Fires can bring
warmth and food.
They also can cause
damage and pain.
Your ideas could be the spark to something big. Outside capital (investments or debt) can fan the flames of your business from embers into a bonfire. Like fire, fundraising has major benefits and serious hazards.
This longer post covers a range of topics that will help you determine the appropriate intensity of your efforts and how much fuel you’ll need:
Mindset
External ways to raise funds
Other options
How much to raise
Concluding thoughts
Where’s Your Head?
For some founders, raising money is necessary to launch or continue their business. For others, it may feel like a rite of passage or even an indicator of success. Raising funds is an amazing accomplishment, but it’s a means to an end, not the end itself.
Raising money may solve some critical problems and may bring a multitude of new issues, including opinionated investors, unsolicited feedback, and reporting requirements.
Be clear on why you are fundraising and whether the pros exceed the cons. Here are some reasons to fundraise:
Expand Exponentially. Once you have established a reliable customer base in one market, you may decide to go deeper into the same market, explore additional markets, or build new products and services to grow revenues.
Move Quickly. If you want to reach new markets sooner or to exit faster, you’re going to need more money and you’ll likely need to sacrifice equity.
Invest Intentionally. Your business may need funds for expensive equipment, extended research and development, or heavy marketing to reach many consumers.
Fight Death. You may need working capital to cover the next payroll or to keep up with rapidly growing competition. Know your risk tolerance. Also, be certain that the money you seek is to grow and not only to delay an inevitable decline.
In all of these scenarios, remember that fundraising is often a tradeoff. The faster the completion, the worse the terms for the founder.
Ways to Raise Funds
There are many routes to generate capital for your business. Depending on the one you choose, you’ll potentially face rejection as you prepare and deliver your message many times. You will get lots of tough questions and, if you’re lucky, useful feedback on how to better present the business.
As you talk with potential investors and answer their questions, a growth mindset allows you to learn ideas about how your business might operate in the future.*
No matter your approach to raising funds, your ability to convey a vision is vital to generating interest.
“The greatest entrepreneurs are incredible salespeople.
They know how to tell an amazing story that will
convince investors to join in on the journey.”
– Alejandro Cremades
Bootstrapping
Using your own funds and support from friends and family is a wonderful way to launch a business and, in some cases, build all the way through to profitability and exit. Depending on your network, you may be able to raise hundreds of thousands of dollars. This process can be “relatively” easy (pun intended) and faster because you will need fewer documents and less legal advice. You’re also likely to spend less in the process. Furthermore, your network may be flexible on interest rates and ask for fewer restrictions.
If you cannot raise sufficient funds through your own network, consider starting your business as a side hustle until you have gained traction and clarified the business plan. Beginning as a side hustle combines the security of an income with investment into your own business. The tradeoff is that it will take longer to build your business.
Bootstrapping may not capture all the funds you need. Be cautious of overcommitting to investors, whether offering them financial terms unfavorable to your long-term plan or exit or giving them too much time to communicate progress. There is also the risk of losing their investment, which may affect you differently than losing the investments of people with whom you don’t have a personal relationship.
Angel Investors
Angels are high-net-worth individuals willing to invest in new startups. They sometimes form networks to review proposals, share insights, and pool resources collectively.
In addition to capital, angels can offer mentoring or guidance that you can choose to take or leave. Some angel investors are phenomenally successful entrepreneurs and industry leaders. Also, they may have specific skills in finance, legal, or banking to assist your growth. Compared to institutions, you may find that they are easier to access, respond faster, and offer more favorable terms.
In some cases, angels may be limited in their financing. You may talk with lots of people over many conversations to raise the equivalent amount of capital you’d gain from working with one VC firm. If you know you will approach venture capital later, talk with an expert about not hampering that effort through an angel round. After an angel round, the cap table or deal terms may turn away potential VC investors.
Venture Capital
Venture capital comes from managed institutions with funds raised from limited partners, including affluent individuals and various organizations eager to see growth. VCs fund startups when they see an enormous upside that will satisfy their investors. They bet across numerous startups, knowing that many of their investments will not yield a return.
VCs can provide expertise, mentorship, and connections. In the best case, the VC not only contributes capital, but also offers strategic direction, refers key leaders, develops business and partnership opportunities, and facilitates conversations for future rounds. Most VCs have worked with many startups and small businesses and have come to recognize patterns of success and failure. They will readily share their insights from a high level.
Keep in mind that the VC is often a long-term relationship. A VC may ask for a board seat and stay involved until an exit. Even if they are not on the board, you will be talking with the VC partner for many years during countless opportunities and crises. The VC is a boss you cannot fire and cannot easily quit. So as you consider taking their funding, interview the partner(s) who will spend time with you. Ask other entrepreneurs who were funded by the VC firm how the partner(s) reacted in various situations, including slow growth, leadership change, and potential exits. You want to know how they supported/pressured other founders to get a clearer idea of what to expect. You may hope for constant growth, but companies often grow in cycles; you want to know what to expect when the business struggles.
VCs will be looking for companies with high growth potential, a talented team, and a solid product and traction. You may pursue advisors and fractional leaders to augment the leadership. The expected depth of these criteria varies depending on the round of funding.
VCs are in the business of pattern recognition, so you either need to fit their ideal pattern of success (industry, traction, projections, etc.) or present a convincing case as to why your business will work despite appearing outside of their pattern. Make sure you know something about each investor you will meet, including their strategy, stage of growth, and if the fund is even open to new deals right now.
You must prepare and present a pitch that demonstrates your traction, competence, and market potential. This pitch will require a lot of time and energy from you and your team. In your pitch, be clear about the potential growth of your business and the exact amount you are trying to raise. You can change the raise amount later, but it helps to be specific now. If you get rejected, do your best to get feedback.
Pro Tip: Fifteen minutes into the pitch, ask how things are going. This pause can help redirect the conversation if needed, save time if there is no deal, and allow you to collect your thoughts.
An interested VC will offer a term sheet full of legal terms and subtle implications that are not straightforward to most founders. One approach is to ask the VC their three most important deal terms early and to offer yours as well to make future discussions easier. Work with an attorney, fundraising expert, or an experienced founder to review the terms. In some cases, the VC will be ready to negotiate some of the terms because they don’t want you to be disgruntled by the deal. While an expert on your side is helpful, the best leverage is to have another VC interested in the deal. In the end, both sides should be excited about building the business together.
Investing firms will monitor your progress and expect quarterly or even monthly updates. Their level of scrutiny can vary, but expect an emphasis on a seven-to-ten-times return in three to seven years.
VCs often ask for a board seat which may result in investors outnumbering founders in board meetings and for control of the company. That could weigh heavily and even dictate certain business, product, and other decisions. Even the best-intentioned VCs have a fiduciary duty to their limited partners, and that responsibility may not constantly align with your vision, growth plans, or company values and culture.
Crowdfunding
There are some wonderful stories of companies crowdfunding their way to success. Like nearly all stories, they represent a rare breakthrough.
To get started with crowdfunding, post a detailed, engaging story of your vision and business. You likely will offer various levels of support for which contributors may receive something in return. Crowdfunding allows you to communicate passionately and directly with many people. If someone believes in you, they can sponsor your work and tell others about your business. Some companies benefit from the virality started through the platform.
Crowdfunding may raise more money than you expect. It helps to gauge interest in your business model before launching, which is worthwhile before dedicating lots of time to it and going into debt. The platform can create buzz for your business, serving as free marketing. The platform can generate support, especially if your business model is incredibly innovative and falls outside the patterns and understanding of institutional and angel investors. Even if they don’t fully understand your business model and vision, individuals may be willing to part with small contributions to support your business. While some campaigns have raised millions on their own, that’s rare. But crowdfunding can build momentum, which can help attract later investors.
On the other hand, crowdfunding sites all have a bunch of founders vying for attention. You may have trouble breaking through the noise and raising a substantial amount.
Projecting the right message and visuals may require expensive, professional services—writing, editing, video production—to engage sponsors. Unlike other forms of capital, crowdfunding comes without the advice or support of professionals. Although there is less demand for founders, sponsors will expect updates.
Incubators and Accelerators
Incubators and accelerators strive to nurture a newly formed business. An incubator helps a company to get off the ground, whereas an accelerator lives up to its name to fast-track a startup with some realization of market fit.
Both programs normally run for two to six months and require a time commitment from the business owners. When the period is shorter, the time commitment is often higher.
The advantages of these programs for business owners are mentorship, structured thinking, and potential introductions to investors. You also may connect with other startups and small businesses with whom you may find a sense of solidarity, share ideas and insights, and discover cross-selling opportunities.
The disadvantages of these programs may include too little pressure, minimal funds—which may require you to keep a paying job—and a lack of support if the people involved lack the right advisors for your business.
Lending Options
Rather than giving up equity, you may turn to financial institutions for loans. There are many options here that may overlap. For example, a community bank may offer direct lending or support your SBA loan.
Bank loan. Entrepreneurs can access large capital, enough to handle working operations or product development for a long time. In some cases, banks can help in other ways, too, such as by making introductions to potential clients and investors.
Banks are more likely to offer a loan if an investor with a relationship makes the introduction, especially if they have other portfolio companies already banking there.
The more you want to borrow, the more information the bank will want to see, including historical and current financials, business traction, information about your assets, investors’ backgrounds, and/or your client receivables. If the business lacks assets or deep receivables to use as collateral, the bank may ask for a personal guarantee, which means that the founder is personally responsible for the loan if the business cannot repay it. Many loans come with covenants that require regular reporting. If the covenants are not met, the company may see additional restrictions, and the loan may be owed back immediately.
Micro-loans. The Small Business Administration (SBA) and other nonprofit groups provide seed loans to businesses. These loans are relatively easy to obtain, demand fewer requirements and restrictions, and offer lower interest rates.
They usually are not large but could provide enough to last a few months. You must complete an application process to obtain these loans.
Unsecured lending. Some organizations provide funding quickly and easily. However, they often require a personal guarantee and include limited funds, short turnaround times, and debilitatingly high interest rates. This type of funding is only a good option if you need funds briefly to enable the business to continue operating and growing in the long term.
Pro Tip: If your company is not positioned to thrive in the future, don't borrow money only to delay the inevitable. This is a hard level of self-awareness, but your future self will be glad you made the hard choice sooner than later.
Customers and Vendors
Find ways to work with and improve your cash flow. Here are some examples:
Payment terms. If facing a temporary cash crunch, you might work with customers to cover the gap. To bolster cash flow, offer a deep discount for paying upfront, lowering payment terms to 30 days from 60 days, for example, and asking renewing clients to pay early.
Product Pre-Sale. If you can sell your product to clients before incurring most of the costs, that could also help you gauge product interest, prioritize features, and receive other valuable feedback. The value to customers is to greater influence features and reporting.
Client Investment. Occasionally, some clients are so excited about your business that they will invest in your success. Consider this option if their business and values align with yours and avoid exclusivity unless you’re willing to change from entrepreneur to employee.
Vendor Arrangements. While vendors will rarely invest directly, you may be able to arrange payment terms and other flexibility that allows you to effectively manage cash flow and grow without being concerned that you can’t keep up with increasing demand.
Other Options
The are other ways to maintain cash flow that may meet your needs:
Personal (loan or credit cards). Some founders are willing to bet on themselves and take on debt to get their idea off the ground. While we sometimes hear incredible success stories with this approach, we never hear about the many founders who ended with crippling debt that took years to pay off, so beware.
Selling Assets. Whether a planned pivot or a necessary move to keep open, some founders sell assets—real estate, inventory, domain names, intellectual property—to keep the main part of their businesses going. If you face this situation, you may be determined to keep the business open no matter what. Consider selling assets only if you are committed to a new direction instead of trying to stall and stave off closure.
Factoring. If you have a lot of reliable receivables and need the money sooner than the expected collection time, you can get a loan based on the receivables. With factoring, there is typically a high interest rate and certain restrictions, so be mindful of the tradeoffs.
Employee Investment. You may already have employees with some tradeoff in compensation and equity. If you face a cash crunch, you can approach employees (some or all) and ask if they are willing to defer payments for a limited period. Asking employees to defer pay is an extreme gesture but could provide enough funds to bridge a temporary, surmountable gap.
How Much to Raise
There are several lines of thinking here:
Milestone. You want to raise enough to reach the next milestone, whether that’s an expected next fundraise, product development, or customer acquisition. In factoring your expenses, make sure to add all new costs, including new team salaries, benefits, and overhead, plus some cushion to ensure you ask for enough.
Coffers. Some founders like to raise more than is needed now to protect them during unexpected emergencies or dried-up markets. Raising “more than needed” will add to your dilution and expectations to apply the funds, so consider the tradeoff.
Valuation. You want to raise with a favorable valuation, one that does not dilute you too far or limit your future options. Valuations that are too high can make it nearly impossible to fundraise again or to exit.
Profitability vs. Growth. If you have no limit on how much your business can grow, engage investors looking for a big return. If you only want enough to reach profitability, consider money from non-investors that you can return later. While in theory you can pursue both, in reality, it’s incredibly difficult for a startup to manage growth and profitability simultaneously.
Concluding Thoughts
Timing. Fundraising takes time—figure at least three to six months—but you may go through the entire process unable to find the right fit for your financial needs and vision.
You fundraise while working full-time to maintain and grow the business. You want strong numbers to present in presentations. Factor in timing with your business metrics when deciding when and how to fundraise.
Pro Tip: Fundraising will always take much longer than you think, so you want to start fundraising before you think it’s necessary to decrease stress and increase your options (e.g., compare equity or debt offers or significantly adjust operations to lower costs and delay the need for a raise).
Impact. You will face countless challenges and crises with the business while fundraising. Consider the effects on co-founders, current investors, employees, and on you. Starting, building, and growing a business is incredibly difficult. Fundraising gets added to everything else you are already tackling. The process is a chance to learn and to reach your dreams but it adds another layer of stress on you and other stakeholders.
There is no standard answer. Your vision, values, needs, and timeline are unique. While others may insist that they know the right option for you, their experience and motivation frame their advice—just like a doctor recommending a prescription for an illness that a nutritionist would treat with dietary recommendations.
Get a lot of input before deciding what is best for you.
Key Takeaway: Like fire, fundraising may be wildly valuable or terribly dangerous in reaching your vision. Explore your options—including the option to put fundraising on hold for a while—by knowing and comparing the advantages and disadvantages.
🔥 Fire can be used in many ways to make life better and worse. Fundraising is equally valuable and dangerous to reach your vision.
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Photo by Mikhail Nilov who can be found here
Photo by Ylvers who can be found here
* Check out the post on Growth Mindset
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