Cradle Investing centers around the philosophy that dedicating time, money and other resources at the inception of a new business venture can significantly improve the strategic and tactical approaches that venture takes so that the venture has a greater chance of success and the investors have an overall reduced cost of investment.
Carolina Seed Investors prefers to work with pre-revenue companies and assist in the development of overall business strategy, go to market tactics, and financial and operational planning. With moderate upfront capital investments CSI can quickly test the failure points of a new business and confirm operations assumptions. The information gathered from this early relationship between entrepreneur and investor is intended to make both parties smarter with regards to investments into and management of a new venture.
Questions are a good thing. The more questions that entrepreneurs and investors ask of each other the lower the chance that some unstated assumptions will undermine the relationship and the company. In Cradle Investing it is essential for both entrepreneur and investors to understand what a company needs to accomplish, why and when.
Unique personalities and business ideas ensure that no two pitches will need to ask the same questions; but, we detail some typical questions below in the hopes that understanding here will improve discussions during investment pitches.
One of the most common questions asked by entrepreneurs is "Should my company be an LLC or a C-Corp"? Many institutional investors prefer a C-Corp because it solves several legal issues allowing for both a larger number of investors and a more complex options pool. However an LLC structure has early advantages for both the entrepreneur and investor. Specifically, the ability to write off losses on individual tax returns, can be very beneficial to entrepreneurs, and their financial supporters, early on in the company's life cycle.
Ultimately this is not a critical question because most states, including Delaware, have in place statutory conversions which allow for a company to convert between a LLC and a C-Corp relatively easily. An entrepreneur can start a company as a LLC and then convert to a C-Corp when appropriate as part of a capital investment.
Where to incorporate is another common question. Often companies will incorporate in Delaware because the legal code there is broadly understood, and then headquarter in their home state. While there are some additional financial costs to this strategy, they are usually small compared to the big picture issues.
When an entrepreneur pitches to a venture investor, they are selling an idea of what the future will look like. This vision of the future needs to be ambitious enough to draw the investor's interest but not spin off into budgets and milestones that border on fantasy.
A bold and aggressively optimistic view of a company's prospects is very common for founders. This view is ok if it is backed up by rigorous market research. It is easy to claim that a business will sell 1,000 units next year and then grow at 20% for 5 years; but, more rigor is often more effective. For example, conversations had with 3 major customers indicate sales of 100 units next year, 175 units the year after than and then 250 units the year after that.
The numbers may be much smaller but the work ethic and market understanding demonstrated with the latter approach reduce the risks associated with the investment from the investor's perspective. From the entrepreneur's perspective, less perceived risk by the investor means more and lower cost financing.
Negotiating the value of a new start up is always hard. Investors have few (if any) concrete milestones from which they can derive specific valuation metrics. On the other side, entrepreneurs often develop an emotional attachment to the company they built from scratch.
A convertible note is a form of financing designed to avoid some frictions associated negotiating the value of a company in a very early round. It is easier to say that the early round investor can buy at 80% of the next round valuation than to establish a price for the early round. While deferring a valuation decision has its appeal, the draw back is that significant conflicts may be left undiscussed and reappear in a more difficult format later.
A convertible note is an option for financing a new venture but it has a very narrow niche in Cradle Investing. Establishing value, goals, and a relationship between the entrepreneurs and investors is a valuable step that can save time and money down the road.
Planning is essential for a start up. A well thought out plan makes an entrepreneur more efficient with both their time and resources. However, at the beginning of a start up, there will be so many potential scenarios that a full go to market plan can feel like a futile task. consequently, many entrepreneurs begin by focusing on short-term execution of individual tasks instead of building a long-term strategic plan. It should not be little or much,: rather, there is a right amount of planning for each situation.
Execution is important. As new information comes in and unforeseen complications arise a successful entrepreneur will need to adjust and possibly completely rethink a company’s plan. Excessive detail can needlessly complicate operations and the reporting of those operations to investors. Further, slavish devotion to a single market strategy can result in a sophisticated product that the market has no need for.
Cradle Investing emphasizes using resources to build strategy development expertise into a start up. The ability to evolve new strategies should provide a new start up with the framework to adapt to their market as the company, the market and their relationship change.