Strategic Fundraising for Startup Companies Part I

Almost every company goes through it, except for the fortunate few. Some people have gone through it multiple times. While never easy, raising money for the second or third time (assuming success the first time!) is a picnic, compared to the first time.

The questions that run through an entrepreneur's mind are nearly endless. Do I even need the money? Is my company fundable, regardless? How much do I need? How much should I try to raise? What's the best time to start raising money? What type of investor should I approach, and what are their expectations? How should I go about approaching them?

I could fill up the rest of a page with salient questions an entrepreneur might have. This might be the most daunting process in the minefield of difficult steps to forming and building a winning high tech company.

So you're a new entrepreneur, with a great idea, a prototype, and a vague notion that you might need to raise some capital. Where do you go from here?

NO COOKBOOK FORMULA

Well, like most things that really matter, there's no easy answer. It depends on what type of company you're trying to build, your own control and risk/reward mentality, as well as the dynamics of your market.

For discussion purposes, I'll focus on an embryonic software company. Most of the discussion will be just as relevant to a later stage business, or an early stage manufacturing business. In a manufacturing business, you'll need to raise more money to fund manufacturing in the ramp-up phase. But the initial fund-raising is very similar.

FUNDRAISING BASICS

First of all, let's quickly cover the various categories of capital sources. There are many variations and shades of gray with respect to funding sources, but the following are representative of the basic categories available to new software companies:

1) Self-funding
2) Friends & Family
3) Angel Investors
4) Venture Capital
5) Strategic Partners

Hopefully, these categories are pretty self-explanatory. Next, let's look at what TYPE of company the entrepreneur is trying to build:

A) Lifestyle Company
B) Solid Single
C) Home Run

A Lifestyle company is one in which you are often intermixing your personal life with your company life. There may be family members involved in the business, your write-offs and accounting are more aggressively aimed at reducing taxes than showing profits, and you aren't interested in or planning to sell the company anytime soon. Solid Singles and Home Runs are similar to each other; the major difference is market size/opportunity.

Lastly, let's talk about what outside investors look for in a fundable venture:

I) Management
II) Market size/opportunity
III) Defensible differential advantage

The three items listed above are all crucial, but they aren't equal in importance. Professional investors look for strong management teams, but if there are holes in the current team, it isn't necessarily fatal for many investors. They're happy to help you fill out the team. Many, in fact, prefer it this way. But having a large market opportunity and strong differential advantage are non-negotiable in the eyes of investors. They are looking for big returns. It's a long-held view among institutional investors that their own management time is the limiting factor in their own business. As a result, they don't feel they can afford to invest in "solid little businesses". If you don't stack up as having big potential in both of these key areas, almost every professional investor will take a pass.

YOU HAVE TO LIVE WITH THEM, TOO

Another important consideration that many entrepreneurs fail to consider is how well potential investors fit with the company's management. Management teams are often so focused on "getting the money" that they fail to consider that you "have to live with them", as well. It's a bit like getting married. You may be thrilled to attract the most prestigious investor (like the best looking potential spouse), but end up with business philosophy and personal conflicts that severely retard the company's development. This isn't a used car transaction, where the sale is made and the parties walk away. You and your investors are now intertwined, but may or may not have the same interests.

So ask yourself: Is this a good match?

Are you seeking a "hands off" investor, or someone that will get involved with the details--providing business guidance and contacts--for better or for worse? Many VCs, for example, have successful business backgrounds and networks that can make them invaluable as advisors. There's another group, however, that don't have the background or skills to run a company. Yet their arrogance leads them to believe they are eminently qualified to drive even the most strategic of decisions. Are they going to be so involved that it will take up much of your scarce management time that is needed to build the business? On the other hand, are the investors so busy that you won't be able to get their attention when you need them? Which type do you want on YOUR board?

It's true that the money that you raise is a commodity--but the people relationships that come along with it can make or break your company. Early stage fundraising, taken as a whole, is NOT a commodity function.