"Every one of my books had killed me a little more," - this profound and highly personal quote by American author Norman Mailer has become one of my favorites since I started writing about startups funding. For with each new article, the more I would dig deep into research, the more I would realize how imbalanced the existing funding system is.
On the bright side, whether working with clients via my company Metropole Capital Group or teaching the Entrepreneurial Finance course I recently created for MBAs or producing my upcoming Alternative Funding Forum here in LA, one thing has become clear to me - we live in times where start-ups have a wide range of funding options like never before.
What VCs are really looking for
The key thing to remember is that VCs are financiers, who expect a return of at least 30% per year over the life of their funds within a sizable total addressable market (TAM) - a market that can generate $1 billion or more in revenues. VC funding is heavily concentrated in just a few industries with their favorites in software (over 30%), high-tech and biotechnology. VCs like to see the value of exit to be two to four times sales and most VCs will not consider an investment unless the potential exit price is $200M - $300M or more.
The ideal assumption for VCs is that your venture will grow fast enough to take first place in the market but most favorable or "fundable" VC projects are those that actually create their own market (aka "blue ocean"), are on at least a second/series B-round of financing, intend to grow to not less than hundred million dollars in revenue and have a clear exit strategy (think Apple Inc., Jet Blue, Home Depot or eBay).
Discouraged? Don't be. Stay with me...
Angel investors: "And I will always fund you"
Angel investors in the US are accredited investors who qualify under the criteria imposed by law - that is having an individual annual income of $200,000 or a liquid net worth of at least $1 million. A lot of them like to assemble in local angel investing groups that occasionally have "pitch calls," aka meetings, with entrepreneurs depending on in which city they are formed.
They generally aim to take a 20 to 50 percent ownership stake and they like to build a portfolio of projects where they typically realize about 85 percent of their total portfolio returns from 15 percent of their portfolio companies since most of them are investing in extremely risky seed stage/series A financing round. Keep in mind that for startups raising their first round of capital (seed/series A financing) the failure rate is at least 90%, while for more mature and developed startups raising a second round of capital (series B financing) the failure rate drops to a 50%. There were only 120 seed stage companies backed by VCs in 2013 vs 32,000 deals backed by angel investors.
These days angel investor groups look for less than $3 million pre-money valuation and as low as $100,000 of an investment. The main catch - unless you present them with a potential revenue plan that would prove you are fully capable to bring at least $50 million in at least 5 years, then you might hear from an angel investor the "Shark Tank" show's most terrifying phrase: "I'm out!"
Equity based crowdfunding and JOBS act - the train has left the station - sort of
I am fully convinced that the main reason for the JOBS act's rules not being finalized is its Title III which has become the most controversial - a part which would allow a general solicitation of up to $1 million annually in equity from everyday "mom-and-pop" investors, regardless of their level of income or financial position. I've been a great supporter and an advocate of this fresh approach (see my previous articles), however when I learned that apparently the SEC is looking to update the accreditation standards towards increasing the income threshold, I suddenly remembered the eminent Niebuhr's mantra "Grant me the serenity to accept things I can not change".
As a serial entrepreneur, the founder of Rock.com and OfficialMerchandise.com, Steve Newman, noted, "What we have now is completely absurd. Individuals who are not accredited can only fund rewards-based campaigns, which guarantee no return, while accredited individuals have an opportunity to invest in early stage companies for high returns. In essence, companies get funded and show proof of concept on the backs of the unaccredited investors, only to turn over those high returns to the accredited equity investors. In a regulatory scheme like that, one has to ask who is really being protected and who is really being benefited?"
I echo Steve's statement and would like to remind you about the story of Oculus Rift, a company that had been crowdfunded by KickStarter's backers who donated a striking $2 million. Right after that, Facebook acquired Oculus Rift for $2 Billion - naturally leaving the backers out of benefiting from the exit event. End of story.
The good news is that the JOBS act still has managed to trigger and bring at least two refreshing changes.
An important change to remember is that now startups are allowed to solicit money from accredited investors publicly - via advertising and social media.
Another thing - raising equity from angel investors has become much easier thanks to a rapidly growing number of equity based crowdfunding (or crowdinvesting) platforms which means that now you can submit your project online having great exposure to the accredited investors community. The most active platforms in the US include AngelList, EarlyShares, CircleUp, EquityNet, Crowdfunder, RockThePost and InvestedIn and there are quite a few emerging equity funding platforms, such as Flashfunders, that strengthen its market position by working in collaboration with a highly respected securities law firm, Stubbs Alderton & Markiles, LLP.
My closing words - stay tuned and get educated. As poker players like to say - if you don't know who at the table is the fool, it might be you.