I just had nice chat over Skype (NB: eBay has just restructured Skype’s worldwide operations and good people like Jérôme Archambeaud were fired yesterday; you don’t get anywhere without the best people. The more I read on eBay, the less I understand their decisions) with Mohamed, a French-Algerian entrepreneur based near London.

Mohamed and I met thanks to this very blog, last week. An exchange student in a London-based school of computer science, Mohamed and one classmate of his have this brilliant open-source-based business idea, no experience and many, many questions to get answers on before they’re getting anywhere. The funny thing: Mohamed hadn’t understood I too were a student, so his first e-mails were extremely formal and polite, raising many issues about entrepreneurship, venture capital, success, etc. As I told you Mohamed, I’m everything but the best person you may ask questions about all these topics. Still, I know you’re in the beginning of the fundraising process, so I tried my best, I can assure you.

So here are, as you agreed I could do, a selection of 3 questions you asked (and my subsequent answers). Let’s see who may help you further.

1) Mohamed: “Success factors of entrepreneurial adventures?”

Me: “I don’t abide by any doctrine or research school on entrepreneurship, or if there’s one, I’d say the Entrepreneurship Center @ Rotterdam School of Management, where I took master-level classes for 4 months back in fall 2004. From what I’ve seen around me, success is conditionned by the following factors: 10% on the idea, 70% on execution, 20% on timing and luck (put these together to leave some confusion ). Most VCs pretend it’s 90% on the team 10% on God. It’s all wrong. As a proof, the first thing a VC does when opening a business plan is turn the pages down to the financials. Business angels act differently and might indeed invest their bucks for sometimes irrational reasons (common sense: they don’t invest other people’s money).”

2) Mohamed: “What is a pre-money valuation? “

Me: “Come on Mohamed, don’t get distracted by VC talks. If you talk to an angel or VC and don’t understand something, be smart and say so: don’t, never, ever, whatsoever hesitate to ask. By the way, they probably don’t know anything about design patterns, so it’s natural you feel disturbed by expressions like ‘pre-money valuation’. It’s just not your background.

To go back to your question: broadly speaking, say you’re company’s worth £100,000, split in 2 shares. You and your partner both own one single share worth a 50% stake in the business (in other words, £50,000). Luckily enough, you’ve just found an angel willing to invest another £50,000 in the start-up.

You’ll most likely proceed through a capital increase. The angel’s lawyer (’cause I’m sure you don’t have anyone yet) will tell you the angel’s investing £50,000 at a £100,000 pre-money rate or valuation. Him/Her investing £50,000 doesn’t mean (s)he’ll own 50% once the deal closed. Actually, once the investment effective, the company will be worth £150,000 after the new share issuance, using the same 1 share = £50,000 relation.

You and your partner will still own 1 share each, worth £50,000 each, but the angel will too. The new capital structure will be as follows: 1/3 for you Mohamed; 1/3 for your partner; 1/3 for the angel. £150,000 is called the post-money valuation. The fact that although the value of your investment remains at the same level despite a decrease of governance clout (from 50% down to 30% in your case) is called the dilution phenomenon. You would have had to invest money as well had you felt like avoiding this relative loss of control. Got it all?”

Still hungry? For further entrepreneurial finance for engineer, take a look at my post about a conversation John & I had over here.

3) Mohamed: “Raising money: when? who? how?”

Me: “Three variables, one equation. On ‘when’ first. My theory (verified twice so far in my own experience) is that you should go as far as you can on your own. This is called bootstrapping: eat your dog when the fridge’s empty, stop calling your mother to save time, work from home or sleep at the office (I’m so kind, you’ve got the choice), talk to your friends on instant messengers and VoIP exclusively, sell your girlfriend to the Bedouins for 40 camels (I know a good address I can give you) and sell the 40 camels one by one to American tourists on a Sunday morning in Camden market, start a consultancy, give math & hip-hop lessons, do whatever it takes but get your first product out of the pipeline before you start looking for money.

Why? Because unless they’re stupid (and they’re certainly not), venture capitalists will ask for a 95% or so stake in the company if there’s no proof (yet) that you are a can-do sort of guy. VCs look for entrepreneurs who i) can execute; ii) badly want to get rich. I recently read an article in the Harvard Business Review in which Noam Wasserman, a researcher, stroke the stance that VCs preferred entrepreneurs with a drive to become billionnaires rather than entrepreneurs willing to become as powerful as a king (‘Rich or Royal: What Do Founders Want?’, HBR, November 29th 2006). If your product is ready and you’ve raised no money from the outside world, it means that: i) you can execute; ii) you understand well that someone who makes $1 and spends 99 cents is, at the end of the day, better off than someone who makes $1,000,000 and spends $1,000,001. Trust me, you’ll instantly become eligible. (There’s a third way though: cultivate your network. I know you told me you don’t know any VC, but before you graduate, find some time to start a Venture Capital club at your university, or get your best friend do it for you since you don’t have time to do so. Organize breakfasts, lectures and visits during which you’ll meet VCs & learn their language, habits, customs, etc. Keep in touch with them in case you need a referral some day. I’d say 200% of deals come from referrals or direct contacts. It’s funny because I’m writing things I deeply believe in but don’t apply myself: I actually don’t know anyone in the VC industry in France.).

Then, i.e. once you’re eligible (you’re broke + you have a product that’s ready to sell), my advice is that you shouldn’t wait for the first sale before cashing in the money from your investors (angels or VCs). I know this is counter-intuitive, but read this out loud: ‘before you make a dollar of revenues, you may sell the dream of seeing sales skyrocket in no time; once you make money, it’s hard to justify crazy valuations since you’ll have to explain how you reach a 6-digit sales growth in your first six operating years.‘ Put it differently, with revenues amounting to $0, you may pretend if you’re a good salesman that you’ll generate a $10,000,000 top-line in your first year. However, it is much harder if you made $55,555 in your first year to claim that your sales will reach 10 million USD in your second year. Fair enough I guess. Want an example? YouTube.

On ‘who’ then. You’re French, and you live in London. Believe it or not, that’s a major fucking asset you have over your mates starting up a company in France. The richest, most risk-friendly, most entrepreneurial Frenchmen are bankers living in London and Switzerland. They have extra-cash available for angel investing, they’re most of the time knowledgeable and willing to share their experience, and since they are golden-handcuffed in their banks and hedge funds, they will see in you the entrepreneur they haven’t become. Again, when fundraising for an Israeli e-Commerce start-up myself a while ago, all the interested angels I talked to and brought aboard were either based in London or in Geneva. So use the expatriate French connection and keep in mind there’s a good reason why these guys don’t actually live in France.

Last, but certainly not least, ‘how’. My advice is that you should focus on developing your business best, not run the numbers or delve into convertible loan contracts. So get yourself a lawyer with a good reputation, and (optional) a financier to run the numbers for you (make sure you understand numbers though), pay them what they’re worth and don’t faint if it’s a lot of money. Think as lawyer fees as an investment: in case things turn wrong (often at exit time), you know at least that you’ve got a strong contract protecting your interests and you’ll sleep much better. But this is for later on. What you’ll do now is bootstrap: call a friend of yours in the law industry and ask her/him to forward you a plain vanilla shareholders agreement contract. This will do perfectly in the short run on the condition that you add a sentence in it stating that the shareholders agreement contract will be re-drafted as soon as the start-up makes enough money to rent the best lawyer in town: when you plan the wedding with your business partners, plan the divorce too – just in case. Same as far as accounting is concerned: don’t buy Quickbook and do your finance yourself. Accounting is a complex human science, so call the UK Chartered Accounting Institute; ask them to fax you the most recent list of graduates. Call these graduates one by one until you find one who sets up her/his own accountancy in a 15-minutes walking range from your office/place. Since you’re her/his very first client, be sure you’ll get premium service at a bargain until someone dies.

There you go Mohamed.”

Hope it helps more to read than to listen to. It was a pleasure speaking to you and I wish you good luck in setting up your venture. (on what it takes to succeed in building a successful software publisher, click here)

Like

Unlike

Related posts:

1. 10 reasons you should start a startup before turning 25
2. Best Newsletters
3. Study Trip to Silicon Valley / San Francisco
4. Minutes of the IE-Club lecture at Microsoft France on European Rising Stars of the Internet
5. Catching up on software and entrepreneurship books