The

Entrepreneurial

Code

Lessons from an

Ivy League Entrepreneur

Chapter Thirty

The more the partners discussed their needs, the more they considered Princeton, New Jersey to be a great location for their new headquarters.  Not only were rents cheaper, but they felt the town had the right image. For a college services company, Princeton, New Jersey was the “Wall Street” of the college market.  Since the Bullfrog Card had benefited from its identifiable address on campus, “Princeton, New Jersey” would be the best equivalent address for a national program.

Johnny and his partners located a sizeable office in Princeton and a 3-bedroom apartment to share, so they wouldn’t have to sleep on the floor.  While they finalized their new business plan, they negotiated preliminary arrangements with banks, mailing list companies, printers, and landlords.  Although they stopped short of actually signing contracts, they gathered enough market intelligence to finalize their strategy.

The three of them slaved away updating their business plan. They emphasized how Maverock had been quoted in the industry publications, and how the Bullfrog Card was the most profitable card system in the marketplace.  After outlining their previous successes, they detailed their plans to aggressively enter the national market.

Unfortunately, their success with the Bullfrog Card didn’t mean they were destined for success with NCEB. Nevertheless, they described NCEB as the evolution of their Bullfrog Card business.  They contended that their branding strategy for College Card and NCEB was analogous to that of the Bullfrog Card and University Services. They also maintained that services like the wholesale bookstore and the national discount program would spark demand beyond just a restaurant meal plan and help them to generate a huge buzz among the student community.

Although their new business model was very different from the Bullfrog Card, they had complete confidence in their ultimate success.  In fact, they believed anyone who gave them money would reap huge rewards. They circulated their business plan to family, friends, and friends of friends. Within weeks, they had over $500,000 of equity interest at a pre-money valuation of $2 million. That meant they were able to raise $500,000 and only sell a 20% stake in their company.

They also selectively approached venture capital firms (“VCs”). Through Maverock’s father, Johnny and his partners met with a fund based in New York. The meeting lasted two hours and, by the end, the venture partner was interested in investing $2 million.  Unfortunately, he gave them a pre-money valuation of $1 million, which meant his fund would own approximately 67% of the equity stake in the business. The VC also wanted a “claw back” provision, whereby 25% of the partner’s ownership vested immediately and they earned the rest over a 3-year period. If they accepted the offer, their immediate ownership stake would be less than 3% per partner.

If they took $2 million from the VC, all of their financial problems would go away, but with those terms Johnny felt like they were being robbed. After dedicating almost two years to the business, it was difficult to sell a large equity stake at such a meager price. Besides, they preferred keeping control of their company, which wasn’t possible if a venture capital firm invested. Undoubtedly, the VC would take control of the board and remove them as managers at the first sign of trouble. 

Ultimately, Johnny and his partners declined the VC money. They reasoned they could raise the financing from their personal networks, get a better valuation, keep control of their business, and make the people they knew rich. They were so confident in their ultimate triumph they never seriously consider how their friends and family could potentially lose money.

The next series of decisions were among the stupidest of Johnny’s life.  His parents, who had witnessed his suffering, were eager to help him.  They didn’t want to see him lose control of his company or get ripped off by greedy investors.  They wanted to be supportive of him, so they offered to invest. Johnny’s parents were investors with a very low risk tolerance, and he should never have considered it.  However, he believed so strongly in their inevitable success that he became greedy.  He wanted to make them a lot of money and he believed investing in his business would make them rich.

Johnny and his partners’ overconfidence were appalling as they fed off each other’s enthusiasm. They accepted $400,000 from friends and family, rejected $200,000 from other “angel” investors, and rejected the $2 million from the VC.  They were funding close to $1 million in expenses with $400,000 in equity.  It was a risky gamble with no financial cushion to withstand unanticipated problems along the way. 

Johnny and his partners knew relying on such a risky financing strategy was playing with fire, but they reasoned they were being “brave.”  They wore their risk tolerance like a badge of honor on their chests.  Like those fabled entrepreneurs they recalled from the popular press, they had a vision of success, they were committed to that vision, and they weren’t afraid to leverage their capital.  That seemed to be the formula for entrepreneurial riches.

Because they turned away the venture capital funding, they used trade creditors to fund the lion’s share of their expenses. They negotiated half upfront payments and 60-day credit terms with their mailing-list provider, printers, and graphic designers.  They cut their cash outflow significantly, which they considered to be good cash management.  They reasoned that by the time the bills were due, they would be flooded with cash from the national mailer.

Johnny and his partners also applied for as many additional credit cards as they could get. It was a grass root funding strategy out of the entrepreneurial folklore.  They reasoned they were following in the footsteps of those “successful entrepreneurs,” who believed in themselves and bet big. As a 22-year old college graduate, Johnny managed to accumulate many thousands of dollars on personal credit cards, which he used to fund business expenses.  Although he was more than a little concerned with the mounting debt, he reassured himself that entrepreneurship was for people with guts.

 

Copyright  2005 by Chris Cononico
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