Do not half-ask it
In my role at Nebraska Global, I have the opportunity to see numerous early stage investment opportunities. One of the regular, recurring problems that occurs in deals that we review is entrepreneurs do not make an ask or they make a half-ask.
A good ask has two parts:
- My company is seeking X dollars.
- We believe that this is worth Y percentage of the company.
Part one of "the ask" is usually the part that entrepreneurs know. I want $1 million for my company. However, many entrepreneurs fail to actually explain HOW the money is to be spent. In general, there are numerous beneficial uses, including:
- Create or expand sales team
- Marketing for a specific group
- Team expansion
- Cost to serve existing customers well
- Special equipment
What is unfortunate, is that these are not usually the responses that we hear – if there is any justification at all. Moreover, there is almost never a cost model associated with how those expenses help generate the growth potential that an investor is seeking. Instead, we have heard responses, such as the following, that we deem sub-par:
- Pay myself or my team
- Take some money or risk off the table for myself
- Hire an executive team full of great corporate experience – and high salaries
Part two of the ask is the place where virtually every company that comes to talk to us fails. The second part of the ask is to explain what the investor gets for their investment. There are two strategic ways to handle this – if valuation is very, very opaque and the company wants to be a price taker then let the venture capitalist set the valuation. However, more likely, the company should have a pre-money valuation that is furthered by receiving money.
So, if a company has a pre-money valuation of $500,000 and wants $1 million in investment, then the investor will expect roughly 2/3 of the company for the amount of capital (and risk) that is invested. Regardless of the company's expectation, the key point to part two is making sure that the ask is not half-way done. Make sure that the team and company have a clear understanding of what percentage of the company will be "on the block" for the investor.
One common issue that arises at this point is that a company will set a valuation based on amount of money needed and wanting to only give away a certain amount of the company. So for example, a company will say that they will give away 10 percent of the company for $1 million. That is a $10 million post-money valuation. Very few companies that we have seen have basis for that type of valuation.
Other common mistakes to avoid are:
- Expecting to give away a very small chunk (1 percent) of the company
- Expecting a big check quickly and in one lump sum (likely the investment will be tranched)
Then, there is a problem where an idea stage company has a "high" valuation based on little tangible evidence. The truth is that there are places where this can generate investment – but the reality is that companies that expect to have investors that do not recognize true value, probably are not getting very good partners. So, particularly with the influx of new Facebook millionaires, company CEOs should be wary of folks that don't have high expectations regarding the plan and effort that it takes to build a successful business.
Ways to push valuation higher for a startup:
- Have customers, even a single Beta (if it is a good one), has value
- Defendable progress, particularly a prototype or MVP (minimum viable product)
- Intellectual property
- An invested team (i.e. – they aren't waiting for a salary to get going)
- A very clear and measured approach to the market that makes the next step tangible and real – with or without money
- Progress and delivered results in between meetings with an investor
In summary – look for smart, early stage investors that have high expectations and want to work with you as an advisor to grow your business quickly. In order to do this, prove you know your stuff by making a full ask that is well-reasoned and justified. Don't give an investor doubt by making a poor half-asked pitch.
Credits: Photo of Tom Chapman courtesy of Chapman.
About the author: Tom Chapman is the vice president of operations at Nebraska Global, a software investment firm based in Lincoln, Neb. The firm specializes in developing complex software companies that can create real, lasting economic development impact in Nebraska and the region. Chapman’s role is to help with deal diligence, business, corporate and strategic development and acting on behalf of Nebraska Global in the broader entrepreneurship and innovation community. Formerly, Chapman was with the Greater Omaha Chamber of Commerce where he had the role of senior director of entrepreneurship and innovation.
Find Chapman on Twitter, @tchap623.