Avoiding the traps when negotiating with investors

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To obtain a meeting with potential investors in your company,

you need of course to prepare a solid business plan

and a convincing investor pitch

that will help you make an impact when you meet them.

In the business plan, you should cover all key strategic items

so as to put your potential investors in a position to make a decision.

Your market dynamics, your targeted client segmentation,

your founding team, your unique selling proposition.

In one phrase, what you have to offer that is superior

in one or several ways to all other existing alternatives in the market.

Your product or service description,

and of course, your financial forecasts.

To build your financial forecasts, you should justify in detail

why you need the precise amount of money you're asking for.

As you know, there are three main financial tools you use in finance

to manage your company.

1. Your Profit and Loss explains how you generate your income

and how you spend your cash.

Be very careful here,

your P and L does not give you a direct vision of your cash situation.

For instance, what is considered as income is what you bill,

but not what you actually cash in.

2. Your balance sheet details your assets on one side,

and your liabilities and shareholder's equity on the other.

3. Last and most important for an entrepreneur and potential investors,

your Cash Flow statement explains how cash

gets in, or out, of your company's bank account.

This cash flow statement

is where you justify the amount of cash you're asking for.

Because it includes, of course,

the amounts you're asking from your potential investors.

And it ends at the bottom line with the projected cash balance of your company

that should stay positive, thanks to the cash invested.

These three financial tools are interconnected.

At this point, I would like you to stop and think

how you would prepare your financial business plan.

Say, for instance, you want to launch a software company or a restaurant,

but you do not have any specific financial expertise in those sectors.

What can you do to make sure your financial forecasts

are as credible as possible?

1. Ask similar entrepreneurs.

2. Search online.

3. Contact professionals in similar sectors.

4. Run different scenarios for growth.

Any options you can think of are valid

as long as you can get helpful information.

Keep in mind that VCs will test you on this exercise

and bring sectoral experts to ask you detailed questions on your financials.

To begin with, there is one thing I will advise you to do.

Go online and download financial reports

of listed companies in the same field as yours.

Of course, these correspond to companies

that have already reached maturity.

Nevertheless, this will give you a precise,

credible idea of the proportions for your financial forecasts.

For instance, should you launch a software business,

you will want to know the average ratio

of sales and marketing expenses compared to revenues,

of R&D compared to revenues,

or of general and administrative expenses compared to revenues.

That way, when you project your financials over a period of time,

you will know which proportions they should follow.

At this point, you should be in a position to send a solid business plan

to your potential investors.

And the process can then go two ways.

1. You could have exactly the right idea in the right market conditions,

and things can go fast with several VCs that want to invest in your company.

And using your negotiating skills,

you manage to close your round quickly at a good valuation.

2. You manage to raise some interest from a few VCs, but

not enough that they immediately want to invest.

Here, you need to understand that the strategy they will follow

is to play with time and try to minimize their risk.

For example, you could obtain a first meeting with a VC in January,

pitch your project and share your financial focus.

Then he might tell you:

"OK, let me have a more in-depth look at your business plan,

and let's meet again soon".

Then you could meet him again, for instance, at the beginning of March.

And what he will do then,

is compare the difference between what your financial forecast said

your company would do in January and February,

and what you actually did.

This could repeat several times.

In the end, he will be able to check if your financial forecasts are reasonable

and if you actually delivered what you had planned.

Think of this as a sort of real-life test phase

for the VC that can help him make a decision with conviction.

This is why you should always keep operations running

when initiating a negotiation with VCs.

Because what your company actually delivers during this period

will potentially decide whether or not they invest.

Now let's say you managed to convince a group of VCs

to invest in your promising company.

Typically, they use a set of tools to refine the assessment of your company

and finalize their investment.

A "strategic due diligence".

This is a strategic review of your company,

focusing on your strategic positioning,

on the potential threats and opportunities, and so on.

This review is usually performed by a sectoral expert,

or a strategy consulting firm.

A "technological due diligence".

This type of diligence is used for projects

with an intensive technological side,

and focuses exclusively on the technology involved in your product or service.

It is done either by a technological expert or by an IT firm.

Last, the "legal due diligence"

that will focus on the legal aspects of your business,

your contracts, and the potential legal risks your company could face

regarding its product or service.

Finally, let's take a step back

and think about financial cycles that could impact you as an entrepreneur.

For example, when the Internet bubble burst in early 2000,

after a period where investors were throwing enormous amounts of money

into startups, it suddenly became extremely difficult to raise money.

So, was it a bad time for entrepreneurs like you?

Actually, the answer is yes and no.

On the one hand, yes.

Because many capital-intensive projects

did not receive the cash they needed to move on, and eventually failed.

On the other hand, if you had raised cash just before the bubble,

or during this challenging period,

you suddenly had a fantastic competitive advantage,

because you had cash in the bank while many of your competitors didn't.

So the odds that your project actually made it were quite good.

In the next video, you will listen to one of our guests

while he shares with you his own experience raising money.

And perhaps you'll be able to better understand

some of the negotiation traps that you might find.

Then, join me in the next video

where we'll take a deeper look at your cash flow management.

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Entrepreneurship Strategy: From Ideation to Exit

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