How To Fund “Nice Little Companies”

by Wayne Willis on September 29, 2010

I’ve met two companies in the last 10 days with the following features:

  1. They both are “value added resellers” of electronic display hardware. The “value added” component in both cases is mainly proprietary software they have developed. One provides the value from their software as a service (SAAS); the other modifies and re-builds the hardware with their software embedded.
  2. Recent sales are in the low six figures annually and a number of big orders are in the pipeline. Some channels have reached out for deals.
  3. Both are seriously under-capitalized, constraining every aspect of their business and even threatening their viability.
  4. Both are led by sales-oriented founders who serve as CEO and rely on technical friends who are not being paid fully. If properly capitalized, these tech resources would come aboard full-time. The techies are drifting away during the delay in getting funded.
  5. Both CEOs are trying to raise money, but they cannot answer the key questions that technology investors ask. Moreover, these companies, if successful, would not have the “home run” potential which investors here in San Francisco like. They will be “nice little businesses” if and when they succeed – but not home runs. As “nice little businesses” they have less risk than a company developing disruptive technology. That is, they can generate a very attractive, risk-adjusted return to the owners/investors.
  6. The scale and traditional capital structure and governance issues involved in “startup” investing does not really apply. They will never get funded from the “angel” or “VC” type investor. They don’t need to “exit” to pay off their investors if they can deliver a cash stream of significance. They likely will either get “friends and family” money or none at all.

What can they do? If they can take a small amount of capital and start ramping up sales (both have very good margins), the companies can be very profitable and bootstrap into a solid company. Given that possibility, I’ve suggested they do the following:

Structure. Set up an S-corp or LLC structure that lets profits be distributed with only one layer of taxation. Distribute those profits in tranches, as follows:

  • Investors get their investment back
  • Then, founder gets his “investment” of time, sweat and cash invested back
  • Then, profits are shared in proportion to ownership interests.

Governance: The founder will serve as President / General Manager, but a new Executive Chairman approved by the investors would do the formal business planning. A Board would make directional decisions and investment decisions.

Business Plan. The Executive Chairman and the Founder/President would complete and agree upon the business plan:

  1. Problem that the product/service addresses. How big is it? (Market size)
  2. How do we solve the problem (our product)
  3. Competitors and competitive advantages of our product over alternative solutions
  4. Go To Market tactics and other distribution issues and opportunities
  5. Steps available to build sustainable competitive advantage (if any)
  6. Financial Posture – capital needed, forecast, return on investment
  7. Management team capable of pulling it off.

Obviously, this requires a deep gulp and some trust by the founder/owner. But if the Executive Chairman is capable and impressive (and doesn’t get vested until funding is secured), it could work.

I suspect that it will work a lot better than continuing to call on investors who ask for business plans that never materialize and that don’t match their investing criteria. And I suspect it will work fast enough so the capital arrives before customers and tech resources abandon the company.

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