The cost of capital
Boring!!! Yes - I know. But there is a certain reality that we have (almost) all been ignoring or covering up or something like that. It is the cost of capital - how much you pay for having the cash to succeed (or fail).
Most pro-forma presentations, most investor prospecti, most companies never mention this, and angel investors, even though somewhere in the back of their mind know it, don't ask and let it slide. But there is a very real cost associated with getting funding, no matter how you do it.
Different versions of how it plays out
You know it's the cost of capital when:
You spend time with yourself or your team figuring out how to get funding. That time should be charged to the cost of capital and made clear to investors.
You fill out a form to get funding. The time you spend is part of the cost of capital, whether you get funded or not.
You prepare slide decks to explain your business to funding sources. I see many startups with hundreds of versions of their presentation slides. The time spent and the supporting systems are part of the cost of capital.
You travel somewhere or buy someone lunch to discuss funding your business. Travel includes all the time spent en route, in lines, in cars, and so forth. It adds up.
You talk to a potential investor. That call or conversation is part of the time that capital costs.
You fill out the investment documents and pay the lawyer to do the paperwork. It commonly takes days to weeks to complete the necessary forms and get them in proper shape for the investor. This is part of the cost of capital.
You pay the interest on your loans (personal or business). Your personal loans are likely there because you spent your money on the business instead of paying off the personal debt. The credit card charges, late payments, mailing costs, cost of credit, and so forth are all part of the cost of capital.
You get into a trivial argument with your significant other because you are worried about cash flow and funding. There is a personal cost to many who start and try to grow businesses. This too is the cost of capital when it involves the fund raising process.
You wonder why you don't seem to have time to run your business any more because you are funding your business. All that time is part of the cost of capital.
Here's an unhappy number. According to my quick review of CEOs going after angel funding, about 1/3 of their time is spent on getting investments while they are in funding rounds. All of that time, is also the cost of capital.
Penny wise and pound foolish
I run A2E, and of course, we charge a fee for companies to "go to angel". The fee is $100, we tell people this as part of the application process, and they agree to it as a condition of applying. We wonder why some of the folks we invite don't every respond to invitations, so we did a little survey of 55 of those who were offered presentations but did not proceed. To be clear, we don't invite everyone. In fact, our statistics show that we decline about 4 out of 5 applications without inviting them. Here's what we found out, and no it's not statistically valid (small sample size):
About 1/3 of respondents said they never got the invitation. We conclude that spam filters are eating us or people don't read or forget the things we send them.
About 1/3 of respondents said they had changed their minds, gotten funded elsewhere, etc. Some have great success stories and we love to hear them.
About 1/3 of respondents said they don't want to pay to present.
This last one bothered me, so I asked a few of the respondents who chose to communicate in this regard about it. Here is a sample response sequence (anonymized - my statements italicized):
We are not looking to pay for this service therefore will pass. Thanks
I understand, and thank you for responding.
If you don't mind, we are trying to debug our process, and I would like to ask why, given "we are not looking to pay for this service therefore will pass", you filled out a form and checked the box indicating as follows:
"I understand there may be presentation and other fees and agree to other terms as follows
A presentation fee, currently $100, is charged to presenters, only if they are chosen to present - the application is free. Additional terms of presenting include; there may be a fee in the form of cash or equity if an advisory board member is engaged by a presenting company within 6 months after being introduced during the online meeting; the presenter must be present in real-time for Q&A, pre-record their presentation, make related information available for accredited investors, make their presentation available for other angel presenters to see at a later time, allow their presentation to be made available to other potential presenters, and provide ongoing reporting of the progress of their startup quarterly. I also understand and agree that all information identified as confidential by any party during any online session is strictly confidential to the parties in the meeting and may not be used for any purpose other than the purposes of the meeting or other purposes agreed to by the disclosing party. I agree not to record the online session. I agree to have the information I provide made available to presenting companies and other attendees."
Your response will help us fix our process so as to not waste the time of others like you, and I really appreciate the additional effort you put forth in answering this question.
If we paid to present [COMPANY NAME] every time, we would be broke. Other angel VC's request money from companies they don't believe in. [COMPANY NAME] is a proven business adventure. We put in over $200k of our own money and searching for the right partner.
If you should choose to eliminate the fee, we would be interested in presenting.
I appreciate that. However, that doesn't explain why you agreed to the presentation fee if invited. If you never intended to pay a fee, why did you submit at all?
Because once VC's seeing the plan in place they eliminate their fee.
A few falacies
Before continuing, I want to mention that I really do appreciate the seeming honesty of this person after having the falsehood pointed out. In essence, they admit that they were lying in the original application. And worse yet, they claim that this lie works.
As an aside, my view is that I only want to deal with honest people. The initial lie is enough for me to not want to do business with them because I presume they will lie from now one and I cannot believe anything they say. The claim that the lie works and, in essence, that they must therefore do it to succeed is more troubling. It means that other investors are willing to fund people who lie to them. Perhaps they don't know it's a lie because they don't ask such questions, but it is troubling nonetheless.
Here's another problem with their response. They say they have $200K invested and yet are unwilling to pay $100 of it for an hour or so of the time of several experts who will evaluate their pitch and provide metrics on why they might or might not get funded, and who are willing to work for equity and deferred compensation (none of their cash) if there is mutual interest. If they paid $100 per hour for a whole year full time that would come to $200K - 2,000 presentations.
Here's yet another problem with their response. They must believe they have something better than sliced bread, or perhaps they just don't understand risk and reward, but in either case, there appears to be a lot of ego there. The folks I work with are not big fans of high ego and bad judgment.
Here's another problem with their response. They seem to believe that folks who charge them are frauds - or at least some of them are. Of course a reasonable argument could be made that people who offer you something for nothing are the frauds, but then we give away a lot of free content on our Web ites as well. But in any case, they seem to justify their own lie based on the presumption that we are lying.
I had another company explain to me that they were not allowed to pay to present - as a matter of policy by their parent company. But they were allowed to fly across the country, stay in a hotel, pay for meals, and take 2 days for a 30 minute presentation, as long as the presentation was free. Of course this did not explain why they applied to present where a fee was required, but it shows something about the nature of the beast.
How does this relate to the cost of capital
There are two problems here. One is that startups somehow think that the time of investors and experts is or should be free. However this came to be, I think that investors and experts should stop offering any free services to startups, requiring at least a minimal fee for everything they do. The purpose is to make it clear that you pay for what you get and to create the resonable expectation that there is a cost to capital and expertise.
The second problem is that investors do not require the cost of capital to be listed in financials. As a result, this very real and substantial expense gets ignored or swept under the carpet. This is easy to fix. Whenever there isn't a line item for the cost of capital, investors should ask about it and refuse to invest unless and until it is included. It's a simple matter of due diligence to identify costs. Failure to identify substantial costs doesn't meet the standard of diligence in any real sense of the word.
The cost of capital is important to understand for all parties. The free ride fiction is problematic because it creates other fictions and fictional financials and because integrity and honesty are fundamental to the trust necessary to justify funding.
Copyright(c) Fred Cohen, 2017 - All Rights Reserved