Five Thoughts on Raising Capital for Your Start-up
While the process of launching and growing a company can be both exciting and financially rewarding, raising equity capital may be one of the most frustrating components of the process. Yet every business needs capital and, in the case of food product and technology start-ups, lots of capital. So this article is designed to shed some light on the equity capital formation process to make it less aggravating and increase your odds of success.
Note: There are lots of different types of businesses. For this article I’m focusing on food technology and food products start-ups.
Thought #1: Understanding what equity actually means. [Use a handwriting font]
Exchanging equity for capital means you are selling “ownership” in your business. The amount of ownership will be negotiated between you and your investor(s). It means you both want the company to grow in value over the ensuing years and you both want to harvest that value at some point.
It also means you now have a business partner who has rights to certain information, and perhaps even control over certain decisions. Which means: Pick your partners wisely! Long after the money has been spent, you will have to deal with the investor. And, just like in a marriage, a business divorce can be a long, expensive and emotionally draining process.
Noam Wasserman, a Harvard professor, wrote a book called The Founder’s Dilemma. The book can be summarized in a question each entrepreneur should ask before raising equity capital: cash or king? In other words, are you raising money for “your baby,” or because the company needs money to become successful (even if you are no longer part of the company). There’s a huge difference between the two mindsets. I would suggest if you view your start-up as “your baby,” don’t raise equity capital.
Thought #2: Are you ready for outside capital?
It’s 2016 and, unless you are a seasoned entrepreneur with a proven track record of returning capital to investors, a PowerPoint presentation or “back of the napkin” pitch is no longer sufficient to raise capital. You shouldn’t be speaking with investors (even family and friends) until you’re able to demonstrate a market exists for the product you are hoping to build. This is typically achieved by building a version of your product that “does not scale” in order to demonstrate market traction.
Over the past 10 years, I’ve probably taken more than 150 pitch meetings. If someone is pitching me to invest in their idea without any proof of market acceptance, he or she is basically asking me to take 100% of the risk on their behalf. So it’s an automatic pass for me (and typically most investors).
The “abstract” is a scary place to be when you are out raising capital. It means the only tools you have available to convince investors are your enthusiasm backed up by some generic data points (it’s called promotion). Every seasoned investor, including me, has been burnt at least once by a great promoter.
What you should be showing is proprietary data points you’ve amassed over a period of time that demonstrate an interesting investment opportunity. Only getting out of the abstract and into the trenches (meaning in the market selling some semblance of product or service that mimics what you hope to build with the investor’s capital) can achieve this.
Which means you may have to rely upon good old-fashioned bootstrap strategies to get your business ready for outside capital:
- Your own money;
- Selling a product or service (any product or service);
- Keeping your day job to finance your start-up; and
- Bartering (trading services with others who can help you).
The great thing about bootstrapping is it teaches you to be resourceful and frugal, which are tremendous qualities to have as a founder.
Thought #3: Understand how much to raise and when.
One of the biggest mistakes entrepreneurs make is trying to raise too much capital. I know, I know: It takes just as much time to raise $100,000 as it does $1,000,000. I also know the best of all worlds is to raise a bunch of capital that provides for a reasonable salary while you’re building the company. Neither one of these is an acceptable reason to go out and try and raise more money than you need to move the business along its optimal path.
Money is nothing more than a tool to help you get from point A to point B. Think about it in the context of a car trip across the country. You don’t haul all of the gasoline you’ll need for the entire trip in the trunk of your car. You fill up the tank at the next logical destination point. Same principle applies to capitalizing a company.
In the early fund-raising cycles, the vast majority of the capital raised should be going towards getting a product out to market you can start selling. Not building the “perfect” product with all of the trimmings. From there, you’ll take what you’ve learned to investors so you can raise more capital to refine the product and position the business for scale. Beyond that, you’ll raise more capital to increase capacity and blow out the sales.
Thought #4: Investors like to fund teams, not individuals.
No matter how talented you are as an individual, there are lots of risks associated with single founders. I was a single founder in my first start-up, and I can tell you I would never, ever launch an investor-backed company as a single founder ever again. Outside the obvious risks of something happening to the single founder, grinding the company to a halt, the bigger concern is that too much control is in the hands of one person. With a single founder, there is nobody at the company on a day-to-day basis who has the authority to challenge the direction of the company. This can be devastating when the start-up is going through a difficult time.
In contrast, two or more founders on an equal footing create a healthy amount of conflict that will ultimately result in the right decisions being made (assuming, of course, that the founders want the company to succeed).
Thus, I would strongly urge you to find a co-founder or, at a minimum, a business partner who is committing 100% of his or her time to the project before asking investors to add their capital. This would take away a large point of friction for sophisticated investors.
Thought #5: Don’t own the rejection.
Lastly, investors cannot predict the future and they are wrong as many times as they are right. Just look at the investors who passed on companies such Airbnb and Uber! Go into the capital-raising process knowing many investors are going to pass on your opportunity. However, every rejection is like a breadcrumb that will ultimately lead you down the path of success.
Some may warn you your market isn’t big enough. Some may say you don’t have a defensible position. Some may argue your product isn’t scalable. Instead of feeling rejected, challenge yourself to think about how you can help minimize these concerns going forward. This process will ultimately make your company stronger and you a better businessperson!