Lessons Learned From a Failed Ivy League Entrepreneur

A "Case Story" By Chris Cononico
 

Chapter Thirty-Three

It soon became obvious that our Manhattan headquarters was a luxury we no longer could afford. New York City was just too expensive for a young company trying to expand operations. Since we had no strategic purpose holding us there, we needed a new location that made better economic sense. The more we discussed our needs, the more we considered Princeton, New Jersey to be a great location for us.

In addition to the tax advantages, Princeton, NJ was home to Princeton University, The Princeton Review, and ETS. We felt the town had the right image for NCRB's headquarters. For a college services company, we reckoned Princeton, New Jersey was the “Wall Street” of the college market. Since QuakerCard had benefited from its identifiable address on Penn’s campus, we figured “Princeton, New Jersey” would be the best equivalent address for our national program.

Soon, we located a sizeable office in Princeton at a fraction the cost of our Manhattan location. We also found a 3-bedroom apartment for George, Mark, and I to share, so we wouldn’t have to sleep on the floor. While we finalized our new business plan, we negotiated preliminary arrangements with banks, mailing list companies, printers, and landlords. Although we stopped short of actually signing contracts, we gathered enough market intelligence to finalize our strategy.

The three of us slaved away updating our business plan to portray ourselves as industry gurus. We emphasized how George had been quoted in the industry publications, and how QuakerCard was the most profitable card system in the marketplace. After outlining our previous successes, we detailed our plans to aggressively enter the national market.

Unfortunately, our success on Penn’s campus didn’t mean we were destined for success with NCRB. Nevertheless, we described NCRB as the evolution of our QuakerCard business. We contended that our branding strategy for Campus Card and NCRB was analogous to that of QuakerCard and University Student Services. We also maintained that services like the wholesale bookstore and the national discount program would spark demand beyond just a restaurant meal plan and help us to generate a huge buzz among the student community.

Although our new business model was very different from QuakerCard, we had complete confidence in our ultimate success. In fact, we believed anyone who gave us money would reap huge rewards. We circulated our business plan to family, friends, and friends of friends. Within weeks, we had over $500,000 of equity interest at a pre-money valuation of $2 million. That meant we were able to raise $500,000 and only sell a 20% stake in our company. It was a pretty good deal for us.

We also selectively approached venture capital firms (“VCs”). Through George’s father, we met with a managing partner of 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 us a pre-money valuation of $1 million, which meant his fund would own approximately 67% of the equity stake in our business. The VC also wanted a “claw back” provision, whereby 25% of our individual ownership vested immediately and we earned the rest over a 3-year period. If we accepted the offer, our immediate ownership stake would be less than 3% per partner.

If we took $2 million from the VC, all of our financial problems would go away, but with those terms I felt like we were allowing ourselves to be robbed. After dedicating almost two years to the business, it was difficult to sell a large equity stake at such a meager price. Besides, we preferred keeping control of our company, which wasn’t possible if we allowed a venture capital firm to invest. Undoubtedly, the VC would take control of our board and remove us as managers at the first sign of trouble. It made me feel like I would be working for someone else.

Ultimately, my partners and I declined the VC money. We reasoned we could raise the financing from our personal networks, get a better valuation, keep control of our business, and make the people we knew rich. We were so confident in our ultimate triumph we didn’t seriously consider how our friends and family could potentially lose money.

The next series of decisions were among the stupidest of my life. My parents, who had witnessed my suffering over the prior years, were eager to help me. They didn’t want to see me lose control of my company or get ripped off by greedy investors. I think they also wanted to be supportive of me, so they offered to invest.

My parents were investors with a very low risk tolerance, and I should never have considered it. However, I believed so strongly in our inevitable triumph that I became greedy. I wanted to make them a lot of money and I believed investing in my business would make them rich.

My overconfidence was appalling as my partners and I fed off each other’s enthusiasm. We felt as if we were creating something great. In the end, we accepted $400,000 from friends and family, rejected $200,000 from other “angel” investors, and rejected the $2 million from the VC. We were funding close to $1 million in expenses with $400,000 in equity.

It was a highly leveraged capital structure, but it was actually much worse than it appeared. After all, we weren’t using the money to purchase hard assets that could be resold. We were spending it on a direct mail campaign, rent, salaries, and intangibles.  We also hadn’t built in the financial cushion to withstand unanticipated problems along the way. It was an all or nothing bet on the success of our mailing campaign. If things didn’t work out as planned, our investors would lose everything.

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

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

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

Copyright  2005 by Chris Cononico
All rights reserved. No part of this manuscript may be reproduced in any form or by any electronic or mechanical means, including information storage and retrieval systems, without permission in writing from the author, except by a reviewer who may quote brief passages in a review.