For today’s discussion, this article will focus on equity funding for early-stage startups that plan on significant growth. The company’s growth needs to be funded beyond the cash flows generated by the business in the near term. Early-stage startups can mean different things to different audiences. We define the significant growth early-stage startups as those seeking funding from angels or small seed funds companies.
When Early-Stage Startups Need Funding Beyond Family and Friends
It is important to focus on your overall strategy of fundraising.
Early-stage startups are looking for funding. And while there may be a certain healthy desperation in seeking the funding – meaning one may believe any money is good money – it is important to focus on your overall strategy of fundraising. After all, if you are successful, you are selecting someone who will be with you through several rounds of fundraising. And, since you believe in your start-up, having an attitude that your investor should feel privileged to be a part of what you are creating, in my view, is the only way to march into fundraising.
Here are five things to consider when seeking your first investors.
Level of sophistication: The SEC has specific criteria for an accredited investor based on net worth or income levels. Think of this as a minimum threshold, in that having a high net worth does not always equate to sophistication in understanding how/when your business will deliver returns. In one example, I worked with very successful real estate investors who could not comprehend that they were not going to receive payments from their investment every quarter. We walked away from the transaction. As the entrepreneur it is incumbent on you to paint a clear picture of how the investor’s money will be used and what/when their return will be, but you should not have to educate them on the difference in early-stage investing and other forms. Even in crowdfunding, select a well-known and established platform that brings investors to you and supports you through your raise.
Shared passion: This communication/relationship is a two-way street. Are you a passionate founder with skin in the game? How prepared are you to take this business forward? Successful fundraisers believe and demonstrate that they will find the path for their startup. Your job in fundraising is to show that passion. You want potential investors who ask lots of questions and challenge in positive ways. This stage of investing is based on beliefs so take these inquiries not as judgment but as the way investors become ignited by your passion and begin to share it.
Connection/Fit: If you have done steps one and two well you have engaged the investor and through this process you can begin to see if there is a fit within your company. Just as you have worked on building your culture, selecting your team members, and deciding how to be with your customers, it is vital to see if there is a fit. Imagine you had to turn to this person to step in when revenues fall short, and payroll must be made. How would they react? Create your own screening tool. Along with the basics of trustworthiness, integrity, ease of conversation, and reputation, what does it take to partner with you? The truth is at this stage – and really all stages – investors put their money in whom they believe. Be that person.
Strategic value: Startup fundraising is a maze that varies depending on your sector, region, and market. So, as you make a list of possible investors, next to the column listing how much money they might bring in, consider what other value they bring. Access to future investors should be at the top of the list, finding someone who believes in you and wants their friends to invest as well indicates they are with you for the long term. Does their network extend to venture capital or other capital markets so they can help guide you along the fundraising path? Are they an industry expert, with knowledge of the space (market or industry) your product targets? Specific recognized expertise in marketing, product development and startups are also incredibly valuable – with a caveat, that they stay at the strategic level and not cross the line to management. On this point, be wary of creating an ‘advisory board’ of people that do not want to invest but want to ‘help’ you. What message are you sending to investors if you are surrounded by advisors? What does the advisor get out of the arrangement? Why are they unwilling to make a minimal investment? You have limited time so consider if the value proposition of an advisory board makes sense and can be actualized. Another key attribute is whether they can they see the big picture and help you realize your vision.
Check your gut: Maybe because of the chaotic nature of fundraising, it is easy to get a connection, make assumptions and move forward. You may have done this with a bad hire – great person but… Similarly, with all the above considerations, make sure to fact check your basic assumptions. The most successful entrepreneurs I know have a finely honed sense of risk. Often painted as ‘cowboys,’ I believe the entrepreneurs we admire the most use their instincts, patience and facts to inform their actions. They dance between their vision and reality by making sure they surround themselves with the best people. This extends to investors.
What to be aware of, wary of, and avoid
Beyond these five considerations, it’s important be aware of and avoid certain scenarios. First be wary of anyone who promises to bring you funding for an upfront fee, or worse, equity. Sadly, because fundraising can be bewildering, I have seen precious capital [both cash and ownership] chewed up by individuals who never deliver investors. If you are using a qualified broker who charges a percentage of the capital raised, you should check their credibility at FINRA's broker check. If they are an advisor, you should be learning from them how to fundraise effectively. Make sure you see results and the engagement letter protects you. Finally, be aware of anyone who offers you a deal that seems too good (to be true.) They usually are just that; trust your instincts and seek advice. It is important to do your due diligence on any potential investor just as they will scrutinize any entrepreneur they plan to fund.
To wrap up, when seeking an investor, it’s best for early-stage startups to look for people who can help them not just financially but someone who can:
a) introduce you to a wider network of potential investors
b) provide industry knowledge/insights
c) offer business guidance/mentoring or
d) all the above.
The key is to seek strategic partnerships that will provide mutual benefits for both entrepreneur and investor(s) for years to come.