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Berkonomics

Raise cash from trusted, close resources first.

This insight follows closely the conclusions from the previous declaration, that professional investors negotiate tough terms, from provisions of control over asset acquisition, eventual sale of the company, future investments, forced co-sale when others attempt to sell their shares and more.  And yet, in an earlier insight, we spoke of the problems that come when taking unstructured investments from friends and family.  So how does the statement above fit into this sandwich of alternatives?

                Trusted, close resources include sophisticated relatives, friends and business associates who know how to structure a deal as a win-win for you and for them, while allowing you to retain control over your vision and execution.  Their investment should be structured with the help of a good attorney who understands the mutual goal of maximum leverage of funds with minimum interference in your business decisions. 

                Remember the admonition that investment from such close sources carries an additional burden for you – to protect your investors and their investment as if they were your alter egos, offering money as if from your own pocket.  Such money should never be taken without clear understanding of the terms, whether a loan with a reasonable interest rate and strict repayment terms, or an investment valuing the company at an amount considered reasonable by a third party professional, even if as a sanity check as opposed to an appraisal.  This money is personal, an investment in you as much or more than in your company.  The degree of care you take increases with the reduced distance between you and your investor. 

                [Email readers continue here…] My very first investment as a professional angel was in a small startup where the entrepreneur’s vision fueled my imagination in the audio market niche where I had run a business in an earlier life.  I was so enthusiastic that I coached the entrepreneur to approach his mother, who invested $50,000 under the same terms as my investment.   A small venture firm and a few more angels rounded out the total investment.  As the company grew and became profitable, it became more visible to others in the market niche.  Two of us who invested served on the board of the company, advising the first-time entrepreneur with our business and industry experience.  Several years later, with the approval of the board and entrepreneur, I was able to engage a very well-known potential acquirer of the business who offered an attractive price for the still-young but successful enterprise.  After weeks of negotiation, the entrepreneur suddenly disengaged, claiming that he was no longer interested in a sale of his company.  The rest of us were shocked and disappointed that after weeks of work and a fair price, we were left with nothing but to follow his lead and disengage.  Shortly thereafter, in a board meeting, I brought up the issue of starting to pay board members for service in cash or in stock options, typical for outside board members but rarely for investors.  The entrepreneur was angry, abusive, in his negative reaction to even bringing the issue to the board for a discussion.  Five years had passed from my original investment in what I now clearly perceived as investment into a lifestyle business, one where the entrepreneur had no interest in selling or sharing.  I resigned from the board on the spot and negotiated a sale of my stock to the entrepreneur at five times the earlier investment, a fair return for both, since the company was by then worth much more.  It is now years later, and his mother along with other early investors are still in the passive game, not likely to see liquidity from this mistaken investment in an entrepreneur unwilling to take money in exchange for the eventual promise of liquidity.

                Why tell this story at all?  Mother is surely satisfied as a passive investor who probably would have given her son the money without structure.  The other investors are probably in the unhappy never land of not being able to see liquidity after a decade and unable to write off the investment as a loss for tax purposes.   This story would probably have ended in a lawsuit if a larger professional investor had been involved, since the entrepreneur did not follow the rules and seems to have no desire to do so.

                Trust works both ways.  Take money from close resources, but treat it as if the responsibility is even greater to protect the investors and their money than from a professional.   These investors trust that you will do the right thing for them if at all able.

  • Tim S

    Dave or Anyone..,

    I have given thought towards the sweat equity process as a means for obtaining the funds needed in order to file the NPPA. I expect to share the royalties once the NPPA has been approved and the method is licensed, or sold.

    My problem is finding the right source to obtain the funding needed. Obviously I am not talking to the right type of VC. For instance, all angel groups are asking for a business plan, projections, etc. I am not a business. My idea is not a widget. It is what’s labeled as a process/method. I am being told by very smart people, “Whoever purchases the right to your idea will immediately take you (the inventor) out of the equation.” That is understandable.
    So, I am searching for direction in finding the right audience to ask for the funds.

  • Tim,
    There are more ways to approach fundraising. Luis VillaLobos was most successful in forming an investment group around a royalty stream, understanding that there was no probability of selling the royalty-generating entity. You might consider the same – sharing royalties in return for investment.
    -Dave

  • Your insight has been helpful in so far as I am going through a learning curve on raising capital. My dilemma is I have a system/ method with a PPA. My next step is to raise funds for the non provisional patent application. I do not own a business, nor do I wish to. Who should I approach for this kind of assistance? Needless to say, the entity from which I receive the funding will receive a percentage of the royalties from the sale or license to the patent. Yes, the due diligence has been performed. Friends, family, and bank loans are not an option for me to raise the capital.

  • Erik

    Dave, this was very helpful for me because I had what I think is a similar experience. I worked for stock over a three year period where an engineer/inventor had a great product. I took it from patenting, to strategic supplier alliances, to an establish relationship with a major aerospace prime customer, to single handedly getting 1M in the defense budget in a four month time frame to have that product integrated into that customer’s product at their request, and brought in three investor groups that gave term sheets structured exactly like what our attys (Brobeck) said they would look like for our exit strategy if it ever came to pass. Now that I had funding and a govt contract in the pipeline, this guy did a 180 and rejected the deals leaving many angry people behind. I immediately left feeling I wasted three years of my prime. Today, he is still in a garage.

    Reading your insight and similar experience helped me better understand my own experience and come to a place of release.

  • Carlos,
    I do not sit on for-profit boards unless I have stock, and recommend that all potential private company board candidates plan to participate only if they have an equity stake. On the other hand, minority investor board members should expect non-qualified stock options vesting over a two-to-four period for their board services, time and risks involved. In future posts, I will lay out typical percentages granted in options to board members and advisory board members…
    -Dave

  • Dave,
    It’s pretty remarkable that on your first angel investment you received 5x in 5 years. Nice.

    You mentioned you wanted the entrepreneur “to pay board members for service in cash or in stock options….”. Dave, of all the companies you’ve been involved with, how many boards have you agreed to sit on, where you did not inject a “major” amount of capital, or any at all? Instead you asked to be compensated with cash or stock?

    -Not including not-for-profits of course.

    -Carlos

  • Nathaniel,
    There were no signs from the entrepreneur up to the time of the final negotiation for the company sale. In fact, two directors (including myself) and the entrepreneur actively negotiated with the buyer at the buyer’s facility located in a distant city.
    -Dave

  • Dave, did you notice any signs from the entrepreneur that he was beginning to see it more as a lifestyle business as time went on? Or was it an abrupt “Nevermind.”?

    I’m interested to learn if there are some common signs to watch for, and how to react as an investor.

  • all of us at some point in time when we either wake up in the morning or before going to bed at night, are faced with a mirror and our images. Friends come and go but they are the record of one’s activities, more vivid and telling than Homer coming in around the fire to tell the story of honor and bravery before the walls of Troy. Blood may not be in all cases thicker than water, but that is your genetic code and if you are not straight with them, the mirror becomes very large and very revealing indeed. Taking money from F&F is a two edged sword. On one hand who better would know you and your integrity but the dark side of the blade is that the person they think they know in order to put money in, has to be that person. Tough standard.

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