Your Entrepreneur World Changes When You Take Money

The naïve entrepreneur thinks he can relax, after he finally cashes the check from a professional investor, but in reality that’s when the work and the pressure starts. His first reality reset is that now, maybe for the first time, he really has a boss, or several bosses, and often very demanding ones at that.

Angel and venture capital investors rarely just give you the cash, and stand back to wait for you to spend it the way you want. First of all, they are usually more experienced than you in your own business domain, so they have strong views on what it takes to succeed, and probably would prefer it done their way.

Secondly, they probably didn’t give you all the money up front, but made a good part of it contingent on meeting some milestones. Your startup is now part of someone’s portfolio, and here are a few of the ways in which you should expect to be monitored by your investors:

1. One or more seats on the Board. Maybe you had an informal Advisory Board before, but now you have a formal Board of Directors. That means you shouldn’t expect to make any strategic decisions or pivots without their approval. You should also plan for a formal presentation to the board each month, with many communications in between.

2. Manage to documented milestones. A normal part of a funding agreement is a set of accomplishments, with dates, that you are expected to achieve in order to remain in good standing and qualify for remaining distributions. These are not optional suggestions, so treat them as management objectives that will get you fired if you don’t perform.

3. Personal visits from key investors. Both angel investors and venture capital partners like to make personal visits to your facility or a regular basis, sometimes unannounced, to see how the business is running. You should expect to personally host these visits, and openly answer any questions or concerns that are raised. Do not delegate.

4. Number of proactive contacts from you. In addition to the visits, every investor expects to be contacted and updated proactively and judiciously on key decisions or issues. A quick way to lose investor confidence is to always wait for the investor to call, or inversely to call the investor incessantly for every minor decision.

5. Access rights to operational information. All investors have information rights which are detailed in the shareholders rights agreement. These are usually extrapolated to mean they expect you to share key operational data, such as the sales pipeline, vendor discussions, and quality issues, at any time. Don’t keep secrets from your investors.

6. Extra focus on cash flow. Remember, it’s their cash, so treat it like gold. Because you now have money in the bank, now is not the time to lease a lavish office building, or travel around the world first-class on company business. Pinching pennies like you did in the early days is still the only approach.

It is also to your advantage to keep track of how your company performance compares to others in the investor’s portfolio. You may think you are doing well, but if your numbers put you at the bottom of their ranking, you may need to decide that taking more risk is better than the risk of being cut from the pack.

On the other end of the spectrum, if you are one of the top performers, a VC may “encourage” you to take big risks and swing for a home run, even when a base hit or double would be a smarter move from your perspective. In other words, you no longer have full control, and you don’t need any surprises, just like the investor doesn’t want any.

The simple fact is that your whole world as an entrepreneur changes when you take someone’s else’s money. Do it with your eyes open. Investor relationships are like social relationships - sometimes it’s better to be alone than to wish you were alone.

Marty Zwilling

How to Give Your Startup Idea The Sniff Test

I have a certain friend who called me a while back, all excited about his latest revelation. “What if you could go to a web site and find all the recipes you could make today, with just the ingredients you already have in your kitchen? I’m going to start a website to offer this service!”

I’m sure you all realize that there could be quite a distance between a great idea and a great startup. But many people don’t have a clue on how to bridge the gap. So, trying carefully not to rain on his parade, I suggested to my friend that he complete the following analysis as due diligence on the idea before spending his life savings (and others) to roll out a solution:

1. Competitors are few. Use Google or one of the many other search engines to search for existing solutions to this problem. A search argument like “recipes from the ingredients you have on hand” might be the place to start. If you find ten competitors who already have this offering, it’s probably not worth going any further.

2. No known patents filed. Maybe the solution hasn’t yet been commercialized, but a patent has been submitted by someone else, putting your idea in jeopardy. Another series of searches on Google Patents and the US Patent Office site and Free Patents Online is in order at this point. Of course, you could pay a Patent Attorney a few thousand dollars to do the same search.

3. Large and growing market. Investors will expect market analysis data from a “credible unbiased third party” – that means a nationally known market research firm like Gartner, Forrester, IDC, or many others. Hopefully, you will find, with your favorite search engine, something like the “Cooking Sauces & Food Seasonings Market Report 2012.”

4. Real customer pain and money. Your own conviction that if you love the product, everyone will love the product, doesn’t count. Customers may “like” a product, but will generally only pay for things they “need,” physically or emotionally. Talk to experts in this domain (chefs, home cooking fanatics), and listen for hidden requirements and challenges.

5. Whole solution viability. Many products fail because of “dependencies” and hidden costs. Auto engines that burn hydrogen are “easy,” but getting service stations around the world and new safety legislation takes decades. Make sure you understand all costs, sales channels, marketing requirements, and cultural issues.

6. Motivated and qualified team is ready. The most critical step is to decide if you really have the passion, experience, and team for creating this solution and business. Startups are tough on even the most dedicated and passionate founders – others will likely fail, and definitely be unhappy. No idea is worth that.

I’m sure that many of you could add additional “idea due diligence” items, from bitter experience, that I’ve neglected to mention. By the way, if team experience and resources are the only limitation, it is better to give your idea away to a qualified group, rather than selfishly sit on it, or run it and yourself into the ground trying to make it work. Nobody wins with that approach.

In case you are wondering what happened to this recipe idea, try the search I suggested and you will find a dozen sites that already claim this capability. Needless to say, after I did the work, my friend decided to quit talking about this one.

But he will be back, he always is, and one of these days he may find an idea that someone can make a reality. It won’t happen for him, because just talking about an idea doesn’t start any business. Am I the only one with a friend like that?

Marty Zwilling

Startup Runway Length Depends on Your Burn Rate

Cash is the fuel of every startup. Your burn rate is the rate at which that money is being spent, and allows an estimate of how long you can go before refueling (runway). That refueling is when you will need more investment, or when you will break even and begin that steep profitable growth curve.

Investors also look at your burn rate to see how efficient and effective you are at running the business. It continually amazes me how two startups, seemingly comparable in stage and objective, can be so far apart in their burn rate. One can build a new website application for $10,000 per month, while another is burning $50,000 per month. Which would you bet on?

For obvious reasons, you need to keep your burn rate low. As a rule of thumb, investors expect each investment round you get to last at least a year to 18 months. Here are some recommendations on how to keep the rate low, and help your startup to prosper at the same time:

• Measure it and manage it. As a rule, you need to review your burn rate every month, and manage it every day. The components are simple - expenses and income. If you don’t have any income, the job is even simpler, be ruthless about controlling expenses. Think twice, at least, before committing to any big outlays, and add up small ones.

• Include buffer when you raise money. The cost of giving up more equity early is often more than offset by the increased flexibility to recover from mistakes. Your startup will require more money than you expect, and the cost of going back to the well is very high. It takes time, the well may be dry, and you look bad for not getting it right the first time.

• Pay people with equity or future revenue. When I was interviewed for my first startup CEO job, I was expecting a $150,000 salary, but instead was offered an opportunity to contribute $50,000 to the business, and work for equity only. Great strategy. Another one to avoid cash burn for software development is a contract for percent of future revenue.

• Do it yourself and barter for services. Do you really need that full-time assistant, regular bookkeeper, and big-name attorney? There’s tremendous leverage in learning to use Microsoft Office, QuickBooks, and how to Google for sample contracts and the latest tax changes. Be humble and offer to clean all the offices, if you can use one for free.

A good rule of thumb for most startups is a burn rate of less than $50,000 per month. For example, a web-based startup should be able to operate for a year if they raise $500,000 from the founders or angels. This will equate to 2 working founders (taking no salary), hiring a 5-person development team for a year.

The cash will be burned on the team salaries and operating expenses of the startup, and should provide enough runway to build an initial product, get a few customers, and an initial revenue stream. That will position the startup to raise a venture round at a favorable valuation.

Always make sure you’re putting the money in the right place. That may mean waiting till you have a product before you add salespeople. Or manufacturing some product inventory to sell, before acquiring office furniture that makes you feel good. Focus precious cash only on producing revenue for your startup business.

Of course, a projected burn rate can’t account for expensive mistakes and unusual challenges along the way. For these, you need a little reserve and a lot of luck. Be forewarned that taking out loans and accumulating debt is not a long-term solution to the cashflow challenge. It’s too easy, and it bites you in the end.

Controlling your burn rate is the only way to get the confidence and resources to ramp up your startup business the way you want. If you forget to check and manage this compass within your new business, you could run out of cash before you reach breakeven – and find yourself managing the ashes.

Marty Zwilling

Here is Why You Need a Good Startup Exit Strategy

If your startup is your dream, why would you want to think about an exit? It’s going to be so successful and so much fun that you don’t need to think about what comes after. Wrong. There are two very real and practical reasons why you need to plan an exit:

• Outside investors want to collect their return. Remember that equity investments are not like loans with interest. The investor sees no return until he cashes out, or the company is sold. Even three years is a long time to wait for any pay check.

• Entrepreneurs love the art of the start. Assuming your startup takes off, you will probably find that the fun is gone by the time you reach 50 employees, or a few million in revenue. The job changes from creating a “work of art” to operating a “cookie cutter.”

In three to five years, you will be anxious to start a new entity, with new ideas and spinoffs that have built up in your mind, and certainty that you can avoid all those potholes you hit the first time around. If your startup was less than a success, you’ll definitely want to erase it from memory.

So here are the most common exit strategies and considerations these days for planning purposes:

1. Merger & Acquisition (M&A). This normally means merging with a similar company, or being bought by a larger company. This is a win-win situation when bordering companies have complementary skills, and can save resources by combining. For bigger companies, it’s a more efficient and quicker way to grow their revenue than creating new products organically.

2. Initial Public Offering (IPO). This used to be the preferred mode, and the quick way to riches. But since the Internet bubble burst in the year 2000, the IPO rate has declined every year until 2010, and is now at about 15%. I don’t recommend this approach to startups these days. Shareholders are demanding, and liability concerns are high.

3. Sell to a friendly individual. This is not an M&A, since it is not combining two entities into one. Yet it’s a great way to “cash out” so you can pay investors, pay yourself, take some time off, and get ready to have some fun all over again. The ideal buyer is someone who has more skills and interest on the operational side of the business, and can scale it.

4. Make it your cash cow. If you are in a stable, secure marketplace, with a business that has a steady revenue stream, pay off investors, find someone you trust to run it for you, while you use the remaining cash to develop your next great idea. You retain ownership and enjoy the annuity. But cash cows seem to need constant feeding to stay healthy.

5. Liquidation and close. Even lifetime entrepreneurs can decide that enough is enough. One often-overlooked exit strategy is simply to shutdown, close the business doors, and liquidate. There may be a natural catastrophe, like 9/11, or the market you counted on could implode. Make rules up front so you don’t end up going down with the ship.

To some, an exit strategy sounds negative. Actually, the best reason for an exit strategy is to plan how to optimize a good situation, rather than get out of a bad one. This allows you to run your startup and focus efforts on things that make it more appealing and compelling to the short list of acquirers or buyers you target.

The type of business you choose should depend on your goals, and the way you grow it should be aligned with your exit strategy. Don’t wait till you are in trouble to think about an exit, rather think of it as a succession plan, or a successful transition.

Marty Zwilling

8 Ways to Surf the Entrepreneur Information Wave

Being an entrepreneur these days requires an understanding of a thousand topics, many of which don’t even exist today in traditional learning vehicles, like schools and textbooks. The Internet and its information wave have changed everything – it’s the problem, with constant change, and it’s the solution, if you use it to navigate quickly and self-educate.

True entrepreneurs love to learn, unlearn, and relearn, whether they are 20 years old, or 60 years old. A new business means change, so they deal in change, and relish the journey. Usually it’s called initiative, dedication, and can-do attitude.

But under these words are some common principles that every entrepreneur needs to follow implicitly or explicitly, to keep up with change, and actually make change:

1. Stay open to learning. Unlearning and relearning doesn’t require that you toss out any of your accumulated experiences or know-how. It just requires a relentless focus and willingness to do better things, and accept better ways of getting things done.

2. Challenge your assumptions. Resist the instinctive urge to only use your proven assumptions. When you believe you know the best way to do something, you are less willing or open to unlearn it or try something new. Routinely check the Internet for alternate approaches.

3. Strive to understand, rather than memorize. You have to understand why you do things a certain way, before you can hope to improve, or even recognize a new and better way. You have to understand why people need something they don’t have, before you can create it, or market it effectively.

4. Share what you do know. The process of sharing what you know forces you to better understand it yourself. When I do mentoring and writing about current experiences, I realize all the things I don’t know, and this gives me more incentive to learn more.

5. Never assume you can’t learn something. With the Internet, new things are much easier to learn than many years ago, when you had to wait for the textbooks and the experts. Perfecting your knowledge is like dealing with competitors, if you aren’t gaining on them, you are rapidly losing ground.

6. Actively look outside the box. The Internet today, with its vast array of sources, and sophisticated search engines, is the perfect vehicle to take you out of your known realm, and allow you to make your own rules. Take the time to follow a couple of results you would normally discard, and you will learn something every time.

7. Focus on relationships. Business relationships with people who know things is the only way to trump the Internet. Their expertise, and their ability to explain it, are a combination you can’t match any other way. You can’t know too many experts, and social networks are the new way to find them.

8. Don’t be afraid to ask for help. Avoid the arrogance trap of never asking for help or asking for feedback. The more open you are to other input, the more accurate your sense will be of how other people perceive you, and which actions to unlearn. At least with the Internet, you can ask for help anonymously.

Entrepreneurs who depend on the ‘traditional’ learning process (schools, formal classes, practice problems, and risk-free iterations) are doomed in founding a startup. Either they never get started, they take too long, spend too much on experts, or they fail using obsolete methods.

Yes, our education system is part of the problem, still pushing the traditional learning process (which bores the kids of today), and our culture is part of the problem, where everyone assumes they will learn all they need in the first 30 years, and can relax and enjoy their leadership role after that. But if your business fails, you are the problem.

If you haven’t started yet, the first thing you need to learn is how to use the Internet effectively. If you are thinking classes and training, you are already in trouble. Try the Internet today – you can’t break it, and it won’t break you. You can ride the information wave, or be swamped by it.

Marty Zwilling

10 People Who Will Drain Energy From Your Company

Every organization, no matter how small, has one or more people who are quite simply obnoxious, and they drain energy from everyone and can strangle your company. Sometimes they are also intellectually brilliant, or closely related to the boss, so there is no easy way out.

In fact, they may even be the boss. So if you find this article taped to your desk, it may be time to look in the mirror. At any rate, if you are stuck working in an office, at least you deserve some clues on how to recognize the different types, and know it’s time to run:

1. “I knew that was going to happen.” This know-it-all has an answer for everything, and is proud to let you know, always after the fact, that they actually predicted ahead of time every calamity that has befallen the world and the office.

2. “You wouldn’t believe my latest conquest.” For the loudmouth, the word ‘discreet’ isn’t part of his dictionary at all. His conversations at the water cooler, or on the phone, always seem to be audible across the whole office.

3. “I’m so angry I could scream.” In my view, people with short fuses and anger issues ought to be banned from the workplace. People are always “walking on eggshells” to avoid creating another outburst, and office tension stays at an unhealthy high level.

4. “Have you heard the one about…” Every office has the joker, and he particularly likes to shock people with crude or off-color stories. He doesn’t seem to take anything or anyone seriously, and especially loves his pranks on shy people who blush easily.

5. “I’m so busy, I don’t have time…” The whiner will always be complaining about how busy they are, and how many hours they put in, but you can never quite see anything they have accomplished. But they always seem to find time for talking loudly on the phone, or discussing the latest gossip.

6. “I have no life.” Woe is me, and I’ll be happy to tell you the gory details of all my lost loves, my amazing string of illnesses, and the strife in my family. These people will definitely suck the energy out of everyone.

7. “I’m so worried about the project.” Always in a state of panic, these people bring stress to the whole office, just by their hand-wringing, hovering over people’s desks, and nagging everyone to double-check for the dire consequences of possible mistakes.

8. “I need a moment of your time.” We all love to help people, but when the request happens ten times every day, and for the same trivial issue, your blood pressure is bound to go up. It’s not efficient to have two people doing every job.

9. “I’m surrounded by idiots.” This person has an ego the size of a mountain, and won’t listen to anyone long enough to assess whether they are a genius or an idiot. In the long run, their statement will be true, because all rational people will have run away.

10. “This world isn’t fair.” This type is often associated with Gen-Y, but some people seem permanently afflicted as they get passed over for promotions. As Bill Gates said a while back to a high school graduation crowd “Life is not fair – get used to it.”

I’m sure I missed a few obnoxious types here, so help me out with additions, and tell me how many of these you have in your office. I wish I could give you specific solutions and antidotes, but that’s a bit tougher, and maybe the subject for another article. In general, survival requires large doses of tolerance, patience, and the ability to turn your ears off.

If it’s your company, you can’t just ignore it. If you recognize several of these types on your team, you need to do something now, before they have sucked the life and energy out of your dream. Tolerance for you is not an option. People will follow your leadership, or lack of it.

Marty Zwilling

Presenting Your Case to Investors is Rarely Free

If you are new to the startup space and Angel investing, you probably don’t realize that some groups of Angel investors charge entrepreneurs a fee to pitch to their groups. This practice has caused a rousing debate among key players, with some calling it a scam, and others defending it as necessary to cover expenses.

Jason Calacanis, a well-known entrepreneur and Angel investor, opened the debate a while back in a strongly-worded article on his blog which attacked the practice on ethical grounds, and called out popular Angel groups charging fees ranging from several hundred dollars to $5,000 or more. He calls these a scam, and “Angel group” payola.

Others, including noted Angel David S. Rose, founder of the New York Angels and Gust, have spoken out in defense of the practice, at least for smaller amounts, commenting that, aside from covering expenses, it also provides a degree of “filtering”. In reality, these fees are usually trivial compared to your real costs of preparing, travelling, and presenting to investors.

While I’m definitely a proponent of full disclosure to prevent surprises, I see nothing wrong with experienced investors charging a fee for listening and evaluating startup proposals, and providing feedback (or funding) to entrepreneurs to help them achieve their objectives. Lawyers and other professional consultants have done this for generations.

I have long recommended that entrepreneurs do their own “due diligence” on potential investors and Angel groups before they waste their time and hard-strapped funds, and here are some additional thoughts for entrepreneurs thinking of paying to pitch their case to investors:

• Be realistic about expectations of funding success. According to the latest data from Gust, only about 3 out of 100 companies who initiate the formal funding request to Angel groups actually get funded. Entrepreneurs who expect to get a hit the first time (or first five times) they pitch their story cold are likely to be disappointed.

• Improve your odds by networking and warm introductions first. With the rise of social tools, potential investors are increasingly more accessible outside the pitch room. If they know you by a warm introduction from a friend well before the pitch, or you have one or more advocates in the room, your odds of success go up dramatically.

• Evaluate feedback from individual investors first. If you have been given private introductions, but the investors declined to hear your pitch, don’t assume that paying money or presenting to larger numbers will solve your problem. There is probably a fundamental problem with your business or how you present it. Find and fix that first.

• Weigh the cost against the track record and “reach” of a specific Angel group. A fair question to ask any Angel group, fee or no fee, is “What is your track record of funded investments, versus number of pitches?” Spending $1K to get $1M is usually better than spending nothing to get nothing. Does their “sweet spot” match your type of business?

• Consider your startup stage. If you’re in seed-stage with young, first-time founders, and think you’re ready to raise some capital, your odds of funding success are so low that I would skip the fee alternatives. On the other hand, if you have solid revenues, good growth, and need to scale faster, it may be worthwhile to get to the best Angels in town.

• Don’t wait until you are desperate. Investors can spot an out-of-money entrepreneur a mile away. They won’t even notice that you are angry because you had to pay for the opportunity, and they won’t fund you on principle, since it doesn’t appear that you can manage your plan very well.

I’m convinced that most Angel investors are not out to squeeze a dollar from poor cash-strapped entrepreneurs, as implied by Jason. They are, however, always looking for better ways to make use of their time, and quickly find the entrepreneurs who have the best case and the least risk. Their only real gain is from a win-win situation, and it’s up to you to take the right first step.

Marty Zwilling

Every Entrepreneur Needs a Mentor, but not a Critic

The dictionary definition of a mentor is “an experienced and trusted advisor,” or “leader, tutor or coach.” The definition of a critic sounds similar, “a person who offers reasoned judgment or analysis.” The big difference, of course, is that a mentor looks ahead to help you, while a critic looks backward to tell you what you did wrong.

We can all learn from both of these approaches, but in my view the mentor is far more valuable than a critic. A mentor’s goal is to help you build your strengths to avoid problems and pitfalls, while a critic feels compelled to point out your weaknesses.

The job of entrepreneur is tough enough without a critic on your team, second-guessing your every move. Here are some tips on how to recognize whether a partner, consultant, or employee is a mentor or a critic:

1. Earns your absolute trust. One of the key characteristics of a successful mentor relationship is trust. You should be easily convinced by actions and attitude that the mentor candidate has your best interests at heart.

2. Mutual respect. You and your mentor must have total respect for each other and show professional courtesy toward each other. A critic is more inclined to offer advice through cynical witticisms, whether they consider you a peer, boss, or employee.

3. Able to communicate directly. Your mentor must be able to clearly communicate his/her expectations and boundaries consistently, whether face-to-face or via email. Critics often prefer to deliver their message to your friends and peers.

4. Similar ethics. You and your mentor should adhere to the same ethical rules, as defined by your business and government community. You will be uncomfortable with critics whose ethical positions are not clear, or vary widely from yours.

5. Long-term relationship potential. Mentors play important roles in the careers of most successful entrepreneurs. The relationships with good current mentors likely will continue and often grow into strong friendships. Most people cannot tolerate a long-term relationship with their critic.

But try as you might to avoid them, we all have to deal with critics and the criticism they offer. Everyone reacts differently to criticism. Here are some tips on how to avoid any extreme reactions to criticism, like confrontations and angry debates:

• Don’t take it personally. One reason people get angry at being criticized is that they take the criticism as a personal attack, rather than a comment on performance. Or they think the person criticizing them is trying to ridicule them. This is not always true.

• Take suggestions from anyone. Sometimes people get angry when they are criticized by others who are younger or older, or not familiar with the subject. That’s a bad move. Commit yourself to always looking only at the content and not who is offering it.

• Don’t reply immediately. Don’t push to reply to a criticism in progress. Allow the point to be made completely, then think a moment before you start any response. First find an agreement portion, ending with points you do not agree on.

• Smile and don’t get angry. It always helps to smile when you are being criticized. This will help you create a non-confrontational debate and shows that you are confident in what you think.

Most critics I know think they are mentors, but I’ve never known a good mentor who is easily mistaken for a critic. If you listen to yourself, you can tell the difference. Are you asking forward-looking questions, or making negative assessments about past events? It’s hard to be a leader if you are always looking backward.

Marty Zwilling

Entrepreneurs Due Diligence on Investors Is Smart

Due diligence should always be a two-way street. A while back, I published an article on “Startup Due Diligence Is Not a Mysterious Black Art,” describing what investors do to validate your startup before they invest. Here is the inverse, sometimes called reverse due diligence, describing what you should do to validate your investor before signing up for an equity partnership.

I’ve had startup founders tell me that it’s only about the color of the money, but I disagree. Particularly if you are desperate, keep in mind the person who finds a good-looking partner to take home from the bar at closing time, but then wakes up in the morning wondering “What did I just do?” Taking on an investor is like getting married – the relationship has to work at all levels.

Due diligence on an investor is where you validate the track record, operating style, and motivation of your new potential partner. Maybe more importantly, you need to confirm that the investor “chemistry” matches yours. Here are some techniques for making the assessment:

1. Talk to other investors. The investment community in any geographic area is not that large, and most investors have relationships or knowledge of most of the others. Of course, you need to listen for biases, but local angel group leaders can quickly tell you who the bad angels and good angels are, and what kind of terms they typically demand.

2. Network with other entrepreneurs. Contact peers you have met through networking, both ones who have used this investor, and ones who haven’t. Ask the investor for “references,” meaning contacts at companies where previous investments were made. Don’t just call, but personally visit these contacts.

3. Check track record on the Internet and social networks. Do a simple Google search like you would on any company or individual before signing a contract. Look for positive or negative news articles, any controversial relationships, and involvement in community organizations. Check the profile of principals on LinkedIn and Facebook.

4. Spend time with investors in a non-work environment. As with any relationship, don’t just close the deal in a heated rush. Invite the investment principal to a sports event, or join them in helping at a non-profit cause. Here is where you will really learn if there is a chemistry match that will likely lead to a good mentoring and business relationship.

5. Validate business and financial status. Visit the firm’s website and read it carefully. Look for a background and experience in your industry, as well as quality and style. Conduct a routine credit and criminal check, using commercial services like HireRight. Be wary of individuals or funds sourced from offshore.

If you think all this sounds a bit sinister and unnecessary, go back and read again some of the articles about Bernie Madoff and the most common investment scams. Remember, if it sounds too good to be true, it probably isn’t true. Entrepreneurs are optimists by nature, so I definitely recommend the involvement of your favorite attorney (usually the pessimist).

I recognize that it has been tough to raise capital these last couple of years, but don’t be tempted to take money from any source. This can be a big mistake, with common complaints running the gamut from unreasonable terms, constant pressure, to company takeovers. Be vigilant and ask questions.

A successful entrepreneur-investor agreement better be the beginning of a long-term relationship. If you don’t feel excited and energized by your first discussions with an investor, give it some time and do your homework. If the feeling doesn’t grow, it may be time to move on. It’s better to be alone than to wish you were alone.

Marty Zwilling

Red Flags To Avoid When Talking About Competitors

One of the most important questions you will be asked by potential investors is how your solutions beats the competition, not just today, but over the three to five year life of their investment. There is no perfect answer to this question, but there are many wrong answers which will immediately jeopardize your credibility.

The concept is called “sustainable competitive advantage.” A good answer might be “We have several patents on the base technology, which is so robust that we expect to roll out new products every year for the next ten years, always staying a step ahead of our competitors.” That implies competitive now, a strong barrier to entry, and the potential to stay in the lead.

We all recognize that there are no guarantees. So the best responses always require a combination of street smarts, confidence, humility, and honesty. Investors are often just checking to see how you tackle hard questions. Here is a collection of common red flags to avoid:

• “We don’t have any competitors.” As everyone should know by now, this is the worst possible answer, since it implies that there is no market for your product, or you haven’t bothered to look for competition. Remember that cars compete with trains, so alternative solutions, or doing nothing, are real competition.

• “We have the first mover advantage.” First-to-market is meaningful for a large company, like IBM or GE, which has the resources to sustain their move, but is not relevant for a startup, when surrounded by “big gorillas.” If they see you getting traction, the giants will awake quickly and step on you. This advantage is not sustainable.

• “Our product is truly disruptive technology.” This is a variation on the first mover argument, implying a paradigm shift that gives you a tremendous lead. Investors will suspect you have a technology looking for a solution. Disruptive technologies typically take years to catch on, which is longer than they can afford to wait.

• “Only our team can make this work.” This statement comes across as arrogance, no matter how much experience and technical degrees your team has. No one in this world has a monopoly on knowledge and implementation skills. Investors will conclude that this is probably an impossible and unrealistic team to work with.

• “We plan to offer it for free, and live off advertising revenue.” Undercutting competitors in price is always a good strategy, but free implies no real value. Free is a good short-term Internet strategy, if you have $50 million to spend on viral marketing to get your page-views up to the million per month needed for significant advertising revenue.

• “Our patent will protect us.” Patents are worthwhile, so this answer is far better than the first five. Yet every investor knows that a mere startup will not be able to afford a patent battle in court, and most patents can be circumvented if the opportunity is large enough.

In the end, after stating your best arguments, it’s probably smart to concede that there are no silver bullets, but emphasize that you have the experience and knowledge to put up a never-ending fight. This tells investors that you are realistic, despite your conviction and confidence in your product. Investors like realists, but not wimps.

A sustainable competitive advantage is not a destination, but a journey. Whether you are looking for an investor or not, every good entrepreneur better plan for this journey before he finds his backside exposed.

Marty Zwilling

Investors Like Ideas, But Measure You On Execution

After the idea, it’s all about execution. I often hear from investors that a great idea is necessary, but not sufficient. The most important thing is a proven team, meaning one who has built a startup before, and has experience with the execution process in this domain.

I’ve talked before about the best personality traits for a good entrepreneur, but I’ve never talked about the importance of process. Yes, even entrepreneurs need to follow a disciplined execution process if they want to maximize their probability for success.

Even though John Spence in Awesomely Simple, was talking about larger organizations, I think his concepts adapt equally well to a startup. Here is my adaptation of the key steps to ensure a winning execution in any business:

1. Create a vision and instill values. The vision may be yours alone, but the communication has to include your team, potential investors, and customers. For most people the communication is the hard part – written, verbal, over and over again.

2. Define a focused strategy. Limit the focus to a few critical areas that will yield the highest possible return. If your strategy has more than ten elements, it’s not focused. Not everything can be a priority. Do not spend any time on unimportant goals.

3. Get stakeholder commitment. People who are not committed cannot be held accountable for delivering ambitious results. The guiding coalition must demonstrate 100 percent unity, or there will be a mutiny. The worst case is a silent mutiny.

4. Align the objectives of principals. I have seen startups implode when principals were pitted against each other on mutually exclusive objectives, like adding more technology versus keeping costs down. Quantify time and cost goals early, get agreement from all, and measure results regularly to verify alignment.

5. Every process needs a system. Define and use well-thought-out systems, manual or automated, to ensure repeatable success of every key process. The most basic element of every startup system is a written, agreed, and measurable business plan.

6. Manage priorities. You must relentlessly communicate to all constituents the current priorities, and keep the total to a manageable number. One of the biggest mistakes I see in startups is a new and larger set of priorities every week, causing the team to lose momentum and lose commitment.

7. Provide team support and training. People are your most valuable asset, so start with the right ones, and make sure they have the tools and training to deliver the results you are asking for. Don’t assume they know everything you know, or learn as fast as you do.

8. Assign and orchestrate actions. Leaders must make sure all team members are taking the right actions (and behaviors) on a daily basis to deliver long-term performance. Even after all the previous steps, great leaders can’t afford to be merely observers. Lead by action.

9. Measure, adapt and innovate. Things change in a startup, and things will go wrong. You won’t notice if you don’t measure. Measure four or five key drivers, not twenty or thirty things. Motivate everyone with an insatiable curiosity to make things one percent better every day (kaizen).

10. Reward and punish. What gets measured and rewarded gets done. Be exceedingly generous with praise, celebration, recognition, small rewards, and sometimes money. Set high standards for performance and use the three T’s (train, transfer, or terminate) to deal with people unable to effectively execute the plan.

I’m not suggesting that your task execution will be perfect if you precisely follow these steps. There are far too many pitfalls and risks in a startup to imply they can all be avoided. But if you adopt this blueprint, it’s much less likely that when things get tough, your investors will be thinking of an alternate meaning for the term “execution.”

Marty Zwilling

Investors Fund Solutions Rather Than Technology

Too many entrepreneurs develop a new product without regard to market demand, then build an entire strategy based on creating a need, rather than acting on an existing market need. Investors characterize this approach as a “solution looking for a problem.” These don’t get funded.

The best startups find a way to drive the market with their technology, rather than push their new technology-driven ‘solution’ on the marketplace. An example of market-driven technology is the basic automobile, but combining a car with an airplane is technology looking for a market.

New technology really doesn’t have any value, until it is integrated into a market-driven solution. Here are a few thoughts on a process that will keep you on the right track:

• Get real customer input first. Temper your product with actual market and customer feedback. Everyone's personal perspectives and interests are different, so the key is starting from market problems, and going from there to technology - not vice versa. Show your prototype to real customers, and listen.

• Quantify the pain points. Measure the major pain points in time or dollars, based on feedback from intended users of your product or service. Users that ‘like’ your product, but have no pain, will not pay real money or endure change for your product (even early adopters won’t make a market).

• Keep it simple and easy to use. Have you solved the user problems in the simplest possible way, with the fewest possible features? Or have many features been thrown in, just because the technology can deliver them? Easy to use and lots of features are usually contradictory statements.

• Analyze how competition will react. If you are tempted to respond with “We have no competition,” then you almost certainly have a solution looking for a problem. Think about how your customers have survived all these years without your product, and how many will pay your price to change. Will your competitors quickly copy you, or under-price you?

• Experience the pain first-hand. The best entrepreneurs solve problems that they and their team have personally experienced. This will keep you laser-focused on the solution, and make you more effective and credible in selling the solution.

  I’m sure that some of you are thinking by now that if all entrepreneurs followed these guidelines, the world would have missed many great leaps in technology, like the laser, television, and the Internet. These are usually called ‘disruptive’ technologies.

  Disruptive technologies and grand new solutions can ultimately change the world, and create a large opportunity, but they are not exciting to early-stage investors for the following reasons:

• Fundamental changes take a long time to happen. According to the Gartner Hype Cycle, every major new technology goes through four stages before reaching general acceptance, and that can take as long as 20 years. Investors are looking for a big return in five years. Only people and organizations with their own big resources will survive.

• Creating a need is much more costly than marketing to an existing need. To build a new market, you have to educate people on the concept, create the “need” in their mind, and solidify it by constant repetition. This means building a brand, viral marketing, and multiple expensive promotions. Early-stage investors won’t risk this much.

So, if you have a new technology that you believe can change the world, you need to team with someone who has really deep pockets. Angel investors can’t help you, and most venture capitalists won’t be interested in contributing the first several million.

Perhaps a better alternative is to focus on existing problems with real pain points, and customers that have money to spend on a better solution today. You will get help from investors, feel the near-term satisfaction of success, and build your skills and your bank account for that earth-shaking new technology the next time around.

Marty Zwilling

This Startup Dream Team Will Assure Fundability

Every investor is looking for the “dream team” of executives to put his money on. Often I find that experienced investors flip to the management page of a business plan, even before they read the product description. That’s how important the people are. What are investors looking for in the CEO and the rest of the top executives?

• Been there, done that, and won. This may not seem fair to all you first-time entrepreneurs, but wouldn’t you choose to bet on a horse that has been in races before, and won, rather than an unknown in his first race? The size of the race is also important. Fortune 1000 CEOs usually don’t make good startup CEOs, and vice versa.

• Experience and expertise in this business area. You may have great credentials as a public servant in your home town, but that won’t get you money to build a social network on the Internet, or start a software company. You can learn a lot about a new technology from Wikipedia and scouring the Internet, but probably not enough to qualify you as CEO of a new company in that area.

• Network of followers and business associates. Introverts and loners need not apply. Your job as CEO involves heavy doses of selling the merits of your company, lobbying (begging) for money, and convincing other executives to help you or join you.

• Bundles of energy, money, and talent. The startup road is guaranteed to be long and hard. Investors look for someone who is able and willing to put “skin in the game”, looks and sounds like he can weather the storm, will always see the bright side despite adversity, and never gives up.

• Able to communicate a vision. To be respected at the top of the pyramid, a CEO must be able to clearly communicate the vision of the company to inspire investors, the team, and customers. Of course, before you can communicate a vision, you have to have one.

• Relentlessly resourceful. Not merely relentless and passionate about your journey, but able to overcome novel difficulties (per Paul Graham). Being relentlessly resourceful is definitely not what you learn in big companies, or in most schools.

• “The buck stops here.” The CEO has to be confident and clearly the final decision maker. Investors don’t like “equal partner” situations, or worse yet, family pairs in top positions. The CEO is expected to make the presentations to investors, and answer questions decisively.

What if you can’t convince Jim Clark (Silicon Graphics, Netscape, WebMD, MyCFO, Juniper Networks) to run your startup? The most common solution is that you “bootstrap” your business, or fund it yourself, at least to the point that your “traction” is evident (you have a product, you have customers, you have revenue). Another alternative is to rely on that famous first tier of investors, called friends, family, and fools.

Everyone loves that dark horse who comes from the rear to lead the pack and win the race, but very few people will bet on him up front. But don’t let that discourage you. Even Jim Clark started as just another associate professor of electrical engineering, but he teamed with some bright people, and proved he could beat the odds.

If you don’t have the credentials today, team with someone who does. The strength of your idea alone won’t suffice to bridge the funding gap. There is no substitute for experience and mentoring. The quicker you get it, the sooner you can be the next Jim Clark and write your own check.

Marty Zwilling

Most Investors Bite Only at Specific Startup Stages

If you are looking for an outside investor, you need to know how they see you. Different types of investors look for startups at different levels of maturity. If your startup is at the wrong stage for the investor you are approaching, fishing for money is a waste of time for both of you.

For instance, if your company is only a few weeks old and you have zero customers and your product offering is still in design, don’t expect someone to hand over $10 million to fund your efforts. It wouldn’t work anyway, since your valuation at that stage would be less than the funding, meaning you would have to give away all ownership for the money.

You also will find that the stage your startup is in dictates where you go to seek funding. Funding sources specialize in certain growth stages. Angel investors typically provide early-stage funding, while venture capital firms typically come in at later stages.

Of course, growth and development are really a continuum. Yet most investors will tend to categorize your progress into one of the following five stages:

• Idea stage. This is the initial excitement period, the time when you dream of riches and fantasize the life of a business owner, but you have no real plan. At this stage, no professional investor will touch you unless you have a beautiful track record of success with previous startups. Funding will only come from you, or friends, family, and fools.

• Early or embryonic stage. Investments at this stage are typically called seed investments. Funding of $250,000-$1 million is available from angels, if you have credentials and have done the homework of a good business plan, financial model, and executive presentation. Anything less the $250,000, or any amount at this stage with no credentials, still has to come from friends and families, loans, or federal grant sources.

• Funding or rollout stage. This is the realm of venture capital professional investors, with funding amounts of $1-10 million, often referred to as the “A-round,” or first institutional funding. At this stage, your startup better be selling a commercial offering, have price and cost validated, with significant customer sales and a real revenue stream. Lesser amounts remain in the angel realm.

• Growth stage. Additional funding rounds for growth are often called the “B-round” through “G-round”, with each being in the $5 million to more than $50 million from venture capital and other sources. Companies at this stage must have a large market, good traction, and be focused on scaling infrastructure and market adoption. This normally means more than 30 employees, and more than $1 million in revenue.

• Exit stage. This is the final stage of investment in venture opportunities, and is the point where investors expect to see the return and gain from the original investment. At this stage, you need investment bankers to negotiate a merger or acquisition (M&A), go private, or help you go public with an Initial Public Offering (IPO).

As startups pass through each stage, they must attract appropriate financial partners that can provide the increasing credibility, capital, and industry networks to support movement to the next stage. Typically, they must also change and tune their executive team, to keep up with the increasing demands of a growing company on process discipline and sustainable success.

Another important thing to remember when selecting investors is that not all money is the same. VC money, for example, usually comes with high expectations of milestones met, board seats, and dominant control. Angels may be less demanding, but typically add less value. Friends and family hopefully believe fully in you, and just want you to show them success.

Obviously, if you bootstrap your business, you can avoid all these stages and the investment implications. Otherwise, not paying attention to the expectations associated with each stage will likely jeopardize your one chance to make a great first impression on potential investors, and landing the big one. Do it right and enjoy the journey.

Marty Zwilling

Startup Due Diligence Is Not a Mysterious Black Art

After you have successfully attracted angels or venture capital with your business case, your million dollar product idea, and you have a signed term sheet, there is still one more hurdle to overcome before investors write the check. This is the dreaded “due diligence” process.

For no good reason, this process seems shrouded in mystery, when in fact it is nothing more than a final integrity check on all aspects of your business model, team, product, customers, and plan. In my view, understanding due diligence can only improve information flow, and leads to a better long-term partnership with your investor.

Remember that up to this point, the investor has primarily seen and talked to the founder and CEO, and studied written documents. Before smart investors write a check, they, or a trusted consultant, will want to meet and talk with your key team members, several customers, and evaluate the real product. If results don’t match what they have been told, all bets are off.

This is where they find out if your team is all behind you, your customers are truly excited, your product is ready to ship, and there aren’t any skeletons in the closet. All private equity groups go about due diligence in their own way, but there are a few key areas of focus that entrepreneurs should always expect:

• Team strength and health. For small teams, every team member will likely be interviewed. Investors are looking for your depth of talent, loyalty and commitment, strengths and weaknesses, teamwork, and management style. A dysfunctional team, or even one naysayer in a critical position can stall your investment.

• Product or service readiness. Technical due diligence typically starts with a full one or two day review with the engineering and product marketing staff. Investors are evaluating your process as well as your product. The goal is to feel 100% confident that the product has the features and quality you assert, and the team and process to keep it true in the future. Finally, they need to validate intellectual property protections and status.

• Market need and size validation. A good investor can do a lot to help a company, but can't make customers buy products. Investors will likely talk to dozens of potential customers, starting with your reference list (undoubtedly well prepped). They will also speak to technical leaders and industry contacts where they have prior relationships. No validated pain, no deal.

• Sustainable competitive advantage. The kiss of death is for investors to find unanticipated competition you neglected to mention. They try to confirm from industry analysts that your differentiators are indeed unique, and that there are no future competitors or big gorillas in stealth mode just around the corner.

• Business and financial status. How well have you met previous financial and business milestones? Investors will validate pre-existing investments and stock ownership to create an accurate market capitalization sheet for your company. Founders with bad credit, active lawsuits, or recent bankruptcies dramatically increase the risk.

As you go through the due diligence process, there are some practical tips to keep in mind. First, be proactive in asking if you have answered all the key questions, and ask how you compare to others. Get to the truth early. Waste no time. Use the feedback to strengthen your presentation and your company.

Secondly, conduct your own due diligence of the investor. This process is the foundation for the long term partnership, so both sides need the same level of comfort and trust. The investor relationship is akin to marriage. It’s nice to have a little mystery in your marriage, but you better understand each other on the fundamentals.

Marty Zwilling

Social Media is a Boon to Startups Who Do It Right

If your startup can’t be bothered with social media, or has no plan to take advantage of it, then you are definitely at risk these days. But simply jumping in is not enough. Before you start spending money and time being a user, you need to understand how it can help you and your business. Using it randomly or incorrectly is a waste of your precious time.

Sherrie Madia and Paul Borgese have addressed the positives of this challenge in their book, “The Social Media Survival Guide,” on “everything you need to know to grow your business exponentially with social media.” They also identify clearly the five key social media mistakes that I often see, along the following lines:

1. Diving in without a strategic plan. Don’t start podcasting, blogging, tweeting, “friending” on Facebook, and posting YouTube videos until you know what your messages are, who will manage them, who your audience is, and how they and you are going to benefit from the content and relationship.

2. Not having a social media policy. Your social media policy needs to outline how team members behave in the online universe during and outside of work. It should include education on style preferences and confidentiality. All messaging coming from employees should be aligned with your company’s values and brand.

3. Failing to tailor the plan to your target audience. Hone in on sites, tools, and applications your target audience is using. Is your audience out walking in the park without technology or are they technology lovers who never parted with their BlackBerry or iPhone? Research your target market to find out who they are and how to reach them.

4. Producing weak, unfocused, or unhelpful content. The same messaging rules that apply to classic public relations and branding apply to social media. Create strong, smart, well-thought-out content. Don’t waste their time with self-serving promotion. Give them something they can use – tips, incentives, new ideas, fun, and inspiration.

5. Allowing your social media efforts to stagnate. Gone are the days when companies could put up a website that sat on the screen like an electronic business card. Social media is about maintaining a dynamic conversation between you and your customers. Done right, it’s not a one-off campaign by a handful of staff; it’s a long-term commitment.

To avoid these mistakes and create compelling and relevant content, you need to focus your startup on the following initiatives:

• Develop a social media plan that targets audience and your business objectives.
• Combine social media seamlessly within your traditional marketing plan.
• Use social media to engage customers in new ways and sharpen your brand.
• Find the right people to staff your campaign and curate its content and evolution.
• Manage your “e-putation” and avoid the most common mistakes of social media novices.
• Measure the effectiveness of your efforts and expenditures – as well as competitors.
• Turn your social media efforts into profit, rather than just another expense.

According to the “Small Business Marketing Forecast 2012” from Ad-ology, Social media for small business marketing has reached its tipping point. Just ten percent say they will not use social media in 2012, down from 24 percent for 2011 and 39 percent for 2010. Lead generation continues to be the biggest benefit of social networking for U.S. small businesses. Other popular benefits were keeping up with the industry, monitoring online conversations, and finding vendors/suppliers.

Many companies believe that getting involved in social media is easy. They mistakenly assume that anyone who uses Facebook, YouTube, and Twitter for personal networking can do it for business. But personal versus business use requires two dramatically different skill sets. I recommend that you “test the waters” before you jump, but setting on the sidelines won’t get you there. Use the many resources available, like the Internet and this book, but now is the time to start.