzle, and it's going to come together to make your

12

business grow and be a success, hopefully. Your well-established business plan

is going to grow your business. If you're a larger company, it could take a

“business-as-usual” rut and turn it right around.

6. Elements of A Good Business Plan For Capital Funding

The phone rings at the Capital MatchPointTM, and inevitably, it's one of the capital seekers, and one of the most frequently asked questions almost on a daily business is about their business plan. There seems to be a lot of anxiety... is it long enough? Is it good enough? Does it contain the information that the investors want to see and does it really tell the story?

From my 30 years of experience and knowing what our investors want to see, plan on spending between 80 to perhaps 200 hours on your business plan. A word of caution: don't try to make it perfect. It will never happen. So, don't try to make it so.

Let's condense this into the simplest terms. The basics: How long should your plan be? What I like to see and what our investors like to see is between 25 and 30 pages. No more and certainly no less. You have to tell the story. And if you have to ask yourself who needs a business plan, then don't plan on getting funding.

Types of plans: Mini-plans, working plans, financing plans, presentation plans.

The contents? The Executive summary, business description, your market strategies, your competitive analysis, how you're going to develop your

13

business, operations, management, and of course, above all, the financial components.

Above all, they have to be very specific and get to the point. I've seen hundreds and hundreds of business plans over the years, and the ones that grab me are the ones that tell the story quickly and succinctly. Remember, its quality not quantity.

7. The Most Valuable Secrets to Raising Capital…Use These!

Should raising money in today’s economic climate be the equivalent of “pulling teeth?” NO! We know. We’ve been on both sides of the fence, as entrepreneurs raising money and as professional investors. We have used our experience and built the Capital MatchPointTM to address this daunting task and make it easy for the capital seeker and capital provider to come together with common goals. That’s just the first, all important step…to get you in front of the right investors who’ll look at your deal.

Here are 10 valuable secrets as you plunge headlong down the path of raising capital that you MUST consider…

SECRET #:1 Who are you dealing with?

Every capital provider, be they an angel, venture capitalist, private equity firm, or your favorite crazy, rich uncle, has their own set of investment guidelines they follow when making investments. You should learn as

14

much as you can about the people you will be asking to become a part of your company. In today’s internet age everyone has a website. Visit the on-line home to potential investors to learn about them and their investment strategies. They will do the same to you. Typical rules include geographic focus, investment stage preference, lead/follow-on investor, minimum and maximum investment amount, industry focus and board seat requirements. Make sure that the strategy of the firms you are targeting match your funding needs. Use the Capital MatchPointTM to automate this exercise.

SECRET #2: Get personal

If you’re cold calling, stop the insanity! It just doesn’t work. You’ll hear the expression, “Deals thrown over the transom,” more than once. It means someone just tosses their business plan over the door hoping someone finds it, reads it, falls in love with it and funds it. We built the Capital MatchPointTM to eliminate this practice by selecting quality business opportunities and matching them with quality investors. Capital providers are looking for good investments and tend to prioritize personal introductions.

SECRET #3: Get to the point, will you?

You’ve secured your first meeting with the person with the money. Hooray! Now, get right to the point. Time is money and if you’ve gotten this far, don’t waste their time or yours. I’ve sat through countless meetings with a capital seeker looking for money; they usually have a great idea or concept, but can’t articulate it and loses me in minutia. Be crisp. Be clear on what you do, who buys your products, how you make money, and how you plan to grow. Keep presentations under 12 slides and executive summaries under 2 pages.

15

SECRET #4: Is your team the right team?

Does your founding team have the passion you do, or does cousin Eddie think he can help because he has knows someone who knows someone? If you don’t have people on board that have the unique combination of experience, passion and who are smarter than you, it’s going to be a tough grind. You don’t have to have a complete executive team, that’s what the new money is for. Be flexible and be willing to listen and give up some portion of the deal to the capital seekers…and don’t think they’re interested in giving you a simple loan and you’ll pay them back when it gets huge, that’s for rookies. One of my old mentors, the late, and very great Hy Federman used to say, “Money is honey, use the company’s paper as wampum for trade. Never be afraid to give up equity for cash.” It’s true.

SECRET #5: I’m different…I really am!

If you don’t know who your competition is and why you’re better than they are, at least after funding, then save the trip. Everyone has competitors. Those that say they have no competitors are not believable. Directly present yours and the measurable difference your product or service offers. Identify them, don’t be afraid of them, and make your deal better than theirs. After all they were there first and can be picked apart for weaknesses.

SECRET #6: The ROI

What is your value proposition to the customer? How does your business save time or money or both? What is the cost to the customer of not using your product or service? Show the investor how darn valuable your product or service is to the market you address.

16

SECRET #7: The real market size may not be as big as you think

Who exactly are your customers and what is the real market you are serving? Don’t be expansive. Be realistic. What is the exact size of the addressable market of purchasers of your product or service? Don’t use “fuzzy math”. If you tell the capital provider “if we capture 1 zillionth of 1% of the market we’ll make billions!” your credibility will be called into question. The people with the money have resources necessary to corroborate or refute your claims. After all they have the money for a reason.

SECRET #8: Know your numbers!

How will your company spend the money and how does this all come together to break even and make a profit? Explain the key business drivers such as number of customers, sales per customer, cost per customer etc. Show a bottom-up analysis of how many customers you need to hit your numbers. Be prepared to discuss what you would do with more money and how you could make it with less, which is usually what the capital provider wants to know.

SECRET #9: Tell me how I exit

These days, the public exit strategy is dead, and I mean DEAD! Don’t even go there. Assume the only way for your investors to realize a return (what this is really all about) is an acquisition of this wonderful business you are going to create. Provide tangible examples of recent and related acquisitions by at least three different categories of potential acquirers (suppliers, distributors, competitors). Be prepared to cite five companies in each category to show that there are plenty of viable of exit options. Oh, and don’t forget to tell the investor the time line to harvest his reward.

17

SECRET #10: Valuations come last

Valuations for start ups and early stage deals are virtually worthless, so don’t get too excited. If there is virtually no operating history and financial data is spotty, be realistic. DO NOT use the words “it’s based on conservative numbers”. Early stage valuations are subjective, so get over it. Your first round of investors will probably own 30%-50% of the business.

Keep these 10 points in mind when you set out to build your business plan, build your company and seek the capital you need to forward it.

8. Top Eight Tips On Raising Angel Financing Today

Here are the eight things companies need to do in this altered financing environment to survive and raise angel funding:

1. BOOTSTRAP Companies must pinch every dollar, when possible. Get individual contributors to work for free, pay upon performance and do everything you can that does not cost real money. Work from home, barter, use stock, and look for services and/or consulting revenue to help build the product.

2. HAVE A FOCUSED LAUNCH STRATEGY - This means ONLY ONE market niche as the initial target. Startups need to be a small fish in a small pond.

3. BE PREPARED TO DELIVER ANY SIZE PITCH – It amazes me how many companies still can’t state what their company does in a few clear sentences! If you cannot articulate your deal confidently

18

4. Cash Breakeven in 6-12 months maximum - Today it is required. Tune your plan to get to cash breakeven in 6-12 months on no more than $1 million!

5. A FINANCIAL BUFFER - I recommend a year's worth of personal expenses in the bank.

6. CORPORATE PAPERWORK - You need to get your "corporate" house in order with written agreements on ownership sharing. If these are not clean you can scare off investors who want to take a closer look.

7. NETWORK AND LEARN - Attend many entrepreneurial workshops regularly. This helps you to learn how to run business models in your head better and see how investors react to holes in plans etc.

8. GET A MENTOR - You cannot afford to learn by trial and error here. Typically, you need someone available for at least two to four hours every week to review all major decisions. This will be the best time and money you will ever spend. An hour or two a month will save you tens or even hundreds of thousands of dollars in errors, can generate sales faster, and will get you to critical milestones months earlier.

Doing all these things can increase your chances of building a successful company and getting angel financing from one in a thousand to as high as 50%. There are few guarantees in life, but hang this list on the wall and review it every month and I guarantee you will improve your chances greatly.

19

9. Raising Capital – Create a Business Plan: Another 10 Point Process!

You know you need to write a business plan, so let's talk about actually writing it. Here are the guts of a great business plan. I've got ten points here that I'd really like you to follow and pay close attention to. Yes, another 10 pointer!

#1 Decide why you're writing the plan. Are you raising money? Probably. Are you clarifying your future? Certainly. Launching a new venture? Figure it out quickly.

#2 Get the big picture. Prepare an outline then visit The Capital Match Point’s online resource library. There's over 750 sites dedicated to this alone.

#3 Grab everything that's already handy. Consider marketing pieces, press releases, anything that you think is important. Websites, notes that you've accumulated over time are great fodder.

#4 Just start. Start typing thoughts, ideas, questions, words, and to-dos in each section of your business plan and place your thoughts in the most appropriate section.

#5 Prepare a rough draft. Take your brainstormed ideas and shape them into a useable draft.

#6 Now it's research time. Compile information and research to support your claims and assertions.

20

#7 Start thinking about your numbers. At this point, you can make assumptions and develop a form of financial statement. If you start any sooner your numbers will be fantasy.

#8 Write a final draft and finish the numbers. If one of our investors sees an error, you lose credibility almost instantly. Double and triple your writing for grammatical and spelling errors and certainly your financials, please.

#9 Set a deadline. Set a deadline you can't ignore.

#10 Finally, polish your plan to perfection. Get critical comments from readers. Not your husband, wife, business partner, significant other. Go to the source. Lastly, prepare an executive summary that encapsulates the highlights of your entire plan and places it up front.

Congratulations, you're now the proud owner of an excellent business plan and ready to present it to the investment community.

10. The 3-Minute Review: What Are Investors Looking For?

Having sat on both sides of the desk as an investor over the past 25 years and as a capital seeker as well, I could tell you, during that three-minute review I talk about, there’s some eye catchers that are going to pop out at you and really grab your attention and those are the deals that are going in the to-do file. Here’s what generally pops out during that review.

21

First of all, I think patents. If you see a patent, you generally know you got something there that nobody else has. It’s worth taking a look at.

Trademarks are pretty good, too.

Additionally, we like to see capital invested personally, call it “skin in the game.” We want to see management teams that have a personal stake in the business and believe enough in it to put their own money behind it before they come and ask the capital provider to add to that.

Management? This is a huge category for us. Executive summaries reveal gems and big names and experience. Companies need pedigrees.

Milestones achieved. It’s good to look at a company and see, have they made it to their stated goals so far? That’s a good indication of how they’re going to handle the capital infusion you’re thinking about providing for the investor.

The value of the idea, or the product, or the service in a monetized basis. In other words, what’s the market for that idea, product, or service look like? Is it a multi-billion dollar market or is it just niche? A couple million here and there is a big difference.

Growing market demand versus shrinking market demand. This one’s pretty obvious. Everybody wants to get in on the ground floor.

Revenue growth year over year…we always take a look back and see what they did last year or the same quarter and look for the trend. You’ll want to see that trend line steadily up. If you see it spiking up, it’s even better.

Strategic partnerships are also very, very important. Who is this company aligned with? Who is supporting the business model and enhancing it as well?

22

Lastly, intellectual property which is a little esoteric, but nonetheless it can be valuable. It can be booked as an asset, and it is something to take a second look at.

These are the things that really catch the eye of the investor. If you’ve got some of those things in your business plan, during the three-minute review, they’ll pop out.

11. How do I Raise Capital in this Economy?

I’m frequently asked this question from our entrepreneurs, “How do I raise capital given this economy?” There’s a lot of anxiety surrounding it, so I think you want to be aware that it’s true. IPOs were down 85% through the years 2007 and 2008. And now, in 2009, it appears that the well has dried up completely. But don’t despair. There are options. Even though the banks have pretty much cut back their lending, and investment bankers are sitting on the sidelines, there will always be entrepreneurs. In fact, there are more entrepreneurs created in times of economic crisis than usual.

I'll give you a perfect example. Top-level executive loses his job. Has a highly skilled position. Has some savings. He’s got a great idea, and he’s always wanted to be in business for himself. There, you’ve got an entrepreneur being born. On the other side of the coin, there’s always the investors. There are professional investors that run just like any other company, and they are in the business of providing capital.

23

The dis-connect is occurring in the deal flow. So, how do you access the deal flow as an investor? As an entrepreneur or a capital seeker, how do you get in front of the investor directly? If you don’t have a strategy, it’s like shooting an elephant with a BB gun.

What you need to do is develop a strategy. You need to be able to package and provide your deal criteria and capital requirements, convey those to a targeted audience of capital providers, and one of the ways that you can do that really efficiently now is through a capital network website. The Capital Match Point is a perfect example.

One of the benefits in going that route is that you’ve got a captive audience of investors that are professional investors. They are interested in your industry, your stage of business where ever it might be: start-up, early stage, later stage and they’ve got the capital level that you’re looking for.

12. Should I Seek the Assistance of Professionals when Raising Capital?

I'm often asked, should I go it alone when it comes to funding, or should I seek the assistance of a professional? I think the best way to answer that is ask yourself a couple of questions. I've got four in particular that you need to keep in mind.

First of all, do you have limited contacts? You're probably great at the business that you are engaged in, but you do not want to call your friend

24

the lawyer, or your buddy the accountant, and see who they know who raises money for your company.

Number two, you are probably strapped for time if you're running a business, and let's face it, time is a precious resource, treat it like one.

Number three, you've got to ask yourself, do you have the experience? If you haven't been down the road of funding a company before while running it, you probably want to seek the advice of a pro.

Lastly, you want to keep in mind this one, raising capital is a two headed monster. You've got to ask yourself the question, am I capable of running this company effectively and efficiently while raising capital? I typically recommend help... the right help. Get back to the business of running your business!

13. Which is Best: Debt or Equity Funding?

I get this question a lot, which is right for our company, debt or equity? There are two really distinct types of financing and you need to understand the benefits and the implications of each.

Debt is an infusion of capital into your company. The expectation is that there will be a periodic re-payment, in the form of principal plus interest. The end result is the ROI for our investor, or the return on investment.

25

A good example of debt funding would be loans or bonds. There are some pluses and minuses. The biggest one for debt is that you don’t have to give up ownership. The down side is you must have sufficient and reliable cash flows and collateral to back it. It is really not a good option for most new companies.

Let’s take a look at equity. Equity is an infusion of capital in exchange for stock representing ownership in the company. Common examples would be: a common stock, a preferred stock, warrants, which are the right to buy the stock at a future date at a given price. The positives here are you have an infusion of cash and no debt service attached to it. The downside is this really is a high price, or high cost of financing. You may ask the question, well why is that? Equity investors take on a high degree of risk, and their expectations are for a higher ROI.

14. When Seeking Capital, How Much Money Should Be Raised?

I think it's instructive to try and get in the investor's head and find out how much an entrepreneur really needs to raise, and I want to talk about the actual amount of capital that's considered being raised and what our investors really look for.

First of all, the amount of money being raised is a pretty good indicator of how much the entrepreneur thinks the company is really worth. The thing I find most interesting is how the company arrived at that number. What our funding sources want to know is where they're going to spend the money. Can they do it for less? What would they do if they had more money?

26

Secondly, the question is, “How much money should be raised?” The right amount of money to bring into a company is enough to reach sufficient milestones, if they raise more money to a higher price at a future date. If all goes well, the money invested will be used to drive all sorts of risks out of the business. Will it be used to take the company to cash flow positive? Will it be used to pay down debt? If they don't know exactly what they're capital needs are or they raise too much money early on, they could be selling off too much of the company for too little capital.

Third, if too little money is raised, the company may run out before the business is proven enough sufficiently to raise additional capital. In other words, raising too little money can be fatal.

Fourth, companies should leverage early stage venture money to drive up the value of the company, so the next time the company fundraises they'll be able to bring in larger amounts of money while suffering smaller amounts of dilution, which is very important for management teams.

Unfortunately, the perfect amount of money to be raised is not always obvious, and the question of why is the company raising the amount of money it's raising is really important.

27

PART II Practical Advice…Putting it All Together

15. What Not to Tell the Investors When Seeking Capital Funding

When in front of a potential investor, the question is, how does an entrepreneur establish credibility?

What the capital seekers say to our investors may make or break their funding. I think the easiest way to understand of what to tell these people is really what not to tell them. With over 30 years of hearing these phrases or some semblance of them have driven me and capital providers to see caution flags that instantly appear. Keep these phrases out of the conversation!

Don't tell me our projections are conservative. Entrepreneur projections are never conservative. If they were, they'd be zero. Or, "the market will be $50-billion in 2010." The magnitude is just not logical in this economic environment.

Here's another nugget we hear. "HugeCo is going to sign our purchase order next week." This line is trying to show the capital provider there is some attraction beneath their heel. Ultimately, nine times out of ten, the purchase order won't be signed until the next week or the week after or the next year if ever.

Employees. That's a favorite turn-off. "Key employees are set to join us as soon as we get funded." Well, my question is, why would an executive leave a $250,000 a year job to join a start up? That's not going to happen in this economy.

28

Here's another one to close the door behind you quickly. "No one else is doing what we're doing." Either there isn't a market or you're incapable of finding your competition on the web. Or, "We have a proven management team." Just because your bio says you have a proven team means nothing to us. Surround yourself with reputable directors and advisors and step aside when necessary.

"Patents make our product defensible." Mentioning patents should be talked about one time in the presentation and that's it. Saying you have a deed filed for patents for what you're doing is enough. Filing back up patents is a defense of a hole through your presentation.

And the best of the best is, "Hurry, because several other funding sources are interested." Creating a sense of scarcity is simply stupid. There are very few people who actually have multiple firms chasing them in this economic climate.

16. What TO Tell the Investor When Seeking Funding

You know what not to tell the investor…so let’s talk about what you tell them to get that much closer to the “holy grail” of a solid funding. At the Capital Match PointTM, we've distilled our best advice in what we call the winning pitch. There are ten components to this, and I'll go through each one of them.

29

#1 Target the pitch. The Capital MatchPointTM actually takes the guess work out of that equation because the person who has interest is the person who talks to the capital seeker.

#2 This is simple: be on time. Or better yet, be early. Capital sources usually have a hard stop. They only have so much time for anybody.

#3 Don't overwhelm the money provider. The goal at the first meeting is not to get all the money at the first time. Don't try to cram six or seven meetings into one meeting. Pique their curiosity but don't abuse their attention span.

#4 Know your audience. Try and find out in advance who is going to be at the meeting and spend some time learning about them at their site and find out who's actually going to be in that room when you're there.

#5 Get to the point fast, and I mean really fast. Funding sources sit through presentation after presentation. That's their livelihood. So, it's easy for them to lose interest if a presentation doesn't get to that point quickly. Here's a little bit secret sauce. To get their attention, answer this: what problem is my company solving? Tell them up front. They'll listen. Trust me, they'll listen.

#6 Use analogies. Use bold ideas to present new concepts. Draw an analogy from an unrelated product. For instance: Facebook for the Rich. podcasting for cell phones, or eBay meets CNN.

#7 Power Points. Over kill or under fill? How many slides to get the message out? My answer is the baker's dozen. Five minutes per slide makes the case. By the way, don't read it to them. They can read it for themselves. Tell them your story.

#8 Know what you don't know and admit it. This is very critical. Our investors don't expect entrepreneurs to know everything. Be upfront about

30

it if you make a mistake. If you don't know the answer, do three things. One, admit it. Two, make a note of that question and after the meeting, follow up, find out, and get back to that person. Do not, and I repeat, do not fake it with an evasive, oblique, or indirect attempt at an answer. Our investors want to know that they can trust the entrepreneur.

#9 Competition. Know who they are and what not to tell the capital provider. What not to tell them. Don't ever say the dreaded words, "We have no competition." That's a death warrant. Capital providers know that it's rare for any company to have no competition whatsoever. They'll know that you haven't done enough homework on your deal, and the company is going to be sort of lacking, and it's probably not worth backing either.

#10 Control the meeting. Don't spend too much time on a particular point or line of questioning. Politely but firmly move on, follow up, and set a meeting to satisfy their concerns.

17. Investors Perception of Your Management Team When Seeking Capital Funding

We've been talking about entrepreneurs so far and what their needs and realities are, and what I'd like to do is talk a little bit about the other side: investors and what their perception is, particularly when it relates to management teams, and how important is the management team? That's a great question, and if you think investors only invest in great deals and leave everything else on the sidelines, well, think again.

31

The management team is probably one of the most important components of the deal. The team is going to figure very prominently in any investor’s decision to fund the company especially if the track record is thin. The history of the management team may be the only solid, understandable piece of information available to the potential investor.

Businesses must be able to succeed in the face of a lot of different challenges and rapidly changing conditions. Experience gives the potential investor comfort that the management team can spot issues and challenges and are flexible and skilled enough to deal with those as things develop.

Integrity and commitment are also a part of that. Investors want to see a high level of work ethic on the part of management and certainly to see that they have enough skin in the game.

Charisma in a management team is great, but too much can get in the way. Our investors want key players to have egos that are big enough to get the job done but not so big that the individual can't be a team player and can't accept advice, and this is a real sticky point with a lot of smaller companies. If our investors suspect that management is too arrogant or egocentric to accept advice, the prospects of the investment being made are going to be very minimal.

32

18. Know the Investor When Seeking Capital Funding

So, the investor has just dragged you through the due diligence knothole. What about the veracity of the investment team? When a company needs our investors, we want them to be ready. You might say, "For what?" Do your homework on them just as they do homework on you.

Due diligence really is a two way street. If you only think it's a one way street when you talk to a capital provider, I'd like you to examine how you can evaluate the funding source themselves. At the same time your business plan is under a microscope, you should be assessing the prospective funding source's strengths and weaknesses. Consider the following questions:

How well does the firm know your industry?

How often does it work with companies that are in a development stage similar to yours?

What assistance can the investor bring to you in terms of management expertise, industry contacts, or support services?

What's the reputation of the firm in the investment community? I

If the firm is going to serve as the lead investor, then how effective will they be in helping to attract additional co-investors?

Has the firm asked for any special reward or compensation for serving as a lead investor?

What effect this will have on the willingness of other co-investors to participate?

33

Will this firm be able to participate in later rounds of financing if the company continues to grow and needs additional capital?

To answer these questions, you speak with the owners and managers of other companies in the investor's portfolio. Determine their level of support, conflict, communication. Be sure you talk to both successful and unsuccessful portfolio companies.

Remember, this is not a “me against the world” scenario. You deserve to know who you're getting involved with too.

19. Negotiations with Investors when Seeking Capital Funding

So, you found an investor that is willing to hear what your company can do and how it will make everyone rich beyond their wildest dreams.

Let's talk about actually structuring and negotiating the deal. The fun really is just starting. Now comes the negotiating and the harrowing process of really doing the deal and making everyone happy. The need to strike a balance between investment and investment acceptance is critical. Keep a few things in mind as we go down this path. The company's concerns and the investor's concerns that really need to be pointed out here.

As far as the company is concerned there's going to be loss of management control, dilution of personal stock, repurchase of personal stock in the event of employment termination. How about adequate financing? Security interests being taken, key assets of the company.

34

What of future capital requirements and dilution of the founder's ownership? And intangible and tangible indirect benefits of our investor's participation, such as access to key industry contacts and future rounds of capital?

Our investors' main concerns…let's talk about some of theirs. Their level of risk. projected levels on return of investment. Liquidity. Protection of the firm's ability to participate in future rounds of funding. Influence and control over management strategy and decision making. Registration rights in the event of a public offering and rights to first refusal to provide future financing. For both parties, how about retention of key members of the management team? A resolution of conflicts, financial strength of the company post investment, and certainly tax ramifications of the proposed investment.

Negotiations have to have ample time to be studied. Legal advice is first and foremost, and I beg you to get great quality securities attorney's working for you. Don't be foolish and try to negotiate this alone. Legal fees are meant to be spent here where it counts for the future of the company.

These considerations can be overwhelming and you may think the deal will never get closed…it will, so be prepared to answer these and have a very good understanding of the terminology and the motivations as you progress.

35

20. What Does It Mean If You Are Turned Down When Seeking Capital Funding?

When a capital source really says no, what does that mean? Let's learn something from this. I tell the entrepreneur, you've had a number of face to face meetings with funding sources, and they turned the deal down, and that's tough. Let's debrief a little bit about what's happened and what they probably told you.

Let me give you an insider’s look and decipher what they've said to the entrepreneur when he gets turned down. Hey, we've all been turned down by financing before, and I think it's instructive to know, but more valuable as a learning tool when these standard push backs occur. They're telling you something, so let's be prepared. I think it's time to read the lines between the standard phrases they get back to you on.

They say, "I liked your company, but my partners didn't." In other words, no. if this person truly believed in the project, he'd vouch for you and get this thing going.

If they say, "If you get funding or a lead investor, we'll follow." And what that really means is, once your first round of financing is completed by someone else, we'd be happy to give you more, but let someone else take the risk.

They say, "Show us some more traction, and we'll invest." What that really means is, “I don't want to say no, because you may land a large customer in the interim. But right now, I just don't believe in it.”

36

They say, "We'd love to co-invest with other VC's or other angels." What it really means is, if your deal was worthy of a VC, they'd want it all for themselves.

When they say, "We love early stage investing." What that probably means is a VC's dream is to put one to two million dollars in a pre-money company and winding up owning 33% of the next Google. VC's aren't that risky. They only want to invest in proven teams with proven technology in a proven market.

So, there you have it. We've heard it all before. These are typical responses when they say no. So, be prepared to hear any of these and take it with a grain of salt.

There's always an investor to fund any deal. We just don't want a capital seeker to shut down after the first one or two turn downs. We can help re-purpose the deal and adjust it and turn that "no" into a "yes."

PART III The Financials: Make or Break Time

21. Business Plans and Pro-Forma Financial Statements Let’s start off this vital part of any capital formation strategy and talk about the building block of your company, its telltale value and how well the company is doing…by its financials.

37

Entrepreneurs seeking funding and preparing business plans frequently ask me to explain the concept of pro forma financial statements. It’s a very important concept and is a critical part of any business plan. Pro-forma financial statements put your vision for your company into language private investors to understand: dollars and cents. Pro-forma, in this context, is another word for forward looking. Therefore, pro-forma financials state the financial results that your business plan is expected to generate. This includes a complete set of financial statements which are a balance sheet, income statement and statement of cash flow, and looks out three to five years. Generally speaking, the first year, when assumptions are more clearly defined, financials are expressed on a monthly basis and the remaining years on a quarterly basis. Making assumptions about your business and market place is perhaps the most important part of assembling pro-forma financials. Investors generally give more credibility to “bottoms up” assumptions as opposed to “tops down”. An example of a “tops down” assumption is estimating a market size at say $200 million and assuming that your company will get 5% market share for annual sales of $10 million. A more credible “bottoms up” approach would be to assume that you will initially hire five sales people who will each realistically call on two clients per day, close 30% and make annual sales, on average, of $2 million for a total of $10 million in annual revenue. Macroeconomic assumptions are also a very important element in assembling pro forma financial statements. When seeking funding the entrepreneur must demonstrate a firm grasp of how the larger economic environment will impact their business. For instance, is your business sensitive to changes in energy prices? If so, then what are your assumptions about the coming months and years? Will your business be impacted by changes in the housing market? If so, then what do you think about the near to intermediate term housing market? When analyzing your business plan investors will realize that your pro-forma financial statements are based on assumptions and will discount accordingly. However, it is important to show potential investors that you have given careful consideration to the real forces that drive your business. The confidence you inspire will go a long way in establishing credibility.

38

22. Complete Set of Financial Statements Let’s talk briefly about financial statements in general. Financial statements express your company in the language investors speak, dollars and cents. A complete set of financial statements consists of three individual statements necessary to give an investor a comprehensive picture of your company from a financial perspective. Specifically these statements are a Balance Sheet, Income Statement and Statement of Cash Flow. The Balance Sheet is a snapshot of your company’s financial position at a given point in time. It is expressed in terms of assets such as cash, receivables and physical items owned by the company, liabilities, or money owed by the company against those assets and stockholder’s equity which represents the initial investment by owners and any past profits that have been retained in the business. The Income Statement measures the success of your company’s operation over a period of time by comparing revenue, money generated from the sale of goods or services, with the expenses associated with providing those goods and services. The difference between the two is called net income, earnings or profit. The ability to consistently generate profit is the ultimate indicator of your company’s viability. The Statement of Cash Flow describes the changes in the cash your company has on hand over a given period of time. It is simply a comparison of actual disbursements and actual receipts. This is of particular interest to investors, especially in start-up and early stage companies, as they wish to see if companies have sufficient receipts of cash to support continued operation and plans for growth.

39

Financial statements can be compiled on a historical basis to give a view of your companies past performance or on a pro-forma, or forward looking basis, to give a financial picture of where you want to take your company. Investors are generally interested in seeing both. Prepare to speak the investor’s language, if you’re not strong in this part of your game, bring in the professional and don’t try to go it alone. 23. Debt Financing vs. Equity Financing…Which is Best for Us? A common question is, “What type of capital structure is best for my company?” The answer to that question is individually dependent upon your company, its stage of development and its needs. In the broadest sense there a two types of financing, debt financing and equity financing. Let’s take just a minute to consider the broad implications of both. Debt financing is the infusion of capital by an investor in exchange for an agreement or repayment and interest over a specified period of time. Debt is usually backed by collateral and subject to other restrictions the investor may impose to secure their position. Common examples of debt capital are loans and the issuance of bonds. Debt may be an attractive means of securing capital for your company because you are not required to give up equity in exchange for the infusion. However, carrying debt on your balance sheet requires that you have sufficient cash flow to make periodic interest payments, projected resources to pay off principal at the time of maturity and collateral necessary for securitization. Debt financing is many times not an option for early stage companies because of lack of positive cash flow. An exception could be debt put in place alongside owner’s cash for the purchase price of hard assets, such as plant equipment or real estate, that’s liquidation price would be sufficient to cover the amount of the loan Equity financing is the infusion of capital by an investor in exchange for stock in the company. Equity issued to investors in exchange for cash can

40

take many forms such as common stock, preferred stock or warrants. Common equity investments are those made by venture capital funds, angel funds and hedge funds. Whatever the agreement structure, equity investors expect a return in the form of dividends and appreciated stock value at the time of a company sale or public offering. Equity financing may be attractive because it allows for an infusion of capital into your company without the immediate cash obligations associated with debt service. Additionally, bringing in equity investors means that you’re bringing in new owners and possibly new board members which may a change in the corporate culture. Many times these new owners are experienced businesspeople in their own right and can offer management valuable insight and perspective as your company grows and changes. While equity financing does not make significant demands on cash flow, except when dividends are paid, it can come at a high price. Equity investors take on a lot of risk when investing in your company at an early state but generally reap handsome returns on their investment at the time of company sale or public offerings. 24. Income Statement and Investor’s Interpretation Let’s take a minute to talk about your company’s income statement. The income statement, by determining profit, measures the success of your company’s operation over a given period of time. Plainly put, the ability to consistently generate profits is the ultimate indicator of your company’s viability. The income statement is divided into two sections, revenue, the money generated from the sale of goods and services, and expenses, the money it costs you to generate those goods and services. The dollar difference between these two sections is called net income, earnings or profit.

41

Revenue and expenses are generally divided into sub-categories so that investors can more easily understand how businesses generate revenue and incur expenses. For example, if your company generates revenue by selling products and providing services it is a good idea to show an investor how much revenue comes from each source. Likewise, expenses are generally incurred in two ways, those directly associated with providing goods or services such as raw materials or labor, generally referred to as direct costs, and those associated with supporting operations such as rent and management salaries, typically referred to as indirect costs. The sum of all direct costs is referred to as cost of goods sold, sometimes called COGS for short. The sum of all indirect costs is typically referred to as overhead. An investor will want to see your income statement broken down into the appropriate revenue and cost categories so that they can determine your gross margin, revenue less cost of goods sold, and understand how much of that is required to support overhead before delivering a return in the form of profit. 25. Cost Categories – Cost of Goods Sold (COGS) and

Overhead

Let’s take a few minutes to discuss two major cost categories from the perspective of an income statement, cost of goods sold, sometimes called COGS, and overhead. When an investor is reviewing your historical and pro-forma income statements they will want to understand which costs are necessary to provide the product or service you sell and which cost support your business from an administrative standpoint. Cost of goods sold, many times called COGS for short, is the sum of all costs directly associated with the product or service your company provides. This could be items such as raw materials and labor for a manufacturer, the cost of inventory for a retailer or cost of delivering web based services for a technology company. Cost of goods sold is important to an investor because subtracting this number from revenue allows them to determine how much raw value, if you will, your product

42

creates (called gross margin) and how much your company can afford to spend on overhead and still generate an acceptable return. Overhead, sometimes called indirect costs, is the sum of all costs of doing business not directly associated with providing the goods and services your company sells. This could range from accounting costs to legal costs to insurance to rent to salaries for management. It is important for an investor to understand overhead so that they can determine how much cost can be curtailed in times of slumping sales or falling prices without compromising the base function of delivering goods and services. A detailed understanding of cost is important for investor and manager alike so that your business can perform most efficiently and maximize return by continually eliminating excesses. 26. Gross Margin Gross margin is actually a very important financial metric derived from the income statement. Conceptually, gross margin is the amount of money your company would make if it only incurred costs directly associated with making and selling the product in absence of the cost of all overhead, such as rent, insurance, professional fees and management salaries that are required to support your business. Gross margin is calculated by taking revenue and subtracting those costs directly associated with making and selling the product, cumulatively known as cost of goods sold. The resulting number, gross margin, is the amount of money your company has left over to cover overhead and generate a return for private investors. This is important to investors because it helps them to ascertain your company’s ability to continue to generate a return in the event that sales are less than expected or overhead costs are higher than expected. Therefore, the answer is yes, you should clearly highlight gross margin in the financial portion of your business plan. This will show a sophisticated

43

venture capitalist, angel or other investor that you have a detailed understanding of your company’s cost behavior. 27. Balance Sheet and Investors Interpretation One question that frequently arises among entrepreneurs when seeking capital for their business is “how will investors interpret the financial statements that I provide in my business plan?” It’s a good question and something every entrepreneur should understand when dealing with investors, whether they be angels, venture capital, hedge funds private investors or any other source of funds. Let’s talk briefly about the balance sheet. The balance sheet is a snapshot, if you will, of your company’s financial position at a given point in time. It is expressed in terms of assets such as cash, receivables and physical items owned by the company, liabilities, or money owed by the company against those assets and stockholder’s equity which represents the initial investment by owners and any past profits that have been retained in the business. The balance sheet is aptly named because the assets of must equal the sum total of liabilities and stockholders’ equity. Said another way, a company’s assets less its liabilities is the stockholder’s equity in the company. Obviously, this is a very important indicator a company’s overall value to an investor. An investor that is considering funding your company will look to the balance sheet to get an indication of your company’s financial strength. The investor will look at assets to see what your company owns. Large amounts of cash and marketable securities, sometimes called liquid assets or current assets, are attractive as they give a positive indication of the ability to meet near term obligations. Other assets such as intellectual property and brand names could also be attractive because the potential to monetize those assets is sometimes substantially more than the value reflected on the balance sheet. Large amounts of goodwill, or the amount

44

you may have paid for your company above its book value, relative to total assets could be a red flag due to its intangibility and illiquid nature. A view of your company’s liabilities gives an investor a picture of leverage, the amount of debt your company is carrying relative to your company’s net worth. In other words, if the company were forced to liquidate could it pay all of its bills and have something left over for them? A close examination of your company’s liabilities will also give the investor an indication of how much cash will be required to meet near term obligations and, by comparing to assets, your company’s ability to meet those obligations. In addition to telling a potential investor how much equity the owners have in your company the stockholder’s equity section of your balance sheet will also give an investor insight as to how much money has already been injected into your company, the number of outstanding shares in your company’s stock and your company’s use of earnings. The line entitled additional paid in capital and shares outstanding lines plainly tell an investor how much capital has been put into your company and how much stock you had to issue in return for this capital. The retained earnings line will tell an investor how much of past earnings you have retained in the company. A historical analysis of the retained earnings account will also give an investor hints regarding dividends. 28. Statement of Cash Flow and Investors Interpretation The statement of cash flow describes the changes in the cash your company has on hand over a given period of time. It is simply a comparison of actual disbursements and actual receipts. This is of particular interest to investors, especially in start-up and early stage companies, as they wish to see if companies have sufficient receipts of cash to support continued operation and plans for growth.

45

The statement of cash flow has three sub-sections, cash generated or consumed by operating activities, cash generated or consumed by investing activities and cash generated or consumed by financing activities. The operating activities portion of the statement of cash flows converts net income from an accrual basis of accounting to a cash basis. For example, depreciation and amortization are recognized as expenses on the income statement but they do not require cash payments. Therefore, these charges are added back to net income for the purposes of calculating cash flow. If your company makes sales to customers on credit you recognize this as revenue on the income statement. However, you do not recognize that sale on the statement of cash flows until the payment is actually received. Likewise, when you purchase materials from vendors on credit you do not recognize that purchase on the statement of cash flows until you pay the bill. The investing activities portion of the reports the disbursement or receipts of cash for purchasing or selling long term investments and property and equipment. The financing portion of the statement of cash flow reports money received in exchange for stock in your company, money spent in re-purchasing stock in your company and money disbursed in the form of dividends. While the income statement is the measure of your company’s operational success and the ultimate arbiter of viability, it can sometimes be misleading, depending on accounting policies and the timing of certain activities. The statement of cash flow leaves less room for gray areas by summarizing the flow, in and out, of something that is easy to understand, cold hard cash. It gives a very clear picture of your company’s ability to meet obligations and sustain operations. That’s why investors depend so heavily on the statement of cash flow as a companion to the income statement.

46

29. EBITDA – What does it mean? Why is it important? I can’t tell you the number of times I’ve been asked “what is EBITDA?” The next question is almost invariably “why is it so important?” When talking with potential investors, entrepreneurs quickly become familiar with the term, even if they’ve never heard it before. EBITDA is actually an acronym for Earnings Before Interest, Taxes, Depreciation and Amortization. Among investors, it is the measure of choice of a company’s ability to generate earnings. Why, you may ask? Are interest, taxes, depreciation and amortization not legitimate expenses? Indeed, they are legitimate expenses. And, before you say it, yes interest and taxes are uses of cash. However, interest, taxes, depreciation and amortization are structural expenses, not operational expenses. When an angel fund or venture capital fund, or any investor for that matter, is considering a large infusion of capital into your company they are assuming that there will be structural changes that will impact items such as the tax structure and debt profile. Therefore, an investor is more interested in your company from the standpoint of its ability to generate earnings from operations. This, in turn, allows an investor to make an “apples-to-apples” comparison of companies in which they are considering for investment. EBITDA is also a widely used measure by investors when valuing companies. Many times a company’s valuation is a multiple of its EBITDA . EBITDA is also a good internal metric for companies when evaluating the performance of operational personnel because it expresses company performance within the limits of these employees’ control. Although it may be tempting, it is important, however, not to use EBITDA as a short-cut to measuring operational cash flow. Remember, it still an income statement and, as a result, subject to the interpretation of accounting rules and policies.

47

30. Burn Rate A frequent topic: “What is my burn rate?” Investors frequently talk about potential target companies in terms of their burn rate. When funding start-up companies, investors try and determine the potential target’s burn rate. Burn rate is the rate at which a company will use its capital to finance operations before generating positive cash flow. It is usually expressed on a monthly or quarterly basis and is a measure of how fast a company will use up its cash. For example, a company with a burn rate of $1 million per month will exhaust $12 million in capital in one year, obviously. Burn rate is synonymous with negative cash flow. This is of importance to investors because it helps them to determine if a company will sufficiently capitalized with their investment and how long their investment allows the company to operate before becoming cash flow positive. If an investor feels that their capital infusion is not enough to sustain operations for a long enough period, they will naturally assume that your company will require more financing in the future. When burn rate is more than anticipated or sales are less than anticipated, companies usually respond by reducing burn rate, which generally means cutting expenses associated with overhead. Accordingly, investors will look at your company from the standpoint of being able to reduce burn rate in the event that actual performance does not meet expectations. For early stage companies cash is king. Managing cash is one of the most important duties of an entrepreneur. Cash required for growing sales usually precede the receipts of cash from those sales. The lack of cash diverts management attention away from running the business and can disrupt operations as bills become more difficult to pay. Therefore, the sophisticated investor will take a very close look at a company’s burn rate, the underlying assumptions and the ability to reduce burn in the event of sluggish sales.

48

31. Ratio Analysis of Financial Information Entrepreneurs seeking capital from investors frequently find that the financial projections they provide are broken down and analyzed using ratios. Every investor has their own idea of what is important and what ratios best reflect that aspect of performance. Many times the task of keeping up with these and understanding them proves tedious and time consuming for an entrepreneur that has a business to run. I advise entrepreneurs faced with sorting out this type of information to think of ratios in five broad categories. First of all there is profitability ratios. This category includes ratios such as return on equity, return on assets, earnings per share, return on sales and, In short these ratios express net income in terms of a percentage when divided by a chosen return criteria. Next there are solvency ratios. These help an investor determine the ability of your company to meet near term financial obligations. The most popular solvency ratio is called the quick ratio which is the sum total of your cash, marketable securities and accounts receivable (from your balance sheet) divided by current liabilities (also from your balance sheet and typically defined as obligations due within 30 days). Activity ratios give investors a sense as to how fast assets turnover within your company. This also gives important insight into cash flow. For example, receivables turnover (credit sales divided by average accounts receivable) calculates the rate at which receivables are collected. A higher number indicates that you are collecting receivables more quickly and are hence bringing cash into the company more frequently. Likewise inventory turnover (COGS divided by average inventory) give an investor a sense of how efficiently inventory is being managed. A high inventory turnover means that product is being sold much sooner after hitting the warehouse and hence turning into cash more quickly than a product that lags in inventory before being sold. Capitalization ratios such as financial leverage (Return on Investment – Return on Assets) and debt to equity gives investor a sense of importance of debt and equity in your company’s capital structure.

49

Market ratios are very important to investors as they will ultimately play a part in the value an investor places on your company and the amount of stock they will require in exchange for investment. Two very important market ratios that companies seeking capital should understand are price to earnings and return on investment 32. Price to Earnings Ratio Price to earnings is the ratio of it a company’s stock price to its after tax earnings per share of stock outstanding for the most recently reported twelve months. For example, if Company A’s stock price is $20, its earnings for the most recently reported twelve month period is $2 million and there are one million shares of stock outstanding then Company A’s price to earnings ratio is 10, $20 divided by $2 earnings per share. Price to earnings ratio of publicly traded companies in similar industries as yours is important to investors because it will give the investment a sense of what your company will be worth when sales and earnings are at a sufficient level for exit via sale or public offering. Once the investor is comfortable with this, he or she can consider how long they believe it will take your company to achieve sales and earnings necessary to support a profitable sale or public offering, compare against their required return on investment and arrive at a number of shares in your company that they will require in exchange for funding.

50

33. Return on Investment Do you know what is most likely of chief concern for any investor when looking to fund a company? It’s their return on investment, also called ROI for short. ROI is the return an investor receives on the money that they invest in a company. It is expressed as a compound annual rate in terms of a percentage. By knowing what ROI they require for a particular investment the investor can then take a company’s business plan and financials, make projections about a company’s growth and profitability and future valuation to determine how much stock they will need in a company in order to achieve their ROI objective. Different investors have different requirements. But according to Clint Richardson, in his book entitled Growth Company Guide 4.0, that in times of an economy supporting prime interest rates of 10% or lower investors generally require greater than 35% ROI for seed or start-up investment, 20-50% for first or second stage and 15-30% for third stage and mezzanine investment. The amount of time an investor feels it will take to exit via sale or public offering will also factor into how much stock they will require in exchange for investment. For example, an investor who gets three times their investment in three years will realize an ROI of approximately 44% while the same multiple in five years will reduce ROI to 25%. So, the investor in this case will require significantly less stock in exchange for capital if he or she feels an exit can be achieved in three years as opposed to five.

51

34. Valuation and Pricing A question that I always ask an entrepreneur is, “What do you think your company is worth?” The answer usually comes back very vague or maybe just simply, “I don’t know.” When seeking capital funding it’s very important to have a fact based, analytical sense of what your company is worth. After all, if you’re seeking equity financing you will be giving up a negotiated portion of your company in exchange for cash. Admittedly, valuation is almost just as much art as science and everyone has their own way of doing it. Also, it’s very dependent on assumptions and how realistic you or an investor believes those assumptions to be. It is also important to remember that an investor is going to be most interested in the value of your company at the time of exit via sale or public offering. You should conduct your analysis similarly. There are several methods of valuing your company. Among them are price to earnings, discounted cash flow, price to sales. When determining the value of your company I recommend that you take all three methods and see if the results are convergent. If they are and the assumptions you made are reasonable and defendable you’re probably on the right track. Let’s talk briefly about the methods we mentioned. Price to earnings (P/E) is a ratio of the value of a company’s stock to its after tax earnings. For instance, if a company’s stock sells for $20 per share and its earnings for the most recent year is $2 per share then the price to earnings ratio 10. In order to value your company using this method you will need to gather market data about the price to earnings ratios of publicly traded companies in your industry and make some assumptions about stock market performance at the time of your planned exit. Price to sales is very similar to price to earnings except that it expresses the value of a company’s stock relative to its sales revenue. Let’s say that

52

our company whose stock price is $20 per share had sales in its most recent year of $20 per share. Its price to sales ratio is one. Like price to earnings, this method will require gathering market data about the price to sales ratios of publicly traded companies in your industry and make some assumptions about stock market performance at the time of your planned exit. The discounted cash flow approach is different to price to earnings and price to sales in that it does not estimate company value by comparison with publicly traded companies. This method measures the cash flows at various points in the future and discounts them to the present and then sums them to arrive at a valuation. 35. Investor Considerations When Valuing Your Company The question that is probably at the top of the list for every entrepreneur seeking funding is this: “How much of my company will I have to give up to get my desired level of funding?” The unfortunate answer is, “It depends.” Investors consider many different factors and each investor knows what is important to them and what is not. That said there are some general questions that investors ask themselves when considering funding. Some examples are:

How attainable are the goals set forth in the company’s business plan? Sophisticated investors are sophisticated analysts. If they think there are items in your business plan that are unrealistic, they will normalize them to something they’re more comfortable with.

When will the company be able to go public or secure a buyer at an attractive price? The longer an investor has to wait for exit, or

53

What will the appetite be like for IPOs when the company is ready to go public? A bullish stock market will support IPOs at higher price to earnings ratios thereby raising the value of your company and reducing the amount of equity an investor will require in return for their funding.

Will the company need more money before exit?

How much does key management have invested in the company? If management has a significant amount of their own money in the company the investor will assume that management is committed to success.

How much of the initial investment will we get back if the company fails?

How will my investment be structured? I f an investor puts all of their money into stock as opposed to a less risky instrument, then the price of investment will go up.

Once investors answer questions such as these, they will then begin to make adjustments to your business plan and consider their risk accordingly. It’s all about managing their risk and you need to be realistic in the actual value of your company to attract the real investors to fund your deal before they’ll get excited enough to move.

54

36. Considerations When Negotiating with Investors If you’re an entrepreneur seeking funding for your company and you’ve gotten to the point of receiving a funding proposal from an investor, congratulations. Now that you’ve got it you may be asking yourself, “How do I analyze the proposal and negotiate?” The most powerful negotiating tool is other investment proposals. Outside of this there are other valid points for discussion that may lower the price of investment (the amount of stock you give up for a given amount of investment money). They generally center around and investors’ assumption versus your assumptions. You may want to consider:

The return on investment the investor expects – Is this realistic and in line with rate generally accepted in your industry

What is the investor’s valuation of your company at the time of exit? How does this compare with your valuation? It’s safe to assume that your valuation will be higher. But is it higher by a few percentage points or a factor of ten?

What did the investor use as a price to earnings ratio? Did the investor choose the low end in a down market? Does the investor believe that the market will be down at the time of exit?

When did the investor assume the company will be acquired or go public? Are these in lines with your expectations? Again, the investors assumption will be more conservative than yours but is it overly conservative?

Get a feel for the investor’s perception of downside risk and why they feel this way. Is there something of which you are aware but the investor is not that may reduce this risk?

Obviously, to ask these questions and engage the investor in a reasonable and thoughtful dialog management must have conducted their own

55

thorough analysis up front and have defendable arguments of their own. Doing this will produce a more compelling offering and just may attract multiple investment proposals and give your company the most powerful negotiating tool of all, another offer. 37. Financial Statements That Will Stand up to Investor

Scrutiny Past experience in helping entrepreneurs prepare financial statements for business plans has taught me that one of the most important factors in getting an investor’s attention is the perceived credibility of your financials. To make sure you pass this “litmus test” consider the following when compiling your financial information for the fund raising process.

1. Have a complete set of financials – This includes the balance sheet, income statement and statement of cash flow. The composite view of these three statements will give an investor important insight into your company. A missing piece will leave some gaping holes and call matters into question that might otherwise not be an issue.

2. Look forward three years – The first year, when assumptions are more clear, should be expressed monthly. Years two and three should be expressed quarterly.

3. Include historical financials – Try and go back at least one year. This may be a stretch for a very early stage company but the effort should be made to get credible information as far back as you can. This will allow the investor to make a fluid transition from your company’s past performance to that you expect. This also a good check for you before submitting your financials to investors. Ask

56

4. Make sure your financials and your business plan “hang together”. For example, if your business plan shows moderate sales growth and calls for the addition of labor but your financials show exponentially increasing revenue and no increases in cost the investor will immediately raise a red flag.

5. Dot your i’s and cross your t’s. – Remember, Investors look at a lot of business plans and have very little time to allocate to any individual plan. That’s why it is important that the little things are buttoned up. For instance, assets must equal the sum of liabilities and stockholder’s equity on your balance sheet, the income statement must be categorized correctly with a clear differentiation between cost of goods sold and overhead and the cash balances on the statement of cash flow must match those reported on the balance sheet. If an investor detects errors such as these they will, at very best, assume a lack of attention to detail and probably move on to the next plan.

Compiling financials that will stand up to investor scrutiny is no easy task. It requires a lot of thought and attention but it’s worth the time an effort. Remember, your financials put your vision for your business into the language investors understand, dollars and cents.

57

38. Term Sheets A term sheet is a document written early on between the entrepreneur and funding source such as venture capital firm or angel investor. The term sheet is much like a letter of intent, in that it is pre-cursor to due diligence but with more detailed information about terms of financing and rights and privileges. Term sheets are non-binding except for confidentiality and exclusivity in negotiation. Nevertheless, the term sheet is complex and should be negotiated vigorously before signing as it is difficult to materially change during the construction and negotiation of the final agreement. The structure of capital transactions such as those that involve venture or angel capital are less dependent on boiler plate stipulations and more reflective of the needs and preferences of the parties involved. Many legal and financial vehicles can be employed to balance the needs of both parties’ individual and mutual concerns. You should consult your attorney to get guidance on which suits you best. However, we can offer some food for thought when considering a term sheet. Your personal needs:

Capital

Maintain Control of Company

Dilution of personal stock

Stock re-purchase in the event of retirement or termination as manager

Operational support and guidance that investor can offer

Investor needs: Return on Investment

Risk

Liquidity

58

Your company’s valuation at exit

Rights in the event of an IPO

Level of participation in management of company

Rights in future rounds of financing

Opportunity to provide future rounds of financing

Mutual Needs: Retention of key management

Forum for conflict resolution among investors

Health of post investment company

Tax consequences of investment

Summary As you can see, there is a tremendous amount of work in getting your idea off of the ground, running it, staffing it, selling it and in general, making it a labor of love. Capitalizing it with the professional investor is typically the culmination of your hard work and after all you’ve been through, you’ll need to go the extra mile and really put your proposition into the proper context. Use the professional marketplace…they have the experience to guide you and to make sure you’re “investor ready!” We hope you gleaned some useful “nuggets” from our experiences and we welcome you to call us or email us and let us use our vast resources to mentor you, guide you and ultimately use the Capital MatchPointTM to locate that all important investment capital you seek and richly deserve!

59

Questions? For further information, call us at 770.433.8250

60