Small business capital comes from three primary sources:
1. Profits left in the business;
2. Debt, like a bank loan;
3. Equity investment.
For most small businesses the third source is, and has been the founder’s investment. In recent years, this option has become more robust and multi-faceted in the form of outside investors, whether venture capital, angel investors, and even with crowdfunding. The challenge is developing a capitalization strategy that matches the right sources with the short and long-term goals of the founder.
It must be said that while many elements of finding and acquiring investor capital are similar to getting a bank loan, the former takes longer and is more complex. In his book Raising Capital, Andrew Sherman addresses this issue with a list of common mistakes entrepreneurs make searching for investor capital. This is the first of two articles where I’ll identify Sherman’s “mistakes” and follow each one with my thoughts.
Mistake #1: Using an investor search that’s too broad.
Each investor has an interest and related strategy. An investor that likes medical ventures won’t be a prospect for your retail idea. Qualify each investor prospect before making contact.
Mistake #2: Misjudging the time involved.
Part of Murphy’s Law states that everything will take longer than you think. Alas, Mr. Murphy is alive and well in the investment marketplace. It usually takes months, not weeks, to find, approach, and get an answer from investors. Even crowdfunding will take more time than you think. And remember, like prayers, sometimes the answer is “no.”
Mistake #3: Falling in love with your business plan.
Every mother’s baby is beautiful. But your plan is not your investor prospect’s baby. Expect that your business plan will have to be adjusted before you get funded. So be prepared to accept that changes will come with the capital.
Mistake #4: Taking financial projections too seriously.
First let’s establish the prime financial rule: All projections are wrong! Of course, you can show projections you believe are achievable. But also include a conservative set that shows your break-even point if things don’t go as planned.
Mistake #5: Confusing product development with sales.
Investors love real customers and real sales. Even sales projections based on history will be highly scrutinized. But projections based on projected sales will be highly doubted.
Mistake #6: Minimizing the management team.
A good management team can fix a bad plan, but a bad team can ruin a good one. Unless you’re asking investors to contribute management expertise, don’t seek investor capital without a qualified management team
Mistake #7: Not understanding the investor selection process.
Don’t deliver information with a fire hose when a pitcher is preferred. If there is interest, investors will request the full details as needed. You’ll need three documents:
- an initial, one to three page executive summary (the pitcher),
- an intermediate 10 page (+) model, and
- a long one with all numbers and research (fire hose).
Deliver the last two only when requested.
Mistake #8: Too little research and analysis.
You must have market/industry research and analysis to back up your assumptions and projections. Investors don’t value promises or hunches. Don’t show extensive data until requested, but reference and summarize what you’ve learned in the short models.
Mistake #9: Underestimating the funding chronology.
If your funding requirements and the investor’s investment schedule are not in sync, guess who makes adjustments? Remember, to an investor, urgency sounds like desperation. And this will be true for crowdfunding as well.
Mistake #10: Being afraid to share your idea.
Sherman says you can’t sell if you can’t tell. Get a non¬disclosure agreement that fits your project and use it. Investors not only expect to sign an NDA, they won’t respect you if you don’t give them one.
Mistake #11: Being dollar-wise and investor foolish.
Trick question: Which is the best alternative: a) $1 million from investors who know nothing about your industry; or b) $500,000 from investors who have industry background and contacts? Since the value of an investor relationship is usually more than cash, “b” is often the correct choice. Consider all forms of investor participation when evaluating an offer.
Mistake #12: Getting hung up on initial ownership and control.
Establishing ownership and control is where most investment negotiations break down. Here’s a handy rule: He who has the gold makes the rules, which usually includes control. Business founders are typically better served focusing more on the investor exit plan and less on initial control.
Accomplishing a successful investor relationship requires thoughtful preparation plus skillful negotiation.
By Jim Blasingame, author of the award winning book The Age of the Customer: Prepare for the Moment of Relevance. Full Bio