So if you bought the click-bait… now I͛ll start with Behavioural Economics. Really, it’s interesting (and allows me to get in my first ever academic footnote!).
In short, economists assume we all act rationally. Adding a bit of psychology, however, shows that people – yes, even venture capitalists – often don’t when making financial decisions.
The well-tested theory of Loss Aversion1 states that “the pain of a loss is greater than the pleasure of a gain” – in studies, possibly even twice greater. So the average person might risk a loss of $10 only if they stand to gain $20.
This isn’t just for my footnote, it relates to many common mistakes made by companies in trying to fundraise. What to focus on first? It’s, not just the upside:
- de-risk your company as an investment
- demonstrate you͛ve considered downside risk as much as showing off your billion-dollar potential
1. Raising money too early – or too late
Bootstrap your business. Use only your and your co-founders’ money for as long as you can.
Investors will (and should) expect you to show belief and commitment to the business – best demonstrated by real ͚skin in the game’. De-risk by proving that commitment, showing that your business can last and that you can manage your cashflow.
You want to be in charge and able to run with your idea until you really need others’ cash. And the earlier you go to outside investors the more equity you’ll need to give away: again, they take more risk, so demand more return and more share in the company.
Avoid even friend & family money as long as you can – also helps avoid potentially awkward Christmas dinners…
That said, do think often about when you will need funding. Another well-tested economic theory: everything takes twice as long and costs twice as much as you expect. You could be surprised how long it takes to get cash in your account – a few months? – and you have to cover payroll while you’re negotiating the term sheet.
2. Not raising enough
Cash is king. Businesses fail because they run out of cash. It͛s like saying “she died because she stopped breathing.”
But over 80% of small businesses who didn͛t make it say their issue was either (1) starting out with too little money or (2) poor cash flow management.
Your fundraising must be based on a realistic budget for say an 18-24 month runway – remembering everything takes twice as long and costs twice as much, etc. You should spell out what the funds will be spent on (and when), and be prepared to back those assumptions up.
Think about a “buffer”, so you’re not assuming break-even magically happens as you reach zero cash.
Again you de-risk for the investor by proving you͛ve thought hard and considered the potential timing and downside risks. Then with any luck, you can overdeliver – making them and others eager to participate in future rounds.
3. Too much “idea”, too little “team”
Let’s all agree you have a brilliant concept/widget/business model. That still won’t get you over the line – investors are as interested in the team that will put it into practice and manage the business.
Do you and your team have the experience (including sales, marketing, finance), the complementary skill sets, the contacts? Investors won͛t buy into the idea without trusting the team that can execute it.
Clearly, it won͛t all be salaried staff to begin. Having advisors on board for professional guidance is as valuable: just think seasoned accounting & finance consultants…
4. Having too many investors
Try to avoid a long cap table. A long list of investors can only make your life – and managing your business – more difficult.
Any investor adds to your stress and time pressures: they have expectations, they’ll want to see how you’re doing, they may demand a say in decision-making. They will likely come with differing expectations – cash returns vs growth, exit strategy and timing…
Communication becomes harder and more time-consuming; you have to give quality time to a long list of people. Decision-making can be slower and at worst risks being “by committee”.
All this takes your time and focuses away from building and running the business. That and the potential conflicts (between them, or you & them) can have devastating effects.
5. Not doing the paperwork
Make it formal, even –or especially – with co-founders and friends.
A VC manager told me recently that over a third of her 100+ investee companies had at least one founder leave. It͛s a possibility you have to face, and the only way to deal with it is to document what-if plans up-front. To quote Kanye (sorry): “We want prenup!”
Bringing in outside funders, whether professionals or family members, makes it even more important to ensure proper term sheets and shareholder agreements are in place to avoid future acrimony or potentially business-ending disputes.
This doesn’t necessarily mean paying hourly lawyers’ fees. You can even get templates online for free, or again find a friendly and competitive corporate finance advisor…