Entrepreneurs often forget the basics of good business when searching for funds. They think money from any source is good money, and in the process, set themselves up for failure.
Here are 10 core principles entrepreneurs need to keep in mind in their search for funding:
1. Not all startups are suitable for equity financing.
Equity financing usually only makes sense for high-growth businesses that have the potential to return 10-20x the initial investment through an M&A or IPO exit event within 10 years.
2. Consider all potential sources of funding.,
Non-equity crowdfunding, grants, business plan competitions, incubators/accelerators, family/friends and potential customers are all great sources of non-dilutive capital. Don’t overlook prospective customers as a source of early capital. If a prospect needs a product badly enough, they may be willing to pay in advance for it.
3. Bootstrapping can set you up for long-term success.
If you are able to raise money from other sources rather than from investors early on, do it. Having investors involved frequently complicates operations by putting another voice at the table and reporting requirements that may consume your valuable time. Making progress before trying to raise money demonstrates that the team can execute, creates tangible business value, and begins to de-risk the investment. This in turn improves the power balance between entrepreneur and investor, and makes for a more productive negotiation of financing terms and the long-term relationship between both parties.
4. All investors are not the same.
Targeting the right investors is critical. The best money comes from experienced investors with relevant industry expertise, useful contacts, and tolerance for the ups and downs and pivots of early-stage ventures. Personality matching is also essential – a poor relationship with an investor is usually a recipe for disaster.
5. Warm introductions are essential.
Investors rarely react to unsolicited pitches. It is important to find someone willing to make a positive introduction and then to arm them with a compelling one-paragraph introduction to the business. Don’t send a lot of information in the introductory exchange. The goal is to get in front of the investor to tell your story.
6. Taking fundraising advice from the wrong people can derail your fundraising.
Testing the pitch with friendly investors and experienced entrepreneurs can accelerate the process. Conversely, taking fundraising advice from anyone who hasn’t raised money or invested in an early-stage company will just lead to confusion and conflicting advice. Network your way to other entrepreneurs who have successfully raised money and ask them about their experience. Have informal meetings with early stage investors who are not your key targets but can look at your investor proposition with a critical eye and provide feedback.
7. Investors are not donors.
Investors expect to see a return on their investment. It is extremely important to clearly articulate a path to a return. Before taking investor money, understand the exit potential of the business and make sure that it is aligned with investor expectations. Although this seems simplistic, we have seen many entrepreneurs who treat their investors as if they are donors. Investors are investing in your business because they want a healthy return on their investment. The greater the risk in the business and funding required, the greater the return potential needs to be.
8. It’s really all about the team.
Once an investor believes in the opportunity, the investment decision comes down to whether they believe your team can execute. For many wise investors, the quality of the team is more important than the quality of the “dream.” If you are a first-time entrepreneur, augment team capabilities with an experienced, active advisory board that fills missing gaps in experience and skills.
9. Every slide in the investor presentation is important and contributes to the story of the business.
Common mistakes in the investor deck include:
– Simplistic “go to market” strategy: Aggressive social media is not a customer acquisition plan. Investors want to see detail around your assumptions related to the channels and cost of acquiring customers.
– No acknowledgement of competition: It is the very rare company that doesn’t have a competitor or alternative solution to the problem it is trying to solve. Pretending that competitors don’t exist is beyond naive. Investors want to see that you have a firm grasp on your industry and competitive ecosystem, and understand how to position your company for success.
– Unrealistic financial plans: Investors understand that early-stage financial projections are a working hypothesis and are looking for a reasonable model rather than concrete commitments. Investors will be dismissive of plans that show extraordinary revenue projections with minimal expenses.
– No explanation about how investment funds will be used or how much future capital will be needed to reach a viable exit or cash-flow break-even: Investors need to feel like partners, from the outset. Withhold critical assumptions or information at your own peril.
10. An investor “No” doesn’t always reflect a judgment of the business plan's quality.
A “no” from an investor does not necessarily mean the idea, plan, or team is not investable. It may simply mean that the opportunity is not a fit for a particular investor’s investment thesis or timeline. A complex set of variables including competing partner interests, fund life cycles, and alternative investment options will impact individual investment decisions.
Ian Mashiter is the director of the BuzzLab at Boston University's Questrom School of Business.