Oct14th
Sunday, October 14th, 2007
David:
This Memorandum is confidential unless you decide to share it with others.
With your permission I am writing to cover several related topics; namely (i) what I consider to be the strengths and weaknesses of the company with an emphasis on how an investor candidate will likely look at the company, (ii) a recommended structure to use with investors, (iii) the importance of having a Plan B, and (iv) approaching Chinese companies you will meet on the trip who may be interested in investing for equity, as opposed to acquiring fractional interests,
1. Strengths and Weaknesses of the Company as Perceived by Potential Investors.
First the Strengths:
(a) Your commitment of funds and the significant amount thereof.
(b) Your vision as to the importance of bringing some manufacturing back home.
(c) Your insight into the fractional ownership concept.
(d) The attractiveness of the franchise concept to be sold to engineering design firms.
(e) The prospect of expanding the manufacturing options.
(f) Branding the company’s name as a name that carries economic value.
(g) The pending patent.
(h) The possibility of a strategic relationship with industry players.
(i) The prospect of doing business with Chinese manufacturers.
(j) The collegiality of your employees.
(k) Preliminary plans to acquire other companies from related fields.
(l) Your success with your previous company, although it was in a different industry.
(m) An anticipated ‘exit strategy’ based on the possibility of being acquired.
(n) This list is not intended to be complete.
Second, the Weaknesses:
(a) The lack of a significant number of customers to date for the business concept.
(b) A shop floor that is underwhelming due to a scarcity of customers.
(c) Financial forecasts that show the company to be in the low-margin manufacturing sector (net income after taxes of less than 10% of gross sales), as opposed to having found a way to break the mold, so to speak, and create a new economic model, one that shows that customers will pay more than industry prices.
(d) Present uncertainty as to the correct direction for the company to pursue, whether China will be a ‘good partner’ or not, and what happens if the business plan and the revenue forecasts do not materialize.
(e) The age of the team, and without someone from the industry who is the CEO and a ‘stud.’
(f) Lack of a board of directors, or of advisory board members (as of the moment), that otherwise shows the strength of its outsiders.
(g) Need for a ‘Plan B’ that can assuage investors’ need to feel safe with their investment.
(h) Unlikelihood that a lead investor will emerge from conventional sources
such as aligned companies, venture capital funds or other categories.
(i) The geographic location of the company, which is too far from the airport to make it convenient for out of the area investors to schedule one day meetings at the company’s offices.
(j) Some personal health issues that may affect you and in turn potential investors’ comfort.
(k) This list is not intended to be complete.
2. Choices, Best Scenarios and the Alternatives Regarding Funding.
Using a balance scale, and trying to imagine all of the items listed under “Strengths” on one end and all of those listed under “Weaknesses” sitting on the other end, it is my conclusion that we should give unbiased attention to whether we can successfully raise the intended $4M before the middle of December. To do so we may have to be creative in the areas of the structure of the investment, with an emphasis on enhancing the return to the investors.
If after we have worked through all these issues we are not prepared to bet the farm on the likelihood that investors will sign up, and quickly, we should begin the process now to identify possible acquirers of the company. Between just us, this will be known as Plan B.
Due to the upcoming trip to China and the time constraints when the management team is out of the office, we have a challenge in fitting in presentations to potential investors when everyone is around. This only makes it more critical to know what we are doing with respect to the terms of an offering, where there is flexibility and how do we get someone with credibility to be a lead investor.
It may be necessary to focus on potential investors who reside nearby, or those who have other connections to the company and/or its team, and leave out of the equation any potential investors who live elsewhere or who do not have any pre-existing connection to the company and/or its team. Furthermore, it is unlikely that we can attract venture capital funds, even if we were willing to live with their onerous conditions. The economic model does not have the ‘big win’ kind of numbers, without gross speculation on our part, to convince them that this fits their portfolio requirements.
To that end, John, your financial analyst and manager of some of your personal investments, may be an important link to possible investors. Can he recommend, or at least offer to show the Business Plan to some of his clients without violating any rules or disciplines? He will have to make a disclosure of his relationship with you. If he can help and is willing to do so, perhaps the company can compensate him when he brings investors in. If so, we should start the process with him immediately.
All of the above is written with an eye on the calendar. If it was six months ago, the trip to China was behind us, and the franchise plan was well accepted by engineers and design firms, then we would have a different story to present. Time is of the essence. And getting behind the ‘8 ball’ is not allowed to happen.
We have to capture the moment and not worry about negative ‘what if’ events could happen. Time is of the essence, and I apologize if this is a repeat.
3. Proposed Structure for the Investment.
Based on the foregoing, I suggest that you consider approving an investment package that has some incentives you may not otherwise be in favor of. These are as follows:
a) Create a strong preferential schedule for paying the investors back sooner than you will recoup your investment. To do this, consider the following. Give these investors a disproportionate return, not in alignment with their percentage of equity ownership. To this end, how about a structure that says the investors will be paid 60% of the company’s net after tax income until they have recovered 100% of their investment?
Incidentally, if the company is reorganized as a limited liability company, as opposed to a C corporation, it would avoid double taxation. As an LLC federal income taxes only apply on funds when distributed to the equity holders. There is no tax on the income at the LLC level, unlike the liability for taxes on a C corporation on its net income, and then taxes are also levied on the distributions/dividends to its shareholders.
b) Let’s consider using Convertible Promissory Notes rather that try to sell Preferred Shares at this time. The Notes will carry say interest at 8% per annum, and be due and payable after 24 months. Furthermore after two years the company can make a demand that the Notes be converted at a set price per share. The conversion will equate to 33% of the then outstanding equity of the company. The Notes would automatically convert into Class A Preferred Shares (with the preferences as shown below) if the company is acquired (or goes public).
c) There will not be an escrow requirement for the proceeds received from investors if we can keep it out. Otherwise we can offer to escrow the first $2Million and then the escrow goes away.
d) Following conversion of the Notes, the holders thereof will have anti-dilution rights as long as the Notes are outstanding. After that they will have a right of first refusal to invest whenever the company elects to sell additional shares so that they can protect their percentages of equity ownership.
e) If the holders of a majority of the Notes elect to convert at the two-year date, then all holders shall be required to convert their Notes.
f) In the event of a liquidation event after the Notes have been converted, the holders will have a preferential right, before any monies are paid to any other classes of shareholders, to be paid an amount, which when added to the monies previously paid from the annual net after tax income of the company, that together are equal to the amount of their original investment.
g) The company will not hold any redemption rights.
h) The board of the company will have at five directors. As an added inducement I recommend that the investors, as a group, be entitled to designate two members of the board, subject to approval of those nominees by the company. You and two others, selected by you, will be the balance of the board members.
i) If for any reason the investors have not recovered their entire investment within three years, they would be entitled to designate a third director and the board remains at five members.
j) Agree to hold equity-holder meetings at least once a quarter and to provide annual financial statements and quarterly un-audited financial statements and reports.
4. Rationality Behind Proposed Structure.
The purpose in suggesting these clauses and terms is to give investors a sense of safety without indicating that the company has concerns in these areas. Also, I should add that in the presentations we need, at the outset, to establish that the company is just beginning to look for investors. The purpose of this is to convey a dual sense of opportunity; namely that they are getting a first look and that you have not been turned down by other possible investors.
There is a thin line between selling an investment and showing an investment. We must be showing, not selling.
5. Capture the Audience.
Another point to make is to create in the meeting a quick sense of mutuality. Body language from those in the room, or what and when they say something is also a harbinger of how they are looking at the opportunity to write a check. It stands out like a sore thumb, hopefully one that is pointing up. The surest way to make this connection from the outset of the meeting is to find something that is common to those hearing the presentation and those making it. It could be backgrounds in manufacturing, schools attended, where they live in the area, who else they know, etc. Hitting on one of these links, or others is very important.
Whoever is presenting, at any part of the presentation, should not get lost in what they have to say. They need to be on the look out for what is being said by the attendees, how they are engaging, whether they are leaning forward or sitting apart from the others in the room. It also helps to have as much GQ on each of the persons in the room beforehand so that we can address those interests and questions before they are asked.
Venture capitalists like to see “Mo” meaning momentum. Rather than getting bogged down in too much detail early on we should begin the meeting with the latest momentum for the company. Numbers can be boring but news suggests that the company is on to something. Stories from recent trips, unanticipated calls from potentially significant customers, etc., are very good indicators of “Mo.”
6. The China Investment Question.
The Ambassador clearly was pushing the proposition that companies in China may want to become investors in the company. I am recommending that before you and the team gets on that plane that a plan is agreed on as to how this will be handled. So much in China hinges on relationships and culture. It may be important from both of those points to give this careful consideration. If the company has no interest in selling any shares to a Chinese company they will, I believe, take it to mean that we do not see them as being worthy. Based on my belief, I see an opportunity to create a genuine interest on their part the more you and the team engage with your hosts. If it makes business sense to have Chinese companies using the company’s facilities for US customers who need rapid prototyping, then it should also make sense for the Chinese companies to acquire some ownership in the company. The amount of ownership, of course, has to be attractive to them but not a threat to the company or its mission (unless they want to pay an Emperor’s ransom).
If this was my company and my chance to interact with Chinese manufacturers who have the capital to become good investors, I would entertain them and the possibility of working something out. Excuse my openness but I know how well Jin can work with them and if you ask him to explain the idea he will do it.
7. Conclusion.
If it was not for the time constraint and the time of the year, things could be easier with respect to the raising capital. I am very mindful of your commitment to the company and will stay very pro-active with you so that you can rest any worries you have. Call me anytime, day or night. I will travel to the company, participate in presentations and keep providing my best advice, whenever asked.
I look forward to hearing your comments, questions and any criticism. Following those we can advance the fund raising process.
Jacques Nichols (c) September 2007
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Aug7th
Tuesday, August 7th, 2007
The Oregonian, on Thursday morning’s edition for July, had a headline in the Sports Section that said: Seattle’s bullpen fails in ninth. Above the headline was a box score that said: Seattle 7, Los Angeles 7 (through 11 innings). Below the headline was a picture of a celebration by the Los Angeles Angels after a two-run, two-out homer in the ninth inning tied the game.
Below the picture a caption said: “. . . the Wednesday night game did not end in time for this edition of The Oregonian.”
We also get the local paper, The Columbian, which was on the porch and I read it first. Apparently the folks who work there stayed up to see the finish of the game. Its headline, also on the front page said: “Mariners salvage win in the 12th”
The article that followed the picture had this for its lead-in sentence: “Yuriensky Betancourt grounded a single through the left side of a five-man infield to score Adrian Beltre with one out in the bottom of the 12th inning and send the Seattle Mariners to a wild 8-7 victory over the Los Angeles Angels on Wednesday night.”
I love sports, especially for the metaphors they provide. In business many times there are those who give up, whether the score is tied or the game has gone deep into extra innings. Then there are those who stay to the end, but they never give up, and then they are the ones who are rewarded for their commitment and perseverance.
The next time you find yourself believing that a particular company or person is going to fail, remember the way The Oregonian handled the story where they highlighted that Seattle’s bullpen failed in the 9th, and then recall what The Columbian had to say because they stayed to the finish. The other day I saw a bumper sticker on a car that was being towed. It said: FAILURE IS NOT AN OPTION.
Yesterday I parked in a lot and the car in front of me said: “Something good is going to happen soon.” And the week before when in Salt Lake my fortune cookie said: “Soon you’ll be sitting on top of the world.” That’s the way it works in baseball (sometimes.)
Our dueling newspapers showed that it’s the final score that counts; not an inning by inning box score. “Fail” did not happen during the game. “Win” comes at the end of the game.
The moral to this story is:
Who cares how many innings it takes to win? A win is a win, salvaged or not!
Jacques B. Nichols
August 3, 2007
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Apr7th
Saturday, April 7th, 2007
TOP CLICHES ABOUT RAISING MONEY
Quotes by Jacques Nichols (unless by others, as noted)
2006 ©
- “There are three types of Venture Capitalist’s: venture, vulture and now the V——- gang. It is time for a new, better, class. It is time for ‘Virtuous’ Capital.”
- “You cannot make dough out of bread crumbs.”
- “You’re the reason I should invest, and you’re the reason I should not invest. I’ll pass.” Bill Tholke, Boardroom Consultants.
- “This is a great idea . . . I wish someone else had thought of it.”
- “Dilution is not a four-letter word, get used to it!”
- “It takes the first 90 seconds to connect with potential investors, everything you say and do after that can only lose them. And that takes less then ten seconds.”
- “Before making your presentation, take a look in the mirror. What do you see? Look and listen very carefully. You may get the gong.”
- “The sooner a potential investor uses the ‘we’ word, the surer you can be he’ll invest. The longer it takes, or he doesn’t use this word, bag the presentation. It ain’t going anywhere.
- “No company ever went broke due to dilution.” Les Fahey, Fahey Ventures.
- “Show me your team and I’ll show you your company’s chances of attracting great investors.” Mark Reed, Common Ground Partners.
- “No” is a very good word. Now you can focus on who may invest. “
- “No one ever calls you back on Monday as they promised.”
- “Be sure to give the good car to the guy who has to go to the airport to pick up the investors, just be sure it is not a Lexus.”
- “And so what’s not to love about getting funded; well there can be lots of good reasons. They should easily come to mind if in your gut you didn’t connect with those guys in the room.”
- “Time is your most important asset. Wasting copious amounts of time on meetings without getting a check is a corporate mortal sin.”
- “Investors write checks somewhere, everyday to someone else’s company. Why not to yours?”
- “Trying to raise money is like fishing. What are you using for bait?”
- “Money follows success. Success follows money. It’s axiomatic.”
- Only one word gets an investor’s undivided attention. It’s the ‘E’ word. Without it no check will ever be written. What is the ‘E” word?” (It’s EMOTION!)
- “Investors fear a future cash call like you fear running out of money.”
- “Get you cheerleader/first investor on board and then let him/her bring in the other investors. Works like a charm.”
- “Always go for potential investors who have a ‘pre-existing’ connection to the company, its products, markets or some other tangible relationship. Avoid educating the uninitiated!”
- “A cheerleader is not as dependable as a bell cow.”
- “Cowboy entrepreneurs need not apply.”
- “God loves the cowboy investors. And so will you.”
- “In the 70’s and early 80’s potential investors considered it rude not to come to the meeting with a checkbook in their pocket. Nowadays, no one has a checkbook handy. Why?”
- “A community with stories and scores of successful investments made in local companies is what makes the Silicon Valley, and Seattle what they are, and what separates them from other cities.”
- “No company I know of ever raised too much money. Take your timidity and naïveté and double up your request.”
- “So what it the investor stands a good chance of making lots of money. How much more will you make if no one invests?”
- Raising money is like going to a new restaurant. It’s all in the presentation.’
- Break away from the mold; throw out 80% of the Power Point slides.”
- “Tell them, who, not what, you are”
- “Make them want to introduce you to their wives. Without the wife’s OK, a lot a promises to invest will die.”
- “Investors need another investment to attend to, like another hole in the head. Make them see you in a different light.”
- “Only you believe that what you are selling really matters. Those in the room will possibly think that you have them confused with someone who gives a shit.”
- “Know your limits, be prepared to counter, and if it means more to you to protect your company’s mission, vision and values, draw your line in the sand.”
- “Use gray matter, when negotiating, and not necessarily your own.
- Make sure you remember all the stories that will be associated with your company and its funding efforts. The moral to the story will be the best part of the story.”
- “Investors are not walking dollar signs. Don’t look at them that way. We want to be seen as real people, with all the common failings.” Donald Moody
- “Go after ‘Harmonic Capital,’ the kind that seeks to balance the Note with the Pitch.”
- “Don’t invest in a company run by a fat guy.” From a 70s’ VC.
- “Women entrepreneurs should tap into the untapped pool of money controlled by women.”
- “The wife may not be in the meeting, but when he gets home, can he sell her on the deal?”
- “Get creative and pop up a new formula that shows the investors that they’ll get their money back sooner, not later.”
- “Meeting milestones should work in your favor too, not just in the investor’s favor. Insist on having some that work for you.”
- “They ought to hold a ‘Morning After’ contest and give the top prize to the company whose Business Plan’s projections actually, over time, came the closest to what really happened.”
- “It’s the intangibles that’ll get a check written. You really can’t know in advance what will really make the difference.”
- “Investors are a funny bunch, but don’t tell them.”
2006 © Jacques B. Nichols: If you wish to reprint, pass around, or copy for any reason, please contact me for permission. I am happy to share my written materials as long as I am given credit for the writing and you have included my blog address.
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Mar27th
Tuesday, March 27th, 2007
- - - -HARMONIC CAPITAL - - - -
by Jacques Nichols
________________________________________________
There are two other defining moments that have contributed to my desire to start a new kind of venture capital fund. Actually, there are three, although the third reason may have to be left for the Rest of the Story, as Paul Harvey used to say.
The first one defined who is an ‘angel’ investor, although in 1981 when the particular investment was made, no one needed to use a label for private investors as being ‘angels.’ That came about later after the venture capital funds saw their money as the most important ingredient in the equation between entrepreneurs and VC’s.
This story goes back to the early investment in FLIR Systems, Inc. I had invited Chuck Wiper, an original NIKE investor to come with me to the Reno Air Show for a demonstration of FLIR’s infrared sensor. We took a flight in a helicopter at night and once airborne the monitor, in its greenish cast, showed the ground below. Suddenly two figures were spotted in the desert below, waving their arms. Looking out of the windows, only pitch black was visible.
When the craft landed I saw that Chuck was crying. His experiences in World War II as a B-17 pilot had come flooding back. I’d heard that he had survived a plane crash and engaged in hand-to-hand combat. He only said: “I wish we had had this during the war.” That comment was followed by: “How much money do you want?”
I replied that the company wanted to raise $2.5 Million and I added that a venture capital fund in Seattle was on record as offering to take one-half thereof. Chuck said, in a few words, that he would get the other half together with his brother and a couple of other friends. Three days later I had checks that came in the mail and his word was good.
About ten days went by and Chuck called me. “Has the fund sent in their money? He asked. I suddenly realized that I had not heard from them since I was at the home of the managing partner for dinner. I recalled that before leaving he had gone into a closet and came back into the room wearing a T-shirt that said: “He Who Dies With The Most Toys, Wins.” Maybe it was a prophetic message for a venture capitalist, as he did point out the large yacht moored at the dock below his home on Lake Washington. Apparently he was on his way to dying.
I promised Chuck that I would call Seattle for a status report. I did and was told that the attorneys were preparing a Stock Purchase Agreement. It arrived a few days later. Just based on the number of pages I suspected it would require a careful reading. But, I also knew that Chuck would be impatient if I did not immediately send him a copy.
Chuck lived in Eugene, Oregon and the mail service was swift. The next afternoon he called again and there was irritation in his voice.
”Have you read this? He asked.
“No, not yet,” I replied.
Chuck continued. “ Read it and go to page 42. Tell me what it says?’
I quickly flipped pages and started to read. He had obviously been referring to a section that said if he and his co-investors, at any future date, desired to sell any of their FLIR shares, they would have to first offer them to the venture fund. I read the offending language out loud to him.
Then he said: “We don’t need them. I just came back from the post office. I’ve mailed you another check for $1,250,000. Call them up and tell them you just got some screw you money!”
I made the call. It only lasted a couple of seconds.
The lesson I learned this time was that one person’s money ought to be as good as another person’s. That is a lesson that the venture community has lost sight of. Once they invest they look down at the early investors, notwithstanding that but for those investors the company would not exist and they couldn’t make an investment.
The second story is also FLIR related. It is in two parts too. During my tenure on the board of the company I urged the hiring of Dick Kerr, Ph.D. Dick had been the president of the Oregon Graduate Center. He held three degrees from Stanford, including the Ph.D. in Physics. FLIR needed a scientist to advance its product offerings and fortunately for Chuck and the other shareholders, Dick accepted an offer to be the Senior VP for Advanced Development.
Over the ensuing years Dick and I met about monthly, either for lunch or drinks. He kept me informed of progress at the company. Toward the beginning of 2001 he began to talk about a new invention he was working on, one that would combine infrared and radar. The more often we met the more I knew he was going to leave the company and continue under a license to further develop the technology.
One day he called and asked me to join him again. This time he was set to launch Max-Viz, Inc. and wanted me to assist in raising the seed capital. I called on Chuck’s son Tim and a couple of other potential investors I knew. Fortunately for the new company, the money, about $2.1 Million came in and they were on the way. I served for a time on the board of directors and acquired some common shares too.
Shortly after I left the board to concentrate on an offer from a major law firm the company engaged in a round of financing from a group of venture capital funds. The valuation at the close of the offering represented a 50% increase over the price paid by the investors I’d introduced to the company. I felt good about this, for all concerned.
Even though the VC’s took control of the board of Max-Viz, somehow the funds were spent before the cash flow could support the undertaking by management. However, knowing that the company and its technology were catching on in the aviation industry, these investors, and a few new ones, continued to support the company with monthly bridge loans. The conversion price for the loans was to be the same per share price as the funds had paid earlier for their preferred shares.
Somewhere along the way, and just before a shareholder’s meeting to approve the sale of shares upon conversion of the notes, the pricing and valuation for the company dropped like a rotor falling off of a helicopter. We are talking about a down round greater than a 90% drop in price! I’ve called it the Down Round from Hell. Nothing so adverse, in my opinion, had happened to justify such action, other then greed.
I spoke at the shareholder’s meeting of my disappointment. I told the story of Chuck and the famous line about the “ . . .screw you money!” As I rose to leave the room, I added: “If I can, I am going now to find some more of that screw you money.”
Here the lesson learned is one I actually knew from the days with First Source Capital Fund. Keep the number of investors down and be sure you know your co-investors well. Having different agendas among investors is more damaging to a company then not having enough money. Management can’t figure out whom to listen to among a room full of investors/directors.
The third story has to do with the termination of First Source. To know that story and the lessons I learned that time, you’ll have to get a copy of my forthcoming book:
WHO THE HELL SIGNED ME UP FOR THIS CLASS?
or
IF YOU WANT TO SEE GOD’S FOOTPRINT, CHECK YOUR BUTT!”
Copyright September 26, 2006, Jacques B. Nichols
If you wish to reprint, pass around, or copy for any reason, please contact me for permission. I am happy to share my written materials as long as I am given credit for the writing and you have included my blog address.
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