7. How do I know how much capital I need to get from investors?

What’s new, reader?! How are you doing?? We’re two columns away to finish our story on how we got “dough” to launch Resuelve, haha. This time, I’ll tell you what you must do, and understand, to estimate the investment you’ll need, and I’ll continue describing some of those who were our initial investors.

From my perspective, one of the most difficult parts, or more sophisticated, about being an entrepreneur and raising capital, is building your financial model. Especially since many of the variables necessaries to plan, are unknown, or unpredictable.

To be able to do this, you must first have clear income and costs models. There are some instances, such as Google, Facebook, and WhatsApp; where the income model wasn’t that clear at the beginning (WhatsApp still doesn’t have one), however, I believe they represent only a small percentage of success cases.

Often, people looking to start a company think only of the idea, but they lack an understanding of the likelihood of it making money, or what must take place for it to achieve profits.

For example, a company called “Spotnight” came out some years ago. It helped people to find the best night-time events in some cities in the USA. In order to work, the app required a tech part to look for, and group, available events, plus an editorial team in charge of curating content. In other words: a group of hipsters telling you what was IN, and what was OUT.

In the end, Spotnight didn’t find a sustainable income model. This product was awesome for dudes who are OUT (like me), and when we travel, we want to pretend we know where things are happening; but it wasn’t as good as to make you pay enough so that Spotnight could cover its operational costs.

So now, what I do is email my former hipster students, like Enrique Bahena, to tell me where to go.

Income models can go from the transactional (or brokerage): Expedia, Carmatch; subscriptions: Netflix, Resuelve tu Deuda; loss leader: Gillette; advertising: Google, Twitter; or a mix of any of them. For example, Amazon launched with a transactional model, and now, with Amazon Prime, it has a mixed-income model. We personally love a subscription model, because it allows you to easily predict your cash flow through time.

After understanding the way you’ll generate income, you need to figure out your cost structure. This can be of fixed costs (production facilities), variable (consumables), semi-variable (your own sales force), and non-recurring (research). Once you’ve mentally figured this out, the financial model comes into the picture.

Often, people make very generic financial models. Along the lines of “I’ll sell ‘X,’ and have a ‘Y’ margin.” Obviously, this won’t be enough for a sophisticated investor.

A good model is built from the minuscule to the most general parts of sales and costs. For instance, you can build the income part if you know the type of salesforce you’ll have, how many leads each salesperson will handle, how many leads should turn into sales, what’s your expected staff turnover, what’s the learning curve for a new salesperson, average income per client, etc. As you can see, many variables reach to the smallest detail of the sales process, just to estimate the income amount.

Once you’ve outlined this, your financial model will help you calculate your Burn Rate (how much money you’ll be “burning” each month), your leading funding need, and the moment you think you might reach your break-even point. This happens when the income flow turns positive. “Nirvana” for every entrepreneur.

The following diagram shows the cash flow behavior from day one.

(Accumulated cash flow graph

Eje X: Accumulated cash flow)

Eje Y: Tiempo

2 valor: First Positive Cash Flow Date

3 valor: Biggest Financing Need

4 valor: ROI date)

Another approach is to calculate how much money you’ll need to reach a certain milestone, which can allow you to raise money to a better valuation, and not until you reach your break-even point.

Many companies reach their IPO phase (Initial Public Offer), regardless of having a negative cash flow (Snapchat, Twitter, LendingClub, Redfin, Tesla). This allows for entrepreneurs to raise less money at the beginning, and later get better results in subsequent rounds. Nevertheless, this also increases the entrepreneur’s risk. If things don’t go as expected, you can reach the said round of capital raising with average results, and it can backfire.

Zorro and I invested a lot of time in our financial model during our last three months at Stanford. One of the best experiences about having worked with the Investment Banking Princes was to learn how to create models under the tutelage of the famous Manolo Gutierrez, aka “El Papayo.” Between him, and “Xavi” Salas, I was overworked to death!

Thanks to those hard times, we were able to build a good model that worked for that first equity capital raiser, and, to this date, it’s the base for our financial model in Resuelve (although it’s now much more complex, and sophisticated, that some parts are now in Python, and not in Excel. Mi geek friends will get this).

In that first model, it became clear that we needed an estimated 2 million dollars to reach our break-even point, and it would happen around the 36th month after launching. With this amount in mind, we took off to raise capital from our 10 investors.

We were looking to keep 20% of the company, give 60% to investors, and leave 20% as shares which Zorro and I could get if we reached our goals. This meant that two assholes, with nothing but a business plan, were worth 3.33 million dollars.

“Pantera,” who was part of the Private Equity Princes’ world, enjoying making fun of us saying: “But you’re just two assholes, with nothing but a PowerPoint, saying it’s worth 3.3 million dollars. A Stanford PowerPoint, nevertheless. Keep it up, guys!” followed by a laughter attack.

After meeting with Lorenzo Gonzalez, we talked with another one of Zorro’s brothers-in-law (remember he has 4 sisters, haha). The one and only Prince of the Princes, head of Goldman Sachs Mexico, “Chacho” Villegas. I like to call him “the King of Dear Valley,” but he doesn’t seem to like it much, hahaha.

Chacho won’t admit this, but I think that more than trusting in our presentation, or in our intelligence at the time; what really moved him to invest in Resuelve was the fear of Gaby, Zorro’s sister. If you manage to make him drink (which rarely happens) he confesses that her words at the time were: “there’s nothing to say, we need to help.”

Additionally, before investing, Chacho would call another future investor of ours, Jorge Alonso, aka “Georgy.” This would give him peace of mind. Georgy, was also a former Prince of investment banking for JP Morgan (there’s a lot of trust among such Princes since the rest of us are just mere mortals).

Chacho was one of the investors who added more value. He always deeply questioned the decision-making process for any relevant things we wanted to execute. He took his time to get to know every single detail. It was important for him to understand our rationale, and the process by which we got from A to B. He was so detailed that, more than once, he corrected some numbers in the analysis we showed him… Even the Head Princes look at Excel files from time to time.

After our visit with Chacho, he sent us to his brother-in-law Ricardo Maldonado. “M” is a partner in Mijares, Angoitia, Cortes, and Fuentes; one of the best law firms in Mexico (if not the best).

In my short experience, I’ve sorted lawyers in 2 groups: The first one comprises negative lawyers that, when faced with something with 98% of probabilities of success, but 2% of failure, they get stuck in that which can go wrong. “Yuca” Guerrero once cracked a joke along these lines: “The perfect definition of MIXED FEELINGS is: seeing your lawyer and banker heading toward a cliff while riding your Ferrari,” whoever thought of this joke was clearly thinking about the negative ones.

The second group encompasses those who, with knowledge of the law, try to figure out how to MAKE THINGS HAPPEN.

Besides being the closest thing to a Mexican Harvey Specter, “M” belongs to the second group. Always proactive, always thinking about how to get the business going, and not constantly focusing on what could go wrong. On top of that, “M” has extraordinary communication skills. The guys at BSV (investors I haven’t talked about yet, but I’ll talk in detail about them in the future) would joke saying that, if we ever wanted to introduce a complicated idea to the Board of Directors, we’d be better telling it to “M”, and have him present it for us because we were a bunch of losers regarding communication.

However, to summarize thus far, after meeting with “M,” we had 9 potential investors who were interested in injecting “dough” in Resuelve; in theory, we were one investor short.

We had 2 pending meetings with potential stakeholders: Georgy and Javier Arrachea. So far, everything had been working out relatively well, and we were quite confident (we had no idea of what was coming our way, haha).

In the following column, I’ll finish talking about our investors, and about what we now call “The Meeting Before the Meeting” (dun, dun, dun). See you! We’ll read each other next month. If you have any comments, questions, complains, or suggestions, nag me on Twitter. Find me as @Javivelop.

P.S. Never in your freaking difficult and bitchy life surrender!