Fred Sancilio: 5 Things an Entrepreneur Should Know Before Accepting Investments from Anyone

1. What are you going to do with the investment? When you get money from someone as an investment, you should know exactly what you are going to do with it. There is a huge difference when you use the money to buy facilities or equipment and spending the money on salaries or other expenses that cannot be sold again (or capitalized). Keep in mind that there is a difference between investment and loan. If you take an investment to buy a building or a machine for your business, you probably want to design it as a loan with an equity “kicker”. That means, you use whatever you’re buying to guarantee the loan, and to sweeten the deal, you give the lender a small amount of equity (stock or ownership) in your business. According to Fred Sancilio If your credit has been established with a commercial bank, you can normally finance up to 80% of the value of the facilities and 50% of the value of the machinery. The good thing about loans from a bank is they normally won’t require the kicker, but they will require you to personally guarantee the loan by taking collateral which may include the thing you’re buying and some other assets you own, like your car or home. However, when you go to an investor, and ask for a loan, your interest could be negotiated lower than a bank, but you’ll be giving away a piece of your venture too. If you are going to use the investment to pay employees or pay for services, the investor may loan you the money, but he’ll want both guarantees that you’re going to pay it back (mortgage or title of your car) or if he doesn’t want a guarantee, he’ll ask for more equity (ownership) and some form of control over you. So, before seeking an investor, be very careful how you ask for the money and try and minimize your own personal guarantee by using the thing you’re buying as the guarantee.

2. According to Fred Sancilio if you do bring in an investor, make sure that a clear contract exists and that you know what the investor’s share of the company will give him in the long run. In big and small investments, regardless of the use of proceeds, set rules for the investor and keep to them. For example, you want to have someone invest in your business so you can buy inventory. In this case, I would be clear if you are asking for a loan or a permanent investment. If a loan, the normal value of inventory is 50% of what you’ve paid for it. So, if you’re going to want to buy $100,000 worth of inventory, most banks will lend you $50,000 and you have to come up with the rest. As you sell the inventory, you need to keep replacing the value, so the bank always has their loan fully guaranteed. If you borrow from an investor and not a bank, they may not want any guarantees but a big chunk of your company instead and demand some sort of control. Use banks as much as possible before giving away equity. According to Sancilio most entrepreneurs rush to find investment partners and haven’t exhausted “non-dilutive” capital sources which will save you a lot of headaches with a partner who may not have the same time horizons as you do.

3. Know what your investor expects of you and what his time horizons are. Most wealthy people and certainly commercial banks know exactly what they expect back when making an investment. There is a great variety of “wants”. Banks simply want their money back with interest paid on time, but strongly guaranteed. Investors, especially sophisticated investors may not always tell you what they want and will disguise their real “wants”. I have been a victim of this kind of investor several times in my career. For example, when I was building my company called Sancilio & Company, I had invested my own money first and substantially de-risked the business, and then decided to bring in two sophisticated institutional investors. They nearly begged me to take their money! When we finally reached terms for the $20M investment, we all seemed to agree. What I didn’t know was that they intended to take over the company as soon as they could. Their contract seemed harmless but wasn’t, especially a paragraph that allowed them to make a second investment and veto all future investments by others. This eventually led to my own demise and caused the company to fail. So, be aware of institutional investors and make sure you’ve checked their references and talk to other people who partnered with them. If you smell a rat, stay away no matter how good their terms appear on the surface. These guys are the real sharks of the industry. However, not all investors are alike, and I’ve also had great, and believe it or not, honest investors. Normally these are family offices that have specific goals that go beyond just making money. According to Fred Sancilio some will enjoy the experience of working with an entrepreneur and want to share their experience with you. Take your time and investigate all potential investors and make it a two-way street. You aren’t taking from them alone, they are taking from you and will be a permanent fixture, so pick carefully.

4. Make sure you plan in tremendous detail before seeking a partner or investor. Know exactly what you need the money for and make sure you ask for enough. In my long career, the biggest problem I’ve had was being overly optimistic. While optimism is a critical trait for an entrepreneur, realism must go hand in hand. So, write a business plan and articulate exactly what you are going to do, when and how much will it cost. Its always been a habit of mine (Fred Sancilio) to develop a spread sheet model of the company I’m trying to build. In that spread sheet, try and create profit and loss statements for the next 3 years at the very least. The first year is done by months, and the second and third are done by quarters. The spread sheet should resemble a budget with revenue, cost of goods and expense items that will be needed to conduct your business. It should look very similar to a profit and loss statement but based on projections not actual results. If you do this right, you should be able to read the budget and tell someone exactly what your plan is going forward. This isn’t as hard as it might sound, and it will provide you insight that you’ll not get by wishing and hoping for your company to grow. It will tell your exactly how much money you’ll need each month and year to carry out your plans and will also tell you if you are making money or not. Try it, it always works and will impress investors who will quickly realize they are dealing with a professional and not just a dreamer.

5. Always ask for more money that you need! This is the major reasons why businesses fail: they undercapitalize. I’ve always used the adage that things will take twice as long and cost twice as much! So, plan for this by getting enough money dedicated to your plans as you can and avoid being cheap. I’ve never heard of a company going broke by having too much money, but virtually all bankruptcies are a result of not having enough cash. So, remember, twice as long and twice as much is a good rule of thumb. At Sancilio, I was assured by the institutional investors that I would have access to enough money to finish the job, but when I needed the money, the price was extortion. So, try not to dip in the well more than once before you begin to make money, and when you do dip into it, make sure your cup is large enough and full.