Here we are, where the rubber meets the road. Your plan on how you will spend your investor’s money is presented to him. If your business plan is like most that I read, you get this wrong.
There are 5 buckets of expenditures:
- Product Development
- The Management Team
- The Sales Process
- Fixed Assets
- Working capital
Nine out of ten of you ask for the money because you need working capital. This is the worst use of an investor’s money. Don’t forget, he is trying to get a 10x to 20x return on his money. If he is funding receivables, inventory and salaries, he is not getting a return on his money.
The VC knows that the product is what will make him a lot of money. So he is more than willing to invest in this bucket. And money spent on a good management team is always money well spent. You can have the best product in the world but if you don’t invest in selling and marketing, it won’t go anywhere – which means the VC is happy for you to spend money on sales.
Items 1-3 make the grade and the last two do not. So if you need money primarily for fixed assets and working capital, you will not get it from a VC and probably will not get it from and angel investor. You need to go to the banks or to family.
To finish talking about cash, here is the other problem you run in to. Your negative cash flows are ALWAYS understated. This graph is called a “J Curve” and all sophisticated investors use it. The line represents your cash flow over time with the red hatched areas the time and amount of negative cash flow.
You, the very optimistic business owner typically produce a J Curve chart like the first one – very little negative cash flow and it doesn’t last long. You arrive at this chart with a sales forecast that is way too optimistic. The second chart is what the VC will produce. As you can see, the red hatched area is much bigger – both in terms of depth (how negative the cash goes) and length (the time it is negative).
The consequences of your not predicting cash flow is horrific. You may not survive and, if you do, lots of bad things happen. When your investor hears you say “I think I need $2 million but I could probably get by with $500,000,” he will run for the hills and you will not get his money. It’s because he knows what the bad “J Curve” is telling him.
Spend a lot of time defining your cash flow needs. It is easy to calculate money out: salary, rent, etc. Make sure you are dead on. Sales are much more problematic because you cannot accurately predict them. So you need to be very careful and do not over commit. Get the advise of a sales professional. Please do not shoot yourself in the foot because you are afraid to ask your investor for more. He is smart enough to smell BS so don’t throw any at him.