To an entrepreneur, fundraising is scary stuff, and rightfully so. Make no mistake about it; FUNDRAISING IS HARD, and even harder during leaner times. However, those working on the next big idea shouldn’t lose their faith. They should keep plugging away, stay inspired, and conduct careful research on the options available to them.
Besides the current recession, most of the fear around raising money comes simply from a lack of understanding. The world of start-up capital is a foreign one to most entrepreneurs, partly because investors are so unlike them (deal makers vs. creators), and partly because they don’t have an intimate understanding of how the world of capital operates. Well, let’s try to straighten out some of the confusion.
There are two main types of investors: Angels and Venture Capitalists. Angels invest their own money and VCs invest other people’s. The other main options for funding are to solicit your friends and family, or to just do it yourself. Given our current economic climate, and the fact that innovation by entrepreneurs is essential to right this economic ship and restore the confidence in our global economy, all options are on the table. So read up, welcome to business financing 101.
The VC Route
Venture capital is the most highly regarded form of funding, but it’s also the most misunderstood. Venture Capital (VC) is funding that comes from professionally managed funds that have roughly $25 million to $1 billon to invest in promising new businesses. Because there are so few of them, and they have control the money, VCs are extremely choosy on who they decide to fund.
VC funding is certainly not for every company, and timing is critical, but if you’re a high-growth company capable of generating significant revenue in the short term (or already have a nice revenue growth curve), funding from an institutional venture fund provides a fantastic opportunity for accelerated growth. Such acceleration, however, does not come cheap.
Most VC firms offer a few other undesirable “benefits” in addition to their money. In many cases they will require the addition of a few senior management roles (of their choosing) to your team. Remember, VCs are usually bankers at heart, so don’t expect them to be able to help with or understand your technology or target consumer’s emotional needs. Go to them when money is all you need. A big name VC will look to own AT LEAST 25% of the company to cover their time and energy for a particular investment. Venture capital is by far the most expensive money you will ever raise both in terms of equity and sanity.
The existing VC model centers around a short-terms focus on a big payout. VC firms do not typically invest in businesses that have a promising long-term future but rather in ones that will likely see a liquidity event in 3-5 years. Because these investors aren’t putting up their own cash, they feel substantial pressure (it’s their job after all) to see significant returns on their investment over a set period of time. The fastest and biggest way to do this is for their portfolio companies to either get bought out or go public, so you can expect them to push for unnatural things to happen. $5M to break the space-time continuum usually looks better on paper than it turns out in practice.
In addition, VCs almost never look at a business plan or listen to a pitch if a trusted individual didn’t refer you. While this practice certainly limits the amount of junk plans (i.e. cubic zirconia) on their desks, it also leaves out the possibility of discovering a true gem. Yes, the old boys networks is a great thing if you are part of the in-crowd, but both parties could benefit from a more open and efficient approach to finding and filtering investment opportunities.
“VCs do initiate on their own when they see a bright startup. But it’s so rare that you seldom hear such stories. And when it does happen, it becomes legend.” – Vikas Rana, entrepreneur
As funding becomes tighter and tighter (until the economy begins to bounce back) the rate of innovation will likely speed up; out of necessity to find new ways to make portfolio companies profitable quickly. And, just as people always say it will be hard to get VC funding, the large VCs will have money to invest. For those fortunate enough to stand out and make a favorable impression, funding will still be available, as it was after the dot com bubble; but it will just take a little more work to get that cash in hand.
It is important to have your priorities straight and your feet planted in reality. If you’re new to the game and have a very early stage venture that hasn’t yet figured out how to make the cash register ring, you are probably better off working out the kinks and creating value than you are putting on a silicon valley road show. Don’t fret, there are other options.
Excerpt taken from Breaking Through The Broken: The Transparent Guide To Overcoming The Inefficiencies In Early Stage Venture Capital. In the coming weeks, we’ll be posting even more insightful nuggets from this paper. However, if you’d like to read & download all 33 pages of constructive prose right this moment, it’s sitting on our website: www.dontgosouth.com.
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