A Healthy Disregard for the Impossible / by Adam Howard

Well, after a couple of Updates discussing capital; where it is, who makes the decisions about where it goes, the types of assets that are purchased with that capital and what returns you could expect I thought this week I would discuss how you would actually go about "raising capital".

Now remember, I am The Rookie.  A generalist, not a specialist.  I have worked in a number of industries, been involved in a lot of different stuff, have read a lot and seen a lot.  As an ex corporate and commercial banker I specialised in lending, but understand equity.

This Update is just a summary of what I have done, seen and learned. 

I use inverted commas as "raising capital" is really industry speak for "getting some money".  It just sounds more professional and somehow more politically correct to talk about raising capital rather than getting some money.

Can you imagine a the following exchange:

"So, whats your 11am meeting about?"

"Well, I am meeting with some investors about getting some money."


"So, Mr Howard, how can we help you?"

"Well, I am hoping you guys will give me some money."

You can't really have a Jerry Maguire moment.  It'd be nice, but you can't.

Doesn't provide the same impression of respectability.  And the purveyors and providers of capital like respectability. 

As I said last week, the Gatekeepers of Capital tend to be quite WASPish, if you know what I mean. And they like those asking for some of their capital to either also be quite WASPish or to be seen to be making an effort to be WASPy.

In addition to how you look, there are number of other idiosyncrasies to be aware of when trying to raise capital.  

Firstly, you need to work out what you want to achieve.  What scale do you want to achieve in your industry and is your concept/idea/product innovative or disruptive enough to achieve that?

Do you want to own a nice little business that trades profitably and provides enough cash for a comfortable life?  

Do you want to own and manage a large, privately owned company which employs hundreds, if not thousands, of people and trades from vast commercial premises?  

Do you want to be a constant producer of new, innovative digital technology?  

Do you want to be the Managing Director of a listed entity in which you own the controlling shareholding? 

Once you have worked that out, you can move onto thinking about "commercialisation."

Here is where we focus on using the right language.

You need to know who to be speaking to at different stages of "commercialisation", which is a nice new word used to describe the following process:

  1. Developing a new concept, product or technology;
  2. Testing it to see if someone is willing to use it, or buy it;
  3. Begin selling your new thing, or promoting your new idea;
  4. Determining the size of the market for the new thing;
  5. Set up a business structure to make/market/sell/support the new idea;
  6. Ensuring you have the correct governance processes;
  7. Ensuring you have the right financial controls;
  8. Employing staff to manufacture/market/support the new idea;
  9. Building a business around the new idea;
  10. Making sure you have enough money both in the bank and coming in to keep the lights on and the doors open; and
  11. Eat, sleep, repeat.

Sounds easy, right?

Well, the difference between a good idea and a good business is execution, and the secret to execution is planning.

The plan is critical when talking to the Gatekeepers of Capital, who are investing in you as much as the idea.  If you are sharp, organised, have a good one page business plan that you can pitch well, then you stand a good chance.  But if you don't???

Check out Shark Tank....

A big part of the planning, at least when it comes to raising capital is the "exit strategy."  If you hadn't noticed I am BIG FAN of management terms, and exit strategy is a beautiful example.  We will talk about these more later, but in short, an exit strategy needs to be considered for both investors and the owner.

What about the probability of success?  Considering I have spoken a lot about luck and probability in the past maybe we should briefly touch on that.

Well, there are around 2,000 companies listed on the ASX and about 1 in 200 start-ups make it to IPO.

That means about a 0.5% chance of a start up getting to IPO.  It also means there are roughly as many as 200 x 2,000 = 400,000 start ups or start up ideas banging around at any one time.

So, obviously your idea needs to be good, your planning needs to be good AND you need to be lucky if you make it to IPO.   In fact, you need to be lucky to end up having a business that makes something and does so profitably for a period longer than 3 years.

I have spoken in the past about a fairly ubiquitous industry; hospitality, where you have a 33% chance of being out of business 12 months after start up, and a 66% chance of being out of business 3 years after start up.

Lets not be too grim though, as not everyone fails and not everyone wants to run a listed company. 

And lets also not get too broad, as I am meant to be talking about raising capital, not the likelihood of success.  BUT, the likelihood of success does, or should, inform the decisions taken about raising initial funds.  More about this later.

I thought, given my reference last week to Sun Tzu's seminal piece, "The Art of War", it might  be a good idea to look at raising capital from the perspective of preparing for battle.  Here is a quick video that sets out the main concepts of The Art of War, and its not about warfare, it's about planning.

First thing to do when trying to raise capital is to know the landscape.  Know all the forms of capital available, who owns it and who makes the decisions on whether you get any.  

Here are a couple of nice tables that show the forms of capital available to those developing a new product:

That's cash, debt and grants.  Now, here is equity:

nd what about the timing?  When do you put in cash, or apply for a home loan top up, new business loan or credit card?  Comparatively, when do you seek to sell shares in your new idea?  Surprisingly I was able to find a nice graph that displays this:

Seed capital.  First and foremost that's your money.  Savings, cash in the bank, equity in your house that you can access via a home loan top up.  If you are confident about sales and profitability you could even set up your own business entity, use your house as equity and apply for a business loan.

Depending on your product or idea the amount you need will vary wildly.  If the idea is new technology, like a website, then it might only be $20k you need.  If you want to develop a mobile application it might be $40k.

But if it's a manufactured item that needs a prototype and testing it could be more.

Your ability to access this type of capital is also largely dependent on your own personal position.  Are you a young person, with little or no equity?  Are you middle-aged and more established, with equity and a reasonable network, or are you older, with significant equity and assets, but lower income?

The youngster?  Credit card debt and gifts from family and friends might be the answer.

A middle-aged person?  A home loan top up, business loan or savings.

The older person?  Savings or maybe even super cash.

So, lets assume that you now have a product, idea or concept that you have developed and tested. You have proven that people find it cool, useful and are willing to pay for it in one form or another.

Now, you need to get bigger.  Market more aggressively, manufacture in significant numbers, or travel to places where you can sell your thing.

This is where the Angel Investor steps in.  But do they?  This statement, and the pictures I include here assume the Angel is waiting in the wings, ready for their cue.  But that's not the case is it?

And that's why incubators, accelarators and innovation and commercialisation hubs have popped up over the past few years.  All these centres are really a place where a large number of innovative people can get together and come up with improvements to their ideas, and where they can potentially be brought together with Angel Investors.

What IS an Angel Investor?  Someone with cash, and lots of it, who is disposed towards investing in cool new ideas.  They will usually have a particular interest in a specific sector, or specific type of entrepreneurial idea.

Some good examples of Angel Investors in WA, and the industries they favour are:

- Marilyn New: heir to Midland Brick fortune and ex-owner of The Esplanade Hotel in Fremantle.  Appears to be particularly interested in eco-friendly technology.

- Marcus Tan:  co-founder of HealthEngine, Doctor of Medicine.  Focuses on medical technology.

- Brett Fogarty:  co-founder of GRD Engineering.  Focuses on mining, mining services and heavy manufacturing.

- John Poynton:  ex Hartley Poynton, founder of Poynton Partners and now Azure Capital.  An appetite for all forms of investment, but leans towards charities and innovations with high levels of social utility.

How do you get in touch with an Angel Investor?  Pray for divine intervention?  Well, we DO live in WA so usually it's a game of 6 degrees of Kevin Bacon to see if you know someone, who knows someone, who can introduce you to one.

After all, they are just people, like us, who have phones and email addresses....

But Angel Investors, by their nature, are actually out there looking for great new ideas, so they may contact you, via an accelarator or incubator.

Angels can either gift the funds (rare), or become equity investors, where they own shares in the company that "owns" the intellectual property.  And they have a long investment horizon.  They are prepared to wait, mentor the entrepreneur and help build the business.

Angels don't usually have large numbers of entrepreneurs they are helping at one time.  It might be as low as 3 or 4, and could be as many as 10, with the size of the portfolio really dependent on the Angel's wealth.

Now is a good time to remind everyone of the Risk/Return Curve.  It's an old favourite, but always relevant.

You will notice Angel Investors aren't on the curve....that's because they are off the top right hand end of the curve.  Super risky investing, as indicated by the number of start ups that fail and our picture above that aptly names the time when Angels become involved as "The Valley of Death."

Probably explains why Angels tend to stick to industries or entrepreneurial types they are familiar with; might mitigate the risks to a certain extent.

Let's move on and assume you have now made and tested a product, marketed your idea, got up some momentum and you are making some money.  Not profit, but making some money.  

A quick interlude.  This stage has actually blurred a little with the current boom in digital technology.  The buzzwords now seem to be "fast failure", with Silicon Valley coining a phrase to "fail fast and fail big".

Lean start up is now possible in the tech industry so that you don't need to test the market and product or app to such a degree, and the focus is on deploying your app quickly.  If it works, it's popularity will grow exponentially.  If it doesn't?  Shut it down and move onto the next idea quickly.

The reason I mention this is it changes the order of the sources of capital.  Instead of using an Angel Investor during the seed capital stage, you may be able to leapfrog straight to meeting some Venture Capitalists (VCs).

VCs usually manage a fund made up of investors funds, that may or may not include some of their own money, and they are not as emotionally involved as Angels.  Their imperative is to make money for their investors and themselves.

These guys are the Gatekeepers I have spoken about.  Now, there isn't really a US-style VC industry in Australia.  As I have said previously, our investment industry is still quite immature and has a less nuanced awareness of and appetite for risk than US VCs.

If you are seeking VCs in Perth, what you will end up finding are blokes offering a mix of Corporate Advisory services and capital raising services.

So, no fund sloshing around waiting to be put somewhere.  More like a stock broker who can raise funds from a database of wealthy and liquid investors.

And the Corporate Advisory bit refers to making sure you have the right type of business structure, the right type of people involved, have a good strategy around market penetration and exit strategy.  And one of my favourites, that you know when the various "liquidity events" will or could occur.

Love that term; "liquidity event."

Here is what it means:

"An event that allows initial investors in a company to cash out some or all of their shares and is considered an exit strategy for an illiquid investment."

I had a mate, whom I have introduced previously as The Restaurateur, who has just successfully engineered a liquidity event for his Angel Investor.  He had an awesome new site and a great idea about what it should look like, but he needed serious cash to make that happen.

He got that cash through his network and after 2 years was trading very nicely.  He then went to a bank who agreed to lend him money which was used to pay out his Angel Investor.

Now he has a loan instead of an equity partner.

This is a good time to go back to our exit strategies.  As I said earlier, they apply mostly to investors, but can also apply to the owners.

If someone has made an investment in a private company that is regarded as an illiquid investment.  There is no real ability to turn that investment back into cash quickly.  First, its extremely unlikely the owner has cash they can use to pay out the investor and second, there isn't really any market for people wanting to buy that investment off the original investors.

That's why points in time where you can pay out investors is called a liquidity event; because you can make that illiquid investment liquid again.

Here is another picture that displays the timing of various liquidity events nicely:

Each type of financing overlaps each other as a lot of the time they are used to pay out each other.  

Briefly back to the VCs.  They will sell shares in your company to investors who realise it is much riskier than a listed entity and also less liquid, but with the understanding that if the idea or product takes off they will make a huge return.

So, a liquidity event/exit strategy for your Angel Investor/family and friends is the introduction of some VC money, or as pointed out with the Restaurateur, a bank.  But, this exit strategy can't occur as the result of luck.  It has to be included at the outset, prior to the introduction of the Angel Investor, as part of the potential life of your business.

The last two potential liquidity events are only relevant if you want to or end up listing on the stock exchange.  They are:

- an Initial Public Offering (IPO); or

- a Backdoor Listing (also called a Reverse Takeover).

Yes, more cash is potentially available.  Yes, there is glamour associated with owning a majority, controlling or minority stake in a listed company.  But there are strings attached.

The cost is also substantial, with an IPO likely to cost between $500k and $1m, and an RTO still costing up to $500k.

RTOs are particularly popular right now, and you want to know why?  There a lot of, and increasing number of, penny dreadful resource and oil and gas companies trading at the minimum after failed commercialisation attempts.

This means ripe pickings for Gatekeepers looking to back in a good idea held by a private company.

BUT, once on the ASX you are subject to scrutiny, heavy regulation and will need a Board full of people experienced in your field and in running a listed company.

And you might not be that keen to deal with and be surrounded by those types of people.  You might think they are tools.

Finally, and praise be for that because this has dragged on for ages, the ace in the hole; the new kid on the block; the unknown.

The Crowd.

Crowdfunding is so hot right now.  And for good reason as they are working and helping people raise money for cool ideas. 

There are lots of crowdfunding websites now, with the first popping up in about 2009.  Here are a few:

Kickstarter - crowdfunding for creative projects.

Equitise - a New Zealand based crowd funding platform that provides access to Australian investors and ventures.

Venturecrowd - Australian equity crowdfunding platform.

The costs of the crowd appear lower, at 5% of funds raised rather than 10%.  And accessing the crowd is limited to private companies and small to medium enterprises, with no listed opportunities.

It does, however, look like a really good method for raising small sums (around $100k but up to $1m) for ideas that have the potential to capture people's imagination.  The pluses continue as you retain ownership of your idea/concept and don't have to work with and sometimes obey people you don't like much.

Raising capital.  So many questions.  So many options.

Food for thought....