Understanding who your investors are
– In order to raise capital successfully, I think it’s important to understand who investors are and what they’re looking for when they review business plans. I, of course, won’t be trying here to give you a one line description that will cover all the types of investorsgiven that each person is unique and has his or her own objectives and way of thinking. There are, though, common traits to many of them which every entrepreneur would be wise to take into consideration. The first thing is that despite whatpeople usually think, most investors are or were successful entrepreneurs or had a very high-profile job in a large organization.
Many of them have been in your shoes starting projects, raising capital, and they know exactly what you’re going through. They also know what it takes tobeing a successful entrepreneur. I won’t list here the qualities required to start or run a business. There are many other courses in the lynda.com library on that topic. They also have seen their share of businessesthat failed, and are weary of business plans that are too optimistic and have entrepreneurs who are too confident and not ready to hear their feedback.
Their feedback is very valuable because investors usually have a great deal of experience starting a business and raising funds. You should definitely hear what they have to say. You could be saving tons of time and blunders by listening to and implementing their feedback. There is one thing they all have in common. They invest in your business to make money, which means getting more money down the road than they have invested at the beginning. And they will not be looking only at your revenue projection, which was sure to be optimistic, but also at what you’re going to spend the money on and when you’ll spend it, because those are elements of your business that you can play with and secure and maximize return on investment.
Investors all have their unique characteristics and goals, but remember to keep the investor’s point of view in mind as you’re pitching your project or idea to them.
Estimating the capital you need
– Before you even start meeting with investors, you need to have the answer to this key question: How much capital do I actually need? To answer that question, you actually need to have a very good understanding of how your company is going to make money, how it’s going to acquire and retain customers, how much up-front investment is required,how much day-to-day expenses you will have, any investments you need to make along the way, how fast you’ll start seeing your first dollar coming in, and last, how long will it take for your customers to pay you once you made those sales? With answers to those questions, and some simple math, you should be able to come up with an answer.
A good place to start is with the course Making Business Projections in the lynda.com library. This course takes you through the details of making financial projections and estimating how much capital you need. One thing you need to keep in mind, though, is that you’re going to need much more than your initial investment. Apart from the original investment, there are two things that weigh heavily on your capital needs. The first one is the salaries you have to pay, including yours. The second one is the time it will take to sign your first customer and get paid.
If you already have a customer, that’s a great way forward and a great way to reduce your capital needs.
The big four sources of capital
– There are four big sources of capital within which we can full all the usual sources we know such as crowdfunding, venture capital, business angels, loans and so on. The sources are the following: Your own money, money coming from the operations of your company, debt, and equity. Let’s look at each one of those in detail. Let’s start with your own money. The first question we need to answer is, why are we talking about your money, when in the first place you’re following this course to understand what other sources of money there are? There are three reasons why we need to talk about your money.
The first reason is that we talk about your money, we talk about any money you can get through your own means, or can get from your family. So in that sense, it is money that you will have to ask for just as you would do with investors you don’t know. The second reason is that you have to put your money into the project if you want to have credibility when meeting with investors. If you don’t put your money into your project, then how can you expect anyone else to put any money as well? How can you convince anyone if you have not convinced yourself? The third reason is that many entrepreneurs don’t pay themselves for a few months and when they can afford it, it can even last for more than a year.
And in that sense, since they have to pay their personal expenses with their savings for example, you can consider that it’s just the same as investing money into the company and using it as a salary. So if you work for your own company and don’t pay yourself any salary or just a very small one and need to compensate with your savings for example, then you can consider you’re investing money into your business. Another great source of capital is the operations of your company. In short, if your company generates a profit, you can use that profit to fund your business and therefore, need less money from outside investors.
Many entrepreneurs start their company when they found their first customer and can therefore dramatically reduce their capital needs. So the key idea is to keep in mind here that the earlier your company turns a profit and the less capital you will need. Next in line are the debts. Usually, people don’t like to have debts. But for a company when you can afford it, it’s a great way to find capital without having investors interfering with your business decisions.Contrary to the equity option that we will see in a minute, with debt, it’s just like the regular loan you can get for your personal needs.
You know upfront how much you get and how much you would pay back. Therefore, there are no surprises.The downside is that you have to start paying back from almost day one which will weigh heavily on your finances. So, the more you rely on debt, the more you have to generate revenue fast and in sufficient quantity to pay those monthly repayments. The next big source of capital is equity. Equity means selling share from your company in exchange for the capital you are looking for.
You could for example, sell 40% of your shares for one million dollars. You would then have the million dollars you need and will remain the owner of 60% of your company. The upside here is that there is no monthly repayment, and the investor is in the project with youfor good or bad. The downside is that since the investor is looking to make a big return on his investment, he will be participating to decisions you make, at least the key ones, and will have a say in your strategic choices.
The other downside is that you don’t know in advance how much money you will pay back for that investor money. The investor himself will be entitled to a portion of your profits and down the road it could add up to much more than you originally received from him. So, you’d better be sure that this money is really needed and that you are really getting a great deal.You’ll also want to make sure you have tried every other option before resorting to giving away your shares. Depending on your specific situation, you’ll have to consider tapping into one or more of the sources of capital.
Deciding which one to use and when is a strategy you’ll have to define.
Raising capital all at once or step by step
– One thing you could wonder, and rightfully so, is to know if you are better off raising all the capital you need in one go or doing it step by step. Let me guess, once would be better. Of course, most people would think that. Let’s imagine you’ve prepared your business plan and you know you need $100,000 to start your business. Then it just sounds logical to find that amount. And if you get it now, it’s even better,since you’ll be able to focus on your business and not raising capital every other week. The only thing here is not only do investors prefer to invest step by step, but it’s actually better for you.
Let’s take the example of raising capital through equity. Or in other words, the sale of shares of your company. Since you are selling shares of your company, then the higher the price of your shares,and the more money you will get. Said differently, the higher the price of your shares, and the less shares you have to give away for the amount of capital you’re looking to raise. So the higher price of your sharesand the better off you are. If your company is successful, which you definitely should be planning on, then as time will pass, the value of your company will increase.
Therefore, the value of your shares will increase as well. So technically, the more you wait before raising capital through equity, and the better deal you’re getting. The only problem is that sometimes you need money right away to get started. So instead of asking for all the money you need maybe you should only ask for a portion of it. Which would get you to give away less shares and will give you the time you needto raise the value of your company and sell some more shares. But much less than with the other raising-all-at-once plan.
So potentially, instead of raising one million dollarswith 40% of your shares, you could raise half a million dollars with 20% and later on, another half a million with only 10%. Or maybe even five percent. So in the end, getting the same one million dollars for 25% of your shares instead of 40. Let me tell you why investors prefer to do it by step, as well. First, and as we’ll see later on, some investors specialize in certain maturity levels for companies.
Some investors do seed investing, which focuses on real startups that are barely starting. Some in the development of startups that have proven that they have a profitable and sustainable business model. So some investors will be interested to do only a portion of the way with you and offering them the opportunity to invest in a single step will open more doors for you. Another reason is that your company will grow by stages. For example, there could be a product development phase which might not even generate any revenue and will focus on putting a product on the market.
Then it could be followed by a sales phase focused on getting a certain number of customers and becoming profitable. The third step could be a marketing onewith a focus on getting the world to recognize you so that at least some of the sales come from people or companies wanting to work with you. Some investors will be interested to work with you on only one of those phases. And sometimes bring with their capital, their skills and network which will help you grow the company. In short, investors like to invest by steps and they call those steps, “milestones.”
A common sequence of events
– There’s a common sequence of events to finding the capital you need for your company. I mean, after you have evaluated how much money you need and that you’ve done everything you could to make it the smallest amount possible. The common sequence is the following. First, fund as much as possible with your own money. Second, get as much loan money as your company can afford to carry. Third, get the rest of the capital you need through equity or in other words, the sale of shares. The logic behind the sequence of events is that as an entrepreneur you’re interested in maintaining as much as possible, control and ownership of your company.
As any entrepreneur in his right mind, when you have an awesome project, that you know you’ll be successful you’d rather split the profits with as few people as possible. That logic means that you would want to investigate every possible way to get the capital you need without sharing the ownership of the company at all if possible and as little as possible if there’s no other choice. Of course, in your particular situation you could consider that it’s well worth giving away a large portion of the ownership but you will be likely to reach that conclusion once you have done everything you can not to do it and ultimately decide to do so because that’s the most probable way of being successful at raising the capital you need and get your project going.
So, this sequence, first start with your own money and that includes any money that you won’t have to give back at all. It includes any savings you have, any money given to you by family members for example.The second step then is to secure one or more loans.The great thing about loans is that you know from the beginning how much it’s going to cost you and for how long. No one is going to interfere in your day-to-day management of the company.
The downside to loans is that you usually need to start repaying right away and that creates an obligation for your company from day one. You therefore need to grow your business as fast as possible to have the means to pay those loans. Once you have exhausted all of the above you’re pretty much left with finding investors those can come in many forms, such as Venture capitalists, or business Angel’s for example.They will lend you money and you won’t have to repay a dime in the short term but the flip side, is that they know own a piece of the company as well, and you therefore have to report back to them regularly, agree with them on key decisions, and of course split the profits once you have some.
This is the reason why it usually comes as the last option. Rare are those entrepreneurs who are looking to have a boss.