When venture capitalists say “NO”—creative financing strategies & resources, by Ron Peterson

Firms that are easiest to fund externally are those with safe, predictable cash flows or assets that have multiple uses so they provide good collateral. Emerging technology firms typically have neither predictable cash flows nor good collateral. Since bankable assets are rarely available with early-stage emerging technologies, debt is usually not an attractive financing instrument.

Highlight flaws in your idea, a suggestion by Donald Sull of the Harvard Business School to help manage risk but otherwise identify:

• What is the phrase that pays? The discipline of describing an opportunity in a short phrase forces the entrepreneur to strip away the peripheral aspects and distill an opportunity to its essence.

• Why is the opportunity still here? If it’s so great, why hasn’t someone done it already? Maybe it’s too early.

• What has changed to give rise to the opportunity? Entrepreneurs need to point to specific changes in the competitive, technical or regulatory environment to explain the origin of their opportunity. They need more than the simple desire to be an entrepreneur.

• What pain are you solving for the customer? Opportunities to solve a customer’s pain are often more robust than those that address less pressing desires.

• How big is the market? It’s often difficult to forecast the market for a new product or service with any degree of precision. However, back of the envelope calculations can provide a rudimentary estimate of market size and provide a check on overblown ambitions.

An expert in Internet law, Jonathan Bick, notes that you can obtain protection inexpensively by placing an invention in the public domain via the Web, and limit exposure to patent infringement suits. Bick, writing in the New Jersey Law Journal states: “An American Intellectual Property Law Association survey found that the nationwide median estimate of total cost through the end of discovery in patent infringement cases was $300,000 and that attorneys’ fees for patent litigation could exceed $1 million. It may be possible to avoid this litigation cost by using the Internet to place an invention in the public domain. Internet publication offers two legal options to parties seeking to avoid becoming unsuccessful defendants in a patent infringement case. The first is to publish appropriate information on the Internet and use it to block the granting of a patent. The elimination of a patent grant will in turn eliminate the possibility of being a defendant in an infringement case associated with that patent. The second option is to identify appropriate information that has been published on the Internet and use it to secure a pre-emptive resolution of a patent infringement case. A pre-emptive resolution normally takes the form of an out-of-court settlement in the form of a cross-licensing agreement between the parties.” Jonathan will provide the entire article with an e-mail to him at bickj@bicklaw.com. An intellectual property law information service is provided by the University of Maryland School of Law in their “Ask Art” column at www.miplrc.org. www.patentcafe.com is a comprehensive source of patent and corporate information with a special section for entrepreneurs and inventors. www.cafezine.com addresses the needs of young inventors.

Another protection is to offer a truly proprietary product. Premarin, manufactured by Wyeth-Ayerst Laboratories and one of the most prescribed pharmaceuticals in the U.S., has been off patent for decades. No generic drug firm has been able to produce a bio-equivalent version of the formulation and obtain FDA approval.

A briefing book by the law firm of McDermott, Will and Emery (www.mwe.com) outlines a process for producing intellectual capital, shows what can be protected and illustrates the kind of revenue that you could generate from IP. Some of the many corporate strategies they report include: Caterpillar, now receiving income from brand extension licensing to clothing and footwear; World Wrestling Federation with $150 million in revenues from licensed events, publications and merchandise; IBM with $2.5 billion in licensing revenue; and Greenpeace with $200 million per year from brand licensing. Nolo.com and Inc.com provide primers on patents that also illustrate what can’t be patented. Hale and Dorr launched a free magazine called IP at www.haledorr.com.

Nearly any investor will be thinking about how he could cash in if he invested with you. A grand vision and growing the firm to substantial size are nice, but show the investor that along the way, they’ll have lots of chances to realize their profits in cash. They’re giving up the liquidity of being able to buy and sell instantly some other investment on a stock exchange in order to go along with you, so remember this sacrifice and think of exit strategies for them.

When you’re working out what the investors are going to get for a certain level of investment, you want to be logical and be able to back up what you say. If you can find comparable companies that have gone before and their valuation levels, that’s a fair first step. Make sure that you can confidently forecast a certain level of sales and profits in a three to five year time frame and you can work back from there. For instance, let’s say that in five years you’ll be able to sell $100 million of product and realize a profit of $20 million. If the average stock multiple on the S&P 500 is twenty, your company could be worth $400 million on the public stock markets. If investors put up $5 million for twenty percent of your firm now, that twenty percent would theoretically be worth $80 million in five years. You can discount that figure back to give a super return, but remember the average venture capitalist is looking for roughly 40% compounded per year so the figures have to be good. This is a simple structure that you can manipulate to generate at least one valuation, even if it doesn’t prove realistic. If your expectations need to be lowered or if you want to change the returns to your investors, you can do so arithmetically, using at least a logical model.

Companies have a difficult time trying to market too many different products or technologies. Better to focus early on with your best bet and to throw your resources behind it, while keeping your options open if things don’t go that well with product or service number one. The ego of managers that feel they can do everything and roll out lots of products or services at the same time has killed many companies. It’s true that companies can do many things but the question is “should they?” Whenever you spread your resources among different or even competing areas you know that the original area is going to lose some talent, money, or emphasis. Big companies can do nearly anything in theory, but their best people are involved in the business they already have.

Most companies have changed their plans in response to what develops in the economy and certainly to new technology. Microsoft is an obvious example that has reinvented itself several times. Their original business model centered upon producing programming tools like Basic and on to producing operating systems. It was Bill Gates who was still urging Apple in 1985 to license out the Macintosh operating system.

IBM, although at a later stage of its development than Microsoft, had to make a shift from the business they had been built on, electrical tabulators, into computers. Change was a huge source of stress for them and stresses like that have been too much for many firms to handle. Intel experienced the same thing with the shift from memory chips to CPUs. Successful companies have to make that kind of transition, and startups often as well.

Netscape is an example of a company that built a product for the market they expected but found people bought and used the product for what seemed the wrong reason. The important thing is that they do buy and that the company begins to understand what the market really wants.