Must-Know Terminology for Raising Money from Investors

How to speak the language of investors with confidence

Q.  Help!  I'm filling out an application to present at an angel investment group.  It's confusing.  What does monthly burn rate mean?  Also, what is a pre-money valuation?  How important are these numbers? 

A.   It seems every industry has its share of jargon.  In this column, I frequently write about how VCs and angels force A-players to drill down to the secret sauce before issuing an LOI.

In non-venture community speak, this means potential investors aggressively quiz well-respected entrepreneurs to talk about the competitive advantages of their business ideas before issuing a written proposal of deal terms.  Whew!

A company's burn rate is, quite simply, the speed in which a company is "burning through cash."    You may also hear venture investors call this number the "monthly nut." So how much are you currently spending each month?  That's your average burn rate.

Smart seed and early stage investors know that one of the biggest risks to their investment, is a company running out of cash before reaching cash flow breakeven (the point in which revenues exceed monthly expenditures.) 

Or, for companies facing a long period of product development, investors worry that a business might run out of cash before reaching certain "milestones" which will allow a company to raise additional funds on favorable deal terms.

If they don't, the company will either close or be forced to raise funds at a lower share price than prior investment rounds.  This costly situation that hurts founding entrepreneurs and first investors most is called a "down round."

It's important to note that angel investors may ask about your current burn rate and projected burn rate.  After all, with new money in hand you may hire more staff or lease office space increasing your monthly expenses.

Here's an insider's tip. Don't minimize your funding needs or current expenses to impress investors.  Be honest.  Once they find misrepresentations, it will be hard to win their trust and respect.

Now to pre money valuation.  While most entrepreneurs believe their business ideas are worth gazillions, your pre-money valuation is what you say is your company's worth today. A post-money valuation is the sum total of your pre-money valuation and the amount of new investor funding.

Because your company doesn't yet have revenues or earnings, you will have to rely on qualitative company attributes to reach your pre-money valuation estimate.

These favorable attributes can include expected high profit margins, patent filings, large target market, the ability of your company to be a market leader, and the potential to be acquired or go public. 

Here's one last comment.  Investors prefer to invest in companies where the deal pricing leaves room for significant upside, plus compensates them for the high risk associated with investing in pre-revenue companies. They like to buy low and sell high.

When entrepreneurs set high pre-money valuations they set themselves up for fast turn downs.  These entrepreneurs are called "unrealistic,"  "clueless" or "financially sophisticated" in terms of the current market rate for startup capital.  There are many angel investment groups, especially in Silicon Valley, that discourage entrepreneurs from applying if they set pre-money valuations greater than $2 or $3 million.

For extra insight, call up the CEOs of companies that have previously raised money from your local angel organization.  Ask for their perspective before filling out your application.  You can do it!

Write to Susan Schreter at susan@takecommand.org for great funding tips for startup entrepreneurs, sole proprietors and small business owners of any age and business goal.

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