Early stage funding: how to improve odds of success - part two

In part two, Jean-Louis Roux Dit Buisson shares his experience in selecting projects for future investments, more specifically looking at how to strike a deal for long term value creation.

(Continued from "Early stage funding: how to improve odds of success – part one")

In part one of two, dedicated to means and ways for entrepreneurs to raise their odds of success while discussing with investors, we focused on the most common mistakes affecting entrepreneurs-to-be during the early phases of the funding process.

This article will deal with the end of the process: valuation and striking a deal for long term value creation.

In early phases of development, putting a price-tag on an NCE is more an art than a science. Care should be taken in selecting appropriate hypothesis, and leaving room for downstream adjustments as the information acquired during development phases is essential in refining the risk profile, the future positioning and the attached sales potentials.

"...a number of brilliant inventors fail to fully develop their ideas because of the fear of losing control."

Methods exist to assess the value of an invention. In a previous set of articles we dealt with the technicalities of methodologies recommended for developing sound valuation models using rNPVs, scenarios and business acumen / judgement in choosing key variables, and presenting results for decision making.

However excellent your staff or your consultant in evaluations, there are still two aspects of the negotiation that can make all your efforts a waste: greed, and the wrong discussion partner.

Greed

In industries requiring large amounts of money and substantial levels of risk in order to bring an invention to the market, it is most likely that the original inventors will be severely diluted at the end of the process, e.g. IPO or market launch.

I have witnessed a number of brilliant inventors fail to fully develop their ideas because of the fear of losing control. Recently I worked with two surgeons who refused to raise €5 million that could have been allocated to essential clinical trials, and preferred to raise 200k so that they would retain 80% ownership. Their decision destroyed all momentum in the project, some of key team members parted and they finally had to call a white knight to bail them out of the situation they entered into.

This mechanism is not only complex and self-destroying; it is an arrogant view on the relation between invention and management.

When faced with such initial resistance to raising necessary funds, I show my clients a typical P&L statement highlighting all the other activities that are necessary to have the R&D budget transform into sales and profits, and I ask two questions: is it better have 5% of a million or 100% of nothing? How will you support your children once they get married, for example?

"Your job as a first-time entrepreneur is to identify the investors bringing smart money to your project..."

Wrong investor

Rumours abound about investors, from the guys who are going to steal your idea to the folks who will provide the funds for you to continue exploring many ideas, the suits who know it better because they have the money, etc.

That's a wrong starting point. Investors need to find the ideas and the teams on which they will invest the funds that need to generate a minimum return so that their funds suppliers get a return, and all the other funds invested in companies that failed can nevertheless earn a return as well in the process.

Your job as a first-time entrepreneur is to identify the investors bringing smart money to your project, and have a deontological sense of fairness in the sharing of created value.

By smart money, we mean someone who knows the industry in which they invest, someone who has connections to facilitate your networking, your hiring, your influence, and someone who can address key management issues such as focusing on the end outcome, avoiding dispersion of efforts, redirecting the team's efforts with you and / or with your team on a more personal basis than quarterly board room presentations. Companies develop because each member knows their job and trust the others to perform as well as they do, so why should this philosophy not apply to relationships between investors and inventors?

We've met such investors animated with the vision that if they help create value for the society, then there will be ample returns to share between them and the inventors. And they invest in very early stages as well.

Prior to going around and presenting your dossier to investors, do your due diligence, speak with other companies in their investment portfolio and assess if the management style corresponds to your company's profile. If your idea is good, you will find the money, if you don't find the money you're either too early on the market, or either your invention or your team aren't very convincing.

In any case, avoid the greedy investor such as the counsellor to the ministry of industry who stated "at this stage of development we are going to take everything from the inventors". Who would ever consider this for such smart money?

About the author:

Jean-Louis Roux Dit Buisson is a Professor of Entrepreneurship at the Grenoble Management School in France. He is founder of Foro Ventures, a company dedicated to provide assistance and interim management for top-line growth projects and turn-arounds.

Jean-Louis is specialized in high technology sectors (such as Bio Pharma, Medtech). He has an MSc from MIT and an MBA from INSEAD and can be reached at jl@forotech.ch.

How can the relationship between investors and inventors be improved?