Great Advice for Soliciting and Spending Investors' Money

The real deal on matching investor expectations on spending their money

Q.  I have a growing, revenue generating business.There are two individuals who separately are interested in investing in my company.  Both believe the sky is the limit for the company.  When selling part of a company, are the funds used for paying off company debt, updating equipment, building up inventory or marketing? Or are the funds pocketed by the founder? I'm really confused.

 A. Here is an admission that entrepreneurs who started their businesses to "break all the rules" will enjoy reading.  When it comes to venture funding negotiations, there really aren't any fixed rules.  It's a matter of negotiating points of common ground right up until the point checks are signed.

"Use of Proceeds" is a common term within the venture community to describe how investment funds will be applied to various business purposes.  For example, a startup management team may propose to investors that approximately half of investment proceeds will be used for product development, with the balance of proceeds allocated equally to patent filings, hiring more staff and licensing other technologies.

While use of proceeds statements are general in nature, they do serve as an important guide for investors.  An entrepreneur who unexpectedly spends investors' money on big salaries and car leases rather than the planned product development will one day have to face unhappy board members, shareholders and perhaps a few hostile letters from lawyers.

So, in answer to your question, you are empowered to develop your own use of proceeds statement.  This statement can allocate all investment proceeds to fund business growth or it can direct funds to a combination of personal and business enhancement purposes. 

It's really up to you to pitch a deal that will be accepted by investors.  Establish areas of priority.  If, for example, you really want to retire debt that has been personally guaranteed by you, then you have to ask for it.

While it is true that venture investing has no rules, I can't resist presenting a few time-saving guidelines.

*   The farther along a company is in its development, the easier it is for investors to accept buying out a founding shareholder.  These investors expect that some of their money will be used to acquire owner's shares plus provide capital for growth.  But don't contact an early-stage venture fund to propose this deal.  Instead check out later-stage venture funds and middle-market buyout funds that compete aggressively for profitable companies with revenues in the $25 million to $100 million range. 

*   Younger companies that are still fighting their way into the marketplace typically require all available funds to meet growth demands.   Investors know this too and typically resist proposals that cash out founders before investors.  If anything, the rule of early stage funding is, investors get their money out before the founders.

*   Individual investors tend to be more lenient with entrepreneurs and have more negotiating flexibility than fund investors.  Why?  Because individual investors make their own rules and don't have to answer to venture fund partners and shareholders.  If they want to do a deal even through the numbers don't really work, they can!

*   When comparing two or more sources of funding, confirm each investor's funding capabilities. Recently I met up with two entrepreneurs who were snookered by some investors who promised to invest in several rounds.  Unfortunately, the entrepreneurs learned that the investors only had enough funds for one funding round putting the young company in a sudden and severe cash bind.

Entrepreneurs who are building their companies successfully really are masters of their own destiny.  This means, entrepreneurs don't have to accept deals that don't make practical sense to the founders. Sometimes saying "no" is the smarter move than saying "yes."

Write to Susan Schreter at susan@takecommand.org for great funding tips for entrepreneurs of any age and business objective.

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