How to get in the best state of mind for raising capital

1. Examine your beliefs about asking for money and growing your business.

Chances are you have little voices in your head undermining you and you may not even be consciously aware of it!

Do a brain dump in your journal about all those beliefs and realize that there is very little, if any, truth to them. Once you drag them out into the light of day, you can loosen their grip on you by noticing how ridiculous most of them are!

Make it a regular practice to expose those beliefs that don’t serve you well and debunk them.

2. Notice the positive side of the things that you don’t like about yourself.

Just about every “negative” characteristic has a positive side. For example, if you worry that you are too cautious and don’t jump on opportunities quickly enough, think about all the times that quality has actually helped you avoid mistakes. Reframe the negative description of that trait to focus on the positive. For example, say to yourself, “investors would be very lucky to invest in my company because I am such a careful steward of resources.”

3. Remember that investors find it very challenging to identify good opportunities.

Remind yourself every day that, for the right investors, what you’re offering to them is at least as valuable if not more so than what you’re asking for.

When talking to potential investors, start by asking them a lot of questions about what’s important to them. If it becomes clear that what you are offering is a good fit for what they’re looking for, make your offer.

4. Practice the ask.

There is a way to ask for an investment that establishes a level playing field from the start. Here is an example of what you can say when approaching potential investors:

You know I’ve realized that the business opportunity that I am cultivating is going to have tremendous impact in a number of ways that I think given who I know you are might be of interest to you.

Are you open to having lunch so I could tell you about it?

I realize this may or may not be right for you. If it’s not, no harm no foul – that’s fine. But if you’re open to it I’d love to share it with you.

Once you get the meeting, start by presenting a short statement of your vision. Before getting into all the details, make sure the potential investor sees your vision – why this is important to you and how you want to make a difference with your business.

You can practice this in advance and get feedback from your supporters until you feel confident that the statement is clear, concise, and inspiring.

5. Be willing to say no to the wrong investor.

If your gut tells you that a potential investor is not a good fit, listen to that. Do as much due diligence on potential investors as they do on you. And listen to both your head and your intuition (body, heart, spirit, gut . . . .) when deciding whether to accept an investment.

6. Cultivate your garden.

Nina Simons of Bioneers says “fundraising is like cultivating a garden.” Take the time to get to know potential investors as well as those who may be able to introduce you to investors. It can take several touch points before an investor says yes. During this process, treat the investor as a whole person, not just a wallet that you’re trying to get into. Everyone, including investors, wants to be seen for the entire person they are and appreciated for all that they have to offer.

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LLC versus corporation

When starting a new business, choosing what entity to form is an important decision and can have implications for how you can raise money in the future, how you’re taxed, how you can bring on help, etc.  Here are some things to consider when choosing whether to form an LLC or a corporation.

Formalities

Corporations are required to follow certain formalities such as

  • Have a Board of Directors which meets regularly (can be a single member under most state laws)
  • Hold annual shareholder meetings
  • Take meeting minutes
  • Provide written advance notice to Board members and shareholders of meetings, including agendas
  • Have officers, including at least a President, Secretary and Treasurer (multiple offices can usually be held by a single person)

LLCs are generally not required to have the same level of formality.

Flexibility

LLCs can be structured very flexibly. For example, company losses can be allocated to one class of investors and profits can be allocated to another class. Different classes of investors can be given very specific governance rights. Corporations are a bit less flexible.

In LLCs, it’s possible to provide a “profits interest” to investors – this kind of interest can be given for low or no cost to the investor in exchange for future services. It entitles the investor to share in future profits. There is no comparable option in a corporation.

With a corporation, the general rule is that when a worker receives an ownership interest in a business in exchange for “sweat equity” instead of paying the actual value of the interest in cash, the worker will owe income tax on the value of the interest received. This means the worker will have a tax bill and no cash to pay it with. This is why corporations often grant stock options to their employees. The options provide the right to buy stock at a pre-set price at some time in the future. Generally, an option grant does not create a taxable event for the worker at the time it is granted. There is a taxable event when the option is exercised and the shares are sold at a higher price. Options only make sense in a company that will eventually have a market for its shares.

The flexibility of LLCs can be a double-edged sword. While flexibility can be attractive, operating an LLC can be more complicated and expensive because there are so few default rules that LLCs must comply with. It is also easier to make costly mistakes making the advice of an accountant with a high level of expertise in LLC accounting essential.

Employment Law

When an LLC provides equity to employees, the employees are thereby converted to partners and are no longer technically employees. They cannot be given tax-advantaged fringe benefits and may not be covered by employment law requirements such as minimum wage, the requirement to buy workers compensation insurance, etc. In a corporation, when employees are given equity, they continue to be treated as employees for all purposes.

Tax Considerations

Corporations can be taxed under Subchapter S or Subchapter C. LLCs can elect to be taxed under those subchapters as well but are most often taxed under Subchapter K (this is the subchapter that governs partnerships).

Both Subchapter S and Subchapter K provide for pass-through tax treatment. This means that all items of profit and loss are passed through to the individual tax returns of the company owners. The entity itself does not pay federal income tax on its profits (although some states do impose tax on pass-through entities).

There are several differences between these two subchapters:

  1. An entity may only elect to be taxed under Subchapter S if it meets certain requirements:
    • Fewer than 100 shareholders
    • Only one class of stock
    • All shareholders must be individuals and not entities
    • All shareholders must be legal U.S. residents.

These requirements do not apply to taxation under Subchapter K. However, corporations may not elect to be taxed under Subchapter K. Subchapter K may only be used by LLCs and partnerships.

  1. Under Subchapter K, all revenues received by equity investors that work in the business are subject to both income tax and self-employment tax, regardless of whether you call it a salary, profit distribution, etc. Under Subchapter S, it is possible for the equity owners to take a portion of their earnings in the form of profit distributions which are not subject to self-employment tax. Because of this, in businesses where the owners take large salaries/distributions, Subchapter K can result in a much higher tax burden than Subchapter S.

For entities taxed under either Subchapter S or Subchapter K, at the end of each tax year, the accountant needs to allocate the entity’s profit or loss to the company owners. Each owner receives a form called a K-1 that instructs the owner what needs to be reported on his or her individual tax return. Many owners do not like having to deal with K-1s because it makes the preparation of their individual tax returns more complicated and they often do not receive the K-1 until late in the tax season.

Another concern with pass-through taxation is that it is possible that an owner could be required to pay tax on profits that he or she does not actually receive in cash. This is a problem called “phantom income.” This happens when an entity makes a profit but does not pay the entire profit out to investors in the form of cash distributions. This is a very common occurrence since most entities need to retain some amount of cash to cover short-term needs. The entire company profit is allocated to the investors regardless of how much cash they receive. Often, investors agree in advance that a minimum distribution will be made to at least cover the tax bills they have to pay because of their investment in the company.

Taxation under Subchapter C is standard for larger corporations. Unlike with the other two subchapters, entities taxed under Subchapter C do pay tax – items of profit and loss are not passed through to the equity investors. Federal corporate tax rates range from 15% to 35%. If an entity taxed under Subchapter C pays a profit distribution to an investor, the investor pays tax on that distribution. These are often subject to a lower tax rate than the standard individual income tax rate. However, these funds are technically taxed twice because they are taxed at the entity level and at the individual investor level. This is known as the “double tax.”

Considerations for companies that want to bring in outside investors

Many equity investors prefer to invest in non-pass-through entities because they do not like having to deal with the possibility of phantom income, K-1s, and other complications that can come with pass-through treatment. On the other hand, there are some investors that may have investments that generate passive income who are looking for an investment that will generate losses that can offset those gains on their tax returns. For investors to be able to take advantage of these losses, the entity must be taxed as a pass-through. Knowing what type of entity/taxation your most likely investors prefer is very helpful in making the choice of entity decision.

Asset Protection

An LLC is preferable from the perspective of asset protection for the owners of the entity. If the owner of stock in a corporation is successfully sued, the creditor could be awarded the stock and gain control of the corporation. However, a creditor of an owner of an interest in an LLC cannot gain control of the LLC. The creditor is limited to a charging order which only allows the creditor to cash distributions made by the company. The creditor cannot force a distribution or demand any portion of the assets of the company and has no voting rights. This problem with corporations can potentially be addressed through the use of a Buy-Sell Agreement that provides for what happens if a major shareholder transfers his or her stock voluntarily or involuntarily.

Conversion from one to the other

From a tax perspective, it is generally easier to covert from a pass-through entity to an entity taxed under Subchapter C than vice versa.

 

Disclaimer: This post does not constitute legal advice! Please consult your tax advisor and/or attorney before making a final decision regarding entity type and taxation.

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Is there more than one way to reach your funding goal?

You’re sitting at a restaurant having lunch with two friends, Pat and Chris. They’re both entrepreneurs and coincidentally, they both just completed a funding round of $1 million for their businesses.

You ask them to tell you the details of their raises.

Chris says,

I brought on an investor who now owns 50% of my business. The investor has a seat on my board of directors and is there to help me make sure my business grows as fast as possible because our goal is to sell the company within the next 5 to 7 years. The investor has veto power over any big decisions I make. Basically, the investor is my boss. What we’re hoping will happen is that in 5 to 7 years when we sell the business, we’ll all make a huge amount of money. In the meantime, the investor is watching my like a hawk to make sure I work my butt off so that the business will become an attractive target for acquisition.

Pat says,

I brought on some investors who trust me to make good decisions about the business and they’re very busy people so they didn’t want any control or ability to participate in the management. If I ask them for support, they’re usually happy to give it, though. At the end of every fiscal year, we look at our books and determine whether we can afford to pay a dividend to the investors out of our profits. We try to pay a dividend of at least 4% per year (meaning the investors get 4% of the total amount they invested). If an investor wants to exit his or her investment, we have a mechanism that allows us to either bring in a new investor to be able to pay that investor back or to buy the investor out using our own reserves. In either case, the investor can never get back out more than what he or she initially put in.

Which one sounds like the better deal to you? Of course there is no right answer – there are pros and cons to both. But in the world that worships Silicon Valley style investing, Chris would be seen as a success and Pat might be seen as a bit of a loser. This is a bit strange since Pat was able to keep control, has a much lower cost of capital, and does not have to put in 120 hour weeks to make sure the company becomes an acquisition target as quickly as possible.

The take home message? Don’t get caught up in how others define success – do what is best for you and where you want to take your business. There is more than one way to raise capital and the Silicon Valley style is not right for everyone. In fact, less than one percent of business go that route! Who cares whether you’re touted as one of the exclusive club of VC-backed company founders if you raise the money you need and you’re running your company on your own terms?

To learn more about alternatives to the Silicon Valley, funding model, apply for a Capital Raising Strategy Session.

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If Startup Funding is so Plentiful, Why Are Many Women Entrepreneurs Still Struggling?

Reprinted from http://www.locavesting.com/featured/if-startup-funding-is-so-plentiful-why-are-many-women-entrepreneurs-still-struggling/

Women entrepreneurs, do any of the following comments sound familiar?

“I’m having lots of conversations and none of them are going anywhere.”
“I had an investor commit but now he won’t answer my phone calls.”
“I got sexually harassed when I pitched the first time.”
“An investor asked if I was truly committed to the business given my family obligations.”
“I had a couple meetings with funders who really didn’t seem to understand the product, or they wanted the product to be something else.”

If so, you’re not alone. For all the talk that startup funding is plentiful, many entrepreneurs are struggling to find investors. Women, especially, are spinning their wheels in meetings with investors that don’t yield results. This takes time away from running the business, not to mention their other priorities, and can lead to a downward spiral of lost confidence.

But it’s not necessarily about you. In my work with entrepreneurs, I’m seeing the following trends:

1. Yes, it’s getting easier for startups to raise money, but this is only true for a very tiny percentage of startups that fit a very particular profile.

There is more abundant funding than in recent memory for tech start ups with high growth potential. I have met lots of women entrepreneurs whose businesses are not primarily tech-focused, but who are feeling the need to focus on the “tech part” to attract investors. So their dream of making healthy nutrition bars or customized footwear has to take a back seat for them to even get in the door with these investors. This doesn’t lead to good outcomes: either the entrepreneur has to sacrifice her vision to get investment or, more commonly, the investor senses the lack of enthusiasm for the tech part and passes on making an investment.

2. Most professional investors, even those that consider themselves impact investors, are driven by making high financial returns as quickly as possible.

Many women entrepreneurs are strongly committed to fulfilling a mission with their businesses. Almost every woman I talk to cares about more than making as much money as possible in the shortest possible time frame. They are very reluctant to sacrifice their mission in the name of raising funds. This creates a big mismatch between these entrepreneurs and the sources of capital they’re talking to.

3. Mainstream sources of information about raising capital are steering entrepreneurs toward a tiny pool of potential investors that may very well not be a good fit—which leads to a huge amount of wasted time, money, and energy.

Type “startup funding” into your favorite search engine and I can almost guarantee that everything retrieved takes for granted that the Silicon Valley model is the only model for raising capital. What is the Silicon Valley model? This is the fairy tale story that so rarely happens in real life where a start up raises a seed round, then an angel round, then several rounds from venture capital, and then the company is sold and everyone makes millions. Because of the articles and blog posts that make it sound like this is THE way to raise money, tons of entrepreneurs try to march down this path without realizing that this model fits for only a tiny percentage of businesses. I also hear from lots of entrepreneurs who tell me that their lawyers and advisors discourage them from trying more creative capital raising strategies.

How to counter these trends? Here are some solutions:

Broaden your definition of potential investors

Your potential investors could include your customers, suppliers, neighbors, members of organizations that are in alignment with your company’s goals, etc. In my experience, non-professional investors are satisfied with more reasonable terms and are less likely to demand control. Identify investors that love what you are doing, totally get it, and want to be a part of it. You will have a much more pleasant relationship with them than you would with a professional investor that only cares about maximizing financial returns at any cost.

Consider hiring expertise instead of thinking you need it from your investors

A lot of women I talk to, when I ask them what they are looking for in an investor, say they want an investor who not only has money to invest but also has industry expertise, is willing to serve as a mentor, and has a huge rolodex of useful contacts. Trying to find all these qualities in a single person is a recipe for frustration. Why not consider raising money from investors and then using that money to hire consultants to help with the other stuff?

Create a blueprint and follow it faithfully

When I work with entrepreneurs that are looking to raise capital, the often want to jump in headfirst and talk to every investor they can get an appointment with. I recommend taking some time to create a plan first. The few weeks it takes to do that could save you months or years of frustration! I help my clients create a plan that includes

1. Getting clear on why you are raising money
2. Your non-negotiable goals and values
3. How much to raise
4. Who is your ideal investor, where are they, and what are they looking for
5. Addressing the mindset issues that get in your way so you can approach investors with confidence
6. Create financial projections that help you see clearly the best way to bring on investors
7. What to offer investors – equity versus debt; exits; etc.
8. What legal compliance strategy to use to make sure you can reach your ideal investors without breaking the law
9. Designing your communication strategy

Once you feel good about your plan, stick to it!  Don’t listen to those who will tell you that you’re not doing it right. I promise you, many of those who “do it right” end up very unhappy, stressed out, and sometimes even fired from their own company.

Get support!

I am working with groups of women entrepreneurs that are all raising money at the same time and I’m amazed to see how helpful it is to be a part of a supportive group. The participants give feedback, resources, introductions, and pep talks to each other, which leads to better results and makes a process that can be very unpleasant actually enjoyable!

If you’d like to talk about your capital raising strategy, click here to apply to have a one-on-one conversation with me.

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Are profits for losers?

I help entrepreneurs raise capital from investors.  One of the main questions I get from entrepreneurs is “Does my business need to be profitable before I can raise money?”

Then one day I talked to an entrepreneur who told me that she went to talk to a professional investor (venture capitalist) and he seemed to be concerned when he learned that her business is in fact profitable.

How strange!  Wouldn’t you think an investor would be more interested in investing in a profitable business than one that is losing money?

Then I read in the Wall Street Journal yesterday that only 17% of the tech companies that went public this year made a profit in the previous 12 months – the lowest percentage since 2000.  As the article puts it, “Unconventional financial metrics woo investors, spark worry.”

Yes, I understand that profits can come at the expense of growth, but it seems like venture-backed companies are playing by different rules – ones that are exposing our economy to a huge amount of risk.

That may be part of the reason why the average VC fund fails to return investor capital after fees.

So, if your company is profitable, be proud!  There are investors out there who will appreciate it.  And if it’s not yet profitable, keep in mind that most companies that have raised large amounts of capital aren’t either.

Here is a link to the WSJ article: http://www.wsj.com/articles/how-tech-startups-play-the-numbers-game-1433903883

 

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