5 Questions Any Money Seeking Entrepreneur Must Be Able to Answer Briefly, Clearly, and Compellingly

Every day, we talk with entrepreneurs who wish to grow or start a business, with the help of other people's money (whether the source is investors, banks, factoring firms, or grants). If you are among them, you HAVE to be able to answer the following five questions, briefly, clearly, and compellingly or you will not get past a first phone call with a legitimate source of funds and each subsequent call to someone else will be a waste of everyone's time. Too often, the entrepreneurs who call us are absolutely stymied by these questions. Don't be like them!

The Questions:

1) How do you (or how will you) make money?

2) How much do you wish to raise (or borrow)?

3) What will you do with the investment (or loan amount)?

4) How will you pay it back (by date) (or how and when will the investor earn a return on investment)?

5) What experience do you and your management team have in this industry and with prior investors' money (or loans)?

Why These Questions are Important:

Each question helps your potential lender or investor assess risk and potential reward. If you hem and haw on any of them, you are doomed, because it means that you don't appreciate the risk you are asking that person to take with money he/she has that you lack. A non-answer to any one of these is akin to asking someone to dive into a dark pool without being able to answer the obvious first question, “how deep is it?”

Components of Compelling Answers

1) The answer to question 1 (How do you make money?) is stronger with any of the following components:

(a) Multiple revenue streams are better than “one trick ponies” because the variety allows the company to stay afloat even if some products or services fail or take longer to succeed or cost more to develop/deliver than anticipated;

(b) The revenue projections are not dependent on unlikely scenarios (like huge market share grabs right away or fuel prices lower than they are today or a a shorter sales cycle than is normal for your industry);

(c) Products and services that are correlated to a variety of economic assumptions are likely to weather the highs and lows of economic cycles better than those that depend only on a high or low. For example, a company might have some offerings attractive in periods of inflation AND recession or when client companies or target populations are growing AND maintaining, aging, and retracting.

(d) Demonstrate profitability, even if in a small market or by another company.

2) Questions 2, 3, and 4 are related, even if they are asked separately, so construct your answers with each one in mind. This is because the amount you wish to raise should be directly related to how you plan to use it and that use should enable you to pay back your lender or investor on time and at a profit. For example, if your reason for raising money is “to rent larger office space and pay me a salary,” or “to research the market potential” such answers do not translate into repayment of the loan or investment and therefore do not encourage much confidence. These are faith based answers, like “just trust me.” Why? A compelling answer is one that directly leads to a believable profit. Good answers might sound like this: “We wish to raise $xx in order to increase our manufacturing speed to meet current demand that exceeds our capacity” or “We wish to raise $xx to buy a competitor we believe to be undervalued and that offers a complementary fit with our firm in terms of customer base, geography, and product lines.” Or “this business model has been profitably test marketed (where) and we are now ready to launch it on a larger scale, with $xx for experienced industry sales personnel in the most lucrative markets.”

3) Your answer to Question 5 indicates your ability to understand and respond to the the risks in the business you propose to run with someone else's money. Managers with a track record of relevant experience are obviously more attractive than those without. Managers who have borrowed money or taken investors' money and returned it, on time, at a profit to the lender or investor are equally appealing. If you have not done the exact thing before to great financial gain (because otherwise you wouldn't need to borrow money, would you?) you can still construct a compelling answer. For example, have a board of advisers experienced in this industry, an excellent credit rating, or prior lines of credit that were paid back on time after being used well. Have a list of pertinent referrals from professionals in your current and prior industries. If you are an expert in the pertinent field, who knows it? Have you published papers, delivered speeches? If not, write some and put them on your website or send out press releases. Neither costs much. Become an expert in your field. Research other public and private companies in this sector, join relevant professional associations, subscribe to pertinent journals.

There is nothing more embarrassing than talking to an entrepreneur who knows less about his/her industry than we do, especially when we don't consider ourselves expert, but just educated business people. Compelling answers could include variants of: “I have x years of experience in this aspect of the industry, and have assembled a management team and advisory board that excels in the other areas we need to anticipate and respond to the market potential.” Or “I am a serial entrepreneur who has run xxx number of companies in other industries and sold them at a profit (or returned investors' money) in most cases and learned hard and lasting lessons when I didn't. I have succeeded by a set of priorities that has guided me in each of the prior companies and will do so in this one, too. Those priorities are xyz.” Or “I have several patented game changing innovations that will enable our targeted client companies to deliver results faster, cheaper and better than their competitors.”

Conclusion

If you can't answer these questions well, don't pick up the phone to ask for money. Put your time, instead, into learning more about your industry or surrounding yourself with others who know it better than you do. They can help you not only answer these questions, but build a profitable company. Who knows. You may never need to borrow a dime to make a dollar.

Summary of Angel Investments over the Past Decade

An excellent source of information about angel investments in the U.S. Can be found at the website for University of New Hampshire's Peter T. Paul Center for Venture Research. Scholars there have been tracking venture funding since the early 1980s, and the most recent ten years of annual and semi-annual reports are available for free, at the school's website. Below is a summary of highs and lows over the past decade. For more detailed information, see the website link that follows.

In 2012, 21% of entrepreneurial ventures presented to individuals and angel groups (beyond a “friends and family” round) found investors willing and able to pony up for their businesses. This percentage, referred to as a “yield” is nearly as high as the peak 23% attained in 2001 and 2007, and far higher than the historic average of 10 – 15%. Interpretations for this influx of investment dollars vary greatly from investor optimism to fleeing the public equity markets to a bubble in the making. In addition to the increased percentage of fundings, both the number of entrepreneurial ventures AND the number of angel investors have peaked for the past decade, at 67,030 ventures funded by 268,160 angels in 2012, and 66,230 ventures funded by a whopping 318,480 angels in 2011. These numbers far outstrip the paltry 36,000 ventures funded by 200,000 angels during the “boom year” of 2001.

However, these investment dollars have shifted away from seed stage companies to those with more of a track record. In 2012, only 35% of angel dollars funded seed stage companies, and 33% early stage, far lower than 2005's 55% of investment for seed stage companies and 2010's 67% to early stage companies. A corollary to this shift is the nearly steady, year by year decline over the decade in the percentage of angel investment as the first investor, from a high of 70% in 2005 to 52% in 2012. In other words, although more angels invested in more companies in 2011 and 2012 than earlier, they have become more conservative, by targeting more developed companies, and preferring to follow other investors rather than lead the charge.

What about exits?

The worst year for bankruptcies was 2009, when 40% of angel funded deals went belly up. More commonly, the percentage is in the 20-27% range, highlighting the risk that angels take – a point that entrepreneurs should bear in mind when asking for other people's money. The same percentage of companies being funded by angels (about 1 in 5) will, once funded, fail. So entrepreneurs should expect attentive due diligence by potential investors, which may well take longer than they wish.

The most frequent positive exit by angels was in the form of mergers and acquisitions. The highest percentage was 70 in 2008. Other years, mergers and acquisitions accounted for 50 to 65% of the exits. For this reason, entrepreneurs are wise to surround themselves with industry knowledgeable management and directors, whose connections may be crucial to ensuring a profitable merger or acquisition.

IPOs don't happen for small companies anymore, and none have been recorded for the past few years.

The industry sectors most popular with angel investors remain remarkably consistent. The most frequent two sectors remain software and healthcare for the past ten years. The next few industries shift back and forth: industrial, energy, retail, bio/life science, IT, and media. Financial services and telecom have both fallen out of favor in the past five years. This does not mean that entrepreneurial ventures outside these industries don't get funded, but it may mean that those management teams will have to explain their value proposition carefully to an audience that doesn't encounter as many deals in that sector.

Like any set of statistics, these data leave plenty of room for interpretation, but a few points jump out to me.

1) Entrepreneurs have a lot of competition for angel ears, as well as angel dollars. So be prepared to stand out of the crowd by being thoroughly prepared for investor scrutiny.

2) The percentage of entrepreneurial ventures that is securing funding is close to beating the decade's high. This could mean that it is easier to get funding now than before, or it could mean that a bubble is forming and the gravy train will derail shortly.

3) Seed funding is harder to come by. So entrepreneurs need to be able to self fund for a longer period than in the past or need to develop some revenue stream early, in order to (a) stay afloat and (b) attract investors who want to see a functioning business, not just a business plan. Besides, being able to generate some payments increases the range of potential funding sources, such as revenue based lenders (like factoring firms).

4) Because the majority of investor exits are through M&As, entrepreneurs need to know their competitors, suppliers, and customer base very well. Any of these could be your partners or bosses in the future.

Source: The University of New Hamshire's Peter T. Paul School for Venture Research.

It has produced annual reports analyzing American angel investment since 1980.

Spot a Fraud

For ten years, my favorite job as Compliance Officer of an Investment Bank was spotting liars. This meant figuring out which finance professionals NOT to hire because they embellished their qualifications, which potential clients NOT to accept because they had obfuscated weaknesses in their companies, and which alleged investors NOT to believe because they would never pony up a dime. On the theory of “garbage in, garbage out,” I figured that anyone who lied to me up front about something I easily discovered was likely to lie later on about something important I might not detect. With 7 billion people on the planet, I endeavored to avoid those mendacious people and work with honest ones.

What appalls me is the frequency with which I have encountered grown-ups who lie, easily, smoothly, and frequently to get something they want, based on merits they lack. Obviously, their blarney must work on some of the people some of the time. I'm also dismayed by the number of companies and individuals who don't do background checks before they hire or recommend people, or who part with their money or let someone into their homes or lives without asking a few logical questions first. So shame on both parties!

The following article shares easy, cheap or free research that anyone can do in less than an hour and examples of real frauds I have encountered. Protect yourself with a bit of skepticism, a few minutes on the Internet, and some judicious questions.

Start with the person's resume. If your interaction is not professional, and doesn't warrant asking for one (such as your daughter's new boyfriend), look up the person on Linked In or similar self-posting websites. Scrutinize the document. Do you recognize the names of the schools and companies? Do the job descriptions and interests correspond to what you know of the person? Some lies are obvious, while others require more digging, by cross referencing this information with corroboration or contradictions available elsewhere. Examples below.

Education:

Examples of Findings:

One CEO of an OTC shell company lied in his SEC filings about his academic credentials. He claimed a PhD from a university that does not even exist! Instead, he actually has an AA degree from a community college in Washington State. I told the SEC what I found.

A potential employee claimed a MBA. The school registrar revealed that he attended adult education classes, but never enrolled in a degree program.

One man claimed to be a bishop in a conservative branch of the Anglican Church(for which he created a Wikipedia page) and to have been ordained after attending a particular seminary. A bit of research revealed that he made up this alleged denomination AND the school! Neither is a legitimate, recognized institution.

A woman listed no college degree but put “post-grad” on Linked In, citing no school at all. She also indicated membership in The Yale Club and Harvard Club. These are rather obvious ploys to sound impressive.

Two people claimed to be members of a national honor society that sounds real but is actually a “pay to post” website.

How can you validate or discredit educational claims?

If you are unfamiliar with the name of the school,search for its website or Google “accredited universities.” If the only reference you find is in connection with this person's posting, such an institution does not really exist. Some other schools exist only as “degree mills” - website companies from which a person can buy a fake diploma. In the case of legitimate, small colleges and universities, you can call the registrar, who may answer your questions about someone's enrollment. In most cases, though, you need to pay a few dollars (usually less than $10) to the National Student Clearinghouse website: www.nationalstudentclearinghouse.org.

Many employers ask applicants to sign an authorization for a background check, and on it to include relevant details such as address and social security number. Such a standard form is an easy to way to separate the wheat from the chaff early, as some people may fade away to evade such scrutiny. If your reason for checking somebody out doesn't provide an opportunity to solicit such authorization, you might ask a friend who is an alumnus of that school to look up the person's name in their alumni database. Alternatively, you can review the school's website to see if, for example, it offers the degree the person claims or to glean some details you might work into a subsequent conversation if you doubt the person's attendance there.

Prior employment:

Examples of findings:

One man claimed to have investment banking transaction experience. A short call to the employee check hotline revealed that he had one year's experience in a back office, administrative support function.

One woman's patchy resume indicated consulting services to the CEOs and boards of international banks. Her prior experience? A BA from a state university, followed by 3 years selling household products for a pyramid marketing company and 5 years as a telecom customer service representative (which her Linked In profile neglected to mention, but which are evident from other Internet sites).

One woman described herself as a real estate investment expert. The real estate broker confirmed that she had worked with them for several months as a brand new realtor but, as yet, had no clients.

Calls to two prior employers of a job applicant were the most interesting I've ever had. One man actually yelled that my applicant was crazy. His prior employer indicated that he was a severe alcoholic with rage management issues who sabotaged several client relationships. He was with each company for only a few months.

Several alleged investors were unable to give me the names of any companies in which they had previously invested. Another investment firm was cited in a public company's SEC filings as having failed to fulfill their contracted investment (the firm needed to explain a revision to their financial outlook).

How can you find out about prior employment?

Review the names of past companies, dates, and duties on the resume. Be sure to look for other resumes on other sites, by googling the person's name and any of those companies. Often, people update one document but forget that the Internet stores prior versions, too, and that other companies and websites may mention them. Red flags of doubt include:

frequent job changes, with short stints at each, an illogical career trajectory, impressive titles or duties surprisingly early with little prior experience, long gaps, multiple resumes that don't match on dates, duties, titles, or firms, companies you can't find through Internet searches, claims of great success yet major swings in industries, cities, or employers. Ask for references and be sure to call them.

Ask if the person worked there, during the years and with the duties claimed and ask “is there anything else I should know?” Some large companies have “employee check hotlines” for such inquiries. If the person claims to have been self employed (as a reason why you can't find the firm) look it up in the corporations list of the state's secretary of state or commerce website. Although each website differs, many allow you to research whether a company name is “available” or associated with an existing or even past company, and many list the officers and directors, along with the address. For some types of businesses, the Better Business Bureau (www.bbb.org) is a good source of information, not about individual employees but about the reputation of the company. I like the website, www.ripoffreport.com on which unhappy clients criticize companies. For public companies, you can review SEC documents and EDGAR filings at www.sec.gov. Most professions that require licensing, such as accounting, law, medicine have websites where you can search for names, specialties, and whether the person remains in good standing with the profession. I like www.martindale.com for searching attorneys and www.finra.org (look for Broker Check) for investment bankers. If you don't find the name of the person, he or she is not licensed. If you do not find the name of a person who purported to be a licensed doctor, attorney, investment banker, etc, call that organization. Ask why you don't find the person. They might be interested to learn that someone is masquerading as a member of that profession. In fact, some groups have posted "wall of shame" websites naming names of imposters. There is one for people who pretend to have been Navy Seals.

Crimes and Lawsuits:

Examples:

A man proclaimed himself an expert in financing small companies, but his credibility was marred by revelations that he had filed personal and corporate bankruptcies in two different states after shareholders accused him of fraud. Even more damaging were the words of the bankruptcy judge, who handed down the most sweeping denunciation of his business practices that I have ever read outside a criminal indictment.

A man sought investors in his new venture, based on claims of great experience in the past. He neglected to mention, understandably, that his past included SEC sanctions for fraudulent business practices so egregious that he is in a case study at a law school!

A man was imprisoned in New Jersey for fraud, and moved to Texas to look for new investors in the same type of business. I reported him to the white collar crime division of the local police but they said they couldn't do anything until he actually committed a crime in their jurisdiction.

A man was barred from licensing in the securities industry and from selling any security in the state of CA based on a law suit by several investors. He re-registered the exact same business in MD and got some attorney who obviously did no due diligence to draft a Private Placement Memorandum so he could solicit new investors! I called the state's attorney general and the lawyer.

One man is operating businesses, soliciting investment, under two different last names. Somebody actually set up a website to expose him as a fraud.

One woman is listed on the internet under several spellings of her name, several different email and physical addresses, and inconsistent resumes, titles, and job histories.

One man sought investment in a pet food company. However, he is under indictment in CA for 48 counts of fraud and cruelty to animals when he ran a pet shop.

How can you discover a person's crimes and lawsuits?

Google the person's name with a variety of search terms for your worst fears, such as lawsuit, bankrupt, and various crimes. Common names, like “John Doe” may be very difficult to search, so narrow the field with details like the city, state, job title, school, or some other such way to narrow the field: "John Doe" + NY + invest + fraud. Some states, such as TX, AK, and FL make it very easy to look up lawsuits, bankruptcies, and IRS liens. Others, like CA and NY have tighter privacy laws. When you search, don't look just at the first page of results. Some clever people bury their past misdeeds with a pile of free press releases, self-published articles, and other more recent information.

* * * * *

Over the years, I have uncovered more lies among professionals that I ever expected. Now I am pretty jaded, with a fine tuned “nose” for people who “don't pass the sniff test.” I'm not talking about women who lie about their age or men who lie about the size of the fish that got away. I'm warning you that there are plenty of charming people who have lied and will lie to get into your company, your home, or your bed. Protect yourself. Check them out.