They Just Aren't Into You

Raising capital is hard, time consuming, expensive, and sometimes humbling. There are as many reasons that investors do not invest in companies as there are reasons why people who meet choose not to date. Sometimes “they just aren't into you.” On the other hand, if you have done your research and have found that indeed there are investors financing companies in your niche, just not you, it is WAY past time to assess whether you might be doing anything to sabotage your own game plan.

Below are five commonalities among companies that never get any term sheets at all. Do any pertain to you? Also, review the descriptions of unfunded (unfundable?) companies at the end of the article. Do any aspects sound uncomfortably familiar? If so, the most common problems are not difficult to address.

The five categories are: talking too much, talking to the wrong people, talking about the wrong things, a business plan with holes that indicate naivete or obfuscation, and inflated pre-money valuations. Do any of these sound familiar?

1) DO YOU WASTE TIME BY TALKING TOO MUCH?

Every entrepreneur I have ever met is as proud of his/her company as a new parent is of that wrinkly little baby. Both groups often make the mistake of being long winded, without first ascertaining the audience's degree of interest. Someone's polite inquiry at a networking event of “What do you do?” or “Tell me about your company” may welcome a 2 minute soundbite between drinks, not an uninterrupted oration.

If your monologue gets interrupted with some version of “I've gotta go,” you've talked too long. Besides, it is in YOUR interest as a social being as well as a finance hunting entrepreneur to be brief in order to ascertain something about the other person. (See reasons below). Don't be a blow hard who confuses stunned silence with abject interest.

2) DO YOU WASTE TIME BY TALKING TO THE WRONG PEOPLE?

Time is indeed worth money. For most entrepreneurs, their burn rate projects a go/no go date by which they need to grow the company out of current financing constraints. This date should be etched on an entrepreneur's wallet, if not his heart and mind. Therefore, value your time (as well as other people's) by being selective about who warrants your time.

In a spontaneous conversation with someone you don't know well, you can be brief and then ask a few pertinent questions such as “That's my soundbite. How about you? What does your company do?” Their answer will help you decide how to proceed. Before a scheduled telephone or personal meeting, you should review a company's website, do Internet searches about the company and management, or ask people who know the company. By whatever process, your goal is to determine whether this person or that meeting is worth your time for whatever your goals may be. Is it direct funding? Indirect referrals? Board members? Employees? Paid services? Customers? You may be juggling several interests. If you know something about the other person's potential for you, you can play toss and catch with the right ball. If you don't bother to find out, you are likely to (a) waste time, (b) blow an opportunity, or (c) worse. Maybe the stranger listening to your loving description of your company is actually invested in a competitor. Maybe she is a service provider masquerading as an investor. Check people out early in order to allocate your precious time appropriately.

Once you determine that a particular person or company is a possible source of direct investment, what questions might you ask early on? Logical questions expected and appreciated by investors include:

- “What are the parameters of your investment interest (stage of company development, geography, industry niche)?”

- “What is the status of your recent investments? (within the last 3-4 years. Any follow on rounds? Failures? Liquidity events?).”

- “Do you prefer debt or equity? How much? Generally, what sorts of terms (they will hedge, but you can learn what percentage of a company they like to buy for equity, or the sort of interest rate they seek for debt)? A board seat or management role? Is the money doled out in tranches (for example, as certain milestones are achieved) or annually (after audited financials)?

Many investor websites address such points very clearly in order to encourage appropriate inquiries and discourage time wasters. Read a few (any at all) to see what they consider important so you can ask the right questions next time. Research those that have invested in your industry or company size or geographic range. If you don't know them, it may be worth paying something to find them, whether buying a list or a hiring a service provider who knows your industry and the financiers in it.

If you conclude that the person or company is knowledgeable but that there is no fit between you, ask if they know anyone who does invest in a company of your stage/size/location. Many people are happy to provide referrals. With a cordial attitude, you may develop a valuable resource person in the future if you don't burn bridges with someone “just not into you” at this point in your company's history.

3) DO YOU TALK ONLY ABOUT YOUR OWN INTERESTS WHEN YOU SHOULD FOCUS ON THE INVESTOR'S ENLIGHTENED SELF-INTEREST?

In a meeting with investors, don't be like someone who walks into a mortgage broker talking about the great tuck pointing on the house he wants. That's NOT important to the lender. Rather, that person is a gatekeeper between you and the mortgage you want. The broker doesn't care about you OR the house. He/she wants to evaluate whether you are likely to make the company more money or cost more money than the other 40 applicants on the calendar that week.

Your conversations will be more respectful of the investor's time, and more targeted for your own goals, if you realize that they DON'T CARE ABOUT YOU. Nor do they care if you make the world's best widget. What they do care about is making money. And since they have some to spend, and you want them to spend it with you instead of all the other entrepreneurs calling for the same reason, the conversation is inherently uneven. AND IT IS NOT ABOUT YOU. You want to convey two messages. 1) You understand their goals and priorities (because you have already researched them) and 2) Your business plan can deliver faster, cheaper, better results for those goals than your competitors, who, at this point,are EVERY OTHER ENTREPRENEUR IN ANY INDUSTRY who is also vying for their attention.

Therefore, do not spend all your time describing your venture in loving detail. Rather, realizing that time is money, prioritize your time by talking about money, particularly those aspects that this particular investor is interested in. For example, you may want to point out in the first three -five minutes that your management team is well equipped to make money in this market because of a proven track record. It is prepared to defend its business from competitors or market fluctuations with some well planned defenses, and that the market is a “rising tide” of growth with high profit potential. THEN INVITE QUESTIONS. Whatever you do, don't spend your whole meeting time talking. You want, and you NEED feedback so you can assess their questions and degree of interest/knowledge, so you can reframe answers in that meeting or as a follow up. Ideally, have someone with you whose job is to keep notes of their comments and also of when they took notes during your presentation. Then debrief with your management team about the resulting notes. If you visited ten viable investors who repeated the same questions or criticisms, and then made no funding offer, for goodness sakes, don't disregard them with, “They don't get it.” Rather, with the curtains drawn and the phones off, re-evaluate your plan in light of what knowledgeable investors had to say. Do you need to say it differently? Do you need to change the plan itself? Do you need a different presenter? Do you need to start allocating more time to running the company instead of running to investors? How long to your go/no go date? Don't be like a pregnant woman looking for a meal ticket. You need to be the meal ticket in order to attract … well you get the analogy.

4) DOES YOUR PRESENTATION HAVE OBVIOUS HOLES? DO THEY INDICATE NAIVETE OR PURPOSEFUL OBFUSCATION? (Either way, you have sabotaged yourself).

Anyone can find templates for business plans and read good and bad examples. Anyone who doesn't have the time or talent to write appropriate documents to pursue funding can hire someone. You don't want to make an amateurish first impression in a world of entrepreneurs who took the time to do a better job than you. After all, why would an investor trust money to a management team that can't even write a coherent business plan? Such a fuzzy document pretty much proves a lack of attention to detail that most businesses require.

The following are frequent weaknesses or omissions in the business plans of unfunded (unfundable) companies:

Biographies: Management team biographies fail to indicate relevant experience in THIS PARTICULAR business area, success in relevant comparisons, experience with prior investors, or, worse, are contradicted by publicly available information in a way that absolutely undermines their credibility and honesty.

Financials: Financial projections may be based on “pie in the sky” assumptions, like “no competition” or “flat fuel prices” or an assertive market share grab right away. Balance sheets may neglect to show costs/profits/taxes for logical elements that a savvy investor will see at a glance.

Market potential: Among companies with good business plans, the best buggy whip manufacturer's documents are unlikely to compete with a business in a growing market. Similarly, an industry with low barriers to entry, many competitors, and a low cost provider advantage is less attractive than one with few competitors and a defensible wall to keep competitors at bay. Thus, high up front costs cut both ways – they may deter others from entering the market space, but they may deter some investors (but not others). Some businesses have the potential to grow and make enough money for “Mom and Pop” to enjoy a profit, but not enough for partners.

Use of Funds: The use of funds should be inextricably linked to a path to profitability, not paying back debt, litigation, or overhead.

Investor protection: The investment terms on a private placement should protect the investor. This demonstrates that management respects the importance of its investors. For example, incorporation in an investor-friendly state, an escrow account, a minimum raise before funds can be touched, quarterly or annual reports and meetings, audited financials, a knowledgeable advisory board, well respected securities attorneys, all increase confidence of the people whose money you want. If you seek money without having these, without understanding why they are important to the people whose money you solicit then you are likely to be rebuffed time and again, except by tricksters who aren't who they seem to be at first.

Consistency, but with a wow factor. Finally, nothing in your business plan should conflict with any other easily accessible information about you, your industry, and your management team. In other words, your business plan must demonstrate that you know what is important, both to the future of the industry, your company, and to investors. So yes, selling securities in your company as a way of raising money means that you have to climb several learning curves, one of which is securities laws.

5) YOUR PRE-MONEY VALUATION IS BASED ON POST FUNDING POTENTIAL

Many, many CEOS have highly inflated pre-money valuations for their companies, often based on projections achievable only IF they get first and second round funding to embark on the necessary steps to achieve any profit in the marketplace. If you need initial investment to launch the process by which to earn that high valuation, then your pre-money valuation is, like adding up the angles in a geometric proof, not the same as the total amount that depends on that initial infusion. It is much lower. This is wholly obvious to investors and should be to realistic entrepreneurs, too.

Inflated valuations may sound great, (“This company will be worth $10 billion!) but when entrepreneurs penalize the rare, early, risk taking investors with such an inflated pre-money valuation, they discourage the very money they need to even start the path to profitable dreams. Any start-up that can't even get off the business plan page, much less into the market needs to give up plenty of the company, like half, to make the high risk investment worthwhile. Some piddly 10% for the life blood needed at that point is insulting to the investor whose money you desperately need. Just as the guy with bad credit pays a higher interest rate, the company that needs the money the most has to give up the most to get it.

EXAMPLES of COMPANIES which, to my knowledge, never received a term sheet.

Touchy-feely: One CEO spoke with passion about how her healthcare solution could save lives, but she couldn't describe how and when it could make money.

A deep hole: One CEO had excellent reviews by past customers in a very crowded field of low cost competitors. To compete, he cut his prices just as fuel prices escalated, so the company has been losing money for several years. The solution? Solicit investment in the hope of having deeper pockets to wait out unfunded competitors who may bail out of the market.

A deeper hole: One CEO had an excellent presentation, but needed money so quickly and desperately that he scared away all but the vultures, who decided to wait until he went bankrupt to pick up the assets.

Bad financial reputation: The management team, which was obliquely described in the business plan, was revealed in Internet searches to have IRS liens, foreclosures, and bankruptcies. Prior “sold” companies appear to have been retained and renamed.

Unproven model: One business plan front loaded expenses for a national marketing campaign without having first proved receptivity in even a regional or local market for the product and price point, much less field testing its (to-be-developed) distribution network and manufacturing capability for large scale sales. In other words, they could envision the business as a huge success, but they couldn't demonstrate how to get there.

HUH? One inventor was so secretive about his invention that no one could figure out what he did, much less what the business model might be.

Takers: One company's PPM offered no escrow protection and no minimal raise required to spend investors' money. The potential company was to become a regional bank.

Day Late and A Dollar Short: Every few years the financial news is abuzz with the latest NEW THING for supposedly making easy money. (1) Develop vacation real estate in various parts of the world. (2) Develop specialty TV channels to sell jewelry, start a food show, pawn something, or move to Alaska. (3) A few years ago, a lot of unemployed financiers wanted to start hedge funds and now they want to get into crowd sourcing. What's the commonality? All of these eager people wanted to embark on these new adventures with SOMEONE ELSE'S MONEY.

No investor friendly structure: “I have an idea” is not a business. Investors don't invest in ideas. They invest in businesses, because corporations offer structures that can protect investors. Some businesses aren't even incorporated or are incorporated as S corporations or are registered in states less friendly to investors. In such cases, the entrepreneur is essentially asking for a personal loan/gift, not a protected investment, and will not attract any funding except from Mom, Dad or Aunt Edna (statistics vary, but the gist is that only 5% of start ups make it past the family and friends funding round to outsiders. This doesn't mean that they all fail. This means that the successes are able to move ahead with no further investment.

Use of Funds: The primary use of funds in a business plan was for a salary and an office, which happened to be rented from a relative. A subsequent round of fund-raising was envisioned to actually grow the company.

Not scalable: Some businesses are essentially local, “Mom and Pop” endeavors which could succeed with a profit for the owner, but are unlikely to generate enough in the short term to get an investor excited, much less pay him/her back.

Personality problems. Entrepreneurs are by nature creative, innovative, independent, optimistic people. But many early stage entrepreneurs tend to have difficulty letting go, and delegating to others who may have significant abilities to contribute. If you are soliciting a stranger's money, you are essentially recruiting a partner who will be looking over your shoulder. Take the money/take the partner. You can't have it both ways.

Note there are scurrilous “entrepreneurs” who are frauds and scam artists, soliciting investment in sham companies for personal gain. Make sure that your company name and management names have no taint upon them and no similarity to others. You don't have a second chance to make a first impression.

If you are not getting traction in your funding search, you are by no means alone. Recent research indicates that among angel-level investments circulated amongst American investors, about 17% attracted some funding during the first half of 2012. 83% did not. How many of them represent some of these five common mistakes? If worst comes to worst, maybe some learned that they did indeed make the world's best buggy whip, but the inventor needs a day job, a business in a rising tide industry, or perhaps, a financially savvy advisor and spokesman.

No Exit

During 2000-2008, virtually every private company’s investment oriented PowerPoint or Private Placement Memorandum I saw (as Compliance Officer of a boutique investment bank), concluded with a “hockey stick” graph of escalating profitability, with a liquidity event in two years. The magic number was always 2 years, regardless of likelihood, because this is what companies thought investors wanted to hear. I cringe when I still hear that. The liquidity event was usually posited as an IPO (initial public offering) with an occasional alternative of being bought out by a large public company.

To outline all the reasons I have long thought that going public early is a bad idea and an expensive mistake for small companies is another article for another day. But here, I will outline why and how small private companies are shut out from public capital, and what I think the liquidity options are in the near future for companies worth less than $50 mm.

Initial Public Offerings (IPOs)

The number of IPOs and their funding totals have declined as both the age and value of the companies has risen, raising the bars for companies considering this access to capital. Statistics vary in frustrating ways for something that should seem so easily measurable, so consider the two following scenarios that follow the same trend line, but with different numbers.

The first is documented in an informative RR Donnelly speech in March, 2012: One long standing bar is that since 2003, the majority of those that launched IPOs were previously funded by more than $10 mm of venture capital. (So companies that haven’t already raised any outside capital might refocus their attention to growth first). Another is that the age of companies going public has risen from the rather ridiculous youth of 3-4 years in 2000-2002 to a more sensible 6-9 years of records, as was the norm in prior decades. The number of IPOs in each of the past three years has been about 100 – 150, raising $41-44 billion, far below the frothy years epitomized by 2000, with 446 deals raising $108 billion. But even with this reduction in the number of deals, to companies presumably older and “field tested,” from 2004 to date, a sobering 22- 39% have not hit their offering price, despite heavy and expensive lifting by those companies’ marketing, PR, IR staffs and hired investment bankers. They didn't mention the ones that withdrew after starting the process.

The second scenario, here gleaned from the excellent charts and graphs of www.renaissancecapital.com of Greenwich CT, but that I have read elsewhere, too, shows much less volume. They count a measly 53 US IPOs in 2011, a precipitous plunge not only from 125 the prior year, but from a high of 486 in 1999. Perhaps unsurprisingly, the number of IPO withdrawals has increased in the past three years, from 48 to 52 to 67 last year. (Did RR Donnelly use the start-out-the gate number?) The Jan-April withdrawals in 2012 are even with those in 2011. The dollar volume raised by the IPOs differs, too. These sources cite $97 billion in 2000 declining to $36 billion last year. Both sources agree that the average age of companies making an initial public offering have aged, but the Renaissance numbers are MUCH OLDER than the others. They identify the average age as 10 years in 2000, 15 last year, and 27 years old for those so far this year.

GrowThink points out that the number of US IPOs since 2001 remain lower than the 1980s.

The final barrier to entry is the value of the companies. This is tough to assess, because pre-money valuations are usually described by those wanting to attract the money to prove the valuations! Not a very virtuous circle. But it appears that the market is not particularly interested in companies worth less than $50 mm and certainly not those less than $20 mm.

Entrepreneurs who want to say, "we should go public" should instead do their homework to research and analyze the trend line and the differences cited here, before being swept into enthusiasm by service providers who will be paid no matter what happens once the bell rings. This summary doesn't even address the costs of going public and staying compliant, year after year, which is another topic to scrutinize carefully.

My black and white recommendation is that if your company is pre-revenue, pre-breakeven, or even pre-$20 mm valuation, don't even think about an IPO. Doing so derails far too many companies from focusing on legitimate expenditures of time and money to grow market share, customer base, or profit margin.

Reverse Mergers

The alternative route for small companies was, since 2000, a fad called reverse mergers. This is no longer an option for many companies either. “Reverse merger” means that a private company buys a public one, often a “shell” company that has no operating business. Reverse mergers are faster than going public the old fashioned way and have been used by some sneaky firms and their service providers to go public without fulfilling the investor disclosure obligations of firms that file for IPOs, such as audits and SEC filings. However, even with such attractions, 2011 saw the fewest number of reverse mergers in US since 2004, 166, well down from even the prior year’s 258. Currently, there is a glut of 1900 shell companies for sale, up from 1200 last year.

The reverse merger doldrums are likely to remain. Why? Financial regulators have caught up with the “end run” many of these firms were undertaking to get access to investors. Rules have been put in place to protect investors after a series of fraud allegations and SEC enforcement actions. The “poster boy” for bad behavior has been the 43% of Chinese companies listed on US exchanges via reverse mergers, many with poor managerial oversight and little attention to American financial disclosure laws. 29 of these companies were delisted last year. Investors lost an estimated $34 bn due to misrepresentations by Chinese reverse merger companies. The companies themselves, lost, too: Chinese Reverse Mergers Index fell 62% in 2011 compared to flat S&P 500. The only people who seem to have benefitted from this fad were the service providers, who encouraged private company management to pay them to find shells and then take them through the steps to become public. Might this money have been better spent by legitimate companies to generate additional sales or product development? You be the judge. In any case, the SEC has taken to task a number of these service firms, among them NY Global, whose leader, Benjamin Wey (Wei), is under investigation by both the FBI and SEC. Since 2009, several companies that gave optimistic speeches at reverse merger conferences have quietly left that business altogether, and clearly by the stark decline in activity, others have, too.

Going forward, companies that choose to be listed on any tradable American exchange (this does not include the notorious pink sheets) by any method have to perform better than in the past before they can move up to more prestigious exchanges or they will be delisted. For example, they will have to fulfill some of the same financial disclosures as the “big boys” like annual audits, an annual report, and all quarterly reports, whereas before, many languished with penny stocks and nary a quarterly statement for years at a time. What a concept for firms trying to attract capital from investors or for CEOs bragging about heading up some tiny public company! Are there really that many people with disposable income in their pockets ready to be spent on a company that doesn’t even pay to audit its financials? Hey, have I got a deal for you!

Foreign Exchanges

Some American companies eschewed American exchanges altogether in favor of going public on European or Canadian exchanges. Like the reverse merger approach, these exchanges offered fewer regulatory hurdles than NYSE and AMEX, but fewer investors, too, so, understandably, the number of foreign companies on the TSX (Canada) and AIM (UK) has declined. As of March 31, 2012, there are only 89 US companies listed on the TSX and most of these are in oil, gas, and mining, primarily mining. Why this paucity of American companies? The TSX attracts many more listings (about 3800 altogether) than LSE/AIM, NYSE/AMEX or NASDAQ (each lists between 2200 and 2900). But the aggregate value is much less (the TSX company values, altogether, are 1/10 the value of those on NYSE/AMEX, and ½ those on LSE/AIM and NSASDAQ. (TSX: US $1.9 trillion, LSE/AIM: $3.2 trillion, NYSE/AMEX: a whopping 11.8 trillion, and NASDAQ: $3.8 trillion). So small businesses find a lot of comparable company there, but they are likely to get lost in the weeds created by companies that spend more to attract investor attention.

AIM is the small company branch of the London Stock Exchange (LSE). It has such a low threshold of due diligence and disclosure that respected observers conclude that only a quarter of its companies would qualify to be on the NYSE and AMEX. Started in 1995, it reached its peak number of companies in 2007, from which it has declined to a current number of only 1118 listings, of which about ¼ are foreign. In one report it estimates its daily average number of shares traded in 2011 at 704 mm, but its excellent monthly reports reveal that most of those firms newly issued in March, 2012 raised no money in their inaugural month whatsoever.

The lesson for American companies that listed abroad was taught by the absolute dearth of interest in them. The costs they evaded in regulatory requirements in America they made up for in having to hire IR/PR firms to hawk their languishing stocks until many of them delisted themselves. The other lesson I hope they learned is that investors are cautious about companies that so obviously choose to evade regulations designed to inform and protect investors in an inherently “caveat emptor” environment. For an American company to list itself on these exchanges always smacked of the short kid who couldn’t make it on the team but wanted to be on the field any way he could, even as a water boy, paying for the privilege.

Mergers & Acquisitions

Despite reports of cash rich companies ready to snap up undervalued companies around the globe, mergers and acquisition activity remains at a 5 year low, in terms of both money and number of deals. In 2011, 725 global M&A deals were consummated. The annual number has remained below 800 since 2008. The value of the 2011 deals totaled $1.1 trillion, half as much as the 1184 deals concluded in 2007 ($2.2 trillion). This, too, is unlikely to change in the near term. Why? For one thing, the UK passed a new Takeover Code in Sept, 2011 that protects target companies in various ways from hostile take overs that would otherwise be more popular in a market of undervalued companies and cash rich acquirers. For another, European banks are rarely lending more than $50 mm, and there is a paucity of consortium lending of, say $250 mm by five banks to support larger deals. Across the pond, in America, debt financing virtually shut down the second half of 2011 and banks are keeping their coffers locked up at the Fed this year, too. All this inertia remains despite the fact that large global corporations do appear to be sitting on cash reserves – the 100 biggest companies in the world appear to have 32% more cash on hand than in prior years. Those with the largest reserves appear to be not in the US but in Brazil, Singapore, and Hong Kong. Smaller firms are shoring up their own balance sheets, buying back stock, cutting staff or hiring younger cheaper ones, investing in efficiencies to make themselves leaner and meaner but not out buying other companies (except as mentioned below). In the US market, M&A deals indicate prolonged due diligence phases which may reflect a game of chicken as both parties stare across a broad gulf between buyer and seller valuations. Who will blink first? We worked on one project for a small company in which the buyer verbally offered an attractive price for 20% of the company. When the deal was papered, just about everything was the same except the portion of the company. They now wanted 50% of it... for the same price. The seller regarded this as an egregious bait and switch. The potential acquirer explained it as the result of extensive due diligence. The seller walked away from the table.

What About…

What is an optimistic entrepreneur of a small private company to do? Hunker down and grow the business organically, the old fashioned way? With cost controls and steady growth in customers? Well, in a word, yes. The funding frenzy from the late 1980s on fueled a generation’s expectation of easy cash and creative financing that was largely as illusive as unraided pension funds. Industry journals highlighted the occasional brilliant success story and published unexamined press releases about pending fundings far more often than the slow and steady bootstrapping or “whatever happened to” stories (when the first tranche was paid but none of the rest). Many sources of government funding have dried up, too, as municipalities, states, and the federal government take in less money from their tax base. Sources like CAPCos (state credits to insurance companies that invested in businesses) are all but closed.

The entrepreneur can also profitably spend time in self-examination as well as exploring relationships (before they are needed) with banks, investment bankers, factoring firms, suppliers, customers, competitors and larger, synergistic firms. The financing and acquisitions I have seen in the past several years are ALL with smart money experts in a given industry, often with resources the acquired company lacked, usually a sales channel to outlets like governments, schools, hospitals or the military that would otherwise take years to develop. Here are three examples: One company that developed a hospital inventory management system was bought by a company that sold, guess what – hospital inventory. Another was a small fish farming company that wanted to get into big box stores but lacked the connections. It was acquired by a large conglomerate with other subsidiaries selling into those stores, as well as the transportation and logistics arm to facilitate delivery of such time sensitive products. Here is an example for service providers: A successful investment banker I know takes only back end fees, never retainers, but he only takes on clients for whom he already knows a few competing money sources interested in what the client company has to offer. He is able to do this because he is an expert in a narrow geographic/industry niche. He knows everyone and has an excellent reputation for honesty. It helps, too, that since he is an expert, he can offer rapid due diligence before saying yes or no to a potential project and can thus conclude a deal faster than generalists who have to climb a learning curve on each transaction they stumble across. The point of these examples is that a scatter shot approach is unlikely to be successful. A company that desires to be acquired or funded needs to seek out smart money or hire industry experts who know those who need to be known, first to get a reality check on valuation and then to approach potential buyers or investors with realistic expectations.

With profit margins and disposable income being squeezed as oil prices and regulations rise, it is only the smart money with deep knowledge that is willing to take a risk on small companies. Small smart companies will already know who those companies and investors are in their space, whether they are looking for acquisitions, and whether the company has met the milestones those money sources want to see. Some angels may be willing to take a flyer with a portion of their money, but I'm not seeing the activity level or the enthusiasm of the past. It seems to me that many angels are really service providers in disguise. This is a buyer’s market. Small companies looking for financing better put their best foot forward, and that foot should be shod in profitability with a sole of sound market (and self) analysis tied with the bow of cost containment.

Liars and Cheats

Many entrepreneurs are dismayed by the slow pace of due diligence checks by potential investors. How many interviews, how many financial documents and resumes and business plans must they submit before getting a thumbs up or down?

This process might be more understandable if entrepreneurs consider two things.

1) Homes they have bought or sold: Just as in that case, investing in a company is proceeded by a period of judicious inquiry and inspection, recognized by both parties, ending in a legally binding closing, scheduled weeks in advance. (This is why I never believe an entrepreneur who blithely reports, “I'll be funded by then” without even having a letter of interest (LOI) in hand.

2) The reason for protracted due diligence is because THERE ARE SO MANY LIARS. Just as a home seller may obfuscate termite or water damage, companies seeking investment may similarly “put lipstick on a pig.” Repeat investors know this, so they endeavor to separate the wheat from the chaff through careful scrutiny. As any on-line dater knows, anyone can sound good, but how do they appear up close?

A sincere and honest entrepreneur may be aided by the following article, which describes several lying entrepreneurs who have approached us recently. Such bad guys add to the time, cost, and effort of investors who understandably, apply the same due diligence to you. Following the list are recommendations to honest entrepreneurs that can help them make a strong, honest, initial impression.

- A Torontoan advertised on E-Lance for business writers with a finance background, including introductions to investors for his new cosmetic company. His website looks great, and describes a very impressive business/finance/investment background for him. Hmm. Why is he trolling the modest halls of E-Lance for help in a highly specialized securities offering? Well, due to his unusual name, 5 minutes on the web revealed that his securities license has been revoked in Canada, he has been fined a 6 figure amount (which he has not paid, three years later), and that his prior financial firm was expelled from the securities industry, all for breach of fiduciary duty to investors. Entire legal documents outlining his shenanigans are available for a free read. Today, he runs an unlicensed financial consulting firm and is endeavoring to raise investment in the U.S. Does he really think nobody will look him up before investing? I sent him a paragraph describing his banishment from the industry. He wrote back that I “just don't get it.”

- A Chicagoan sought investment for his real estate fund. His company is rather opaque but his copious litigation record isn't. An Illinois court ordered him to pay an ex-partner nearly $800,000 several years ago for breach of contract and a protracted effort to rack up legal fees he apparently endeavored to foist onto the other party. When he did not pay up, he was sued again. This time, public documents (on-line) reveal that he has moved more than $1 mm in assets among companies and relatives, emptied bank accounts to avoid paying the prior fine and has taken out additional loans on which he has defaulted and owes penalties. Surely this guy will end up in jail.

- A Hawaiian sought funding to buy land on Maui and build a mansion. After that, he plans to run for mayor. However, a bit of digging uncovered his prison record. In addition, notes from an open meeting at which he appealed the denial of a real estate license, indicate that he has not been seeing his psychiatrist and taking his medication as often as he is supposed to, and that various court documents sent to him care of the YMCA in lieu of a home address did not find him.

- Sometimes people aren't liars and cheats, they are just naïve and pushy time wasters. A young New Yorker wanted to attract investors so he could develop a high-end resort on Antigua. He touted his relationship with political leaders on the island, but his only “proof” was a form letter from the Tourism director thanking him for exploring real estate there. Furthermore, he has no business experience in real estate or finance, and no track record with investors either! Yet, he called us often, apparently “into his cups” demanding that we invite the island's political leaders to the U.S. And that we line up investors for him. We reported his obnoxious behavior to the service provider through whom he had gotten our name and, have enjoy a blissful silence ever since.

- Another liar was actually a client in London. I still don't understand his game. He promised to pay us up front, and more than we sought, which is obviously so rare that we were alert to something being awry, so we slow boated services. For the next month, he called or wrote every day with a litany of excuses for why the wire, the credit card, the bank draft, PayPal wasn't transferring our fee, why the contact information he provided for his banker and accountant never reached a real person, and why the confirmation forms we requested never looked like real transaction reports we receive all year long. I was actually so entertained by the number and variety of his excuses that I started taking notes for a future article about types of business lies. However entertaining his calls might have been, they wasted time we could spend on real clients or nail clipping or anything else, so we finally conveyed a “don't call us; we'll call you” sort of message. I still wonder. Was he just lonely? Did he like creating a fictitious personality that had a business? I guess I'll never know.

What can an honest entrepreneur deduce from these anecdotes?

• From an investor's point of view, evaluating entrepreneurs is a process of weeding out those companies that are not suitable for one reason or another. The first thing I do is look for red flags like lies, litigation, and customer complaints. Those people get a quick and decisive “no.” Others are just an unsuitable fit for the specialized interest of the investor or because the investor is not liquid at that particular time.

• Action step for entrepreneurs: Before you EVER approach a funding source, spend time on the Internet researching everyone on your management team, their prior company affiliations, and any companies with names similar to yours. I promise, prudent investors will do so. If your VP has public disclosures of liens, bankruptcies, criminal convictions, litigiousness, investor complaints – you are sunk. If another company with a similar name has a bad reputation with investors, you will have an uphill battle on initial calls. If none of you has relevant positive experience... please wait until you do. This is other people's money you are seeking. Also, investigate the criteria of an investor before launching into a long monologue selling your deal. If the investor specializes in oil and gas equipment and you make marinara sauce, it is not a good fit. Find out early. Maybe ask if he/she knows who does invest in food companies.

• From an investor's point of view, it is sometimes difficult to discern whether an entrepreneur's behavior is truly naïve or purposefully obfuscatory. Either one requires additional time. A naïve entrepreneur does not understand the process of financing, may not have appropriate documents organized well, and may have ridiculous notions of value. An honest investor may not want to take the time. A dishonest (vulture) investor may take advantage. A purposeful obfuscator is hiding information relevant to a well informed investment decision. Many investors will pass either way. Let's face it – there are lots of strong ventures and well prepared managers asking for money, too.

• Action step for entrepreneurs: The more you know about how business transactions (including financing) work, the faster you can assess whether you are likely or unlikely to secure investment and whether a purported investor is real or really interested. Ignorance is expensive. Many a naïve entrepreneur has wasted time shopping for dollars they will never get or has been deluded by complimentary intermediaries who promised a rosy future (in exchange for monthly fees) while knowing that the entrepreneurial venture was unfundable. So do some research on bank loans, valuations, investment banking fees, success rates on crowd funding or web posting sites, SEC and FINRA rules regarding the solicitation of private investment. Enlist trusted mentors or advisors before approaching investors and intermediaries. This education will save you time and money. By all means, check references or anyone you work with. Don't just read resumes. Make calls. Familiarize yourself with the sorts of logical questions any investor is likely to ask (see other articles on this site). If you fumble a key question, the investor may not know whether you are just ignorant or hiding something. Organize your corporate documents in a professional manner (see other articles on this site or the $50 workbook which lists them and explains why). If you do encounter an interested investor, you will be able to respond promptly.

• From an investor's perspective: People who say, “You just don't get it” often have secrets they don't want you to get. This was Enron's response to investigative business journalist, Bethany McKuen. Guess what, she did get it and she exposed it as fraud.

• Action item for entrepreneurs: If you can't explain what your company does, how it makes money or what you will do with investors' funds, no one will trust you. Practice your answers to logical questions that any investor will want to know. Be prudent, be prepared, and assess the company you keep.