Financing a startup in Northern Nevada? Here’s what not to do
RENO, Nev. — Don’t be a zombie company.
That was one of the messages spread to eager entrepreneurs packed inside the University of Nevada Reno Innevation Center, where StartUpNV hosted a StartUp Financing Panel Discussion on Jan. 15.
So, what is a zombie company? In a nutshell: a startup that raises a ton of money at high valuations and then stagnates, shrinking the returns of entire funds and hurting investor returns, said panelist Jeff Saling, co-founder and executive director of StartUpNV, a statewide business incubator.
“If you talk to angels (investors), a lot of them will complain that they’ve invested in a company in good faith, thinking, ‘this thing is going to get big,’” Saling said. “And sometimes along the way, the founder gets comfortable. They’re like, hey, I’m making a nice living, my employees are making a nice living, I don’t need to raise another round (of funding), I don’t need to sell my company.
Pausing, he added: “In angel (investor) parlance, that’s a ‘zombie’ — the walking dead, your money’s dead, it’s not going anywhere.”
This, Saling explained to dozens of local entrepreneurs, is why when it comes to seed investment, StartUpNV has written an “anti-zombie clause” into its convertible note.
For those uninitiated, according to techcrunch.com, a convertible note is a short-term debt that converts into equity. Specifically, investors loan money to a startup as its first round of funding and then — rather than get their money back with interest — receive shares of preferred stock as part of the startup’s initial preferred stock financing, based on the terms of the note.
If a startup becomes a “zombie,” Saling said, the clause gives investors the right to, for example, take 5 percent of a startup’s gross sales until it’s paid back two times the amount it was loaned, plus the interest rate at that point.
NAVIGATING VENTURE CAPITAL WATERS
With that in mind, perhaps the first question entrepreneurs seeking venture capital should ask themselves is whether or not they have an exit strategy, said Grace Chou, director of the Innevation Center and moderator of the discussion.
“If you don’t plan to sell your company — if you want to keep your business for a very long time — then venture capital is not the right thing for you,” Chou said. “Because, eventually, you need to have an exit; you need to sell your company or have an IPO (initial public offering).”
For those seeking venture capital, the process of raising money should have already started, said Rick Winfield, angel investor of the Reno Seed Fund. For starters, Winfield suggested scouring the websites of every angel group on the West Coast to see what they are looking for in a startup.
For the Reno Seed Fund, he said the group of investors is looking for established companies with “early market traction” that “have a product with customers” already, primarily in tech spaces.
For companies that fit the bill, Winfield said the Reno Seed Fund is looking for companies that can return them “at least 20-times our money.”
In other words, that’s a very-much-alive-and-growing company, not a zombie. In 2019, of the 85 companies the Reno Seed Fund looked at, 35 made its screening process, and ultimately six companies were invested in, he added.
From the time the Reno Seed Fund meets a founder it invests in, Winfield said it typically takes nine months before a check is written.
FINDING THE RIGHT INVESTORS
Chris Riche, a serial entrepreneur and current CEO of Reno-based software Fox Optimization, stressed the importance of choosing the right investor group. After all, he said, it’s especially challenging to “balance the fundraising role with the running-the-business role.”
Riche said having investors who bring different perspectives — whether by way of tech, finance or operations — and give great advice makes “everything a lot easier.”
“My main advice,” he continued, “is to be flexible and really think about where you get your money from because those people are going to have a huge influence on your success.
“And be ready to answer a lot of detailed questions, because your investors work very hard for their money. And they’re trusting you, they’re investing in you, and you need to be deserving of that trust.”
Outside of raising capital, entrepreneurs can also look into applying for a small business loan through the Nevada Small Business Development Center.
Rod Jorgenson, a senior business development advisor at the SBDC, said the center tends to deal with the “bread and butter” businesses, such as bars, restaurants and convenience stores.
He noted that 60 percent of the businesses that apply are startups, while the other 40 percent have been running for two to three years.
Jorgenson said a small business owner’s personal credit plays a vital role in the approval process. To that end, he warned against using national small business loan programs like Lendio or Kabbage.
“Once you’re in with them, unless your margins are great, it’s impossible to get out,” he said. “You’ve flushed the toilet and you’re just waiting to go down the hole.”
Saling added that debt financing is “just not possible” with most of the startups StartUpNV works with.
Another financing avenue discussed was the U.S. government’s Small Business Innovation Research (SBIR) grants and Small Business Technology Transfer (STTR) grants.
According to SBIR.gov, the program encourages high-tech startups to engage in federal research and research and development that has the potential for commercialization.
Ellen Purpus, Assistant Vice President of Enterprise & Innovation at UNR, said the university has developed the Sierra Accelerator for Growth and Entrepreneurship (SAGE), which will provide training, mentoring and proposal-development support to selected applicants.
She said the federal program is looking for “soundness of science” as well as market research and a commercialization plan.
In terms of funding, Purpus said startups could receive grants of up to $150,000 during the “proof of concept” phase one, and up to $1 million during the “product development” phase two.
“The whole point is to help companies position themselves for these grants and hopefully help them get towards an award,” said Purpus, noting the SAGE program will be rolling out in February.
Bryan Wachter of the Retail Association of Nevada said his organization is “very concerned about disruptions to the supply chain.”