A couple of months ago I got a phone call from my granddaughter Emma, age 6. Emma was very excited. Her first grade class was raffling off gift baskets assembled and donated by class parents to raise funds for St. Jude Children’s Cancer Center. Emma was very well-informed about her mission and passionate about helping people less fortunate than she is.

How could any grandparent not invest in the consortium that Emma was assembling to make the ultimate raffle bid? (Note: there were as many baskets as there were bidders, so everyone was a winner.)

The payoff, of course, went far beyond the goodies in the basket. Buying stock in a six-year-old’s initial concept of social responsibility was bound to pay dividends. Nevertheless, my job as an investor was to ask key questions to make sure that the concept took root.

” Who are the people that you are helping?”

” Why do they need the money?”

” What are they going to do with it?”

” How much do you want me to give you?”

” When do I have to contribute?”

Emma rose to the challenge. No operating through a broker (her mother) for her. She patiently responded, then delivered her close, right from her six-year-old heart: “You know, Papa – this isn’t for me. We all have to do what we can to help other people.”

So, where do I sign?

There’s nothing like passion when you’re trying to close a sale. My client Tom has it. His second-round $3M financing closed in January, 2007 and was expected to last for a year. Achieving the company’s next developmental milestones by then would enable him to raise the third and final round at a significantly higher value.

Not surprisingly, on the way to the market Tom has run into costly unexpected challenges, which his team has addressed, absorbing his entire financial contingency. At the same time, he and his partners have also discovered some impressive new opportunities which promise to bring the company to a much higher level prior to the ultimate liquidation event.

So they’re back in the fund-raising business, three months earlier than anticipated. Tom’s “family and friends” investors, through his board of directors, all know what’s happening – he’s kept them well-informed. We have updated the financial projections every two months as the out-of-cash date ratcheted forward. Everyone knows that another round is imminent, and almost everyone will invest again, reluctant to have their stake in this increasingly valuable start-up be diluted by their non-participation.

Tom expects to close this Series C round himself, one-on-one with each investor. He has the vision, the immediate knowledge of the marketplace, and the results of his customers’ very favorable first-hand experience with the product. He’ll have to offer a little sweetener in the form of a warrant to close Series C quickly. But he has the answers and the tools. It will get done.

Ed is another guy with passion. A client for the past year, he’s capping a successful service industry career by moving out on his own, having raised $5M of the $6M that we expected it would take to conclude Phase I. Unlike Tom, Ed has worked through an investment banker who successfully raised funds for companies that employed Ed in the past. The money has trickled in during the past ten months in ever-smaller increments, producing a commission expense of $250,000.

While Ed has made the key presentation to each investor, it’s been Doug, the broker, who has closed each sale and collected the check. Doug’s interest in the business is directly related to his flow of fees. The investors are mostly his contacts, and Ed has developed only tenuous lines of communication with them. There’s no formal board of directors and no regular operational or financial briefing.

The financial projections developed last fall have been on target – $4.8MM to launch and $1.2MM for working capital in the early months to get to Phase II. All of the start-up problems have been surmounted except one – Doug. As he’s gotten to the end of his Rolodex, Doug’s commitment has waned. He’s reluctant to go back to his existing investors for more funding, in effect admitting that he, a professional fund-raiser, failed to deliver the full $6MM.

The fire still burns in Ed, starting with the fire to relieve Doug of any further responsibility. Ed will finish the job himself, with tactics that he should have been using from the start, including:

1. Developing a personal relationship with all of his investors;

2. Making sure that everyone, including the whole management team, understands the economic model of the business;

3. Constituting and consulting with a board of directors or an advisory board;

4. Building personal credibility by sharing the news, good and bad, about the development of the business;

5. Treating investors like the partners they are: they collectively provide the funding; Ed and the management team collectively drive the business.

Ed needs another million. The investors are all sophisticated; they’ve been down this road before. They all need a first-hand dose of Ed’s passion and continuing vision on a regular basis as he answers their Who-What-Why-When and How Much questions. And then Ed can deliver the ultimate close: “This isn’t just for me – we all have to do what we can to keep from going down the chute together.”

It may not be a lesson that a six-year-old could offer, but self-interest in the face of both fear and greed works far more often than not. Ask any ten-year-old.

Alligator Bites

Amar Bhide, Professor of Business Management at Columbia has researched and written extensively about entrepreneurship. Although it was published a number of years ago now, his Harvard Business Review article, “Bootstrap Finance, The Art of Start-ups,” contains many nuggets that haven’t lost their luster:

“Seven principles are basic for successful start-ups: get operational fast; look for quick break-even, cash-generating projects; offer high-value products or services that can sustain direct personal selling; don’t try to hire the crack team; keep growth in check; focus on cash; and cultivate banks early.”

“For the great majority of would-be founders, the biggest challenge is not raising money but having the wits and hustle to do without it.”

“Many entrepreneurs thrive in rapidly changing industries and niches where established companies are deterred by uncertain prospects. Their ability to roll with the punches is far more important than planning and foresight. Investors, on the other hand, prefer ventures with plausible, carefully thought-out plans to address well-defined markets. A solid plan reassures them about the competence of the entrepreneur and provides an objective yardstick for measuring progress and testing initial assumptions.”

“Start-ups entering new industries seldom get it right the first time. Success, especially in new and growing industries, follows many detours and unanticipated setbacks; strategies may have to be altered radically as events unfold. Failure to meet initial goals is a poor guide to future prospects.”

Draining the Swamp

“The number of companies receiving venture capital funding for the first time was at the highest deal and dollar level since 2001. Venture capitalists put $1.8 billion into 340 first-time deals in the second quarter compared to $1.7 billion into 252 deals in the first quarter. Seed/Early stage companies received the bulk of first-time investments garnering 57 percent of the dollars and 72 percent of the deals.

“Companies in the Software, Medical Device, and Industrial/Energy groups received the highest level of first-time dollars. Other industries in which venture capitalists placed more bets this quarter were Biotech and Telecommunications.

“The average first-time financing for the second quarter was $5.2 million compared to $6.7 million in the first quarter. This decrease in average rounds is consistent with venture capitalists investing fewer dollars into more deals.”

Source: PwC/NVCA MoneyTree™ Report based on data from Thomson Financial, released August 6, 2007