September 28, 2020

You’re the Boss: Six Tips on Taking Outside Investors

TerraCycle has raised $18 million in five rounds of financing from both angel and institutional investors.courtesy of TerraCycleTerraCycle has raised $18 million in five rounds of financing from both angel and institutional investors.
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Having a great idea for a company is one thing. Getting the money to get it moving and growing is quite another — especially when you’ve got an unconventional product or business model that your average investor isn’t likely to recognize as an obvious winner.

When we started TerraCycle as undergrads, my co-founder and I entered and won a number of business-plan competitions around America, effectively financing our business from the resulting prize money. The best thing about prize money is that it provides financing without diluting your ownership in the company; the challenge of relying on prize money is that it is relatively limited — $5,000 to $100,000, generally, and you can’t enter the same contest more than once, especially if you do well the first time.

Soon after depleting our prize winnings, we realized we had to find a new path. Because we were nervous about institutional financing, we focused on angel investors, high-net-worth people who can invest anywhere from $10,000 to $1 million. Compared to venture capital investors, angels tend to be more drawn to the mission of the business, and they tend to be more flexible about changes in the business model (an important consideration for TerraCycle, as I wrote in a recent post). And they’re also less likely to get upset when things don’t go well. In part, that’s because their time horizons tend to be longer. While a typical V.C. fund has a three- to five-year time horizon on an investment, most angel investors are comfortable waiting up to 10 years before they see a return.

We were both proactive and reactive in seeking investors. Our proactive strategy was to contact angel investor networks (a great resource for this is thefunded.com). The benefit of these cold calls was that we were given, for free, the opportunity to present our business plan in front of a room of people, any of whom might invest personally. Many times they did — or they gave very critical feedback (the best kind).

Our reactive strategy was to follow up with  people who called us asking about investment opportunities after reading articles about TerraCycle. About 20 percent of the capital we raised came from fielding such inquiries. All together, over an eight-year period, we raised $18 million in five rounds of financing from both angel and institutional investors.

As I said, institutional investors tend to be more demanding and less flexible. They have their own investors to satisfy, are impatient for results, and have low tolerance for any deviation from the original plan. While there is nothing necessarily wrong with this, it can make it very hard for the founder (especially a young one) to remain chief executive. It’s very easy to catch “founders disease” and end up relegated to being the chief creative officer with no actual power or influence. This is typically accomplished by a board that hires a chief operating officer to “help run the company” while you, the chief executive, get to focus on “creative” and “strategic” questions. You can guess who’s really in charge.

In my case, because I’ve had to sell a significant portion of TerraCycle, I no longer own a controlling interest. That’s been a critical issue when I’ve wanted to deviate from our business plan. In 2007, for example, I decided to shift TerraCycle from making fertilizer from worm waste to manufacturing consumer products like tote bags and rain barrels from non-recyclable industrial waste. The immediate result of this shift was a 2008 loss of $4.5 million on sales of $6.6 million. As you can imagine, I had to struggle to save my job, and I was able to do it only because of a few things we did in the course of arranging our financing. Based on that experience, here are my suggestions:

1. Whatever mix of investors you bring in, make them diverse, with no one entity owning a majority of the business.
2. When you’re negotiating, you should always submit a term sheet and try to stick to it rather than letting an investor drive the process.
3. Don’t agree to milestones or performance hurdles — you never know what will happen.
4. Make the deal simple and clear, preferably cash for stock without any bells and whistles. For example, don’t agree to crazy multiples or special clauses about taking money out.
5. Don’t guarantee board seats permanently unless you have no choice.
6. Most important, build your terms assuming the worst will happen — in the time it takes you to establish your company, it just might.

Of course, the best solution of all is to not take outside money.

Tom Szaky is the chief executive of TerraCycle, which is based in Trenton, N.J.

Article source: http://feeds.nytimes.com/click.phdo?i=253dd62abb26080c73ff908231caa634

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