Funding, an overview, post #4 of “Startup Briefs”
Every first-time entrepreneur is excited and intimidated by the concept of fundraising. It’s a world that they don’t know, and it lures them while scaring them. They ask people like me numerous questions:
What is my company worth?
Will I still have control?
How will I find investors?
What will the deal look like?
Will my investors want to run my company?
How will I provide the return that investors require?
It’s clear that they have not done this before. They have no idea what to expect. What I tell these early stage entrepreneurs is that fundraising is like painting a room. Have you even painted a room a beautiful color? It’s gratifying, right? BUT, in my experience, painting is absolutely the LAST THING THAT YOU DO. First, you have to scrape all the crap off the walls from previous, probably bad paint jobs. Then you have to fill all of the nail and drill holes. Then you have to spackle over all of the uneven sections of the wall. Then you have to sand. And sand. And sand. Then you get to paint on the primer. Starting to look pretty good? Oops, I forgot. You have to sand the primer coat. And you may need to spackle more than once, with sanding in between (my contractor husband trained me well). Even after I have done all of the prep, he goes over it once himself with his eagle eye to make sure that I haven’t missed any obvious spots. ONLY THEN ARE WE READY TO APPLY COLOR, or, in my analogy, to fundraise.
Another way of looking at this is what I call the Pinocchio effect. You all know the story of the wooden puppet who wanted to be a real boy. If you, as an early stage company – like a wooden puppet – want to be a real company, a real boy, which means a fundable company, then do your prep! Walk, talk, act, and look like a real boy, a real company. A couple of areas of preparation are outlined below. Before you can paint, you have the prep the walls.
Boards. I recommend that you develop a strong board of advisors and a small but engaged board of directors (or managers depending on your legal entity). See an earlier NewVenturist blog post on this subject that I am revising to become part of this “Startup Briefs” series. Once you get funded, chances are, the investors will want a board representative. If you, the first-time entrepreneur, have never been on a board or are not experienced about boards, then use your initial board to train you as to what a board is, what boards do, how they function. Put someone on your initial board who will train you how to run a board meeting! Having advisors and a board of directors will also help in the fundraising. Chances are they will have done it before and will be able to assist with introductions to potential investors, review investing documents, and general sage advice.
Team. In addition, if you are thinking of raising money, take a good look at your team. Generally, investors, particularly at the early stage, invest in people. People means more than one, and often more than two. Find co-founders or team members that fill in the gaps of where you need help, where you are weak. Don’t wait, thinking that you can raise the funds and THEN find co-founders and/or team members. You may not need to bring them all on board until you have the funds. They may need to be paid in order to eat. BUT, you can identify them and tell your future investors that. And you never know, some may jump on board and help you get those funds in to pay them.
De-risk. Investors do not like risk. They are not investing in you because you are high risk. They invest because they expect high returns. While this may correlate with high risk, let’s be realistic about what their risk tolerance is – making your deal as low risk as possible is your goal.
How do you accomplish that? Look at the four buckets of risk: People, Money, Market, and Product/Technology. Most investors will categorize risk into these four areas. Look deeply into the risk inherent in your deal in each one of them. Above, I address two areas of people risk: board (advisors and directors) and teams. Reduce risk in that bucket.
Look at how you can reduce risk in the other areas too. How do you reduce risk in the Money bucket? Maybe raise some funds from friends and family to get you to the next level? Bootstrap as far as you can? Test your pricing? Do enough customer discovery and validation to be sure that your product has value to customers; they will pay for it.
Reduce risk in product/technology areas by building and testing prototypes. Understand through talking to potential customers what features they will value and what they don’t need, at least in version 1.0.
Reducing risk in the market area is probably the most important. Make sure that you have identified your customer segments and talked with your potential customers. Understand your competition, the entire landscape of competition, both indirect and direct. Can you articulate clearly your unfair competitive advantages? What are your barriers to entry? What can you erect as barriers to your competition?
In conclusion, do your prep work before painting the room (fundraising). Find out what it takes to be a real boy (walk, talk, and act like a real company). In the next sections on this topic, we will cover types of investors and investment structure. This will help you to understand the basics of funding. When you finally go out to raise equity money for the first time, be ready for the final transformation that a coat of paint can give to a room. It may not be recognizable at first. Don’t be surprised. Be prepared. DO YOUR HOMEWORK!