Innovative finance strategies for startups

Lawrence Gennari, partner at Choate, Hall & Stewart, LLP

With the stock market entering a modest equilibrium, many emerging growth companies, whether venture-backed or privately funded, are reconsidering financing strategies and looking at their next steps.

Yet, bank financing remains elusive, and many venture capitalists, particularly those previously funding Series A and B rounds, seem to be focused on stabilizing their existing portfolio companies or investing in later stage enterprises. So what’s a technology company to do if it needs financing and hopes to be sold or go public within two years? Consider the following:

Doing more with less. Financings are still getting done, even in this environment. The key is adjusting financing strategy to what is available — and from whom — in the near term. For example, a planned venture round for $7 million may need to be scaled back to a $3 million targeted angel investor offering. Angel investors, both in groups and as individuals, ­still are reviewing business plans from local companies in compelling industries or with demonstrable near-term financial success, such as achievement of break-even cash flow. Any management team that is formulating plans and presentations for institutional investors should have a parallel plan to reach out to angels.

Milestones matter. Whether the target investor is large or smaller, the questions will be the same. How have you spent existing cash, and how will you apply proceeds from the new financing? Be prepared to demonstrate how past investment led to objective milestones, such as a new upgrade or version of software, registration of unique users, or achievement (or near achievement) of break-even cash flow. For any new offering, you’ll need to show cash outlays that are real, achievable and narrowly tailored to meet near-term milestones. Remember, even if you can’t raise all of the money you ultimately need right now, you’ll position the company for a greater financing valuation later — perhaps in a better or more hospitable economic environment — if you can execute on meaningful milestones this year.

Consider the audience. No financing is “typical” or “standard,” and today, more than ever, investment documents must fit investor objectives. If valuation is stalling discussions, would the investor take convertible debt with a right to participate in future equity rounds at a discount? If future upside protection is the issue, would investors be satisfied with preferred shares carrying an agreed-upon liquidation preference on any future sale? Flexibility and fitting documents to meet stated investor needs is critical — do not draft or present “standard” documents at initial meetings. Angel investor groups will have their own term sheets and documents, while individual angel investors will rely on the company to generate documents later to fit specific discussion points.

Don’t wait to approach investors. How does a promising company with customers, revenue and real prospects find investors, and are any angels still writing checks? The answer is “yes.” Granted, angel investments overall fell in 2008 compared with the year before. Yet the number of deals was relatively unchanged, with 55,480 startup companies raising angel capital, according to the Center for Venture Research at the University of New Hampshire. Most angel investor groups have websites and will respond to online inquiries. The best approach, however, is to approach groups or individual investors through an introduction from someone they trust, which includes fellow investors, an accountant, a lawyer or a banker. The party providing the introduction also might prove to be an important source of information regarding the investor’s preferences, investment appetite and co-investing circle of friends.

Bottom line. Whatever financing strategy you choose, be prepared to think, resize and readjust creatively based on today’s market realities. An innovative and flexible approach is key to raising money now — and for the foreseeable future.

Lawrence Gennari is a partner in the business and technology group at Choate, Hall & Stewart, LLP and an adjunct professor at Boston College Law School. He can be reached at lgennari@choate.com.

Posted by: tplatt@p… / Friday, July 17th, 2009 – 8:36 am EDT