Keith Cunningham is one of, if not the top mentor when it comes to entrepreneurship, business, investing, and decision making. Having worked alongside Tony Robbins and even mentored a close friend of mine, he is able to distill the nuances of these topics into a format easy enough for the “average joe” to understand. In this Keys to the Vault summary, I will be going through the key learnings and takeaways as they apply to starting a business and raising outside money.
Keith is also famous for his other book called The Road Less Stupid in which he advocates something called “thinking time” and discusses the importance of being able to answer key questions like, “What don’t I see here?” in order to be able to outthink your opponent (aka your competitors).
As with any of the books that I discuss on this website, I strongly encourage you to pick up a copy for yourself, go through it with a fine-tooth comb and make your own notes on it. Anyone can read or listen to a book. It’s the retention and recall of the information that really matters. This is why you almost want to essentially re-write the book yourself via notes (this was one of the primary reasons for me starting this blog).
With that being said, let’s jump into my Keys to the Vault summary by Keith J. Cunningham and discuss the key lessons and takeaways…
Chapter 1: The Egg And I
Chapter 1 begins with Keith telling a story from his childhood about how he started a farm to table egg delivery business by sourcing eggs from his grandparents’ farm and selling the eggs to houses in his neighborhood.
He uses this example to illustrate a concept called “The Universal Formula For Success” (TUFFS)…
TUFFS is the underlying foundation for success that is made up of three core things:
- Find out what they want (the pain points in your market)
- Go and get it (assembling a world-class team, innovative product/service, action plan, start-up capital)
- Give it to them (execute, execute, execute)
Keith says that anytime you run into trouble in your business, it’s likely that you have lost focus on TUFFS due to ego or obsession.
Most importantly, TUFFS not only works for creating a sustainable business but it’s crucial for raising capital (also referred to in the book as other people’s money or OPM).
Chapter 2: Keys to the Vault
In chapter 2, Keith discusses the six keys that will take your business from an idea to a success…
- Think like an investor
- Research and prepare a great business plan
- Attract a team that’s smarter than you are
- Get the correct business and capitalization structure
- Sell the deal to the investor
- Take risks and rebound from mistakes
So let’s start with the first one…
Key #1: Think like an investor
Keith says that one of the biggest mistakes that entrepreneurs make is not looking at things from the point of the investor and therefore not tailoring their approach in a way that presents your business as a sound investment opportunity in their eyes.
Key #2: Research and prepare a great business plan
A business plan is essential for answering the questions of potential investors and to help you grapple with the issues that will almost for sure come up in the course of raising money and running your business. One of the key focuses of the book is how to write a business plan that meets the objectives of professional investors.
Key #3: Attract a team that’s smarter than you are
The quote that stood out to me the most is “it’s never what you do that will determine your success, but rather HOW you do it”. Keith then goes on to explain that the HOW is always about the people involved in the business.
The reason that every company that was once small grew to be a big company is because of management.
Key #4: Get the correct business and capitalization structure
In a nutshell, the type of business you set up (i.e. partnership, c corp, LLC, etc…) will have a significant impact on the type of capital you can raise.
Key #5: Sell the deal to the investor
“No business skill is more important than the ability to sell, because nothing happens until the cash register rings.”
“Selling” in this sense, applies to being able to sell your vision to investors in addition to being able to sell your product/service to your consumers.
Keith then goes on to explain that great salespeople do not sell at all. They simply educate their audience. When it pertains to an investor, you are educating them on why your business can go the distance.
Key #6: Take risks and rebound from mistakes
Normal people are amazed by the mega-rich and successful and think they must have some kind of superpower. But in reality, successful people simply abide by one core principle – get back up after you fall down.
Most successful entrepreneurs have experienced disaster, gone broke, been fired, etc… But what sets them apart is their resilient spirit.
In the rest of this Keys to the Vault summary, we will be discussing each of the six keys listed above in further detail.
Think Like An Investor
Meet Your Investors
Keith explains that there are five types of investors – four “Fs” and the “P”.
The four Fs are:
Friends
Family
Founders
Fools
The P is for “professional” investors.
One of the reasons why most businesses fail is because money is invested emotionally rather than analytically. Family and friends will give you money because they love you, even if you have a business that has no legs.
That is not to say that family and friends can’t be a good source of money but you should still fo about crafting your business plan in a professional way with professional investors in mind throughout the entire process. You can even use professional investors to document your deal, which is something we will get into later.
Angels & Venture Capitalists
In short, an angel investor usually has a high net worth that is self-made (think successful entrepreneurs, etc…). They view investing as a hobby and will typically invest smaller amounts like $25,000 to $750,000 in early-stage deals.
A venture capitalist has large sums of money from financial institutions that they are entrusted with to go invest using a very specific criteria to generate about a 30-40% annual return on the capital. They normally only invest in projects that have been validated and already have a profitable business model.
This quote explains it well, “VCs invest to create wealth. Angels invest to create companies.”
Professional investors will have the most stringent requirements out of anyone, which is why you should tailor your business planning with them in mind to ensure you give yourself the best chance of success.
How Professional Investors Think
The better you are at understanding the rules and mentality of a sophisticated investor the better you will be at structuring and analyzing your own deals.
You can accomplish this by simulating various scenarios while pretending you are the investor.
Keith goes into an experiment and asks you to pretend that you have $10,000,000 to invest…
You could invest it in a variety of different ways depending on your criteria and risk tolerance:
- CDs/time deposits or Treasury bills at a return of 2-5% annual return (low risk)
- Stock market 10%+ annual return (higher risk, higher liquidity)
- Real Estate: 12%-25% annual return (good return, no liquidity)
- Promising Startup: 40% or potential bust (big risk, big return)
Professional investors hate risk but will accept it if certain conditions are met.
All successful investors have the same psychological makeup: emotional stability, healthy skepticism, ability to think independently, and a willingness to take risks and make some mistakes.
Keys to the Vault Summary Takeaway: For professional investors, it’s not about the amount of money they make on a certain deal but rather the risk they take to achieve that return.
Compatibility Test
After determining your tolerance for risk you would then go into setting-up your investment criteria…
I.e. things like; are you seed-stage, early-stage, late-stage? In which sector will you focus? Your desired rate of return? The influence or control you want, your exit strategy, etc…
You must look for an investor who has experience in your specific field and present it to them. If you are a biotech company and take your deal to a real estate investor (for example) they will not take your call as it is outside their area of expertise.
Deal Flow
After setting your criteria as an investor, you need to focus on getting a constant flow of deals so you can measure the quality of the deals that come across your desk against one another.
Investors Are Skeptics
Once you have a steady deal flow, it’s only natural for you to be skeptical of 90% of the deals that come across your desk.
Keys to the Vault Summary Takeaway: “Optimism is the enemy of a rational investor” – Warren Buffett
You Say, “I Know.” They Say, “Maybe, Maybe Not.”
Investors. are always trying to figure out “why won’t this deal work?” or “what could go wrong?”.
Entrepreneurs are almost always overly optimistic.
Keys to the Vault Summary Takeaway: Professional investors know that what you can’t see if what will cost you money.
Professional investors must ask three basic questions:
- Are you financeable? (is the management right?)
- Is the deal financeable? (does the deal makes sense?)
- Is the risk financeable? (is it worth the risk?)
The mantra of professional investors: question everything and quantify all the risks.
You Have To Be A Skeptic Too.
The reason why most entrepreneurs struggle with raising money is because they don’t show the investor a clear path to profitability.
Key Takeaway: Your ability to ask “What don’t I see?” and proceed to plug those holes in your business before seeking an investor will help improve your chances.
Keys to the Vault Summary Part 1:
The Business Plan
This is the most lengthy part of this Keys to the Vault summary and it’s for a good reason…
You should always be writing your business plan with the professional investor in mind.
A business plan should capture the imagination of the investor and quantify the risks as well as the rewards.
The executive summary is the most important part of the business plan and should be written at the end as it sums up the key points of the entire plan. If it’s not written clearly or convincingly enough, it will be thrown out. It must generate excitement for the investor.
The following 15 questions MUST be covered in your business plan:
- Who are you? – Who is your management team? What is your track record? Who are your advisors?
- What is it? – Simply explain your product or service in an easy to understand way.
- Where are you? – The status of your business (aka in prototype, MVP, operational, etc…)
- Where are you going? – What are your goals, milestones…
- Who wants it? – Who is your target market? What pain point are you addressing?
- How many people will want it? – I.e. potential market size
- How do you know they want it? – What’s your proof of concept?
- How much do they want it? – Can you sell it?
- How will you tell them about it? – I.e. Marketing plan, how are you different, etc…
- How will you deliver it to them? – Distribution channels
- Who else has it? – Competition & your competitive advantage over your competition
- What are the risks? – What could go wrong?
- What are the rewards? – Projected financial results and potential returns
- What do you want? – What business deal are you proposing?
- What’s the exit? – How does the investor cash out?
You must struggle with these questions yourself as they will be sure to arise in actually operating the business as well. Once you have struggled with the questions, the business plan will practically write itself.
Moreso than just checking off the 15 questions listed above, you want to tell a compelling story to your potential investors and make it exciting.
Management, Management, Management
No business will ever go fully according to plan. There will be roadblocks and unexpected events and your management will be the ones to deal with those obstacles.
Dreamworks was a production company launched by three men who raised $500 million for 25% of the company. They were able to raise that money because of their track record in producing hit box office movies.
Your business is not special. In every industry, there are businesses of the same type that are massive successes and massive failures. The difference-maker is the team behind each project.
A great architect with a bad contractor will produce a bad house. Just as a great business plan with poor management will result in a failed business.
It took William Proctor and James Gamble 22 years to reach $1 million in sales. During that time, hundreds of other door-to-door salesmen came and went. But they persisted and built one of the biggest CPG companies known today.
The key is the management team and hiring people smarter than yourself.
The management team is the main selling point of your business. If there are gaps in the management team, you must address them in the business plan.
Ignoring weaknesses will result in red flags.
In the “management section” of your business plan, you should also mention your board of directors and advisors. These people will lend you guidance and credibility and will help convince the investor that you are financeable. You can give your advisors stock options in the business for their expertise.
Most entrepreneurs assume that they will be the management of their company so they can be their own boss, have full control, etc…
But if you are not planning on hiring a competent management team for your business, then you are not starting a real business. You are starting a job.
Sophisticated investors will be more attracted to scalable businesses with a competent management team in place versus owner-operated businesses. Growth cannot be accomplished by one person.
You want to give your investors confidence that you will be focusing on growing the business while the day-to-day operations are in capable hands.
Your board of directors is meant to be your “sounding board” for your ideas and decisions in the business. Their job is to look after and protect the long-term interests of your business. When entrepreneurs do not ask questions to their board of directors they are wasting their expertise.
On the other hand, an advisory board is more about providing introductions and “ins” to various industries and business deals.
Some people might be hesitant to become part of your board due to potential liabilities so they may be a better fit for your advisory board.
The ideal board member for your business is someone who has an interest in what you are trying to accomplish and has the experience and “know-how” to help you navigate problems that will arise.
It’s not uncommon to allocate 2% to 5% of the ownership in your business to your board of directors.
A management team with a solid track record means that a lot of risk is eliminated in the eyes of your potential investors.
What is it?
Here is your opportunity to explain what your product or service is in a SIMPLE and CONCISE way.
Avoid jargon and the urge to display your brilliance at all costs.
Explain your business in a way that your grandma would understand it.
Next, you want to explain
Where are you?
In this section, you will explain the current status of your business.
The further along you are in having hit certain benchmarks, the lower the perceived risk.
Having even some revenue/profit put you at a very different position on an investor’s risk/reward radar.
Don’t shop your deal to the wrong types of investors as it can get “worn out” similar to a house that is on the market for too long. Investors might think there is something wrong with it.
Where are you going?
What’s your vision for how big your company will get?
This is the part where you should outline your ultimate destination.
Will you be local, regional, or international? A single location or a franchise? And so on…
Investors will be hesitant to fund your deal if:
- Your plan does not call for significant market penetration
- The market is too small
Avoid overly optimistic or unrealistic projections and timelines.
Who wants it?
You must go out and talk to as many of your potential customers as possible.
Most entrepreneurs try and build before ever asking potential customers if they would even use their product/service. Furthermore, you want to know how much and how often they would be willing to pay you for it.
Keys to the Vault Summary Takeaway: You never truly know what the market desires until you ask. You must focus outward on the marked instead of inward on your product.
You don’t know enough.
The most dangerous thing is what an entrepreneur thinks they already know.
People succeed in business not because of what the currently know but more so because of their desire to know more.
Keys to the Vault Summary Takeaway: Stop defending what you know and start discovering what you don’t know.
Keys to the Vault Summary Takeaway: A good sign that you have listened to the market is that your idea has shifted from the original one.
You need to constantly listen to your customers and their everchanging needs and make adjustments when necessary to appeal to those interests.
Market Size: How many people will want it?
The total number of potential customers is of extreme importance to investors because it tells them how bit the company could get (i.e. their potential upside).
But you must be able to show meaningful evidence that proves it.
The more factual that data behind your projections are the more believability they have.
Prove it: The Proof Is In The Purchase Order
If you can show your potential investor that orders are going unfulfilled because of a lack of capital the deal will appear much more attractive. The risks will appear less.
If you have a list of customers ready and willing to pay you then you essentially eliminate the customer-demand risk for your potential investors.
Secrets, secrets, secrets…
Entrepreneurs typically place way too much emphasis on NDAs and often this is a sign that they are too hyper-focused on their idea more so than the execution behind it.
Investors are not out to steal ideas and very rarely is an idea so unique that it needs to be patented.
If the idea truly is a secret, it will be very hard to demonstrate the “proof of concept” that investors require.
Can you sell it? At a profit?
The perception of value is always from the customer’s perspective. The price they are willing to pay you is based on the value you provide to them.
How you define your value proposition is crucial because it defines your competitive advantage. Your value proposition is communicated through marketing.
People buy things for three main reasons:
- Brand (customers tend to buy the same toothpaste they bought last month)
- Product (maybe your product offers unique features, a money-back guarantee, greater selection, etc…)
- The quality of experience (this is the most important one)
People will pay more for an outstanding experience even if the product is inferior.
The reason someone buys something is because they perceive it to have more value than their money. You are able to set that perception with your positioning and marketing.
Value Creation
This part of the book is about creating profits for the business and investors.
Your business must deliver value-add to your customers as well as value creation to your investors.
Napster is a great example of massive value-add to the customer without any value creation.
Keys to the Vault Summary Takeaway: Great value-add does not necessarily equate to value creation. A successful business needs both.
Investors will almost always look for alternative sources of revenue in case your primary one doesn’t work out as planned.
Business doesn’t happen until the cash register rings.
Moving into new un-proven markets is very risky. Tesla never profited from his work – Edison did. The Wright brothers never profited from the aircraft like the big airlines did that came after them.
How will you tell your customers about your business?
Advertising is just one small part of your marketing strategy.
Marketing is the messaging and positioning behind your business to ensure your customers know about you.
It must be clear to the customer the problem that your business solves for them (the value proposition). And more importantly, why they would pay for your solution.
Here is where you need to including your pricing strategy.
Here is the marketing formula…
Leads x Conversion Rate x Frequency of Purchase x Number of Units Purchases x Price per Unit = Revenue
Your ability to keep the customers that you attract is of the most importance.
Repeat business and referrals are crucial.
Stake your claim.
A successful niche defines how you are different from the competition.
A good example is Microsoft vs. Apple.
Singapore Airlines is known as the highest quality airline, while Southwest Airlines is the complete opposite. That said, Southwest Airlines has grown at a much more rapid pace.
Because the philosophy and niche of Southwest Airlines apply to so many people, it makes more money (similar to McDonald’s).
Keys to the Vault Summary Takeaway: The more profitable your niche, the faster it will disappear unless protected by a moat. When your niche is encroached upon, you must pivot your marketing and positioning to another, while not forgetting what got you your initial traction (i.e. a second idea).
Eventually, you want to move from focusing on your “niche differentiation” to your “reputation” as a brand.
Delivery/Distribution
How will you deliver your solution to the customer?
You must find a way to get your product/service into the hands of your customers and explain it clearly to your investors.
Competition: Who else has it?
There is ALWAYS competition for your product or service. Even if you think yours is the most unique and nothing is completely like it, there is still always some competition somewhere in the marketplace.
Competition can be direct and indirect. Anywhere where the customer chooses to spend their time versus interacting with your product or service is competition.
Finding out everything you can about your competition will pay off dividends.
The quote from Sun Tzu summarizes this best…
“If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself, but not the enemy, for every victory gained you’ll also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”
A barrier to entry like a patent or other legal protection, special location, or secret recipe makes it even harder for your competition to compete with you and should be highlighted for your investors.
Address The Unkowns & Risks…
One of the biggest causes of entrepreneurial failure is the inability to accurately assess the risks in the business. Most entrepreneurs will omit this section due to fear of deterring investors.
Every investor knows there will be potential problems and risks so to avoid addressing them is silly. Instead, you want to communicate the solutions that you have for them.
Investors are okay with taking on risk. But that risk must be quantified, mitigated and managed.
What are the potential rewards?
Here is where you outline your projections.
Anybody can create an Excel spreadsheet that says they will be making $100 million in four years. But the accuracy of your projections depends on the earlier parts of your business plan (largely your management team section since they will be the ones making the key decisions that drive those assumptions).
Good decisions = good numbers
Bad decisions = bad numbers
If your business cannot show serious growth potential then investors and VCs will not be interested.
Assumptions are the most critical part of your financial projections.
You want to show how you are going to spend the money that you are asking for. Investors hate paying for “yesterday’s problems”. They want their money to go toward future growth.
What is your burn rate?
The burn rate essentially tells the investor how long their money will last.
You should be able to ease their worry of you running out of cash before becoming profitable.
Money does not solve all problems. Business who say that they die from a lack of capital is like a doctor saying a patient died because he stopped breathing. Both could be right, but it’s not the underlying cause.
Keys to the Vault Summary Takeaway: Too much money can cause excess optimism.
If anything can go wrong, it will go wrong.
Don’t ignore Murphy’s Law.
Account for errors and unexpected bumps in the road in your initial “ask” amount because doing so later will be more dilutive as investors will view it as riskier.
Keys to the Vault Summary Takeaway: If you double the amount of cash you think you need and the time it will take to achieve your goals then you are probably getting closer to reality.
Outline exactly what you are asking for.
How much money do you want? And what are you willing to give up for it?
By outlining exactly what you are asking for, it shows you have considered both your needs and the investor’s needs.
You must be able to tell your investor if you want debt or equity or a combination of both.
If debt – What payment terms? What interest rate? What repayment period?
If equity – What yield will they get? Will they receive a preferred return? Are you willing to give up control?
All of these questions are essential and will eventually be addressed in your term sheet that will outline the details of your deal.
Don’t be a hard head.
Don’t lose the deal over stubbornness.
Investors evaluating whether or not you are going to be a good future partner. Haggling over half of a percent could result in no funding at all.
Keys to the Vault Summary Takeaway: It’s better to own 65% of a company worth $100 million than 100% of nothing.
Exit plan
Normally, investors look to have a time frame of 3-7 years before exiting a deal.
You should have a plan that outlines how they will receive their share of the profits and returning their initial investment.
Taking a company public is fairly uncommon, so your most likely options are a private sale or recapitalization.
Be willing to walk away
If you have honestly assessed all of the points mentioned above and you do not feel comfortable with the question marks and risk factors then you need to be prepared to walk away.
But if you do feel that you have a strong business case then you should move on to the executive summary…
Your Executive Summary:
This should be 2-3 pages long and summarize everything discussed above.
Here are some key points…
- You want to arouse interest and create excitement.
- It should begin with an overview of the opportunity:
– The need you’ve found in the market and how you will fill it
– The industry you are in and the size of it
– Progress in the company to date - The most important part to focus on is the management team, board of directors and technical advisors.
- You want to focus on why your product is different and who your competition is.
- Explain your target market, how big it is, and how fast it is growing.
- Explain how you will use the funds
– The amount you are requesting
– Where it will be spent
– Which milestones will be reached and when - Financial projections for 3-5 years for revenue, net income, assets and liabilities.
– Address cash position (burn rate)
– Breakeven
– Working capital requirements
– Anticipated future rounds
Keys to the Vault Summary Part 2:
Your Business & Capitalization Structure
This Keys to the Vault summary wouldn’t be complete without highlighting the key takeaways about properly selecting your business and capitalization structure strategically.
Choose the right business structure.
The business structure has massive implications in three main areas…
- Taxes
- Liability
- Control
Angel investors and VCs prefer different structures.
You should feel out an investor’s preferred structure before forming an entity (if possible).
These are the basic types of business: sole proprietorships, general partnerships, limited partnerships, C corporations, S corporations, and limited liability companies.
Is A Sole Proprietorship Good?
Keys to the Vault Summary Lesson: The only advantage to doing business this way is that it’s cheap and easy. There are tons of risks because you have exposure to unlimited liability.
Quick Answer: No.
Are General Partnerships Good?
Keys to the Vault Summary Lesson:A general partnerships work like a marriage. Both have equal share in the profits, losses and both have unlimited liability. This is not an attractive set-up to an investor.
- Taxes are paid at an individual rate – BAD
- Liabilities apply to both partners – BAD
Quick Answer: No.
Are Limited Partnerships Good?
In a limited partnership, there are two types of partners: general (who usually operate the business) and limited (aka money partners).
The operator has unlimited liability, while the money partner has limited liability.
The general partner could be set to a separate legal entity (corporation) to shield the “founder” from personal liability.
Banks will only lend to limited partnerships if someone individually guarantees the debt. VCs will almost never fund limited partnerships but angel investors might.
Keys to the Vault Summary Lesson: If your business is a one-of-a-kind small-to-medium-sized business (restaurants, nightclub, etc…) then a limited partnership could work fine. If your goal is to reach any kind of significant scale then forget about a limited partnership.
If you plan on going “big” then go with a corporation.
If you intend to raise any money from VCs or envision a large-scale operation then a corporation is your best bet.
All corporations start out as a C corp or an LLC (limited liability company).
You should definitely use a company like LegalZoom or Stripe Atlas to help you get through the legal hoops to get the corp set up.
In a C corp you have shielded from most liabilities that you could face in the aforementioned business structures. Profits and losses do not flow to you personally. C corps can have unlimited shareholders and unlimited classes of stock.
Venture capitalists ONLY fund C corps.
An issue could arise with C corps when it comes to double taxation…
Usually, buyers will want to buy the assets of the C corp instead of the shares of the C corp. The sale of an asset would result in double-taxation at the corporate (capital gains) and shareholder level (dividends).
The advantages and disadvantages of an S Corp:
Advantages:
- Can pass through earnings for tax purposes (no double taxation)
- Have all the same liability protection from corporate shield
Drawbacks:
- Can’t have more than 75 shareholders
- Only one class of stock
- Normally only individuals can be shareholders of an S corp
LLCs offer flexibility.
All members of the LLC have limited liability, flow-through of profits and losses, minimal restrictions on management structures and flexible capital structures.
A great option for small-to-medium sized businesses.
Ultimately your business structure will be determined by your investor’s needs.
Disclaimer: Remember, this is simply a Keys to the Vault summary – not legal advice. So make sure to seek out professional legal counsel on how to best structure your business.
How to build your business with equity…
Equity investors are co-owners with you in the business. These investors expect to make 3x, 10x or 100x their investment back.
You will likely have earned a certain percentage of sweat equity for getting the deal to the point where it’s ready to be funded.
It’s not uncommon for founders to retain 50% to 75% and give investors the remaining 25% to 50%. However, some deals require investors to receive more than 50%.
Equity investors might require the following:
- Priority return (e.g. a 12% return on their money before you earn anything from your equity stake)
- Liquidation preference (they get paid their investment back first in the event of a sale)
Preferred stock provides an array of appealing features to investors to help them reduce the risk of not getting paid back.
Warrants are an option that allows the investor to acquire common stock in the company at a set price for a certain period of time. Warrants can be attractive to investors to help enhance the return on their investment.
Equity capital is often the most secure and least risky for new start-ups due to the lack of collateral and risk of failure which makes debt a dangerous option.
Building your business with debt…
Being able to secure debt financing is not likely until the operating risk of your company is largely known and under control (i.e. revenues and predictable cash flow).
All debt agreements have some common elements:
- Term length (how long do you need it for?)There are 4 classes of loans:
Demand – Due upon the demand of the lender
Short term – One year or less
Intermediate term – One to five years
Long term – Longer than five yearsThe payments can be monthly, quarterly or yearly. - Interest rate
- Collateral (an asset that is pledged to the lender)
Lenders might require to monitor your debt coverage ratio, which will measure the cash flow of your business compared to the debt payments. A typical acceptable ratio is 1.3/1 meaning the cash flow should exceed all debt obligations (interest and principal) by 30%.
Sometimes banks even require personal guarantees from you or another high net worth individual in order to secure the loan.
A convertible note is an option for VCs and angel investors as it allows them the right to convert their loan into equity at a predetermined price per share. This allows them to play both sides of the fence.
An important part of this Keys to the Vault summary is that where your investors are in the financing hierarchy will determine the amount of return they require. Since debt is senior to equity, debt lenders are likely to be paid back first. So determining who gets paid when is very important.
What does debt/equity ratio mean?
It’s simply the amount of debt versus the amount of equity. The more debt relative to equity (aka higher leverage) then the more perceived risk is associated with your company. Being higher leverage is riskier because the chance of failure is much higher because of owed monthly payments (cash outflows).
Leverage (aka debt) can magnify your wins and losses. When things go well you own more of the upside. When things go bad, debt can destroy your company completely.
When you reach a certain level, debt can be a useful tool to grow your company further.
Almost every bankruptcy case is caused by debt that was unable to be paid back.
What is an accredited investor?
There are three main things any entrepreneur should know about spotting an accredited investor. An accredited investor is:
- Someone with more than $1,000,000 in net worth (can be joint net worth with a spouse).
- Someone who has more than $200,000 in income over the last two years ($300,000 if jointly calculated with a spouse).
- An officer or director of the issuer.
Before closing on an investment, accredited investors will often need to sign a form proving that they meet these requirements.
What is SEC Rule 504?
Rule 504 allows you to raise less than $1,000,000 in seed money from whoever during a 12 month period without having to register with the SEC.
What is SEC Rule 505?
SEC rule 505 states that you may not raise more than $5,000,000 through selling securities, which you can raise from an unlimited number of accredited investors. You can also have 35 or fewer investors who are not accredited or sophisticated.
What is SEC Rule 506?
This rule allows you to raise an unlimited amount of money from an unlimited amount of investors who can be non-accredited but must be sophisticated. If you raise a large sum of money from professional investors you would be exempt from registering with the SEC.
Keys to the Vault Summary Takeaway: Anytime you involve unsophisticated and non-accredited investors you usually need to disclose more information. Often you will need to provide them with something called a private placement memorandum (PPM) that advises them about the specific risks in your business. It will also mention key points from your business plan.
Keys to the Vault Summary Takeaway: Always consult a lawyer when dealing with this stuff as it will be worth every penny.
What stage is your business in?
The stage of your business depends on the type of funding you will get.
The later the stage of your business the more funding options you have.
How do I know what stage my business is in?
There are four types of stages and characteristics associated with each stage…
- Seed Stage
– Your business is likely a concept
– Normally just one person and a dream
– No management team or systems in place
– Research is in progress
– No revenues
– Deal sizes are small - Start-up Stage
– The idea is fleshed out
– A management team is in place
– The marketplace is giving feedback to your idea
– A focus on getting sales and market traction - Expansion Stage
– Customers are buying the product or service
– You have a predictable and increasing revenue stream
– Positive cash flow from operations (might be short on cash though)
– Debt financing can be an option at this stage - Later Stage
– The company is known in the marketplace
– The company has a brand reputation
– The company is focused on growth and innovation in the form of offering new products to its market
– Financing options become more sophisticated (pretty much all become available)
Keys to the Vault Summary Part 3:
Sell Your Deal To The Investor
You want to shop your deal only to those investors who would be interested in your type of business. Don’t waste your time with technology investors if you are in real estate and vice versa.
The benefits and drawbacks of bootstrapping your business:
Advantages:
- You could retain a lot of equity
- If it’s your own money involved you tend to make better decisions (it imposes discipline)
- Raising money is extremely time-consuming
- Raising money can dull your creative edge
Disadvantages:
- Your personal funds or funds of those close to you could be jeopardized if your business fails – which is likely
- You may not be able to expand as fast as you’d like
- Your competitors may notice your niche and take it over since you can’t act quickly
Keys to the Vault Summary Takeaway: The time it takes to do a deal with an angel is always shorter than a VC.
How can you find investors?
For VCs you can check out Pratt’s Guide to Venture Capital Sources.
But I personally think that everyone is reachable through LinkedIn. I have personally connected with hundreds of angels and VC contacts through LinkedIn. Professional investors are more open to hearing your pitch than you think.
Strategic alliances with other companies, where you can convince them that you could add value to their ecosystem can be a great source of equity funding and relationships. These types of alliances can be a strong exit strategy also.
You need to network with other people. You can do that via cold calling or by talking to people you know and leveraging their networks. With the internet, you can do this with many tools online.
With Clarity.fm you can hire business professionals for a 1-on-1 call to solicit their advice directly.
You always need to be asking people for recommendations on who to talk to. And then recommendations from those people and so on and so on…
The credibility of having a mutual acquaintance is the difference-maker here.
Even if they say “no” you can still ask them for recommendations on who else you can ask. You should also ask them for feedback on why they said “no”.
This Calvin Coolidge quote sums this up perfectly…
“Nothing in the world can take the place of persistence.
Talent will not; nothing is more common than unsuccessful individuals with talent.
Genius will not; unrewarded genius is almost a proverb.
Education will not; the world is full of educated derelicts.
Persistence and determination alone are omnipotent.”
The Four Investor Hot Buttons:
- Proof of market
- World-class management team
- Obstacles to competition
- Viable risk/reward relationship
Keys to the Vault Summary Conclusion
I hope you found some use in this Keys to the Vault summary. Again, I strongly recommend that you buy the book for yourself and make your own notes as the most important part about these types of topics is the retention and recall of the relevant information when you need it.