Top Five Mistakes Entrepreneurs Make When Seeking Funding

by

Carlos N Velez, Ph.D.

I’ve advised a number of start up life science companies in my career. Many of them start off the same way. A faculty member at a University or a former executive has an idea, for example. They decide to write a business plan. They meet with investors. And…they fail. They never get beyond a few initial meetings, or they struggle for years to find that one “home run” investor. Why do they fail? I have observed this process a number of times, and have found that there are at least five mistakes that entrepreneurs commonly make.

First, many entrepreneurs assume that receiving an equity investment (venture capital, angel investment, and the like) is the first step a company has to take before the company gets started. I have found that many entrepreneurs are unwilling to self-fund the initial necessary steps to started, such as forming a Limited Liability Corporation, or in-licensing a technology from a University in exchange for equity. A few entrepreneurs I have run into cringe at the thought of pursuing a home equity loan, even when many banks offer excellent rates for loans to start new businesses. Some are even unwilling to use personal funds to perform even simple things such as creating business cards, dedicated email addresses, and blogs.

The fact is that any entrepreneur, whether he or she is starting a biotech company or a bakery, is going to have to invest some personal funds to get started. Today, it is extraordinarily easy to set up a blog which serves as an initial web site (free at Blogger.com), get business cards (free from VistaPrint), get an almost free business phone line (a Skype.com phone number is $30 per year), and so forth. Many attorneys and consultants, especially those working in geographies where start ups are a hot topic, are willing to work for reduced billing rates or even at risk.

Closely related to the first is this second mistake. Many entrepreneurs assume that venture capital or angel investors are the only source of start up funding. I have found, for example, that many ignore the US SBIR/STTR programs, due to their complexity. If anything, with the growing scarcity of angel investors, these programs are becoming increasingly important for entrepreneurs.In fact, a cottage industry of independent grant writing consultants have emerged who specialize in writing SBIR/STTR grants. The Small Business Administration web site (www.sba.gov) is full of information on these programs. Similarly, a number of state governments, state universities, and even private universities have set up funds and other resources to assist entrepreneurs. New York is a prime example of a state which has a number of potentially helpful resources within state government, state university system, and within the major independent universities. Many of these programs provide entrepreneurs with cash, tax incentives, laboratory space, and so forth. I have also advised entrepreneurs to consider traditional forms of funds such as home equity loans.

Third, many entrepreneurs do not have a sense of how long it takes to receive some form of equity funding. For instance, assuming that venture capital is the right source of funding (and it is often questionable whether it is or not), I advise my clients to plan on the process taking anywhere from 6 months to up to a year to close on an investment. Look at it from the investor’s perspective. That investor is evaluating multiple opportunities at once. All of them sound attractive initially. All of them have risks and flaws. The investor has to decide which risks and flaws s/he is most willing to accept, and decide which flaws s/he can rectify…all this while also being able to generate a positive return on the investment.

Fourth, the previous mistake touches on a broader concern that I have, which is that many entrepreneurs do not have an understanding of the venture capital process. Terms such as “IRR” and “Preferred Shares” are naturally foreign to many scientists-turned-entrepreneurs. Many do not realize that a venture capitalist is managing other people’s money. They do not understand that the venture capitalist has a responsibility to return the capital entrusted to them AND also generate an above average return on the investment. Many entrepreneurs also have misunderstandings regarding equity dilution and control, and the role that softer issues play in the analysis conducted by a venture capitalist.

Lastly, there are entrepreneurs who still do not have a sense of what types of companies are appropriate for venture capital in terms of revenue potential, time to exit, value at exit, and so forth. Again, learning the process will help address these questions before a lot of time is wasted. Lastly, entrepreneurs frequently fail to seek professional help in creating their business plan and their presentation. I am amazed at the number of great technologies and product concepts which are packaged poorly. This is a problem because without a high quality plan (especially the executive summary) and presentation, an entrepreneur may not even get their foot in the proverbial investor’s door! Many plans are too long (more than 30 pages), full of technical details (which are likely confidential, and hence should not be in the plan anyway), and emphasize the wrong things, such as financials, over markets and competition. Worse still is when the “business plan” takes the form of a poorly conceived PowerPoint presentation instead of a well-written, prose document, or presentations which are not synchronized with the prose document. Having a professional prepare these documents and advise the entrepreneur on the process can save a lot of grief in the long run.

Now I recognize that there are some prospective investors who will say that a full plan is not necessary. There are some who will say that 10 slides or a 3-page Executive Summary are all that are needed. And for some prospective investors, that may indeed be the case. But in general, undertaking a funding drive with 10 slides is a grave mistake. The notion that you are writing the full plan so that the investor can file it away and forget it is also a grave mistake. The business plan is first and foremost a document for the entrepreneur and the team. It is an expression of how the company is going to uniquely capture the economic opportunity which has been identified. Perhaps some investors will take the plan and file it away, but each sentence and each slide must contain the essence of a great deal of thinking and planning. It is the thinking and planning which should be written down in the format of a business plan.

Many entrepreneurs forget (or don't realize) that a business plan is indeed a PLAN. While the content is fairly standard, the plan should be a uniquely crafted document which captures the thinking of the initial management team. The most important aspect of the plan is to document how the entrepreneur intends to capture the unique economic opportunity she/he has identified. It is easy to prepare a plan that describes a market which is large and growing rapidly (China, India, baby boomers, diabetes, cardiovascular disease, Google, Web 2.0, etc.). It is an entirely different matter to explain to a prospective investor or to you how this opportunity will be captured. It is amazing how the mere act of writing things down raises unanticipated questions which must be answered before seeking funding.

Critically, the "How?" question must be kept in the forefront during the planning process. How will you market this product or service? How will you retain and service customers post-sale? How will you approach potential licensing partners? The answers should be action-oriented, and that is what any prospective investor will want to know. Yes, the opportunity is huge, but HOW will you execute?

Much has been written about the poor quality of many presentations, especially those prepared for prospective investors. Many people assume that the use of bullet points in PowerPoint is the best way to present material because it is essentially the default presentation design in PowerPoint. In my view, if an entrepreneur has a 30-40 slide presentation that has each slide with the same background and full of text written in Font 14, then that entrepreneur is going to have an extremely difficult time generating interest and excitement. Pretend, for a moment, that you are an entrepreneur. You have an appointment with a venture capital fund at 1 pm on a Thursday afternoon. You set up your projector, the lights dim, and you start to present. For the audience, this is the third such presentation on that day; perhaps the tenth that week. All of them look familiar…similar bullet points, similar backgrounds…page after page after page...

An entrepreneur is there to sell. An entrepreneur is there to generate excitement and enthusiasm. Can you imagine a television show or commercial where the camera does not move? Where the background remains the same? Where there is only one actor? Would you watch?

Additionally, many go through great lengths to create very sophisticated slides, with complex charts, graphics, arrows, clip art, and the like. It is almost as if they think PowerPoint prowess will be correlated in the minds of the audience with investment attractiveness! Who can listen and read at the same time, with full comprehension!?

Hiring a professional who can prepare business plans and presentations is an obvious way around many of these issues. This is especially true if the professional knows the industry and the investors in that particular industry space. The professional will know what information his contacts are looking for, and will not be locked into standard templates and formats in order to deliver a quality set of documents. However, there is also a second and arguably more important reason to hire a professional. Before one even begins to write a plan, there are a multitude of strategic issues that should be discussed and debated before writing the plan. Let me provide a brief example. One of my clients is a drug discovery start up company. The company has a process whereby they can discover novel targets and, in turn, novel drugs for those targets. So, what is the business model? Is this company a licensing company, generating targets and agreements with pharmaceutical and biotech companies? Or, are they internally focused, keeping all of their discoveries for development and commercialization themselves? Are they both?

Many investors (but certainly not all) would prefer a hybrid model. Having a company sign development agreements would not only provide some incremental cash, but it would also validate the company's fundamental technologies and processes. So this then raises a number of other questions. For instance:

Who is the best partner(s), and Why?
What therapeutic areas should we "give away"?
Which ones do we retain?
Should we focus on one indication, or multiple indications?
Should we offer exclusive or non-exclusive rights?

The more this is spelled out in the business plan, to the extent that it can, the clearer the picture that is presented to prospective investors. I concede that much of this will be speculative. After all, the business plan might say that the company will pursue an agreement with company X. But that fact is that the agreement may not be in place at the time the plan is distributed. So, some VCs will not invest until that agreement is in place! Others, who see a clear road map in the plan with multiple options (e.g., if Company X declines, we will reach out to company Z), and who see that value is being created concurrently (through internal research), may be interested in a model like this. Indeed, this is where having a strong Board will make a tremendous difference. The good VCs understand that there will be ups and downs as the company evolves.

In hindsight, one of the mistakes some of the genomics companies made during the bubble was their attempt to position themselves as licensing machines. That is, companies who would reap millions in licensing fees for genes, targets, and the like. When the model flopped, they all of a sudden became internally-focused drug discovery and development companies! Many of these companies flopped, were recapitalized at heavy discounts, or were otherwise folded into other companies.

So what is the “secret” to attracting investors? What is the “template”? I do no think there is a template, but I also think this is good news. A lack of a “template” means that entrepreneurs have no limits regarding how they express their unique value proposition. The business plan and presentation are an opportunity to be highly creative. However, this very lack of a template also points to the need for entrepreneurs to seek professional help early in the process.

I have a great deal of admiration and respect for folks who believe so strongly in an idea that they are willing to sacrifice career and personal finances in order to see it through. However, it also pains me to see entrepreneurs unprepared to enter a culture which is quite different than what they are accustomed. Some prospective investors understand this, and are willing to hold the entrepreneur’s hand a bit. Unfortunately, investors with that kind of time and patience are rare. The onus is really on the entrepreneur to drive the process forward.

So, are you an entrepreneur seeking to start a company, biotech or otherwise? Here is my advice.

1. Be prepared to assume some of the start up costs, some of which may be significant. Conversely, do not let this discourage you!

2. Consider all potential sources of funding or in kind services, and don’t be afraid to network and ask! You would be surprised how helpful people will be if they learn you are trying to create a company which will create jobs, develop a drug, create wealth, etc.

3. Plan on a lengthy process, and arrange your personal finances accordingly. If you can keep your “day job”, then do so for as long as possible. If your current employer can be involved in exchange for equity, then explore this option, but do not sign anything without legal counsel.

4. Understand the process from the investor’s perspective, and be prepared to speak their language. Understand what angel and venture investors are looking for from their investments in terms of revenue potential and time to exit from the investment.

5. Seek professional help to create legal structures, business plans, presentations, and other materials to maximize the probability of success. Leverage these relationships to identify prospective investors and prospective members of the management team. Do not underestimate the importance of having a sound product and business development strategy in the plan.

About the Author: Carlos N Velez, Ph.D., is a writer and consultant to many life science companies, from nascent start ups to multinational companies. His consulting practice includes the preparation of business plans and presentations for start up life science companies. Carlos earned a BS in Pharmacy from the Albany College of Pharmacy, a Ph.D. in Pharmaceutical Science from the University of North Carolina at Chapel Hill, and an MBA from the Rochester Institute of Technology. He often shares his perspectives on the life sciences and entrepreneurship on his weblog, http://nylifesci.typepad.com He can be reached at carlosnvelez@eriehudson.com

Disclaimer: The ideas presented in this article are only the opinions of the author, and should not be interpreted as investment, legal, or financial advice. The author strongly recommends seeking the assistance of qualified professionals before making any investment decisions.