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Finding the Golden Needle
Netpreneurs Discuss Their First Funding Experiences

The Chia Pet Strategy

Mr. Riechers: Bob Nelson is the founder and CEO of CrossMedia Networks. This company develops software and systems to enable mobile professionals to access and manage their communications using any telephone anywhere in the world. Today, with CrossMedia, you can call an 800 number and use your voice to play email messages—not voice mail, email messages—send customized replies and forward copies. Soon you will also be able to enter your most frequently called telephone numbers on the CrossMedia Web site and use your voice to place calls by merely saying a name. CrossMedia was founded in 1996, raised a seed round of $250,000 in 1997, a $600,000 round earlier this year, is currently closing a $1 million round and is talking to a select group of VCs about a $5 million first institutional round. They have 10 employees today, including Bob.

Mr. Nelson: Thank you, Gene. Before I start, I'd just like to learn a little bit, how many people in this room are out there looking for money now or will be within six months? Now keep them up if you are doing it for the first time.

This discussion is for you. I was there two years ago in that crowd wondering, "How can I be rich in two years?" My wife will tell you, I was dreaming about it.

The most important thing to a company is great employees. Tonight we have three people here from our company. Before this presentation, I asked them, "Can we get one of those fancy projectors to put it up on the wall? I've got a road map I want to share with people. It distills two years of fundraising experience to one spreadsheet." Kathy said, "Bob, that's 400 bucks, it's not the best use of our money. But I've got the technology that you can use."

Everybody should have a piece of paper on their chairs. Where I come from in Nebraska, they say, "If you don't know where you are going, you are probably not on the right road." This is my road map for you (spreadsheet not currently available ).

If you are starting today to build a company, set three milestones over the next 18 months, such as alpha version, beta version, release. Go out and talk to people you know who have built companies before and ask them how much it will cost to get to each one. Maybe it’s $80,000 to get to alpha, $200,000 to get to beta and $400,000 to get to the actual release. How much do you need to raise, then? You always need to raise more than you are going to spend or else you will have to stop your development to build capital.

Get a great lawyer who has been through this a number of times. Figure out what the valuation for company that crossed those hurdles would be. Maybe a valuation would be $2 million at alpha , $4 million at beta and $10 million at release, if you had a couple of happy customers. We can quibble over whether it's $10, $5 or $15 million. But build a spreadsheet that's at least close, because without the road map, you won’t know how you are doing.

From that, go back and look at the amount of money you need to raise and figure out your pre-money valuation and post-money valuation. Then work with your lawyer on the number of shares you have to authorize. For instance, at start-up you might say, "My initial investors need to see a 40 times return on their money to even be interested." People who are willing to throw away $50,000 on an early-stage project are going to have to get a heck of a return.

Get somebody that loves you: family, friends, a co-worker or your credit cards. For $100,000, you give them two million shares. Split four million shares between your founders, and reserve two million for future employees. All together, that’s eight million shares and gets you to the point where you can launch a company with a couple of employees. You've got some money and you can go for a few months burning $10,000 or $15,000 a month.

Now look at December '98. You will go out and raise a million dollars—or $250,000. And you’ll say, "I'm worth $2 million." At that point, issue another million shares. At the next milestone, issue another million. The next milestone means you are ready for venture capital or angel money. Each time, figure out the price per share to offer people to get them in at that round. One easy break down would be in an early, early round, to give somebody an upside of 100 times their money.

Later on, offer investors 40 times their money. As you get to the VC stage, you've got to show somebody why you are going to make them 10 times the money. If you are at a dollar a share at that point, you are going to try to drive within a year or two to 10 bucks a share. It's pretty simple math when you look at it.

Please flip the page over for the next slide (spreadsheet not currently available ). You look at the upsides you are offering people and think, "Okay, I need to go out to people that can give me that money." If your first $100,000 investor is not your credit cards, relatives, friends or somebody who owes you money, they'd better be worth a minimum of $2 million bucks. There is about a 90% chance you are going to lose their money, so you better pick somebody who can afford to lose it. Go down that column and figure out what investors’ net worth should be at each of these different stages. Look at potential investors and ask whether the upside is enough for them if you win. At one point I talked to someone about making a $50,000 investment. "I'm going to return 40 times your money. You're going to make $2 million." He dryly said, "I made $2 million on stock yesterday."

So there is a range of net worth that you want to go after when you are asking for $50,000 or $100,000. Who are you going to approach? You have to approach 10 times the number of potential investors then you need. If you want five investors at $50,000, or if you want one person at $250,000, it changes who you go after. But it doesn't change the fact that you are going to have to go after a ton of people. It's a numbers game, and we're all marketers or else we wouldn't be here.

By the time you get to the VC round, know what kind of VC you want. Find the VCs that invest in your space and who have money available. Narrow it down to 15 or 20 who are really good in the space you are in. After two years of fundraising, you'll know who you need to target. Then look at the amount of man-hours it takes to raise this money. This is a rough number but expect to spend 200 hours raising that first bit of money. If you have two employees, 200 hours is five man-weeks doing nothing but raising money. If you do that, you are not building the product or writing the plan during that time. Hopefully you will get referrals after you get your first four or five investors, and the amount of hours it takes to raise capital goes down.

Follow the column on staff. You probably start with two or three employees. When you grow to four it's exciting. Once you have eight, my gosh, you have committees and things. Eventually you are ready for venture money, and you have 12 or so employees. Now you can afford to have somebody full-time doing nothing but raising money.

Now, here is the fun part of the game. How much of the company do you still own after you've done all this? CrossMedia jokingly calls what we did the "Chia Pet" strategy. There was no water and no food, but we still survived. The only good side in doing it that way is that management manages to retain a large percentage of the company. It's not necessarily the best strategy. But the reason to retain ownership is shown in the final column. In two years using this formula, the founders' stock alone will have grown from $200,000 to $4 million. You are splitting a big number. Always keep in mind that you must be poised at this point for 10-times growth, or no VC is going to invest in you.

So now you have built the basis for a great growth and a great personal worth. Thank you.

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