by Dave Sherwin
This week I was approached by a friend with that series of questions that every entrepreneur faces at one point or another, “Should I entertain raising investment money for my business idea? And if I do, what are some things I should be aware of and watch out for?”
I’ve decided that his query deserves a well-prepared response, and should be shared with the community at large. And without further ado, I give you a two-part response:
When should I entertain raising money for my business idea?
First of all, you should recognize that there is no perfect timing or recipe for success. The ironic thing is that first-time entrepreneurs don’t usually know when the right time is to raise money. Many successful entrepreneurs bootstrap their first business to outstanding success, sell off the business, and know better the second time when they should have raised money.
But for all of those who aren’t seasoned, second or third-time entrepreneurs, what’s a good rule of thumb to follow? Here are my top five questions that you need to be able to answer very definitively before you should decide to go raise money:
Would my business, my team, and I perform better with someone holding us accountable? And in what ways?
In a very real sense, when someone invests in your business, you are taking their money as a steward and putting that money to work in your idea in order to produce returns for them. The very act of them handing it over to you doesn’t mean it’s yours. You a have a duty to responsibly put that money to work, and that investor will very likely want to know not only what that plan is, but how the plan is going from time to time. Having this form of accountability is oftentimes just what a founding team needs to run faster.
Am I willing to give up some control and let others help determine the destiny of my baby?
Especially if your founding team is giving up significant amounts of ownership, investors will likely participate not just as passive investors, but board members, and sometimes even in a full-time capacity. They will want their voice to be heard, and now it will not just be your vision, but a shared vision. Sure, you can remain the visionary, but if you’re not prepared to listen to others ideas and let those help to influence and shape the company, you may be better off passing on additional capital.
Do I have extremely specific objectives and goals for which I am going to use the money? And do I have multiple backup plans and directions that I could pivot if my primary objectives are not well received by the market?
The name of the game is to spend the money on revenue-generating activities or activities that get you closer to revenue. After all, revenue is the cheapest form of capital. Paying six-digit salaries to founders is not an idea of a lean startup machine that is taking investment capital to grow the company faster. Put the money to wise uses such as hiring additional developers to complete revenue-critical software features or expand your proven sales machine. Just be sure to review your planned spending for “nice-to-haves” and unnecessary items.
If your initial plans to generate revenue fail, be prepared to pivot. You may need to attack the market from multiple angles until you get it just right. Remember that when digging for gold, it is rarely the first time you dig that you strike gold.
Do I have very good evidence that the market not only needs what I can supply, but is willing to pay for it? Is my business (and revenue model) already well established?
Do you have paying customers? Not only will a yes to that answer increase your chances of raising money, but you really shouldn’t entertain the idea of raising money unless you have serious reason to believe that what you’re building will be gobbled up by your target market. And if you don’t know what that is, well, you fail this question. Other valuable evidence includes market research, prototype testing, and other market tests that will help you wrap your mind around your market if making a revenue-generating product is near impossible without capital.
Is the lack of capital in my business constraining my growth directly?
This is the most important question you need to answer. If you had $50,000 today, do you know exactly where you put it to work to make you $100,000? If you have a proven formula in your business where for each dollar you put in you can generate that dollar in return plus some, and the only reason you can’t grow faster is that you don’t have enough money to put in the front-end, then yes, by all means you need to raise capital.
Obviously, it won’t be an infallible formula that you’ve developed. There will be some risk. But if the risk is fairly low, and your business has been around a while, consider alternative lending options that might not be so costly as equity investment. Other alternatives include revenue-based financing, subordinated debt, SBA loans, and where possible, lines of credit.
In the end, you should have a very good plan. Raising money is not a game, and in the early stages, it certainly should not be viewed as a payout for your idea. Be ready to put the money to work. But before you do, read the next article where I highlight the:
Things of which you should be aware and/or warned?