Further to my last post, I wanted to delve into the options available to entrepreneurs for funding their start-up. The topic may seem obvious – the founders have an idea and need capital – easy enough. OK, let’s hurry up already, get out there, raise some dosh and get this show on the road, right? Not so fast Kemosabe.
The correct answer is not a simple one. It depends on multiple factors which include but are not limited to: skill set, previous experience, sector, capital required, macro and micro environment, long term objectives of the company, including the exit strategy and much, much more.
Let’s take a look at a few ways to fund, and the advantages versus disadvantages.
As the name implies this is where founders do everything they can without raising any outside capital. They use their savings, take personal loans, credit cards, they sell furniture, cars, clothing, their bodies…whatever. Baked beans on toast and Ramen noodles are frequently on the menu of the bootstrapping entrepreneur.
One thing that will often turn me away from a deal is when it’s obvious the founders, who have little to no previous experience or track record, have invested little more than their time. I’m not suggesting that all good ideas have to come from those who can financially back them, but an entrepreneur who hasn’t exhausted much of his or her own personal resources to make the business work can’t seriously expect others to take a flyer on them.
What I can say from an investor’s perspective is that it’s often a choice between being a “nice guy” and striking the best deal for yourself (the investor). Since I’m not a nice guy the answer is an easy one. I’m in this to make money first and foremost. It’s taken me too many sleepless nights burning the midnight oil for me to frivolously disseminate my capital to “hopefuls”.
Bootstrapping is under-appreciated, and is easily one of the most advantageous means of running a business. It teaches founders lessons which they can learn without giving up equity, and of course lessons learned which are not on someone else’s dime. If you really believe in your business and its potential then why on earth would you want to give up equity unnecessarily?
Takeaway: Bootstrapping is great for founder/entrepreneurs who don’t wish to give up equity and/or those who have little track record on which to rely on for funding.
2. Family and Friends
This is typically where most entrepreneurs start, or soon go when their “bootstrapping” needs a boost. After all, if the people who know you best and love you most aren’t willing to back you…why should someone else?
One of the MOST important things to consider when raising money in this fashion is that your relationships will change, as they must. They may even end, which is something that you need to seriously discuss with those loaning you the money. Do you really want to be disowned, or lose your best mate over any potential (likely) disputes?
Once you take money from anyone it’s no longer your business but “our” business. The “our” being you and your financiers (family and friends in this instance). You have taken in capital, which isn’t yours but is now part of the company. As such, it is no longer just your company.
This statement may sound obvious, but I’ve seen plenty founders who treat investor capital, even family and friends investor capital, as if it’s “free money” and the respect for that money is indeed very low. Not good!
My personal opinion is that entrepreneurs should look to raising capital only after they have bootstrapped to the point where they have at least 18 months of operating history behind them. This track record will greatly enhance their ability to raise capital. Importantly, it will also provide founders with a much clearer picture of their business.
Starting and growing a business is in many ways a moving target and not even the experienced founder with a half dozen successful business builds under their belt knows exactly what the future holds.
Takeaway: Bootstrap first and build a track record. Then talk through it carefully before borrowing from those close to you.
This is a topic we’ve covered in our posts: Crowdfunding; Dissecting Crowdfunding; Crowdfund This; and, Crowdfunding – The Real Story. Crowdfunding is something which we believe has a lot of potential, provided the bureaucrats can get out of the way. That’s a big “IF” in our book, as one thing that seems almost guaranteed is the governments ability to screw up a good thing.
There are an ever increasing number of companies helping entrepreneurs in this space, including but not limited to: Rockethub, Kickstarter, Gofundme and Indiegogo, just to name a few.
Crowdfunding currently provides a company with a very unique opportunity to raise money for a product or service without any dilution. For now, selling equity via crowdfunding isn’t approved, but it’s getting closer.
The most unique thing that crowdfunding does, in our opinion, is VALIDATE the company’s business model and/or product/service quickly. If you look through Kickstarter and review the projects that have been funded you can start to see what the consumer is most interested in, and why.
A tech entrepreneur with a great idea for a new digital wi-fi wristwatch that can download email and text messages can place the project on Kickstarter, describe the product and “sell it” to prospective customers, who are really pre-buying the finished product. If nobody contributes to the project they don’t move forward. If they get $5 million in orders, then “Hell yeah” they go for it. This scenario has played out multiple times on Kickstarter and elsewhere. It’s the ultimate in market research meets purchase order financing!
For more information we suggest reviewing the posts we linked above.
Takeaway: Alternative avenues for raising capital exist. Know all your options.
4. Angel, Venture Capital & Private Equity funds
Lots can be said about these three. Mark covered Angels and VC’s in his post Who Needs Angels Anyway?, so I won’t rehash here, but let’s briefly review.
Basically, PE funds are simply funds investing in non-public companies. A lot of them target LBO’s (leveraged buyouts), and start-ups are not typically a focus of their attention. That said, I included them to round out the discussion.
Contrary to depictions in films such as “The Social Network”, many angels and VCs will be more inclined to finance proven businesses, as opposed to start-ups run by college kids. Entrepreneurs with a proven track record can typically attract capital from these sources.
This is a difficult route to tackle, and it’s finicky. The angel, VC and PE industry tends to go through cycles much like any other. This means that there are times when their capital is chasing a particular industry, paying high valuations for businesses, and then there are times when the opposite is true. If you hit it right, and your particular “niche” is in focus, you could get lucky. If you hit it at the wrong time it will be a much tougher slog.
It’s also worth noting that this will EASILY be the most expensive and dilutive capital you’re likely to take in. There are always exceptions, but as a rule this is “tough love” money.
Takeaway: For experienced founders with a proven track record, looking to scale up quickly, who know how to deal with the players involved it makes sense to raise capital via this route.
Some hard facts
I don’t like risking my money with unproven hopefuls. After all, I have no obligation to fund an idea. I’ve stated before in my post 8 Reasons Not to sign an NDA that ideas are like grains of sand on the beach. This really is true. Mark and I get inundated with emails for all sorts of ideas, supply is NOT the issue.
Most investors I know are exactly the same. Those that are not, and have thrown their money at every “good looking” deal that comes across their plate, are lo and behold…broke.
Successful angels and co-investors we know simply aren’t interested until an entrepreneur can demonstrate prior success. If they haven’t, then a VERY solid plan needs to be provided, along with a willingness to give up a LOT more equity than most will care to. In short, if I’m going to take that level of risk then I’m going to own the majority of the company.
Some additional thoughts and obvious No-Nos
Raising capital can be difficult and time consuming. Many start-ups I’ve looked at would be much better served by allocating that time towards their product development, market research, etc. Unless the company is being run by serially-successful entrepreneurs the odds are that you’re staring at an idea in search of a business model. This can be very expensive for an early investor.
Many people tend to think that a start-up is a small version of a large company…WRONG.
What shouldn’t you do?
- Raising money with list items in the expense budget for fancy office space, vehicles and other “unnecessary excesses” will immediately turn me off.
- Hiring of sales personnel BEFORE the product is created, excessive travel budgets and “entertainment” expenses are all red flags.
- Raising too much capital early on and leaving insufficient room for future investors and/or diluting excessively is something to avoid. For example: Lets say founders are seeking to raise $200,000 for a company with a pre-money valuation of $300,000 and post money of $500,000, and investors now own 60% of the company. Now unless this is all the capital that will be required we could be facing a problem whereby founders land up with a piece of equity too small to make it worth their time to “fight” for the company. Another reason that raising too much capital can be bad is that in some situations it promotes laxity amongst management. See my post “Betting on Cornered Cats” for further detail.
- Understand your capital needs. Raising insufficient capital can be just as bad as raising to much…for obvious reasons. I’ve met far too many founders who don’t have a clear view of their existing and future burn rates. This is easily one of the most important variables for both investors as well as founders to establish.
The final take away is that entrepreneurs need to have a very solid understanding of how much capital needs to be raised both now and in the future BEFORE heading out the door on a fund raising mission.
“Do whatever is required to get to product/market fit. Including changing our people, rewriting your product, moving into a different market, telling customers no when you don’t want to, telling customers yes when you don’t want to, raising that fourth round of highly dilutive venture capital – whatever is required” – Mark Andreeson