Adam Smith wrote in “The Wealth of Nations” in 1776 that the four factors of
production are: land, labor, capital and enterprise. This still remains more or
less true today.
Land – factory buildings, equipment and other tangible
fixed assets. Nowadays we also add to the list intangible assets such as
intellectual property – patents, trademarks and so forth.
employees and middle management.
Capital – finance which we will discuss
Enterprise refers to several parties who are directly involved
in creating and running a company: the person with the initial business idea;
the founders who set up the business and makes it happen; and the upper
management leadership (CEO, CFO, CTO, etc.) who consolidate and expand the
business, take it public, initiate action against perceived threats to their
business, and so forth. These entrepreneurs and management do not employ
guesswork; they develop, apply and re-develop a strategy.
These are the
elements of capitalism or free enterprise. Capitalism has had its ups and downs
over the centuries, but the alternative concepts of communism and dictatorship
have proved to be short-lived in historical terms. A modern business must apply
capitalist principles to advance its development according to its chosen
Fundraising Capital is money for operations.
large and small need finance, just as a car needs fuel to run, and the way it is
utilized for their operation and activities is the global measurement of success
The new product being developed in the company’s lab
(R&D) may be a world-beater in a few years time, but salaries and expenses
must be paid now, if all the people involved are going to be able live and work.
This requires financial credit in the form of investment money which is paid for
by the owners in the form of shares in the company ownership. Bank loans may be
hard to obtain when there is no income or other securities available to repay
Finding investment money is very time consuming and disruptive for
the smooth running of the company.
Once sales revenues begin, investment
from the R&D stage must be recouped.
Clients take time to pay usually
and when they do pay, some of the money must be re-invested in advertising,
trade shows, more R&D and so forth.
When raising funds, you must
prepare a business plan with a budget which takes all the financial needs into
account and any others specific to your business.
is done in several rounds. This is because not all the money needed may be
raised in one round. Most investors want to see the company successfully achieve
milestones (R&D progress, revenue progress, etc.) before committing more
Who are the investors? These can include: · Founders, and their
families & friends.
· Angel investors (private wealthy
· Venture capital/private equity funds.
Institutional investors (pension, savings and mutual funds, finance and
· The government (e.g. R&D grants from the Office
of the Chief Scientist and Israel’s bi-national funds; fixed asset grants from
the Investment Center).
· Large enterprises that need your
· Employees – stock option or purchase plans to retain and
incentivize good employees.
· And the public if you raise money on a
stock exchange in Israel, the US, London, Toronto, etc.
What do the
investors look for? Investors look for good companies that seem likely to
generate dividends and/or capital gains in the medium term – typically (but not
always) in the next three to five years. The world economy may be in periodic
volatility, and peace in the Middle East may be elusive, but a good company with
a good strategy will aim to generate value for its shareholders over
More specifically, investors typically expect a company to have all
of the following: · A good product with unique features that is scientifically
· Good demand for your product from sufficient paying customers -
this signifies marketability and also helps to show that the technology
· Good management - proficient CEO, CFO, CTO and other executive
· A business plan setting forth a clear concise strategy for
· A well-thought out marketing strategy and a business
· Clear presentation of the company by its senior
· Good well-protected intellectual property – technology,
brand name, etc.
· Sales revenues – or at least sales contracts or other
solid commitments. In practice, in a small country like Israel, most sales will
need to come from international markets.
Have you planned for this? ·
Stable, skilled employees.
· All regulatory approvals necessary for
unrestricted selling of the product.
· Follow-up products, new
applications or markets in the pipeline.
Fees for finding investors for a
company Typically, for a private finance round, assume four percent to 6% of
capital obtained for the company in cash plus 4% – 6% in options/warrants. This
has to be carefully structured to avoid unnecessary VAT (16% in Israel). Service
providers who locate investors for you deserve to be reasonably rewarded for
their efforts according to the going market rate. If you try to negotiate the
fee down to the point that it is unattractive for them they will likely avoid
you or at best, invest most of their time to their other clients.
about loss of control? If you accept outside investors, their capital will
dilute the founders but will hopefully increase the overall value of the company
later on. The founders will generally not lose control over the business as they
are needed to run it – most investors are passive investors just bringing much
needed money to the table.
A few will be strategic investors who can open
important doors to customers, etc.
Business model The business model of a
technology company needs to be well thought out in order to implement its
strategy into practice.
Here are a few elements to consider: · The
marketing strategy – how will you find customers? How will you attract them to
your product? What will be your pricing policy? · Should you sell products or
should you provide them as part of a service under your control? · Is a BOOT
(Build Own Operate Transfer), leasing or licensing model likely to make you more
money? · Should you provide the basic product cheaply but charge a lot for
consumables/replacement parts later? · Is it easier to license the IP to third
parties for a royalty or franchise fee? What about withholding taxes on these? ·
What will be your optimal supply chain? Which company(ies) in the group will
purchase raw materials, hire labor, process, distribute and sell to customers? ·
Where will you establish companies? Remember that American customers prefer to
buy from Americans, Japanese prefer to buy from Japanese, etc.
· How will
international operations be managed? · Which company will own the intellectual
property? How will it conduct R&D? How will it make the IP available to
other companies? · Which company will manage business risks and how? There may
be many risks – bad debts, currency risks, product defects, inventory theft,
country/political risk, etc.
Are there Is insurance or hedging or
regulatory approval needed? Tax Strategy Do you have a well-planned
international tax strategy? On the operational side, Israel offers reduced
corporate and dividend tax rates for “preferred enterprises.” Every dollar of
tax saved on profits may add around $15 to the market value of the
Most Israeli companies fail to check out withholding taxes and
VAT or sales tax on their revenues even if they are not yet in profit. Also
needed is a transfer pricing policy – tax authorities around the world
(including Israel) require related companies to conduct transactions between
themselves on arm’s length market-based terms.
This requires a transfer
pricing study and is an opportunity for tax planning.
may now enjoy an Israeli tax deduction when investing in Israeli tech companies
if certain conditions are met.
Foreign investors are now exempt from
Israeli capital gains tax. But beware VAT and withholding tax on loan interest,
Check out detailed rules regarding share options. As always, do your homework
and consult experienced corporate, technical and tax advisors in each country at
an early stage in specific cases.
Barry Plotkin is an engineer and MBA and a Director at MA Finance. Leon Harris
is a certified public accountant at Harris Consulting & Tax Ltd and a
Director of MA Finance.