(credit: GapingVoid)

I get this question a lot, so here goes.

A shorter version with 20 Tips is over at US News.
Assuming you have used up your personal funds, and that you need outside capital to develop your business, here are some ideas on raising outside money for your business.

First, you should be able to show how you can make the investor more money than he can make investing in some safer investment vehicle. This means you need to develop a business plan that shows how he can invest a dollar today and over the next 5 years, and that dollar will increase in value by (rule of thumb) 30-50% each year.

Ah, the valuation question comes up now. One can google on ‘valuations for startups’ but here is a shorthand version: How big will your business be in five years and how much net profit will it make? You can look up PE multiples for your industry—to keep it simple, let’s say your industry PE is 20. If your business can make a million dollars net, then you multiply a million dollars by the PE of 20, and voila—in five years, if you have this level of success, your business is worth $20 million. Continuing the example, if you had 20 investors, all equal, each would own $1 million worth of stock in NewCo, at that point in time. What would they be willing to pay now to get a $1 million ‘win’ in five years.

Backing up to the starting point, if you only have an idea, maybe a prototype, maybe a person or two, how much is your business worth today? Remember that ideas are basically FREE. This means that if ideas themselves were marketable, there would be some kind of eBay market for them. Last I checked, there wasn’t. Your task is to put some substance around the idea, in all the forms you can imagine…actual customers paying you money for your product and service, repeating it again, a good management team, and so forth.

So, roughly, your idea with some enhancements, let’s agree is worth $1 million. If that sounds too low, keep it in perspective. Would you sell it for that amount now? How long have you really, truly worked on it? How much money did you invest so far? Do you know how hard it is too accumulate $1 million?

Moving on, we agree that your business today is worth $1,000,000. You have a plan that will cost you $250,000 to execute. Have a realistic plan—this $250,000 will finish the prototype and get some customers to try the product. You will hire your first team members. The business goal is simply to get to the next stage of the business.

This money will be the most expensive money you will raise. It is the riskiest money and you should structure the return to allow for this. It is like you are asking your investors to buy a condo being built on swampland. The builder says he can, the brochure looks great, but he needs YOUR money to drill into the swamp to make sure the foundation can hold the building. You may want to be the first buyer in this project, but your price should be significantly lower than the later buyer who buys the last unit. Same-same.

At each milestone, the value of your business increases. So your plan should identify those milestones, which will allow you to increase the valuation over time. A good valuation model might look like $1 million today, to $3 million in a year, to $7 million in two years, and will allow for three raises of new money, each at this higher valuation.

Ok, let’s say you are prepared to sell 25% of your company today for $250,000.

First, find a good attorney and have him put together a private placement memorandum. You can do the business planning part of it, but have someone with experience do this actual document. This is absolutely necessary if you are raising money. Do not skip this step.

From now on, every dollar put into the business by you and others, will be accounted for properly. Your attorney can create pool of stock, maybe 20 million shares but for right now, only 1 million have been issued. You own 750,000 of them which you earned by sweat equity, your idea and some cash that you invested already. You can raise the $250,000 by finding ten people, angel investors who believe in YOU and the idea enough to invest $25,000 each. For this example of an investment, they get 25,000 shares for a $1 each.

Here is where my advice might be a bit different. The lawyer is going to talk about different ways of raising money. You can form an LLC, do convertible debt deals, or preferred stock offerings.

I recommend that you only consider doing common stock. Common stock is easier, simpler to understand, and gives everybody the same type of security. Your investor pitch needs to be simple to these angel investors—and common stock is the only way to eliminate confusion. It is hard enough to find an angel investor and once you find him, why let any confusion at all creep into the discussion.

By going the private placement route, you are limited to the number of individuals you can bring in as shareholders if they are not accredited. You can get as many accredited investors as you want, those are people with a net worth of over $1 million or who make at least $200K/year. You must follow this exactly.

The real issue becomes how do you find angel investors. They are out there, in a lot of different forms. Some are your neighbors, some might be potential vendors or customers. Some belong to investing groups, there are people who love being involved in startups. They do it for a variety of reasons, some are almost patriotic, others look at the price of their GM stock and think, why not, this might be the winner I need to balance my stock portfolio. Investors can invest in startups even via their IRAs, by the way.

Be prepared to tell and show your story countless times to investors. You should spend as much time raising money, as you do working on the product itself. Your job as founder is simply to NOT run out of money. And, no one else can do it for you, no matter what they say.

Here are ten more “learnings” over my career in raising money for three startups:

1. Everyone is a prospective investor. One of my investors was an old baseball coach-friend of mine who I happened to see at the gas station.
2. If someone offers to find investors, only pay upon success and only a small percentage of what they actually raise, no more than 10%. Tell your attorney what you are doing.
3. Future rounds of financing may get more complicated, which is fine and necessary. If you can get your first round done as common stock, you will write me later and thank me.
4. Keep your investors in the loop. More than likely, they invested in you and in your dream. They want to participate along the way. This is doubly important because you may want to ask them to invest more, so you need to maintain contact and information.
5. Run the company as you would a public company. As soon as you bring in outside money, you have real partners. Treat them that way.
6. A guiding principle for investor presentation: after the meeting, when the investor goes home, what does he say? Keep your pitch simple and passionate. Keep the offering price less than $3 per share.
7. If you think it will take 3 months, what happens if it takes six? Will the money last while you are fixing problems?
8. Nothing is more important than getting the money. Wait, one thing is: getting someone to buy your product or service. If they buy it again, you probably have a financable business.

9. Be prepared to show how the investor will get his money-investment back.

10. There are many people who want to invest in a new company just like yours. Your job is to find them. You can do it.