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Friday, March 18, 2011

“Show Me the Money”: Is This the Right Business Opportunity?

I have actually spoken to a number of out of work professionals that believed the quickest way to a salary after being let go by the previous employer was to start a company. They defined themselves as entrepreneurs when all they wanted was an income.   The fields being considered were medical, biotechnology, or technology types of business opportunities.   If you have been keeping up with my posts and you reviewed the article I referred to in the last posting, you should now realize you are NOT LIKELY to receive a salary in the near future when starting a new company (NewCo). 

This series of articles is NOT addressing the creation of businesses like landscaping, local mom & pop restaurant, cleaning service or many other opportunities that are intended to remain small.  These are great businesses for many entrepreneurial individuals.  These business opportunities could transition to national chains and that such an undertaking would be more applicable to this series of articles.  I am addressing a specific type of business that is likely to require significant capital and require you to issue equity or borrow large sums of money via some type of financing.  I am also discussing businesses that can grow to potential valuations well in excess of $100MM.

I referred you to an article written by Martin Zwilling in my last posting.   I want to summarize where what the basic points were in the article and add a few more considerations.

·        Most Startups get no professional investment in the early years

·        Self-funding is a great option IF you can afford  it; do not quit your day job

·        Friends & Family and maybe Angels and high-net-worth individuals are sources possibly of sovereign wealth funds and integrated high-net-worth networks

·        Small business, SBIR, Government, State Grants and/or loans are sources. The military, NIH, and NSF can also be considered.  There are also not-for-profits specific to certain diseases that fund programs as well.

·        Loans or lines-of-credit.  I am usually not in favor of borrowing against your house but people do it.  You can borrow from certain state agencies against your technology in the company; that is OK.

·        Startup Incubators.  Sometimes you can get services for equity in incubators.

·        Angel Investors and VC.  Angels often like to get in very early VCs usually come after the company is better established and better developed.  Be careful, you will start to lose control and could be extensively diluted in ownership.  The dilution can affect your potential financial gains whether you stay or are asked to leave the company.  These are topics that need a full article. 

·        Equity or future revenue streams could be traded for services.  You are trading paper today for promises in the future when you have money or value.  I always like this one!

·        Licensing or Partnering with a BigCo or Vendor.  You are forming a deal which will hopefully be a Win:Win arrangement.  These can come with upfront cash and future payments from the partner, or for services now and promise of future payments.  Again, this is a topic for a full article.

·        Commit to a major customer.  This may be more for technologies which are user oriented but may not fit with medical products for example.

Be creative and vary the approach finding something that works for you and your potential investor or partner.  You may find other ways to get the company off the ground with limited resources. 

In dealing with “Where’s the Money”, it is critical to relate this back to the technology and what the final marketed product will be.  Most professional investors in the medical area are looking for substantial returns because there is significant risk.  The risks are: 1) operational, the company fails to execute well, 2) regulatory, some agency like EPA, FDA, or USDA will not approve your product, 3) commercial, your product does not meet expectations on sales.  Other risks include; 4) IP, is there a “Freedom to Practice”, 5) flawed science, there are other risks associated with many technology related areas as well as with the management team.  The higher the Risk, the more the Reward expected by investors. 

Many VCs seek to gain 5-10 times their investment in as little as 3-5 years!  If you need $15MM, they want $75-$150MM in 3-5 years!  This means your product(s) have to generate potential sales that can make the company appreciate in price for them to capture their desired returns.  A recent example of a biotech company that has achieved success is Dendreon.  The company has appreciated to a value of more than $3BB.  At a conference, I sat by a friend that was also an investor in the company.  It was on the day of the FDA approval.  My friend’s fund had 5MM shares in Dendron.  You should have seen the smile on his face!  That is part of what you strive to do, make money and make your investors happy.  By the way, you own shares and are an investor too.

In the last few years, I reviewed programs seeking funding in the range of $1-5MM in investment.  Two come to mind as examples of what to NOT look for:

·        Company 1 had licensed a technology to create a device.  The device was quite useful in a laboratory and the company wanted to develop and sell the device.  When I asked how many potential USERS there were worldwide, the answer was between 100 & 1000 users.  The company planned to sell the product for around $500.  The product was not a consumable. The potential users would buy one and not need another.  The potential SALES of 1000 x $500 = $50,000 where all the company had as prospects.  Why would anyone ever consider investing a large sum of money for $50K total sales?  This is not a viable business, there is no real market, and the company could not identify alternate uses to make the market larger.

·        Company 2 had a similar problem.  They had a product that would sell for around $500 to a total market of 5,000 for projection of $250,000 at 100% capture.  They had the ability to expand the business to other USERS and had prospects of as much in $5MM per year in annual sales.  This product was a consumable which cost little to make.  Problem is that the development expenses required to create the final marketable product was estimated at $10MM.  Their annual peak year sales were estimated at $5MM for 100% of total market (you never get 100%).  A possible purchase price of the company at peak year sales would be 3-5 x earnings, or 3-5 x sales if they were really lucky; company value tops was $25MM.  The company potential appreciation of value would never reach a level to attract investment. 

You must consider the financial prospects of your product as well as the future value of the company and the time it will take to get to a reasonable level. Also, consider how you can achieve maximal growth with minimal or no funding in early years.  Potential investors are mostly interested in how will make money by investing in your company.  Nearly all investors will ask WHERE’S THE MONEY?  Ask yourself, will I get what I expect as my return?  Remember, you may have worked for extended time and worked hard work with only equity for your efforts.  Your high risk should be rewarded in the end with a large financial payout.  This can only be done if you build a company with high VALUATION potential in the future. You will always be able to look at new investors and say we have the same motivation; WHERE’S THE MONEY.

  Taffy Williams is the author of:  Think Agile:  How Smart Entrepreneurs Adapt in Order to Succeed to via Amazon