Trevor Loy, General Partner, Flywheel Ventures

When searching for investors, many entrepreneurs and inventors first present their product or technological innovation and then vaguely present the target market as “people who need this product.” But this isn’t how customers think when deciding whether to spend money.

Consumers start with a problem or “pain point” they desperately want to go away. They watch for anything that proposes to solve this problem. Discovering it, they decide whether it’s affordable or whether another product offers a better or cheaper solution. They might even decide they’re willing to live with the inconvenience if the solution is too costly.

The most successful venture capitalists first want to know how well the entrepreneur understands the target market’s problems. Only then do they want to hear about the solution.

Defining What Ails Us

The most compelling investment for a venture capitalist is one that has a meaningful number of potential customers with this same “pain point” and a strong desire to live without the pain. These potential customers must have the financial resources to buy the remedy, and they must be willing to pay more than what it costs the entrepreneur to make and market the product or service. These potential customers must be identifiable. They must be easy to contact, sell to and support. And there must be a way for them to express their delight with a product so that demand builds the way a virus spreads — exponentially. That’s the kind of rapid growth that attracts the attention and resources of a venture capitalist.

Fewer than 10 percent of entrepreneurs start by identifying a problem and then attempt to develop a product or solution that targets that opportunity. For this reason, I teach students in my entrepreneurial business classes to thoroughly analyze the market before they spend any time on a business plan. This approach forces students to describe all the elements of a compelling market opportunity from the customer’s perspective without proposing a possible solution. If it looks profitable to present a solution, that’s when the inventor needs to offer it.

Getting Their Minds Right

Entrepreneurs with science and engineering or manufacturing and operations backgrounds have an especially difficult time shifting to a mind-set that puts the priority on analyzing what a customer would buy and not on the product. They often seem unable to embrace the idea of exploring a market opportunity unless they have already chosen a specific product or solution they want to bring to market. This subtle misjudgment of priorities drives most venture investing mistakes and might account for the poor performance of the industry in the past 10 years.

The product or service is essential, of course, but its conception should be driven by what will serve and delight customers by solving their problems and eliminating their pain. Most successful entrepreneurial teams can take the proper approach by adopting disciplined and efficient “customer development.” This involves seeing things from the customer’s perspective and constantly tweaking the product or solution until it holds the greatest and widest appeal.

Flywheel Ventures manages several funds, including the New Mexico Gap Fund, which invests up to $200,000 in seed-stage business ideas. For more information, visit www.flywheelventures.com.

Download 219_Venture Capitalists Put Market Before Product PDF

Betsy Gillette, Director of Market Research & Planning, TVC

Technology Ventures Corporation exists to help innovators find investors for technology-based products they hope to bring to market. In January, 2012, the Albuquerque-based company will select up to 20 entrepreneurs with the most commercially marketable ideas and help them prepare business plans to pitch in April to funders at TVC’s Deal Stream Summit, formerly called the Equity Capital Symposium.

Most of the scientists and engineers who become clients of TVC are sophisticated about technology but novices when it comes to selecting target markets, appraising market needs and attracting venture capital funding. Entrepreneurs interested in being coached by TVC should prepare now by developing the marketing aspects of their business plans. The more realistic they are about the need for their product, market size, customer base and branding, the more likely they are to draw investors.

Gauge the market: Many ideas falter because their proponents don’t spend enough time determining who genuinely needs the product. A product must provide a tangible benefit that saves businesses or consumers time and money or demonstrably improves their business operations or quality of life. The most thorough plan evaluates market need early and uses that knowledge to refine the product. Someone with a product that caters to a specific industry should vet it with industry groups that would benefit in quantifiable ways from the innovation.

Measuring the market: Even if a product concretely meets a market need, it might not be worth the investment if the market is too small or exclusive. An entrepreneur who overestimates the market for a product won’t fool an investor; those in the business of making money on investments will do their own research before putting their capital on the line.

Customer base: If a business misidentifies its target customer, its measure of the market will be inaccurate. To make this assessment, an entrepreneur can interview or survey potential customers or conduct focus groups to determine the likelihood of building a customer base around the product. Such research often helps an entrepreneur learn how the product can be tweaked to appeal to more people.

Branding: A company brand is more important than a product brand. Apple computers didn’t succeed on the strength of a single product; it built the brand over decades by producing reliable, user friendly technological tools and toys that set high standards for the entire computer and tech-based gadget industry. An entrepreneur should protect her individual and business interests by obtaining patents and trademarks for the company and every product generated under its name. Before naming a product or company, a search at www.uspto.gov can assure that the trademark isn’t claimed. Legal assistance can be important for securing brand protections.

The TVC summit will be April 3-5 at the Hyatt Regency Tamaya Resort & Spa north ofAlbuquerque. TVC must receive plans by Jan. 6, and entrepreneurs should contact TVC (www.techventures.org) right away at 505-246-2891.

Download 216_Entrepreneur Time to Prepare for Technology Summit PDF

Holly Bradshaw Eakes, Principal, The Holly Company Business Consultants

The greatest challenge an entrepreneur may face is finding capital to launch a business, especially when the business idea is related to high-cost startup such as that found in the technology sector. For an entrepreneur with realistic plans for rapid business growth and the potential to scale to larger markets, trading partial ownership for capital may be the only option.

Venture capitalists currently fund about one out of every thousand startups. With the odds stacked against obtaining equity capital, an entrepreneur must identify the investors most likely to invest in his business. Determining which source to pursue depends largely on industry focus, business stage and the amount of money needed. A handful of equity investors have offices in New Mexico and actively pursue investments in the state.

Bridge Between Self-Funding and Venture Capital

The New Mexico Angels is a network of accredited individuals who invest personal capital in early stage New Mexico businesses with the expectation of substantial return. Initial investments range between $100,000 and $500,000. The New Mexico Angels makes investments in a wide range of industries, although alcohol and gaming-related ventures are excluded. Entrepreneurs can submit business plans on the Web site found at www.nmangels.com.

Phase One Ventures is a new, highly-targeted fund developed by several angel investors active in the New Mexico Angels. Phase One looks for investment opportunities in new companies with technologies at the intersection of biotechnology and nanotechnology. Learn more at www.phaseoneventures.com.

Early, Seed and Startup Venture Capital

Seed stage, the earliest stage in the business continuum, is the point where an idea or business concept is still being developed and there is no revenue stream. Venture capital firms invest other people’s money, usually comprised of pooled institutional funds. In New Mexico, most active venture capital firms concentrate on early and seed-stage companies.

Flywheel Ventures manages the New Mexico Gap Fund, which provides up to $200,000 to seed-stage entrepreneurs. Other Flywheel funds invest up to $1 million. Flywheel specializes in digital services, infrastructure technology, energy technology and water technology. Find more information at www.flywheelventures.com.

Verge invests in companies located in the Southwestern United States and puts an emphasis on those in New Mexico. Initial investments range from $100,000 to $1 million, and later stage investments are only made in their portfolio companies. Verge focuses on technology businesses, including clean technology, electronics and materials. Visit www.vergefund.com.

Epic Ventures targets early stage companies in software, Internet infrastructure, energy efficiency and advanced-materials fields. Initial investments range from $500,000 to $2 million. Learn more at www.epicvc.com.

Village Ventures focuses on emerging businesses in consumer media and financial services sectors. Initial investments range from $500,000 to $1.5 million. Their goal is to own at least 20% of each of their portfolio companies. Find out more at www.villageventures.com.

vSpring Capital invests in information technology and life sciences companies. They invest in later stage companies only under special circumstances. Investments range from $250,000 to $5 million, with most investments in the $2 million to $3 million range. Learn more at www.vspring.com.

Cottonwood Technology Fund provides early and seed stage investments in technology companies located in the Rio Grande valley between Los Alamos and El Paso. Investments range from $500,000 to $1 million. Find more information at www.cottonwoodtechnologyfund.com.

Growth and Special Funds

Sun Mountain Capital manages a $60 million state investment fund. It looks for co-investment opportunities ranging from $300,000 to $10 million in any industry and prefers early-stage, startup and expanding ventures. Learn more at www.sunmountaincapital.com.

New Mexico Community Capital focuses on high-potential, underserved businesses in the water, energy, healthcare and agriculture industries in New Mexico. Initial investments range from $500,000 to $1 million. NMCC also provides early and growth capital through its Tribal Business Initiative. Visit www.nmccap.org.

Fully-invested venture capital firms operating in New Mexico include Mesa Capital Partners and Invencor/International Venture Fund. Other investors with limited active New Mexico investments include Psilos Group Managers and Altira Group.

For more information about equity capital in New Mexico, attend Coronado Ventures Forum’s annual venture capital discussion on October 20, 2011, in Santa Fe. Learn more at www.cvf-nm.org.

Download 211_Identify Specialty Before Looking for Investors PDF

Kim Sanchez Rael, General Partner, Flywheel Ventures

Jim Collins, author of Built to Last and Good to Great, and an old friend of mine, has written that the critical questions in life are who-decisions, not what-decisions.  “The primary question is not what mountains to climb but who should be your climbing partner,” he writes.  As professional investors, our evaluation of each potential investment opportunity emphasizes the entrepreneurial team more than market strategy, technology or financial projections. When evaluating the pros and cons of bringing on an investor as a partner in your business, your considerations should be similarly weighted toward who-decisions.  Professional investors should provide assistance and value in many areas beyond financial resources.  Here are some key areas to consider when selecting an investment partner:

Strategic guidance. Venture capitalists are typically former entrepreneurs or industry executives with experience and skills to contribute. Additionally, lessons learned from previous investments give them a unique perspective that allows them to identify key trends and challenges. While they will never have the entrepreneur’s depth of market knowledge, their experience yields objectivity. Exceptional venture investment professionals provide strategic insight and act as a sounding board, while respecting that the ultimate judgment about operational matters are best trusted to the entrepreneur.

Fundraising. Most venture capitalists prefer not to be the sole source of a company’s financing. They should help attract additional debt or equity capital by improving the company’s positioning and fundraising materials, and recruiting industry colleagues to join the venture. A good venture capitalist should relieve the entrepreneurial team of some of the fundraising burden.

Talent recruitment. Venture capitalists have networks of relationships across a variety of industries, and their contacts are often with senior-level executives. Because they have observed entrepreneurs and management professionals in similar positions across various portfolio companies, venture capitalists can provide guidance and insight into the performance and proper compensation of most positions.

Exit strategies. The ultimate goal of any venture-backed company is to achieve financial liquidity for all shareholders, entrepreneurs, employees and investors. Venture capital investors develop experience and relationships by working with multiple companies on exit strategies.  Entrepreneurs should evaluate the ability of their venture capital partners to assist, when the time comes, in achieving this all-important goal.

Venture capital investors are more than capital providers. They are partners in almost all aspects of the business. Given this, entrepreneurs should give equal consideration to who they bring on as investment partners as they would to any other team member.

To learn more about Flywheel Ventures, visit www.flywheelventures.com.

Download 210_Venture Capital is More than Money PDF

Richard T. Meyer, SCORE

Business owners know it takes money to make money; production expenses must be paid before products are sold and revenue is received. Entrepreneurs with a business idea have an even greater need for up-front cash. They must have enough capital to cover negative cash flow in the early months or years of new business creation and growth. Without adequate initial investment, they risk falling into the so-called valley of death – the deep and wide gulf that separates a company’s need for capital and investors’ willingness to supply it.

Also known as the grand canyon of capital need vs. availability, the valley can be shallow or deep depending on the amount of money needed to develop the idea or product. Width of the valley is the difference between initial investment and the amount that is available from professional investors.

For example, technology startups often need a minimum of $1 million of initial investment to generate evidence or proof of concept that will provide professional investors with confidence to invest. Initial investment is typically raised from friends and family, and entrepreneurs are lucky if they can raise the full amount needed from these initial sources. More often they find themselves short of funds, peering from the precipice into the valley depth. Some are able to secure angel investments, which keep them from falling into the valley by slightly narrowing its width; but angels are only helpful if they have alignments with venture capitalists who will make the follow-on investments required to bridge the remaining capital gap.

Compounding the problem – and adding to the width of the valley – is the increasing minimum investment amount venture capitalists prefer. As venture capital firms matured over the years, their pools of money grew and so did their expenses. With larger amounts under management, they can no longer expend the time and expense to manage small investments. Where at one time investments ranged from $250,000 to $500,000, most venture capitalists now look for opportunities of $2 million to $10 million. These larger opportunities tend to be in growth or maturing companies rather than startups in need of research, development, and market entry.

Some states, includingNew Mexico, have established seed and early-stage investment funds to bridge the valley of death, but many can not decide whether their investment goal is pure job creation or cash return on investment. As a result, state legislatures keep changing the management and/or strategy of their investment program, or they terminate their program altogether.

The valley of death remains wide and deep, trapping many young companies. The result is that many innovations never enter the marketplace and many new jobs aren’t created.

SCORE counselors provide free and confidential advice to New Mexico entrepreneurs and business owners from offices in Albuquerque, Las Cruces and Santa Fe. To learn more, visit www.abqscore.org, www.scorelascruces.org, or www.santafescore.org.

Download 203_Entrepreneurs Beware the Valley of Death PDF

Tom Stephenson, Managing General Partner, Verge Fund

Once an entrepreneur decides that equity capital is the best way to finance his business, the next questions are how much and when should it be raised? One approach is to determine from the business plan how much cash shortfall is projected early on and raise that amount. But raising money in multiple rounds is often a better choice, allowing the entrepreneur to retain a greater portion of ownership.

If a business plan calls for $3 million in total financing to achieve profitability in three years, a startup raising that money all at once will give up a large portion of the company — perhaps as much as 75 percent. New companies are high risk; if investors put in less at the beginning, they will be willing to bet more money on a promising venture later, taking fewer subsequent shares of the business in the process.

Ideally, raising money in rounds will give the entrepreneur and early investors the most profit when it is time to sell the business.

Balance Ownership with Cost

Raising money involves cost, the biggest being the time spent negotiating specifics of the deal — and the more money involved, the more complex the negotiations. After a financing source is in place, at least 200 hours goes into any transaction, and more if there is protracted negotiation. The entrepreneur often must pay the investor’s legal fees in addition to her or his own — meaning two sets of legal fees on the entrepreneur’s tab – easily reaching $20,000 or more. So fewer rounds are less expensive, and an entrepreneur should have a minimum amount in mind for each. Verge usually considers $250,000 as the absolute minimum, with $500,000 being more attractive

These costs are comparable to those a homeowner incurs when refinancing a home. Just as a homeowner should not refinance more often than every few years in order for the home’s appreciated value to cover the costs of a refinance, an entrepreneur should not refinance his or her business more than once a year.

Types of Rounds

Seed capital, typically the first phase of investment, is used to pay for preliminary operations such as product development and market research needed to launch a product. Investments are usually lower because risk of loss is greater than at other investment stages. Entrepreneurs often raise money from friends and family or angel investors at this stage.

While some venture capital firms specialize in seed capital, most make investments at later stages of product development or market entry. Venture capital rounds are often denoted by consecutive letters of the alphabet and refer to the number of investments made so far. For example, a B round is usually the second investment a company has received. Major restructuring of a business sometimes causes letters to revert back to the beginning of the alphabet, often with double letters such as AA.

Benchmarks Spur Rounds

Reaching benchmark successes is important to the value of a business and can help attract investors for another round of financing. For example, a business that requires regulatory approval will increase in value when that milestone is achieved.

Many, but not all, professional investors hold additional money in reserve for emergencies or to participate in later rounds of funding. Generally, professional venture-capital firms plan to participate in future rounds, but this should be confirmed. If they can’t or won’t commit to a second or third investment, other ways must be found to get the needed funds – or enough capital must be raised at the start to carry the business through to a new round of financing with new investors, or better yet, to take the business to cash-flow breakeven.

Most businesses that pursue equity financing end up raising one to three rounds of equity to reach profitability — and this should be a result of careful strategic planning to benefit the entrepreneur and financial investors.

Learn more about Verge Fund.

Download 198_Consider Strategy before Seeking Equity PDF

Paul F. Goblet, Financial Advisor, NM SBIC

Few businesses follow a predictable path and timeline from one stage of life to the next. Some linger for a long time as startups, while others dash directly from startup to rapid growth. Knowing the life cycle of a typical business can help an entrepreneur know where to find capital to reach the next stage.

The seed or startup stage starts with an idea or a prototype for a product or service. At this stage, entrepreneurs either tap friends, family members or other personal contacts for funds, or they seek angel investors, SBIR grants, micro loans or very early stage venture capital.

When a company is preparing its product or service for a market launch, it’s in the early stage of life. As it begins to produce products and secure customers, the business might need a cash infusion for inventory or equipment and is most likely to find it through a bank loan, micro loan, angel investor or venture capitalist.

When the company outgrows its initial goals, it’s in the expansion or growth stage. Banks, SBA lenders and venture capitalists are interested in companies like these that are moving into new markets, gaining more market share, introducing new products or services, acquiring new customers and rapidly accelerating revenues and profitability.

Changes in the economy or market conditions can cause sales to decrease and a company to decline. Faced with a negative cash flow, the owner must decide whether to seek another opportunity or find ways to salvage the business.  Possible funders at this point include suppliers, customers, co-owners or partners.

At the exit stage, an owner is either selling or shutting down a business. Accountants and financial advisers can help decide the best exit strategy, but common ways to raise money at this stage are through management buybacks, Employee Stock Ownership Plans or Initial Public Offerings.

Capital at any stage

Satisfying a business’s appetite for capital requires knowing which kinds of investors to approach at each stage.

Funding sources have their own guidelines for when to help — and how much to give — a company that’s hungry for capital. But the first thing all investors want to know is what stage a company has reached and what chance it has to grow and make money.

The number of equity funding sources in New Mexico has increased significantly in the past decade. Several companies collaborate with the New Mexico Small Business Investment Corp. to get capital where it’s needed.

ACCION New Mexico, The Loan Fund and WESST provide small to mid-sized loans to all types of businesses. Flywheel Ventures, the Kickstart Fund and Verge provide early stage venture capital primarily to technology-based companies; Flywheel also manages the Gap Fund, which typically invests in technology companies just getting on their feet. New Mexico Community Capital provides growth stage venture capital to manufacturing, distribution and service companies. The Mezzanine Fund is a hybrid of debt and equity and is appropriate for special situations.

More information on the various funds doing business in New Mexico can be found at www.financenewmexico.org.

Download 196_Businesses Have Stages PDF

Tom Stephenson, Managing General Partner, Verge Fund

Specialization is common within the equity investment world, with investors generally focused on specific stages of business development. A “seed” stage investor, for example, has a different specialty than a firm that provides expansion capital.

An entrepreneur who knows the terms used to describe development-related types of equity financing is more likely to seek the investor right for her venture and increase the chance of obtaining funds.

Most investor specialization terms fall close to the following:

Seed-stage venture capital refers to investments made in firms with products under development or recently introduced to the market. These companies have no revenue or have recently received their first revenue. Seed stage investments tend to be less than $2 million and are sometimes as little as a few hundred thousand dollars.

Early-stage venture capital is invested in firms that are receiving revenue but have not yet reached profitability. Investments generally range from $3 million to $5 million.

Expansion capital refers to investments of $5 million to $20 million in firms with substantial revenue streams.

Buy-out investments are purchases of profitable, mature firms with revenue greater than $10 million. Investments are usually more than $10 million.

Many venture capital funds further narrow the scope of their investments by industry or geography. The New Mexico Small Business Investment Corporation has been instrumental in setting up funds from which investments can only be made in New Mexico-based companies. The venture capital firms that manage these funds might further specialize in technology, aviation or healthcare.

Entrepreneurs looking for investment can find the right specialist by researching firms through their company websites.  It can be harder to research the specialties of individual investors, but a few questions asked while arranging a meeting can avoid wasted time later.

Specialization has substantial benefits.  Good equity partners bring experience, industry knowledge and networks of contacts. They can provide introductions to important vendors and other potential investors.

Entrepreneurs who narrow their search to investors that specialize in a development stage and industry that matches their startup or business will improve their chances of finding the investment they need and increase the probability of their venture’s long-term viability.

Article 184

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Tom Stephenson, Managing General Partner, Verge Fund

Anyone looking for a business investor must examine their personal goals before looking for funding – different reasons for starting a business mean different ways of finding money.

Venture capitalists classify entrepreneurial businesses into two groups: growth businesses and lifestyle, or legacy, businesses. Only growth businesses will be attractive to venture-capital firms.

Lifestyle businesses are those started by people who want to have control over what they do and how they spend their time. These businesses tend to be focused on a local market, and entrepreneurs expect to own and run the business indefinitely. Heads of families sometimes start these businesses to provide a legacy that can be passed on to children, ensuring future family security through ownership and employment.

Growth business entrepreneurs are interested in getting rich. Often, this means identifying a national or global market that can be reached with limited personnel from limited locations. These business owners want to build as much value as they can and sell for a profit. “Serial entrepreneurs” expect to do this repeatedly, turning new deals about every six years.

The first thing an entrepreneur has to learn when taking equity money is that the investor is now also an owner. Venture capitalists, like successful stock market players, make money one way — by buying low and selling high. This means making an investment, helping management develop the company, then selling that investment for a substantial profit once the company has matured. This may be acceptable to the owner of a growth business but it is contrary to the lifestyle-business owner’s need to retain control. And while there are mechanisms to allow investors to recoup their investments without selling the entire business, these solutions seldom produce a venture capitalist’s required level of return.

By understanding personal motivations for starting an enterprise, entrepreneurs can identify the right capital partner. Entrepreneurs interested in building a business and selling it for a lot of money will find venture capital appropriate. If goals are personal, business owners will be better off looking for loans or other sources of funding. Both are equally valid and both have contributed significantly to the creation of wealth and jobs in America.

New Mexico’s Small Business Development Centers offer workshops on finding appropriate business capital. Visit www.nmsbdc.org for workshops held in 20 locations around the state. To learn more about Verge Fund, visit www.vergefund.com.

Article 180

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Monica Abeita, Regional Development Corp. for Northern NM Connect

Northern New Mexico technology companies have been using the Venture Acceleration Fund since 2006 to help bring their products to the marketplace. The fund, administered through Los Alamos National Laboratory, awards up to $100,000 to qualifying ventures.

This year, the VAF is changing some of its rules: calls for ideas will be accepted year-round, and companies no longer must have a direct technology-transfer association with the lab — though some preference is given to those ventures.

The fund supports tech ventures in almost every step of the commercial process, including proof of concept, prototyping, product engineering, finding customers and market validation. Startups and companies that receive the funding work in diverse fields, including biotechnology, software development and renewable-energy ventures.

In the past, some of these projects involved scientists who formed spinoff companies using LANL technology. For example, Santa Fe’s Mesa Tech is applying a DNA dipstick developed at LANL to the real-world concern of food safety.

The VAF also supports New Mexico startups and small businesses developing their own ideas.  The Taos renewable-energy company ThermaSun used VAF funding to develop a prototype and manufacturing capacity for its home and commercial solar-energy systems. SimTable, a Santa Fe company that creates wildfire simulations for use by emergency responders, used its award for marketing and business development.

VAF also helps attract additional investors. Albuquerque’s Southwest Biofuels’ award gave the company leverage for investments and loans, which enabled the company to design and build a high-capacity biofuels processing plant to meet increased demand. 

“Acoustic Cytometry Systems was the first company we assisted with VAF funding,” recalls Belinda Snyder of the LANL Technology Transfer Division. “Within a year, the company hit a home run and was integrated into a major biotechnology company based in Oregon.  Most companies we assist make more incremental progress by increasing their revenues, hiring new employees, and advancing their technology and business to the next level of success.”

VAF is one program of Northern New Mexico Connect, the principal economic-development investment of Los Alamos National Security, which in part oversees the lab’s commitment to helping small businesses in New Mexico. Many award recipients also participate in other Northern New Mexico Connect programs that provide coaching, market research and technical assistance.

Technological and business advancement are the real winners for VAF recipients. Proposals are evaluated on regional impact, technical feasibility, market opportunity and the availability of matching funds, which might come from grants, government programs, investors or other sources.

 Visit www.nnmconnect.net for more information or to submit a proposal.

Article 176

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