How to Fund your Business: Equity, Debt, Unfund

Unfunding is a very creative way of getting access to resources without paying for them. Basically, it deals with changing the way we think about cash. We tend to think that we need cash to get things done. Let’s break that paradigm.

As you might recall, funding is the mechanism of providing cash to pay for resources. That cash is provided by one of the two conventional ways of funding: debt and equity.

The needs for funding, or cash, result from evaluating what cash is coming in and what cash is going out. Which is called the cash flow.

Traditionally, we estimate funding needs by looking at the numbers. Strategically, however, we can have a much better view of those needs if we take the time to specify what are we going to use that cash for, what are we paying.

For example, if we take the financial view, we could estimate that we need 100,000 dollars to purchase a 3D printer, a car, and a desk, and another 100,000 dollars to hire an artist, and a sales executive. If we take the strategic view, we realize that we need molds or parts, transportation, drawings and sales. We could then share a 3D printer, ask for Aunt Lucy’s desk, and partner with a taxi company, or lease the vehicle; we can also share an sales executive and seek a rep that carries a line of products complementary to ours.

In a personal example, you can take different approaches. You could search for the best possible house you can buy. Or find a dream house first and then look for ways to purchase it. Or, find ways to live in a house by taking care of it, swapping houses, or leasing it. Unfunding is similar to this last approach, focusing on the use of the house, not the ownership.

Unfunding requires the interest of stakeholders who benefit from your activities and have the capacity to share expenses and rewards with you. I love this topic because it allows us to discuss different schemes and opens a whole world of possibilities that might not be immediately apparent. As a result, the need of cash diminishes greatly or disappears completely.

Think for a moment on what would happen if we thought about we wanted to achieve, and instead of limiting ourselves to what we can get funded for? If we focused on discovering natural collaborators to drastically diminish or even completely eliminate our capital needs?

Reverse financing refers to getting cash in before spending funds producing or delivering what you offer. Some large companies, such as Avon and Tupperware use it. Also some phone companies pre-charge you for their services. Gift cards work in a similar way.

Reverse payment is used by companies large and small to reduce their capital needs. If you are starting something new, you might not think this is for you.

Let me tell you how I did that.

When I started my first informal venture, a cookie and cake company, I was a poor student, and did not have a car. I wanted to make sure that all of the products I made and delivered to the University were sold.

By trial and error, I ended up picking the most popular product, a never-fail 7-up cake, and sold it only on Fridays. I ran my routes through the hallways every other week to not bore my clients. One day, a secretary ordered a cake for the following week and prepaid for it. I thought it was pretty cool to have money in hand to buy the materials.

Pre-payments provide three main benefits:

• ·It validates a need in the market at specific prices
• ·It lowers inventory expenses
• ·It reduces funding needs, which in turn reduces management time and financing costs

The best way to use pre-payments is to discover or create an opportunity with a unique value, and provide some form of benefit for early payment. This system is also used in seminars and conferences for early-bird discounts.

An alternative to buying and owning assets is leasing. Leasing is essentially the rental of assets or the payment of appreciation. Once again, let’s look at leases from the financial and the strategic point of view.

Financially, leasing eliminates the needs for large amounts of cash, changes the depreciation benefit, and transforms an investment into an expense.. It can be a little bit more complicated as we will explore in the course materials because the depreciation, tax implications, and internal lease interest.

Strategically, leasing allows for the use of assets that can become obsolete or unneeded in the near future.

The lessee, who receives the asset, commits to making a recurrent payment, similar to a loan, usually a little lower. The lessor retains ownership of the asset.

The lessor can be the supplier of the asset, a banker or other financing institutions.

For example, a company might require a loan to expand its manufacturing capabilities, and could talk to a banker to secure a loan to then pay for the purchase of the equipment, or the supplier of the equipment could propose a lease option that will make it easier for the company in financial terms. A bank then might be giving a loan to the supplier. A combination of lease and loans are also possible.

Disappearing involves the elimination of funding requirements by creatively sharing rewards with other stakeholders that can benefit from a unique company. It does not include the use of government funds that give support to innovative, exporting, and young local companies, including those that are minority-owned or that fulfill specials requirements. That is what I call granting and will be discussed at later. An example of disappearing is asking for free advice from a consultant friend; asking for volunteers to take on the role of employees; using space or equipment for free; traveling with frequent flyer miles for flights and lodging; and brand flattering. Brand flattering is the process where the image of a company or institutions benefits from an association with another one, typically for a ‘good cause.’

I use disappearing extensively in my businesses, and for many of my clients. I developed a process that is easy to understand and apply by following a five-step plan:

1. Define the uses of capital. Examples of uses of capital include: salaries, rent, transport, supplies, packaging, marketing, legal fees, import duties, salaries, and storage. Imagine every single possible invoice that needs to be paid.
2. Identify the larger impact of the company in stakeholders and the community. As a general rule, most organizations provide jobs and pay taxes, but there are some less obvious benefits, such as extra traffic brought an area when a new store is opening. An opposite impact is also possible, noisy activities might detract traffic.
3. Discover the natural allies of the project or company. The third step involves evaluating the different stakeholders. Typical stakeholders are owners, employees, and clients. I prefer instead to look for natural allies or collaborators. For example, years ago, a commercial airline painted some of their planes in a chocolate candy motif. The candy factory paid for it, and it was good for both brands.
4. Create effective propositions. Crafting an interesting proposition is critical, as we are not trained to think about collaboration but about competition. In all of the cases that I have seen the disappearing method work well, the entrepreneur has been able to create an irresistible proposition seeking how to add value to a collaborator more than based on charisma and inspiration. The approach taken by these entrepreneurs is more likely to be towards the extreme of ‘you don’t want to miss this opportunity’ than towards the extreme of ‘I need your help, otherwise, I’m done.’ An ideal proposition has a very high probability of success with high visibility and a very low probability of failure with a very low visibility.
5. Plan an adequate follow-up. On many occasions, plans fail and there is a need to make the necessary adjustments. A good example of a follow-up plan is to delineate clear goals and expected procedures.

Disappearing avoids conventional norms of practice:

• ·It relies on the input from stakeholders
• ·It is guided by the beliefs and desires of participants
• ·It is very dynamic

Thus, it is critical to be flexible and focus on making sure there are benefits – mostly non-financials – to those who participate.

Many young and small organizations have the advantage of size. Because they are small, they can do with lots of ‘unwanted’ products. Gifts are products or services given away without an expectation for a return. They come from many sources: from charities, from other businesses, or from individuals like employees or customers.

Typical examples of gifting are:

• Office equipment: computers, printers, telephones, lamps and desks, samples and so forth
• Free or underpaid labor, like a friend’s help to write a press release, or a free radio announcement
• Free supplies like paper and packaging materials
• Free support, like brainstorming with consultants and lawyers
• Free undefined materials like unused merchandise, equipment and marketing material
• Transfer of patents, equipment or property that no longer has a value
• Free samples or other freebies.

Gifting also provides for a way to test new products or services. Companies select potential clients that have expertise and are willing to provide valuable feedback so that they can improve their products or services before launching them. In some cases, especially for high-tech companies, tester are very beneficial, and are more flexible that current customers. I invested in a video game company that review new platforms and programs. This saves them time of programming for technologies that could become obsolete.

Some companies use gifting as a way of conducting business: recycling paper, doing public relations, and receiving what others give freely because it is not intended for use. Public relationship companies typically use their strong ties to get press releases into media as information and not advertisement, saving their customers large amounts of money.

Crowdfunding is the process of engaging a large crowd of backers to provide cash to fund organizations or causes. There are two types of crowdfunding. One is via donations or presales, and the other is via investments.

Donation crowdfunding websites such as Kickstarter or Indiegogo facilitate the matching of donors with creative projects. The payoff for the donor is usually some sort of merchandise associated with the project, like an autographed copy of a book. This model works well for small projects.

Crowdfunding is about establishing meaningful connections on a short period of time. Individuals provide crowdfunding because they care, receive participate, and are inspired by the organization’s vision.

Let me explain this with more details:

• They CARE. They share the passion for your project.
• They RECEIVE. Their support is received with gratitude and is reciprocated.
• They PARTICIPATE. They want to share with others their support.
• They HAVE PRIDE. They feel honored to help you out.

Crowdfunding has expanded into crowdinvesting.

In the US, the Jumpstart Our Business Startups (JOBS) Act, allows small, unsophisticated investors to buy shares or debt privately for startup companies. Private companies can raise up to $1M a year through crowdfunding if they provide audited financial reports and without undergoing the expense of an Initial Public Offering (IPO). An individual with earnings or net worth under $100,000 can invest five percent, up to a $2,000 cap. The percentage rises to ten percent and the cap increases to $100,000 for wealthier investors.

Join us on a conversation with Piper's founders. They raised $250K on their kickstarter campaign.

Partnering involves synergy derived by combining two different units that can achieve something that would not be possible or convenient without a joint effort. Synergy comes from the Greek word syn-ergos, which means "working together". Typically, partnering involves doing something for the benefit of two independent units that continue to be independent.

Partners can reach a specific goal by working together without merging or forming a long term relationship. For example, many car rental companies have realized the advantage of establishing an independent single location for all of them at major airports. Efficiencies in costs and operations, ranging from construction to maintenance to safety, benefit everyone and dramatically reduce the needs of funding for rental companies both for investing and for working capital.

Partnering is very flexible but not as unorganized as the previous unfunding mechanisms. One of my favorite support programs for small and medium size businesses in Chile –Profo-- was created with the idea that working together will give businesses competitive advantages, which it did! A group of complementary firms – a minimum of five and a maximum of ten – would work together on a specific program and hire a manager for that program. The government paid half of the program’s cost for the first year. As a result, small and medium companies could, for example, organize a production facility providing specific supplies for each one of them that otherwise would not be cost effective to procure. They could also organize an export organization, increasing the number of models to be offered and their production capacity. Working together helped companies find specialized expertise as they helped each other, and forced them to establish processes and evaluate efficiencies.

Bartering involves exchanging products or services without exchanging capital. Barter was actually the precursor of the capitalist economic model before the introduction of money. It includes an exchange of products, services, or information that fulfills promises. The commitment using bartering is simpler than with partnering.

Tax issues have also encouraged bartering among enterprises. Enterprises facing high tax burdens try to avoid their payments by using barter schemes. As a consequence, in 1982 the Internal Revenue Services in the US^, passed a law for barter tax. This law equated barter system with banks and credit card systems.

If used properly, barter can provide a boost for any business. The main problem with utilizing bartering is that it depends on an existing benefit to others that might not be related to funds -- therefore, profit margins are not appropriately measured

In the following classes we will cover the basis of equity funding. Equity funding involves the exchange of funds for a piece or a promise to own a piece of the equity of the firm. That means that equity investors own a part of the organization in general terms. As owners they share the success or failure of the organization.

When we speak about equity funding, we tend to think about Venture Capitalists. Venture Capital funds are only one of the many possibilities of equity funding. To organize the wide spectrum of possibilities I have created a categorization based on: the involvement of the provider of the funds, his or her involvement in the daily operations of the organization, and the expected rewards. As usual, I would add some street-smarts tips that will help you increase your probability of getting funds from the most appropriate investor.

This session covers the following types of equity investors:

Founders, Family, and Friends – also called the 3 fs.

Angel investors

Equity investors

Venture capital (or VC) funds

The ideal type of investor varies according to the strategic intent of the founders. For example, a company that grows steadily to reach a stable point, like a local restaurant, will be more suitable for an equity partner or family and friends. Should the same organization seek to establish a new category and grow exponentially, then it might be more suitable for a VC fund if the investment is large or an angle if the investment is smaller and is used to establish a small set of prototyping units.

In the following segments I would explain what are the basis of each type of equity investor, what do they do, where to find them, and the major pitfalls to be aware of. Please go to the unfunding section for capital-less options, and to the debt section for loan options. Ready to go? Let’s get funded.

Founders are the first investors in any organization. Not only in terms of capital but also in terms of time and effort, especially taking out ideas that do not work. Founders provide the initial funds and much of the time and analysis to create the business plan and initial set up. They also receive the highest rewards for such efforts, not only because of the funds they have committed but because they make things happen. And, especially in new organization, making things happen is difficult. Also, founders need to take a risk. An idea is not enough to warrant a part of the ownership. Action, and more importantly, recurrent action is required. Dreams are cheap, goals are expensive. The value is in the execution, and such value is captured by the concept of sweat equity.

Sweat equity is a way to capture part of the energy and ‘make it happen’ capacity of founders. Because it is a subjective value there is a lot of debate about that, and I have not found a mathematical equation to calculate the value of sweat equity.

A way to overcome this problem is by allocating shares according to milestones, in a process called vesting. We covered that concept in the segment of basic concepts.

When founders act as investors they face the following challenges: poor planning, lack of focus, financial slack, failure to recognize opportunities, failure to cut losses, and self-employee mentality. To overcome these pitfalls, define a business plan, establish a road map, and organize a group of advisors and use them.

If you have some funds, use them as part of the initial capital contribution. After all, if you don’t believe in your idea, why would someone else believe in it?

Founders provide the energy and determination to run any organization, UNTIL it is mature enough to be managed by others. This short video highlights the main challenges faced by organizations funded by founders ONLY or during the period where founders are the 'funders' of the company.

If you disagree, read on...

One of the golden rules of funding is that founders have to take a risk. Otherwise, they have not proven that they trust their idea or project, and therefore why should others? This golden rule applies to every type of financing. Founders must discover a way to prove they are taking some kind of risk before inviting others to do so. If you prefer not to take that risk, do not expect others do so in your place. Instead, review your plan and make the necessary changes so that you are sharing the risk from the start.

Relatives usually invest to support someone they care for because they want them to succeed. Compared to friends, relatives can be more skeptical about the idea and more vocal about their opinions. Also, relatives seldom want to be publicly recognized as investors. Sometimes they take on work in the daily operations of the organization, and can become co-founders if they take on a managerial role.

If you have a relative that has been an entrepreneur, start having a meeting with him or her, and explore if your idea is worth investing. Be open minded about your relative’s observations during the initial meetings. If they decline to invest, remember that most ideas that don’t get funded are bad ideas.

If you are about to receive an investment from a relative, make sure you have a plan in place that you both agree and establish a payback mechanism: is this a loan or a straight equity? When does the payback start, and when does it end? What are the triggering points for payment? What is the impact in the case of default, death, or disability? Is this a personal loan that you apply to a business, a straight business loan? Or a straight investment in shares? A special consideration in family investors relate to inheritance issues. Depending on the size of the investment, you might want to consult with a expert in inheritance taxes.

Family investments face two main challenges: well-intended, but ill-prepared advice, and family politics. If the investor has no experience in the industry or in entrepreneurial activities his or her advice must be carefully considered. It is critical to define what power the investor will have in the decisions of the firm. With regards to family politics, I found that it is best to keep the details of the investment private between the parties involved.

Many founders do not seek funds from relatives because they fear, rightly so, that their relationship will change. Well, as long as there is an investment, the relationship does change. You end up talking about the new organization all the time! To keep your relationship, sure you keep business meetings and also establish personal time where you don’t discuss business. I once invested in my daughter’s firm, and we struggled to find time to talk about NON-business related items. Months later, my grand daughter, then five years old, asked me to have a meeting. What kind of a meeting I asked? A business meeting she replied. We had become so used to discussing business issues that it had impacted everyone.

To manage family investors make sure you provide information – good and bad- about the business in a timely fashion.

When founders don’t have enough resources they usually revert to family and friends to ask for help. In this segment we will explore how to find, use and avoid pitfalls from friends as investors.

Friends usually invest to support someone they care for with an idea that is credible. As investors, friends benefit either from wanting to be part of an exciting organization or because they find it is better to help someone become financially independent than to just provide funds or support – yes, like that couch where you can sleep, an introduction, or a smart conversation.

Start the process by asking friends if they could provide comments about an idea you want to implement and judge their level of excitement, value added, and interest. Ask them if they think this is an interesting idea worth investing, but always make sure you can provide what I call an ‘elegant way out’. Instead of asking: would you invest in this project? Ask: do you think this project is an interesting investment? Or do you have any recommendations as to whom to ask for x funds?

If you are about to receive an investment from a friend, make sure you have a plan in place that you both agree and establish a payback mechanism: is this a loan or a straight equity? When does the payback start, and when does it end? What are the triggering points for payment?

Once the investment is going, there are three main challenges in having friends as investors: they might provide well-intended but ill-prepared advice; they might have unrealistic expectations especially if they do not have experience in start-ups; and they might speak about your idea in ways that you might not approve of.

The best way to manage friends are investors is to provide clear expectations as to what they can and can’t do, keep them informed, and filter their recommendations. Especially if they don’t have experience in the industry and/ or in start-up settings.

Last, make sure you keep the friendship by spending time in activities that are not related to the investment.

Excerpt from the book Funding your Million Dollar Idea - Funded by Family and Friends

Angel investors invest their own funds and track the journey(other word) of the company personally. Traditionally , they take an active role in helping a young company grow for a limited period of time. These individuals have funds to invest by personally assessing the opportunity and the team. However, having cash to invest does not makes a person a good angel investor. Successful entrepreneurs who have received funding from angel investors are the best angels.

Angels’ non-financial contributions are as important as their capital contribution: they open doors, suggest changes to the strategy, provide input in hiring, help think about business development, and can be instrumental in defining an exit strategy. Because of these contributions, angels traditionally do not invest far from where they live or in industries where they have no expertise. If they invest as part of a group, these considerations are less relevant.

There are several ways to find angel investors. Where there is a mature and active community of angels, an internet search will lead you in the right direction. In areas where the angel community is very small or invisible, look for professional associations, universities and chambers of commerce.

The main barrier to finding angel investors is the entrepreneurs’ mentality of being at a disadvantage because he or she is seeking funds. The second biggest barrier is the lack of preparation and the lack of a fundraising process.

To reach out to Angel investors you have to be prepared. Use a consultant to help you but do not send a consultant to represent you. You only have one chance to make a good impression. You will need a well thought-out business plan, including a full set of financials and the terms of the deal. You also need to have a working prototype, some feedback from customers, and you must be taking a risk.

If you are not ready, you will not get funded. Simply because there are a lot of great deals around. If you need funds to get there, use unfunding, or the 3Fs (founders, family, friends)

Some individuals invest in equity in low risk ventures. Unlike angel investors, they want a steady, predictable payment in dividends rather than the eclectic, unforeseeable return that angels seek. This type of investors behave like lenders but want to own a piece of the business instead of providing a loan. I have not found a name for this type of investors so I have called them equity partners, although all of the types of equity investors are equity partners. Perhaps you could come up with a name and send it to us on social media?

In any event, what I call equity partners are not well known in articles and academic research, they are not as sexy as angel investors or vc funds and you don’t hear their crazy success stories, but, I find that they are very, very common. Like angel investors, they usually invest their own funds in the early stages but they differ on the expectations. Angels want to exit in few years, whilst equity partner seek to remain in the organization for a longer term and seek stability and a return in the form of dividends.

Equity partners want to invest in solid, low risk, small to medium firms. That is usually aligned with developing a niche or having a geographical competitive advantage. Their level of involvement varies greatly. In many cases I have found that retired executives who want to work part time typically in accounting of finance, fit this profile.

The mayor challenges when dealing with equity partners include: defining lines of authority and decision making, managing expectations, and dealing with changes. To manage these challenges, communication is critical. Define clear lines of authority. For example, establish prior to the investment, what decisions can be made without consulting the investor. Also define what are the expectations of the equity partner, and what role is he or she playing.

Last, equity partners must be chosen much more carefully than angel investors as they tend to stay in the firm for a long time and might not support a change of strategy if needed.

• Excerpt from the book Funding your Million Dollar Idea

Venture capital funds are the Olympics of equity investing. Also called VCs, these are professionally managed investment organizations that take a focused approach to rapidly grow and exit from a disruptive firm. Traditionally, VCs fund projects that have customers, are scalable, and create new markets, and are managed by passionate and professional CEOs. VCs provide capital but a huge network, experience, and strategic advice. In some cases, VCs help find a CEO that is better prepared to run the company for exponential growth. That was the case of Google for example.

VC funds expect to make a very large return for their investment. Two of the most successful exits are the investment of DEC (Digital Equipment Corporation) by the first VC fund –ARDC in Boston- which provided a return of over 500 times the investment (an annualized 101%) from 1957 to 1968. More recently, Google provide an estimated 344 times gain to Sequoia.

There are however, few facts about VC funding that most people are not aware of.

First and foremost it that the funds of the VC fund do not belong to the general partner or to the individual or individuals making the investment decisions. The cost of supporting each investment is large, therefore, VCs usually fund companies that need over 1 million dollars. Also VC funds have a limited life span. Yes, they must ‘close’ the fund after a number of years, usually 10 years. Then the managers might open another fund.

Last, VC funds traditional invest with others and invest in series of groups of shares. Like series A, B, C and so forth. This allows for new investors to join at a different valuation – usually higher. And helps break down the investment risk, by tying the valuation to specific milestones or accomplishments.

VC funds are easy to research, so you have to do your job and evaluate if there is a good fit between your project and the fund, also you might want to check if they have invested in a company that competes with your idea. If a VC fund has invested in a company that works in your industry, it might be easier for them to evaluate your firm.

Excerpt from the book Funding your Million Dollar Idea

Funding by debt is very convenient, and it is also relatively cheap, when compared to equity funding. I like debt because it works like a reality check, and it makes the value of the use of capital very visible. Although in some cultures it is not acceptable or even legal to charge for the use of capital. There is a paradigm breaker for you.

The key word in debt funding is certainty. Debt is the ideal funding mechanism when there is certainty about repayments.

As a general rule, the lender evaluates your capacity to pay back based on your future income and your past behavior. Lenders might also want to make sure that in the worse case scenario, they can liquidate your assets to get paid. Liquidate your assets means that they could sell something that you own.

So, an ideal candidate for debt funding can tick all of these five Cs: credit (your personal and business credit ratings), character (your reputation and integrity), capital (positive net worth), collateral (assets you can pledge), and cash flow to pay back the loan’s installments.

In financial terms, there are three components of debt funding: principal or the amount of capital that is borrowed, interest, the cost of having that capital, and period, the time at which the capital, the interest or a combination of both are paid. There are many free tools to help you make all sorts of calculations but you need to know those three components: principal, interest, and period.

Debt can be classified according to the expiration date of the principal. Usually, short-term debt (up to 1 year) is used as working capital and long-term debt (over 1 year) is used to acquire property or equipment, which in turn can serve as collateral for the loan.

If you haven’t done that yet, take the time to speak to a lender about your choices and begin to understand the system and build up your five Cs- credit, character, capital, collateral, and cashflow, so you can increase your funding options.

Short-term debt is paid within a year and is accounted for as current liabilities in the balance sheet, either as accounts payable or short-term debt. Accounts payable or AP is related to suppliers’ invoices that need to be paid, and short-term debt involves a financial institution, like your credit card, a bank, or another lender.

The first type of short-term debt is self-generating debt. That is money you owe for the use of products or services that you haven’t paid but have used. For example, the payment of a consultant, electricity, or that computer that you bought with your credit card.

In the case of accounts payable, most suppliers and vendors provide short-term financing in the form of credit terms. For example, a net 30 invoice means that you have 30 days to make payment without incurring an interest charge. A term of 2/10 net 30 means that you will receive a two percent discount if you pay within ten days, the full amount is due within 30 days, and there are interest charges after that.

Accounts payable to a client are accounts receivable to the supplier. And here is a tip for you from my experience. Collecting payment can be expensive, add a note to your invoices that say: buyer agrees to pay for collection expenses for invoices due over 90 days. You can also consider factoring, which we covered in unfunding mechanisms.

Credit cards are a form of revolving debt, meaning that the amount of credit available is a function of the outstanding balance on a line of credit. Payments reduce the amount owed, interest increases it. Principal and accrued interest must be paid until the owed balance is zero. Credit cards are especially appropriate for debt that occurs on a monthly basis, such as fuel and material costs.

Another type of short debt is a line of credit. This is a very flexible type of credit source extended by a bank or financial institution to a company and can take the form of a cash credit, overdraft, term loan, demand loan, export packing credit, discount or a purchase of commercial bills. A company can tap into this resource when a need arises. Even though this represents a reservoir of available capital, interest is only owed on the money actually borrowed. This type of credit is usually used for short-term needs, and is paid back in a short period of time.

A letter of credit is different than a line of credit. It is a trade loan issued by a bank to an international exporter of goods. The terms of the letter specify an amount of money that can be collected when the letter is presented to a bank. Often, the letter must be accompanied by certain documents, such as bills of sale, that evidence a sales transaction. The purpose of the letter of credit is to ensure that an exporter receives payment not to negotiate sales transactions.

Long-term debt is debt that does not need to be paid in its entirety for at least a year.

It is classified on the Balance Sheet as a non-current liability.

A traditional loan is an agreement between a borrower and lender that includes terms regarding an exchange of capital (principal) for a future and timely repayment of the cost of the loan (interest) and the repayment of the principal. A loan may be called in for repayment when certain conditions are met, independent of the amount of time that has elapsed -- for instance, if sales drop more than 50 percent from the current level. Loans are typically reserved for financial companies, whereas bonds can be issued by any enterprise and ‘bought’ by lenders. Bonds are financial instruments that entitle the issuer to be repaid the principal amount plus interest. In the case of bonds the lender can change, as bonds are bought and sold with relative ease. Bonds usually have a fixed number of years until maturity: notes are bonds with maturities up to ten years; bonds can have maturities that stretch out from ten to 30 years.

Long-term debt may have a fixed or floating interest rate, and generally charges higher interest than short-term debt. Analysts review the debt-to-equity ratio (the ratio of long-term debt to equity) to calculate the amount of leverage (debt) used by the firm. Highly leveraged firms are riskier because they can be forced into bankruptcy if they default on a debt payment.

The borrowing capacity of an organization is limited by the total borrowing levels imposed by lenders, and it is often determined by available collateral.

Lenders institutions look at a credit request and make a couple of assumptions. First, they determine whether they will loan money based on past performance. And then, they make a second assumption: the interest rate they assign to a loan. Interest rates vary greatly, depending on the current market rate and additional considerations about risks. Lower credit scores and longer repayment times increase the risks and therefore push interest rates higher.

When looking at collateral, lenders don’t evaluate the market value of collaterals but the liquidity value. Liquidity is a measure of how easily an asset can be turned into cash. In accounting terms, cash of a bank account is easily converted to cash at the rate of 1 to 1. A finished product –that is part of the inventory – might be easily converted to cash if there are sales in place. Two different asset classes may have equal monetary value, but are considered differently by lenders because their liquidities are very different. Money from a bank account is similar to cash. A building or an equipment cannot be converted into cash that quickly. The only way to access the money from a building is to either to sell it (which takes time) or mortgage it – also a time-consuming exercise. An expensive yet old piece of equipment has low liquidity because there will be few buyers for it -- it could have a high book value in the Balance Sheet but a low liquidity value. This is also called obsolescence.

That is why the lenders don’t use the book value to calculate borrowing capacity.

A hybrid or a bridge between debt and equity is a convertible note. On the surface it works as an incredible loan that beats the odds of debt funding because it does not comply with the requisite of certainty. Who are the crazy lenders of convertible debt? Investors. We love it! It is an excellent way to manage the uncertainty and cost to estimate a company’s valuation. It does not mean that it reduces the risk or eliminates the due diligence process. Yet it makes a lot of sense when both parties – fund seeker and provider- want to shift the discussion on valuation to a later round of investment, when the company is more credible and when new funds are expected.

Convertible notes provide an agreement that defines the amount of capital provided to the company, the interest rate, and three new concepts: cap, discount, and conversion. Interest rates are usually a little higher than traditional loans.

Valuation Cap or Cap refers to the maximum valuation that is accepted as appropriate for both the fund seeker and supplier.

Discount refers to the benefit an investor/lender receives in terms of a lower value of the company’s equity in future rounds of investments. That means that beyond the interest, there is an upside to the investor/lender that chooses to convert to equity by using the money owed by the company to purchase shares at a discounted price that the price accepted in that funding round. The amount of the discount is negotiable, but a good rule of thumb is 20 to 25 percent per annum. This has to be balanced with the cap rate described before. An alternative to discounts are warrants. A warrant is an option to purchase a certain number of shares at a pre-determined price. It is more complicated and less common than discounts as it focuses on the funds that are loaned or invested and less on the new valuation of the company.

Convertible notes are also flexible in the sense that it is an agreement between parties that are less scrutinized than financial institutions. It is fairly common for the parties to make adjustments as the company evolves.

Being a debtor means that: someone believed in you enough to lend you some money; you used that money to get some benefits; and you pay interest for having access to that money. The only reason such a system works is because the risk of not fulfilling promises to each other is assumed to be very low. Timely payment is expected and neither party should take unfair advantage of each other.

If you are raising funds you need to have a funding strategy.

Things don’t just happen…we make them happen.

To plan properly however there are several things you need to know.

You can go step by step organizing your thoughts and learning from your actions so you can improve your probability of success.

I want to give you the process that I developed through years of funding… seeking and providing funding, advising others, teaching and researching.

There are ten steps that can help you craft a funding strategy:

1. Define your vision, based on your passion
2. Outline how will you measure success
3. Create the team
4. Define the resources you need
5. Clearly define the current stage of your organization
6. Select the ideal source of funding
7. Prepare a funding proposal
8. Customize the message
9. Start, test, improve, and grow your list
10. Close the deal, and let the fun begin

Make sure you check our course on Crafting a Funding Strategy!

Funding decisions are as emotional as they are rational.

This has two major implications: One about you, the individual requesting funding and one about the individual providing funding. It is easier to raise funds if you are passionate about what you are doing, and it is also easier to raise funds when the individual making the decision to provide funds likes your proposal and believes in your cause.

You are more likely to raise funds if you leverage on your passion, not on your skills. By leveraging on your passion you are more inspiring and resilient. You are also more likely to raise funds if you are creating wealth, instead of making money. The subtle difference in intention between creating wealth and making money creates a huge difference in the outcome of your actions. If you are attentive to creating wealth you grow the economy, and you take a piece of the wealth you are creating for yourself. It is then more likely that others' follow your vision and collaborate with you, as they can also share your big picture. If you are attentive to making money, chances are that you capture a part of the wealth that already exists for your own benefit and it might be more difficult to gain the support of others. Creating wealth is a much more powerful proposition than capturing wealth (and is one of the foundation principles of the Wealthing® Institute). You can't create wealth unless you are passionate about what you are doing.

In the case of those providing funding, a return on investment is an important consideration but not the only one. The individual making the decision to provide funds or resources also considers how likely you are to accomplish what you promise, how you both relate to each other, and, in many cases, how comfortable he or she is with your project. What you promise to accomplish must be meaningful to the individual making the decision to provide that cash or resource in whichever role he or she is playing. The connection of the individual to you and your project plays an important role. For example, the same individual can be a family investor, a venture capitalist, a lender, or a collaborator for different projects. Different funding mechanisms and sources of funds have different needs for the investor.

A good deal turns into an irresistible proposition when the goals and needs of the supply and demand of capital are well aligned. Businesses don't make decisions, people do, and we can't discard the human nature of the fund raising process.

Successful people have big dreams and make them happen. They can do that because they are in-tuned with their passion and act on it. They don't spend their time asking themselves if what they want is possible; instead they focus on how to make it happen.

You can create such vision by first identifying what is it that you are passionate about: What keeps you awake at night? What is the problem you want to solve? What is your offering? Why is this important to you? What is the legacy you want to create? Who do you serve?

Make your vision personal; let your passion come through. Stamp your own identity to your vision; it will give you more credibility.

Once you've identified your passion, fast forward to the future and visualize how you will organize a team to accomplish this: What type of entity is more appealing to you? What does your successful organization would look like? How large is it? How many users or customers do you serve? How many people are working in your team? What is your geographical footprint? What is your role in the organization? And so forth. Decide the type of organization you are building, including its growth rate and size. For example:

·A small firm, with an intimate and few, personalized services (bed and breakfast)

·A small firm that uses technology to contact a large number of people (Instagram)

·A company around a new technology that is licensed to another one (some medical devices).

·A fast-growing agile organization that goes viral and reaches millions (Facebook)

·A project, not even a firm, around a cause you care for (pool, a giant pool on kickstarter.com)

Defining your end-goal is not enough. Plan your work and work your plan. Establish how to measure success along the way. In this way you can think strategically and evaluate progress, and communicate more effectively with your team, as well as those who can provide cash or resources to help you.

Use milestones and Key Performance Indicators (KPI) to keep on track. Milestones are events and KPI are measurements. To make an analogy of a road trip, a milestone can be arriving a specific location, and KPI could be traveling at certain speed. In a company, for an example, the break-even point (the time when revenues cover expenses) is an important milestone; the number of customers, the user acquisition cost, or the sales price are KPIs. In a non-profit, securing a major sponsor, or hosting an event can be a milestone, whereas the amount of donations and the number of volunteer/hours can be KPIs. In general there are three KPIs I could not live without: income, users, and expenses.

To outline milestones and KPI, think about the main activities that lead to achieving the goals of your project or organization. Why are these metrics important to your vision? Are they achievable? What is the reasoning behind them?

A big idea, with a large value proposition, requires a great team. Define how you see yourself and others within such organization, not only now but in the future. Think big picture and long term. The end goal is to have the best team.

Members of great teams take ownership and feel accountable. Accountability does not necessarily mean responsibility, it means taking action to make things happen. Accountability is also a bit different than leadership. Many people think that if they have an idea, or they start a company or a project, they must lead the team. That is not necessarily true. Not all founders are good managers or want to be managers. For example, in Silicon Valley many founders are not the CEO of their company. However, they find a person that can fulfill the leader's role, has the necessary support, and is evaluated and rewarded properly.

A team is supported by a board of directors or, in earlier stages, an advisory board. The board of directors provides the guideline for the strategy, and the team executes the strategy. The board of directors is lead by the chairperson, chose this person carefully. If you are not ready to have a board, set up a group of advisors. Influential advisors provide mentorship, add credibility, and make investors more comfortable.

To execute, you will need team members with experience in the following areas: Big picture and strategy, operations, sales and marketing, human resources, finance, and any area that is critical to your idea or project. Sometimes the same individual has multiple roles. For example, I have been the CEO and CFO in most of my start-ups. You also need to establish how the team is organized: A formal hierarchical structure (one boss, few managers, many employees); an organized group of independent contractors (franchise); a flat organization (self-organized peers) and any other form.

Most people think fund raising is only about money. This approach is simplistic and weakening. Fund raising goes beyond just money. Money is a means to an end. You need to understand what it is that you are using money for. (Additionally, money by itself is not a deal. There are many more considerations beyond the amount of money that you are raising. For example, terms and conditions can impact future fund raising.)

Carefully consider the resources (products and services) you need to pay for. Products are bought, for example, office equipment, a car, a computer, software, etc. Services are felt and executed, for example, marketing, advertising, accounting, administration, transportation, etc. Intricately understanding what resources you need helps you define your cost structure. You can pay for the resources you need in cash by raising funds or you may find other ways to have access to the resources you need. For example, you may be able to partner with others and reduce costs by doing pre-sales, exchanging synergistic services and collaborating with strategic partners. This is the basis for the ”Unfunding” mechanism.

After you have defined the resources you need, organize them by areas: administration and finance (rent, utilities, office supplies, etc); personnel (full-time, part-time, consultants); and production and research (direct expenses, research and development, design, intellectual property); and marketing and sales (advertising, commissions, business development). You might want to include specific information about an area that is critical (for example, traveling, laboratories, franchising and so forth depending on your project).

Understanding fixed and variable costs is also important.

The current status of your organization is critical; it establishes a starting point for fund raising. This is a big consideration, not only in selecting the funding mechanism but also the sources of funds and the way you communicate with such sources. Unfunding is more appropriate during these stages: Ideation, implementation, survival, stability, and slow growth. Equity funding is more appropriate during these stages: Opportunity, implementation, survival, stability, slow growth, fast growth, reinvention, acquisitions, and mergers. Debt funding is more appropriate after the survival stage. These mechanisms are explained in the next step. Step 6. “Select the ideal source of funding.”

Organizations (for profits or not) go through stages defined by specific challenges as seen below:

Stage >>> Challenge

Ideation >>> Identify a market opportunity

Opportunity >>> Identify competitive advantages, align with passion, and form team

Implementation >>> Set up entity (project, organization, company)

Survival >>> Generate first revenues: Sales, sponsorships, etc

Stability >>> Cover ongoing costs with revenues

Slow growth >>> Define primary market and offer

Fast growth >>> Organize platform for rapid scalability

Usually, after a period of Fast Growth, there is a period of invincibility and managers can become arrogant. Then the organization enters into one of the following stages: Continuous growth, reinvention, acquisitions, mergers, dissolution, closure, or even forced closure.

Each stage has an ideal source of funding. You will save a lot of time and avoid rejection and confusion by selecting the source of funding that is most compatible to each specific stage and to the needs of your project. There are three major funding mechanisms: Unfunding, equity and debt.

Unfunding is based on sharing rewards and is provided by collaborators. These are individuals and organizations that would benefit by the existence and success of your organization. I developed the concept of “Unfunding” observing strategies that reduce or eliminate the need to pay for resources or raise funds. Unfunding includes: Reverse Financing, Factoring, Lease Financing, Disappearing, Gifting, Partnering, Bartering, Granting, Crowdfunding, and Business Plans Competitions. Benefits of Unfunding include: Access to resources, lower need for cash, reduced risk, and increased credibility.

Equity funding is based on promises in exchange for part of ownership, and is provided by investors. These are individuals or firms that can provide capital with a higher risk and would share the rewards on the success of the company. These rewards are measured by an increase in the value of the shares (capital appreciation) and by dividends. This type of funding is patient and more flexible than debt funding, yet equity investors expect a higher return because they are taking more risks. Equity funding includes: Founders, Family and Friends (3Fs); Equity Partners; Angel Investors; and Venture Capital Funds. Benefits of Equity funding include: capital plus strategic advice, knowledge, and contacts. Investors can also reduce risks with their feedback.

Convertible notes are hybrid debt instruments that may convert to equity under certain pre-established conditions.

Debt funding is based on obligations, and is provided by lenders. Debt lenders take lower risks and need predictable and reoccurring payments. The level or risk assessed by the lender is reflected on the interest rate and other conditions of the loan. Debt funding include: Supplier's payment plans, short term loans, long term loans, credit cards, and lines of credit. Debt funding is more appropriate after the survival stage. Benefits of Debt funding include: capital, predictable cost of capital, and, if managed well, an increase on return on investment by leveraging on equity.

Proposals that get funded provide a clear value proposition, identify funding needs, align with founder's passion, and consider the needs of funding sources. A funding proposal therefore includes a general component (regardless of the funding source) and a customized component (covered in step 8: “Customize the message”).

Make sure you clearly define:

·Market (users/ clients): _________________________

·Problem and solutions (value proposition to clients)

·Actions and uses of funds (activities performed by the organization)

·Team's intention (dreams and goals) and

·Team's expertise (capabilities and experience)

The proposal must also include specific information about your project as follows:

1.What is the problem you are trying to solve?

2.Why is this relevant to the users, what is the impact of having this problem?

3.How are others' solving this problem, what are the alternatives?

4.How much is the value of a similar alternative?

5.What is the solution your are proposing? What are the components of your offer? Who are your clients?

6.How much are you do you expect to receive for your offer?

7.How can you demonstrate that you create such offer? Who is in your team?

8.How much does it cost to create and deliver such offer?

9.How much money do you need? And for what (resources)?

10.What are you giving in return for the money or resources you are requesting? And when do you need the funds?

A key consideration in crafting a funding strategy is the customization of the message based on the funding mechanism and the source of funds. Look at the benefits of the funding sources (See step 6. “Select the ideal source of funding”), and define what are the non-capital benefits you expect from such source of funds. You may also evaluate the interests of a particular person related to your idea source of funds and try to establish rapport with that person. Remember that people will look more attentively at an idea that resonates with them, as opposed to something they don't understand.

To define the non-capital benefits from each funding mechanism, cater to the unique needs of the individuals that supply funds or resources:

1.Investors providing equity funding believe in a promise. Depending on the type of investment, they may want to help by providing expertise-based guidance, strategic ideas, contacts, and/or emotional support.

2.Lenders providing debt funding need to be certain that the principal and interest can be repaid, and ideally want to continue lending you more money in the future. They can also help with contacts and connections for partnerships with other organizations they relate to.

3.Collaborators providing unfunding believe in creative partnerships. They want to help your organization typically because their image improves when they are associated with your organization or project, or because they want to try something at arms-length. The message for potential partners has to be strategically customized to each individual collaborator.

For example, if you were looking at raising $500,000 funds to create a new gadget, a wearable camera, and want to move from the survival stage to the slow growth stage, you can customize your message in this way:

1.For equity investments*: We are seeking to raise $500,000 dollars to improve our prototype and streamline our production in exchange for 15% or the company.

2.For loans: We are seeking a $500,000 loan to purchase equipment and improve our prototype and streamline our production. (It is easier to obtain a loan secured by physical assets than to ask for a loan to pay for salaries and services).

3.For unfunding: We are seeking to collaborate with a video software supplier to provide access to 500,000 developers in exchange for a 15% commission on presales.

*This is an oversimplified example. Equity investments have many special considerations: pre and post-money valuation, specific rights as shareholders and can also use convertible notes.

Once you have your proposal and message ready, create an initial list of qualified contacts (investors, lenders, or partners). Your first contacts should listen to your presentation and provide constructive criticism. Start with those closer to you and never have your first meeting with an ideal investor! Practice makes perfect. Your message will improve with each presentation; you will become clearer and more confident as you go.

Your first meeting is always the most difficult. Make sure you are well prepared: Practice with friends, family members, or in front of a mirror several times. If you are nervous, it is OK to say this is your first meeting and make a mental shift from getting to a yes to practicing and improving your message. Try to capture as much feedback as you can and thank people for questions and comments.

You can improve your presentation and grow the list of your potential funders by asking questions. Follow these three magical questions in this exact order:

1. The golden question: "Do you think this is an interesting investment proposition? Why?" Then learned to take a "no" gracefully and take lots of notes.
2. Then ask the platinum question: "What do I need to change to make this more attractive?" These answers provide you with the best and most relevant learning opportunities you would receive.
3. And then ask the diamond question: "Do you know someone that might be interested in this proposal?" Most people will not only provide you with names and contact information; many might even make an introduction, saving you countless of hours.

Thank and leave. Then analyze the results of your meeting as soon as possible. Explore if you want to take their recommendations and change your proposal, clarify your message, change your strategy, or be more convincing. After all, it is YOUR idea. I don't recommend having more than 2 meetings per day.

Send a thank-you note as soon as possible (email is perfect if you have it), recapping their main suggestions and, if you are going to use them, tell them so. If you feel strongly about a misunderstanding, please also refer to it, but don't waste their time explaining how you are not going to use their suggestions, and don't try to impress them showing how smart you are. Authenticity is a rare gift in fund raising.

Keep a copy of the thank you note. It will be useful when these individuals introduce you to other potential investors, refer business deals to you, contact you, or if you contact them in case you raise funds for the second time.

Is also a good practice to send periodic updates when significant progress is made and meaningful milestones are reached.

The fund raising process follows a series of meetings that trigger decision-making points to gain trust. This is particularly important the first time you raise funds. Both you and your counter-part evaluate each other through these meetings to decide if, after closing the deal, you can work together.

Once a person expresses an interest to explore your project, the due diligence process starts. This is a period to test assumptions. Most of individuals that work providing funds know how to carry out a due diligence process because it is part of their job (except in the case of founders, family, and friends). That is not the case in most people seeking funds. A rule of thumb is to never engage with someone whom you can't trust.

'Closing a deal' means formalizing a contract to receive a loan, an investment, or establish a partnership. To navigate comfortably from interest to closing a deal, you must:

·Define your deal-breakers early so you don't waste your time or others' in deals that are not going to work for you. Chances are that you have some deal-breakers in mind but are could think of others after receiving a draft contract that might have clauses you did not think of. If you feel strongly against something, negotiate to take it out.

·Ask for professional advice from experienced individuals. Use mentors –even ask on linkedin – BUT evaluate their capacity to provide a useful recommendation. Be strategic about your mentors. A friend who has never used a specific funding mechanism might not be the best person to give you a good recommendation.

·Select a lawyer. They play a critical role in understanding contracts, can provide critical reasoning and words of caution. Chose lawyers that have proven experience in deals with the funding mechanism you are using. Ask for referrals and personally make the point to talk to some of their clients (not their friends).

·Set the timeframe to close a deal, and speak about it. In the long run, we are all dead. Time can be of essence, you might run out of cash whilst in the due diligence process. Don't expect to close a deal in less than 3 months. In my opinion it is not worth to wait over 9 months to close a deal.

·Always have an elegant way out, for you and for your counter-part. A deal might fall, but when you lose a deal, don't make it personal and don't burn the bridges. You might need each other in the future.

Remember that once a deal is closed and you receive the funds or resources, the fun starts, and you have to prove that you are capable to achieve what you set out to.

As an investor that wants more women in high-impact firms the following changes would apply to any entrepreneur but seem more prevalent in women-led firms:

Instead of Thinking small, think big

Instead of Managing by intuition, use data

Instead of Getting the work done, behave like an owner and delegate to grow

Instead of Using your network, grow it strategically

Instead of Pursuing reinforcement and avoiding rejection, be open to the comments and use them to improve your model!

Instead of Seeking compassion, trust yourself (use other's opinion but maintain your sense of ownership and leadership)

Join us on a lively conversation with Dr John Watson about myths on failure rate and women-led firms.

Managing a Healthy Strategy helps you organize income and expenses and use financial tools to PLAN and IMPROVE your results, not just to report what had happened.

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