CircleUp is a Potential Source of Capital for Idaho Entrepreneurs

"CircleUp is an online social marketplace where individual investors can invest in small private consumer companies and be part of their success" https://circleup.com/

Idaho-based company Prosperity Organic Foods (www.meltbutteryspread.com) recently concluded a successful raise of equity capital using CircleUp. Disclosure:  I am an investor in Prosperity.  Prosperity produces and distributes a line of delicious and healthy substitutes for butter under the brand Melt® Organic.

Prosperity CEO Meg Carlson reports the process was quick and easy.  It was about eight weeks from the time Prosperity first submitted documents to CircleUp until it received the funds.

I visited with CircleUp COO and Co-Founder Rory Eakin. CircleUp was founded with the vision of providing the means for small consumer products companies to efficiently reach accredited investors.  Growing consumer products companies need capital to support their inventory and receivables, but it is often extremely difficult for small consumer products companies to raise expansion capital. 

Companies most appropriate for CircleUp’s services already have some traction in the market place and are seeking equity capital to support expansion.  In the case of Prosperity, this was the company’s third round of investment capital and will support national expansion from about eight hundred stores to several thousand.

Companies seeking capital submit an on-line application.  CircleUp reviews the application, does a background check on the entrepreneurs, and conducts its own research on the company and the industry.  They accept around 2% of the applicants.  Once accepted, the investment opportunity is opened up to potential investors.  Companies must declare a minimum and maximum raise.  Unless the minimum is reached, the company does not receive any funds.  After the minimum is reached, the company can continue to raise capital until the maximum is reached. 

For investors, there is a simple process to join CircleUp.  You must certify that you are an accredited investor. Once your account is set up you can then browse the potential investments. Each potential investment has a deal room where documents have been posted.  Potential investors can ask questions of the company management and exchange comments among themselves. 

Once an investor decides to make an investment, money is sent to CircleUp’s escrow account and held until such time as the company achieves its minimum raise. Then the funds are transferred to the company and the company issues its investment certificates to the new shareholders.  CircleUp withholds a commission for their services.

CircleUp is similar to the coming crowd-funding platforms authorized by the JOBS act (The JOBS act will change fund raising for startups).  Unlike the anticipated crowd-funding platforms, CircleUp is limited to accredited investors only. Accredited investors have a net worth of more than $1 million exclusive of the equity in their primary residence or meet an income test.

Based upon Prosperity Organic Food’s successful experience, other Idaho entrepreneurs in the consumer goods space may want to consider CircleUp for a portion of their capital needs.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is past- president of the Boise Angel Alliance (www.boiseangelfund.com), and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. 

Treasure Valley Angel Fund -- A Lesson in Raising Capital

The valley’s second angel fund, The Treasure Valley Angel Fund is now open for business. It reached its first close milestone of $750,000 in July.  Full disclosure:  I am an investor in the fund and my firm, Loon Creek Capital helped guide the fund through the organizational effort.

The new fund presents a case study in the process of raising seed capital in Idaho. It took about 24 months from early discussions until the capital was raised.   Active fund raising began in January of this year and reached the minimum in July. 

Why does it take so long to raise capital?  There are several reasons:

• Investors are conservative.  There are always more reasons not to invest than there are to invest. 
• Investors are busy.  It’s hard to get the attention of busy people. In most cases someone has to sit down personally with an investor to review the business plan, explain the risks and the potential benefits. It takes time to get these appointments.
• There is usually a “minimum raise.” Most security offerings have a minimum amount to be raised before capital can be released to the company.  In the case of the angel fund, that minimum was $750,000.  While a minimum raise protects the investors, it usually means it will take longer to conclude the offering and begin to put the capital to work. 

The implication for entrepreneurs is it takes a long time to raise capital.  You must plan for this and be sure you are beginning to raise capital well in advance of the time you actually need it. 

Now that the fund has reached its minimum raise, it is accepting applications from entrepreneurs for funding.  Applications will be managed by the parent organization, the Boise Angel Alliance and can be submitted at www.boiseangelfund.com. 

In the first fund about 5% of the applicants actually received funding.  I don’t expect the second fund to be any less restrictive.  So entrepreneurs should make sure they have done their homework before applying.

The web site contains information on the kinds of deals in which the fund will invest, the typical terms, and the processes used to make the investment decision.  I strongly advise entrepreneurs to read through this information before submitting an application.  And they are welcome to contact me for an informal discussion if they believe that would be helpful.

The fund is authorized to raise a total of $2 million and will continue to seek qualified investors as it begins considering investments in local entrepreneurs.  To be qualified, investors must be residents of the State of Idaho, must qualify as an accredited investor (generally a net worth of more than $1 million not including the equity in his or her primary residence), and must represent that the investment does not exceed 10% of the investor’s net worth, exclusive of the investor’s home, automobiles and furnishings.  Additional information for potential investors is available at www.treasurevalleyangelfund.com.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is President of the Boise Angel Alliance (www.boiseangelfund.com), an investor in both of its funds, and is a principal in Loon Creek Capital (www.looncreekcapital.com) which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875.

How To Make Convertible Notes Attractive to Investors

 A popular funding instrument for very early stage financing is a convertible note.  With this instrument, the investor loans the company money.  In exchange for the loan the investor accepts a promissory note.  The note will accrue interest at a high interest rate, perhaps prime plus 4% to 8% in today’s market.  Principle and interest are due at some point in the future.  At that time the investor can elect to convert principle and accumulated interest into stock in lieu of payment.

Typically the price at which the note can convert into equity is based upon a discount from the price at which stock is ultimately sold. The language may read something like:  “The note and accumulated interest can be converted into common stock at a discount of 20% from the price of the next equity round of at least $250,000.“

What this means is the entrepreneur and the investor do not have to negotiate the value of the company today.  Rather they recognize that at some point in the future the company will sell stock.  When that occurs, they will use the price of that stock sale to determine the price at which the investor can convert from debt to equity.

The advantages to the entrepreneur are that she does not have to negotiate and accept a lower value on her company today when the value will likely be higher later.  And, since convertible notes are simpler than stock sales they can usually be done faster and with lower legal fees than apply to stock sales. 

Theoretically, the investor’s position is at lower risk than had the funds been invested in stock.  But practically speaking, in an early stage company, there’s little difference between holding a note and holding stock.  If the company fails, both will be worthless.

A convertible note has one very large disadvantage to the investor.  His capital is at risk, but his upside is limited.  If, for example, the company is able to sell stock later at a valuation of $2 million, the investor will convert at a valuation of $1.6 million (20% discount from the $2 million).  This is likely substantially more than the investor would have paid had he insisted on purchasing stock rather than loaning the company money, even though his funds were at risk as if they were invested in stock.

For this reason many local angels do not participate in convertible debt offerings.  They don’t like the risk/return ratio.  However, a way around this is to negotiate a cap on the maximum value the entrepreneur will have to accept. For example, the above conversion language might be qualified:  “The note and accumulated interest can be converted into common stock at a discount of 20% from the price of the next equity round of at least $250,000, or a valuation of $1 million, whichever is less.“

This provision allows the entrepreneur to gain the benefits of a quick and relatively inexpensive transaction, while preserving for the investor the full upside should the company be highly successful.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is president of the Boise Angel Alliance (www.boiseangelfund.com) and a member of both of its affiliated angel funds. He is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. A version of this post was previously published in the Idaho Statesman's Business Insider.

Research on angel investing

Gradually we are learning more about the impact of angel investors in our economy and about the behavior of the angels.  Three new research reports have been recently released.  The Angel Resource Institute has published its first Halo™ report (http://www.angelresourceinstitute.org/halo-report/). The Center for Venture Research at the University of New Hampshire published its annual Market Analysis report (http://wsbe.unh.edu/sites/default/files/2011_analysis_report.pdf).  And Silicon Valley law firm Fenwick and West have published their 2011 Seed Financing Survey (http://www.fenwick.com/publications/Pages/Seed-Finance-Survey-2011.aspx).  The Boise Angel Fund contributes data to both the Halo and Center for Venture Research studies.

Here’s a summary of key findings of these reports.

1. The amount of angel investment is increasing. The below data from the Center for Venture Research annual Market Analysis reports show how the market has changed.  It peaked in 2007, and then contracted severely.  While the amounts invested have not yet reached 2007 levels, the number of investors and the number of deals are at all time highs.

Year	2007	2008	2009	2010	2011
Invested	$26.0b	$19.2b	$17.6b	$20.1b	$22.5b
Number of deals	57,120	55,480	57,225	61,900	66,230
Number of investors	258,200	260,500	259,480	265,400	318,480

 

The angel capital  market is nearly as large as the venture capital market.  According to PriceWaterhouse/Moneytree, total venture capital invested last year was $28.4 billion. But these funds were invested in only 3,673 deals, only 5.5% of the deals angel supported.

2. Early-stage deals are increasing. The Center for Venture Research reported that 42% of angel investments were in early stage companies, a significant increase from 31% in the prior year.  The Fenwick & West report says the early stage environment is expanding

3.  Angel investing remains rewarding but risky. The Center for Venture Research annual Market Analyses report about a quarter of the exits each year are due to bankruptcies; but returns on successful investments are in the neighborhood of 25% compounded.  

Year	2007	2008	2009	2010	2011
% of exits due to bankruptcies	27%	26%	40%	22%	24%
Yield on positive exits	28%	26%	23-28%	24-36%	18-28%

4. Not everything happens in California.  The first Halo report tracks angel investing by geography.  Of the dollars invested, 30% occurred in California; 2.3% on the Northwest.  Angel groups are now active all over the country and I believe we will see increasing dollars invested in Idaho and other areas that have not traditionally received early stage angel capital.

5.  Angel capital is relatively easy to secure.  For the last two years the Center for Venture Analysis reports a bit more than 18% of all deals brought to the attention of investors received money. This is atypically high and the CVR expects this rate to drop back to its historical average of 10 to 15%.  By this measure, the Boise Angel Fund is conservative.  About 5% of the deals that have approached the fund have received funding.

6. The Boise Angels’ volumes are typical.  Last year the Boise Angel Fund reviewed 20 deals, including requests for follow on funding.  The medium reviewed by participating groups was 15.  The Boise Angel Fund made three investments, one new and two follow-on.  The median for last year was 3. 

What do all these data tell us?  Angel capital is alive, active and a growing influence throughout the United States.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. 

The JOBS Act Should Make Early-Stage Capital More Accessible by Idaho Entrepreneurs

On April 5 the President signed into law the JOBS act, which stands for “Jumpstart Our Business Startups.”  The Angel Capital Association, to which the Boise Angel Alliance belongs lobbied in favor of the act. This law, which will be implemented over the next nine months, radically changes the laws as they pertain to raising equity capital in the United States.  In my opinion, the changes are for the better, although we must be mindful of the potential for abuse.

This is a complicated law.  The SEC is charged with writing a number of regulations. Until they are written, we can’t know exactly how the law will affect entrepreneurs and angels.  But there are key changes that have the possibility of making it easier for Idaho entrepreneurs to sell stock.

First let’s review pre-JOBS law.  Under those laws, you may not sell stock unless it is registered with the SEC (an expensive and time consuming process) or qualifies for an exemption.  Broadly speaking, there are two exemptions that are commonly used:

1.  Offer stock only to accredited investors (generally a net worth of more than $1 million excluding the equity in the primary residence) in private transactions. A private transaction means there can be no general solicitation including advertising or the use of the Internet.

2.  Offer the stock only to residents of one state in which case state law applies but federal law does not.

I wrote earlier about these two exemptions (see "State Small Corporation Registration" posted December 29, 2011).

The JOBS act removes the need for both of these exemptions for many businesses.  It

1.  Allows equity-based crowd funding.

2. Removes prohibitions on general solicitation.

Crowd funding is where an entrepreneur uses the Internet to solicit relatively small amounts from the universe of Internet users.  Until the JOBS act was passed, this was illegal in that offers were being made to individuals who were not accredited investors, and of course, the Internet is a means of general solicitation.  There are crowd funding platforms, but they ask for “donations,” not for the purchase of stock.

The JOBS allows up to $1 million of capital to be raised from non-accredited investors, so long as each  individual investor does not invest more than the lesser of $10,000 or 10% individual investment on all such investments during any one year. It also allows general advertising and preempts state law so this device can be used to raise money from throughout the US. 

It's not clear how the issuer will make sure a non-accredited investor has not invested more than $10,000 in all crowd-funded investments in any one year. The funding platform will have to be registered with the SEC, but it's not yet clear what this means or what obligations will be imposed upon the platform.

For offerings of more than $1 million, or where the company does not wish to be restricted to $10,000 per investor, a company may still use the accredited investor exemption, but is now allowed to advertise so long as the ads are focused on accredited investors.

We won’t know for sure how these new permitted activities will impact local entrepreneurs until the regulations are written. But generally I believe they will have a positive impact, making it easier for local entrepreneurs to raise equity capital.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. 

A successful software company is more than software

A few weeks ago a software entrepreneur made an appointment to visit with me at the Idaho Small Business Development Center.  She brought a mock up of the web pages that encompassed her idea.  She wanted my opinion as to whether or not the idea was worth pursuing.

This is a common occurrence. Someone gets an idea for a very cool new piece of software and the next step is to mock up a design.  For some, the next step is to hire programmers and begin the process of development. But, I think the correct next step is to determine the business potential.

Here are the questions I asked my client to her determine the business potential of her idea:

1.  What is the problem being solved?  In order to have a successful business, her product or service must address a problem in the market place.  Unless there is a real problem for which people will be willing to pay money to solve, the company will fail, no matter how unique or beautiful the software expression. 

For example, in the case of Group-on, the problem addressed is:  businesses would like a cost effective and measurable way to reach new customers.

2.  How big is the problem?  How many people or businesses have this problem.  Unless there is a sufficiently large number of potential clients, the problem while real, may not be worth solving.

For example, Pinterest has discovered there is a very large number of people who are interested in posting pictures to the Internet, and for whom Facebook does not present a satisfactory solution.

3.  How will the company acquire its customers?  Sometimes referred to as the “go to market strategy,” this crucial question is often trivialized.  I often hear answers such as “social media” or “it will go viral.”

The fact of the matter is it is difficult to identify, target and communicate with the market, especially when you are new, have no brand presence and little money to spend on marketing.

Many successful businesses will identify a channel already talking to the target customers and then tap into that channel.  For example,  dealsaver.com, a Group-on competitor has partnered with the Idaho Statesman to bring its service to local advertisers.  The Statesman’s sales force is already calling on businesses so it is relatively easy and inexpensive for that sales force to also pitch Dealsaver to the Statesman’s customers.

4.  What will it cost to acquire a new customer?  Software companies can be very profitable once the software is developed, as the cost of selling another copy is virtually zero. However the business has to find the customer and convince them to use the product. This typically takes money--sometimes lots and lots of money. In order to have a profitable business, the cost of acquiring a customer must be less than the revenue the customer will bring to your company. 

For example, the rumor is that Amazon initially sold its popular Kindle devices for less than its cost.  But, so long as the loss Amazon took selling a Kindle, along with the other costs of acquiring and serving the customer is less than the revenue the customer will spend on e-books, the completed transactions will be profitable.

I recommend all software entrepreneurs think deeply about the above questions and the possible answers before they begin to spend money developing their dream product.  If the answers to the above are not favorable, developing the software is likely to be an exercise in disappointment, and quite possible a financial disaster.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. 

Why the Entrepreneurial Community Should Support the School Levies

I wrote earlier about the fact that new businesses account for most of the new jobs in our economy (“Where do jobs come from? June 20, 2011).  In that piece I argued that to create new jobs in the Treasure Valley, we needed to create an ecosystem that supported entrepreneurs.  Every since then I have been writing about one component of a healthy entrepreneurial ecosystem-early stage capital provided by angel investors.

Today I want to talk about another component of this ecosystem—intellectual capital.  We now live in the knowledge economy where much of the goods and services created by our  businesses, especially our new businesses, are dependent upon a well-educated workforce that can supply the necessary skills and knowledge.

All eleven of the businesses supported by the Boise Angel Fund depend upon access to an educated workforce to provide the brainpower they need to produce and market their cutting edge products and services.  They need, for example, engineers and marketeers; accountants, financiers and intellectual property attorneys; computer software writers and food chemists. None of them need unskilled or semi-skilled workers. 

We obtain these knowledge workers from two sources.  Some are produced by our education system locally.  Others are recruited to move here.  First lets address our own production.

We are not producing enough knowledge workers for our economy. For example, KTVB reported in November that Treasure Valley employers had openings for hundreds of computer programmers that they could not fill (“Demand for software engineers in the Treasure Valley outweighs workforce,” KTVB, November 15, 2011).

There is no quick or easy fix for this problem.  We will solve it only by providing a high quality, challenging education system, from kindergarten through Ph.D programs.

Our state, like most, has had to reduce the resources it can provide to the entire educational system.  Our educators have done a terrific job at holding the system together in the face of declining resources, but the system is fraying. 

Our colleges and universities have made up part of the shortfall through tuition increases, contributions and research grants.  But the K-12 schools have no such options.

They must either reduce services or ask the taxpayers to pay more.  Both the Meridian and Boise School Districts will ask the voters to raise their taxes to provide additional resources on March 13. 

It’s clear to me that the consequences of our failing to provide additional resources to the schools will be a lower quality education for these young people which will result ultimately result in fewer workers with the skills needed to match the demands of our employers.  And without the skilled employee base, our entrepreneurs will not be successful in creating new businesses.

 A note about importing workers.  Yes, we know many people move here for our quality of life.  But they bring families with them and high on their list of requirements in determining to move is the quality of the public education system.

So, my argument to the entrepreneurs who create our exciting new businesses and the angels who finance them, as well as to those who believe a healthy entrepreneurial ecosystem is important to our valley, is to support our local school districts by voting to increase their resources. 

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds.  He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. 

New Angel Fund Under Development

I am delighted to report that a new angel fund, to be known as the Treasure Valley Angel Fund is in formation and seeking investors.  The purpose of the Fund is to support economic development efforts by providing capital and advice to local entrepreneurs while providing an opportunity for the investors to make a return on their investment.

The CORE, an economic development group based in Meridian and focused on creating a CORE competency in the state in Health and Research sponsored the initiation of the fund. Leadership of the Core worked extensively with the Department of Finance to develop offering parameters that ensure that sales of interests in the Fund are properly qualified under the Idaho Uniform Securities Act.

Over the past few years both the Boise Angel Fund and Highway 12 have been potential sources of early stage capital for local entrepreneurs.   However, Highway 12 is no longer accepting applications for new investments and the Boise Angel Fund is nearly out of capital.  So a new source of capital interested in supporting valley entrepreneurs will be a welcome addition to the entrepreneurial ecosystem.

The Fund will be a “member-managed” LLC.  That means the investors (called “members”) in the fund will make the investment decisions. Once capitalized, the Fund members will appoint a screening committee to consider initial applications from entrepreneurs.  When the screening committee recommends an investment, a due diligence committee will be formed to thoroughly investigate the entrepreneur and his or her business plan, and if warranted, to negotiate the terms of a possible investment.  The recommended investment will then be brought to all the members for a vote.

Whether or not the Fund members agree to make an investment, members will be encouraged to help the entrepreneur by providing advice, access to their contacts, and such other assistance as may be appropriate.  Individual Fund members will be  free to make an investment in the company whether or not the Fund members decide to make an investment of Fund capital.

Before the Fund can make any investments, it must first raise capital to invest.  The Treasure Valley Fund is raising between $750,000 and $2 million.  Units of $50,000 each are being offered to qualified Idaho residents.

The offering to form the new fund is subject to a number of restrictions, the most important of which are:

1.  Only accredited investors (who generally must have a net worth greater than $1 million, excluding the equity in the investor’s primary resident or income greater than $200,000 per year) can participate in the Fund.

2.  Investors must be residents of the State of Idaho

3.  Any investment must not exceed 10% of the net worth of the investor excluding the value of the equity in the investor’s principle residence, furnishings and automobiles. 

Of course, such an investment is very risky and no one should invest in the Fund unless they can afford to lose their entire investment.

If you meet the above criteria and would like to know more, additional information and a copy of the Fund’s Confidential Placement Memorandum can be requested through the Fund’s web site at www.treasurevalleyangelfund.com.

I hope to chronicle the formation of the Treasure Valley Angel Fund over the coming months so that others interested in forming such capital pools might learn from the experience of the Fund.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. Loon Creek Capital provides consulting services to the Treasure Valley Angel Fund. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. 

Improve your Chances of Receiving Angel Funding

I recently attended a seminar on Trends in Raising Capital in Palo Alto sponsored by the Angel Capital Association (ACA).  The ACA is an association of about 300 angel groups throughout the US and Canada.  Those 300 groups collectively represent about 10,000 active angel investors.

The seminar provided information to leaders of angel groups on the current state of the angel capital market.  One section I found particularly interesting was titled “Meeting Investor Expectations.”  The information, which I summarize below, was based upon a membership survey by the ACA.  58 groups participated representing more than 3,400 individual angels.  Those angels participated in more than 200 deals in 2010, and invested more than $45 million.  

Generally only one out of ten or twenty applications receives funding. According to this survey, there are things the entrepreneur can do to improve the chances of favorable action. While the survey was of member groups of the Angel Capital Association, I believe the findings can inform entrepreneurs approaching individual angels as well.

Get a Referral.  The typical group receives 15-30 applications a month, which is more than they can thoughtfully respond to. A referral to a group by a trusted party (e.g. another angel group, a respected individual angel or VC, an entrepreneur in which the group has invested) may help move the application to the top of the pile.  Referrals from economic development organizations and websites are viewed as having little value.  The perception is that the interests of these organizations are not aligned with those of the angels and therefore their referrals cannot be trusted. 

The Importance of the Executive Summary. The executive summary is like a resume.  The purpose is to get a interview.  Likewise, the purpose of the executive summary is to get a meeting with the angels. In the case of the Boise Angel Fund, over four years we received 214 applications.  Only 66 were invited to a meeting. So two thirds of the executive summaries did not capture sufficient interest to result in a meeting.

Good executive summaries are hard to write. In my experience entrepreneurs often spend weeks on their business plans and minutes on their executive summary, when in fact they should devote a great deal of effort to the executive summary.  In the ACA survey, only 38% of the executive summaries were rated as good.

Writing the Executive Summary. Compelling executive summaries are not more than two pages in length.  They are well written and without grammatical and typographical errors. They are delivered in PDF format so there are no accidental changes or formatting problems.

They cover the following both “POST” and “STORM.”

P-the Problem

O-the Opportunity or market size

S-your Solution (your product or service)

T-your Technology

S-your go to market Strategy

T-your Team

O-Others in the market (the competition)

R-Resources needed by your business

M-Milestones you intend to reach with the resources

Obtaining a referral to a group or an individual angel and preparing a thoughtful executive summary will improve your odds that you will be invited to a meeting with angels, which is the first step in the funding process. 

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. Loon Creek Capital is working with The Core to help create the new Treasure Valley Angel Fund (www.treasurevalleyangelfund.com). He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. 

State Small Corporation Offering Registration (SCOR)

Federal securities law requires that securities issued by companies to their investors must be registered with the Securities and Exchange Commission unless the offering qualifies for an exemption from registration. Registration is a complicated and expensive process, generally prohibitive for smaller companies.

One exemption from registration is available if the company offers securities only to accredited investors in a private offering.   An accredited investor must meet certain criteria, the most important of which is that he or she, including the spouse if one, has a net worth of more than $1 million, excluding the value of the person’s primary residence.  A private transaction means that there can be no advertising or publicity about the offering, including no mention of the offering on the company’s web pages.

This type of offering is problematic for many entrepreneurs.  If they don’t have deep networks of accredited investors, it may be virtually impossible for them to raise capital, given that they can’t talk publically about their offering.

There is an alternative.  An entrepreneur can chose to register its company’s offering with its state securities regulator.  This offering is known as a Small Corporation Offering Registration or SCOR.  A SCOR offering allows a company to raise up to $1 million from an unlimited number of investors resident in the state using public advertising. The investors do not have to be accredited.

A SCOR offering is not simple, but it is doable. Boise entrepreneur Doug Joseph is currently conducting a SCOR offering for his company Locate Express as a means of raising capital to expand his business.  Doug reports that he was able to do most of the work of registering his offering himself.

In Idaho our regulator is the Securities Bureau of the Idaho Department of Finance.  The Bureau has published a SCOR manual and other useful documents on its web site. Click on “SCOR/U-7 Filings” under “Forms Available Online” in the upper right of their home page.

I’ve summarized the basics of a SCOR offering below.  But there are technical details that are important and anyone contemplating such an offering must engage legal counsel to advise the company and to give an opinion regarding the securities.

According to the SCOR manual the company must be a corporation or limited liability company.  This offering cannot be used for companies engaged in petroleum exploration and production, mining or other extractive industries.  And the company must not be a development-stage company with no specific business plan or purpose other than a merger.

The stock price must be $1 per share or more.  Financial statements must be provided.  If the company is raising less than $500,000 the statements must be reviewed by a CPA; for offerings between $500,000 and $1 million, the statements are generally required to be audited.

To register your offering with the State, you file a disclosure document known as a U-7 and other documents along with a filing fee of $300.  The purpose of the filing is to disclose all material information about the Company that a typical investor would want to know before making an investment in the company. 

The Idaho Securities Bureau is willing to talk on the phone or meet with an entrepreneur considering making a SCOR offering to review the requirements before the entrepreneur submits the documents.  You can reach the Bureau at 888-346-3378. 

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu.

New Data on Pre-Money Valuations

I thought my previous article was going to be my last for a while on the topic of valuation. But some germane new research has just been published.

In previous articles I discussed the concept of pre- and post-money valuation. Pre-money valuation is the value the entrepreneur and the angels negotiate before the angels invest. Post-money valuation is the pre-money value plus the amount of the investment, and it used for computing the percentage of stock the founders will retain after the investment by the angels.

In the second article on valuation I noted that one of the factors in setting pre-money valuations is the average regional deal value; that is at what value have other similar deals in the area been done? Since angels tend to invest close to home, the entrepreneur will have to compete for funding locally. Angels will look at the value of other similar deals in the area in deciding what value to offer or accept from the entrepreneur.

Bill Payne is a well-regarded angel investor in Montana. He is a member of the Frontier Angel Fund. The Boise Angel Fund and the Frontier Angel Fund have a close working relationship, from time to time investing in each other’s deals. Bill teaches classes on angel investing for the Angel Capital Association and has made more than 50 angel investments himself.

He just completed a survey of 35 angel groups in 26 states and two provinces. The complete results are available on his blog at http://www.billpayne.com/. His survey asks the question “What was the average pre-money value for investments made by your group in pre-revenue companies?” The average answer was $2.1 million, an increase of $400,000 from the previous year.

However, averages hide a lot of data. Valuations ranged from a low of $800,000 to a high of $3.4 million. Interesting for local entrepreneurs is that the Boise Angel Fund was one of two with the lowest valuation of $800,000. The other was Fargo/Morehead Angels, another group with which the Boise Fund has a relationship. In fairness, the Boise Angel Fund only did one pre-money deal in the past year, so that value was very specific to the deal that was done.

There are several implications for Idaho entrepreneurs.

1. Many Idaho angels have generally avoided pre-revenue deals due to their inherent riskiness. In order to entice investors to accept that risk, you have to offer a terrific deal, which means a low valuation.

2. While it is even more difficult to secure money outside of Idaho than inside, an entrepreneur with a truly exceptional opportunity may want to try to get the attention of non-Idaho groups.

3. Some valuations are skewed by the fact that bioscience and medical device deals typically receive higher valuations at the pre-revenue stage. Most Idaho angels will not do such deals.

4. Your pre-revenue deal will likely receive a lower valuation in Idaho than it might receive in a money center. The cure for this is to not seek funding until your company has secured its first revenue, thereby lowering the risk to investors. With a lower risk profile comes a higher valuation.

In our consulting practice at the Idaho Small Business Development Center at Boise State we frequently work with entrepreneurs to help them set a value on their businesses before they go to the market to raise capital. Our services are free and confidential. Call the SBDC at 426-3875 for an appointment if you would like to discuss your company’s value with one of our counselors.
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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu.

Valuing Early Stage Businesses, Part III, Understanding Angel Math

This is the final article in a series on valuing early-stage businesses from the standpoint of the angel investor.  You can find the earlier articles at my blog, http://kevinlearned.blogspot.com.  Thanks to Mark Woychick, a participant in the MBA Honors Program for his assistance in preparing this series.

In the earlier articles we talked about the riskiness of an investment in your company and how lowering that risk will result in a higher valuation. We also talked about the importance of comparable such as the average regional deal value and similar businesses and about the value of the team.

In this article we want to present the math that most investors go through in order to validate a valuation.  It’s pretty simple.  Take these variables:

1.      How much money does the company need in this round?

2.     How much can the company be sold for and in how many years?

3.     What multiple of my investment do I believe I need to have the potential to earn to justify my taking the risk?

Given the answers to these questions, we can compute a preliminary valuation of the company.  For example:

1.     The company needs $500,000.

2.     The entrepreneur and our own due diligence suggest the company can be sold for $20 million in five years. 

3.     Given the risk profile, we believe we need to have the potential to receive ten times our investment. Therefore we need to have the potential to receive ten times the investment of $500,000 or $5 million when the company is sold.

4.     If the company will sell for $20 million and we need $5 million of the sales proceeds, then we need to own 25% of the company at exit ($5 million/$20 million).

If we need 25% of the company at exit in order to meet our return objective, and IF the company does not need to raise any more funds between now and exit (admitted a tenuous assumption in that most companies will need to raise additional capital which will dilute our ownership), then we can compute the value of the company today as follows:

1.      Money raised, $500,000

2.     Percent of company needed for this investment, 25%

3.     Value of the company after investment (the “post-money” value) must be $2 million.  That is, with a value of $2 million, our $500,000 investment will purchase 25% of the company.

4.     This means the value of the company before the investment (the “pre-money” value) must be $1.5 million (post-money value of $2 million less investment of $500,000).

Most investors will triangulate on a number of different approaches to valuing the company to substantiate the value.  In the above example, they will compare the computed value of $1.5 million to what they believe similar companies in the region are worth.  They may adjust the value up or down depending upon the quality of the management team or the strength of the intellectual property.  They may run a discounted cash flow analysis on the pro forma projections to see how it compares. 

Valuation of early-stage businesses is difficult and as much art as science.  In the end analysis, the value is what the investors and the entrepreneurs can agree upon.  But the well prepared entrepreneur will understand the different approaches and be prepared to negotiate with the investors based upon them.

In our consulting practice at the Idaho Small Business Development Center at Boise State we frequently work with entrepreneurs to help them set a value on their business before they go to the market to raise capital.  Our services are free and confidential.  Call the SBDC at 426-3875 for an appointment if you would like to discuss your company’s value with one of our counselors.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu.

Valuing Early Stage Businesses, Part II, Comparisons

This is my second article on the valuation of early stage businesses. These articles have been written from the perspective of angel investors in the hope that I can give some insight into this mysterious process for entrepreneurs who have to negotiate valuation with prospective investors. I have been assisted in preparing these articles by Mark Woychick, a participant in the Boise State MBA Honors Program.

The focus of these articles is valuation from the standpoint of the investor.  I hope they will give entrepreneurs some guidance in how their businesses may be valued when they seek capital.  I assume your business plan (e.g., business concept, market size calculations, competitors, use of investor capital, etc.) makes sense.

I should point out that in my opinion the traditional discounted cash flow method of valuing businesses doesn’t work for an early stage business. This method may be appropriate for a stable business with an operating history where you can have some confidence in the projections.  But an early stage business has neither an operating history nor stability and therefore projections for such businesses are unreliable. In the many deals I have reviewed, I have never seen an investor do a discounted cash flow analysis.

Last time I discussed the fundamental relationship of risk and return, how the earlier in the business cycle a business is, the riskier the investment is likely to be, and therefore the lower the valuation of the business will be for purposes of seeking investment capital.  Of course this is an important factor but not the only one.  Here are some others that will likely impact the value of the company:

Average regional deal value. Sophisticated investors know the current valuation of deals in their region.  For example, the Boise Angel Fund participates in a monthly phone conference with about ten other angel groups throughout the Northwest.  We talk about the valuation of the deals we are seeing.  This gives us a basis for the initial valuation of a local deal.  For example, we know from this discussion that pre-revenue deals in the Northwest rarely have valuations of more than $2 million, and they are usually substantially less no matter how exciting the potential.   So if you approach local angels for your startup company with a valuation of $3 million, you are likely to not even get to negotiations as your proposed value is completely out of line with what other deals are being done for.

Comparable businesses. If there have been other companies started in your space, then angels may want to use the valuation of those deals as a basis for the valuation of your deal. For example, many Software as a Service (SaaS) deals have raised capital in the last year.  Generally well thought out SaaS deals are valued a bit higher than businesses which carry inventory and accounts receivable as they have the potential to be very capital efficient and to be highly profitable.  

Team. All businesses are dependent upon the quality of the management team.  A superb team with background and experience in bringing a company to market in your space is unusual and valuable.  In my experience, all investors will increase or decrease the value of a business based upon their perception of the management team.

In the next article we will examine the most important, and most difficult component, which is projecting the exit value for the investors and then try to bring all these factors together.  

Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu.