Five Mistakes to Avoid When Raising Capital
by Peter Tilles
Human and financial capital is the fuel that allows businesses to aggressively pursue their objectives. However, without financial capital, all too often, businesses can find themselves treading water or sinking altogether due to an inability to invest in critical value creating activities.
Being forced to bootstrap for a while can be a good thing because it forces entrepreneurs to be creative and to focus on what is truly important to move the business forward. That said, there comes a point in almost any business’ lifecycle where the business cannot be propelled forward on human capital alone.
Whenever I have had the opportunity to work with early stage entrepreneurs there has been one universal constant – the need to raise financial capital. Having participated in both successful and unsuccessful capital raises, as well as having observed others who have been on both sides of the fence, here are some key mistakes to avoid when seeking to raise capital.
- Underestimating the amount of time and effort it will take to raise capital:
Depending on whether you are looking to raise capital from friends and family, angel investors or venture capital, the time to successfully navigate a capital raise will vary. At a minimum, assume that it will take six months and more likely it will take a year of nearly full time effort to network, write a business plan, get introductions to potential investors, pitch, address follow-ups, secure term sheets, support due diligence, negotiate and close a deal. Too often, entrepreneurs wait until they really need the money to commence the capital raising process resulting in a loss of negotiating leverage. The best time to look for money is when it is not desperately needed.
Additionally, it is not unreasonable to assume that you could need to contact well over 100 potential investors to end up with one who will ultimately invest. As a result, it is never too early to reach out to potential investors (see “When do I…?” by Lou Wagman).
- Not being able to communicate your business’ value proposition in 30 seconds or less, in a manner that even a third-grader can understand:
No one knows the businesses better than the entrepreneur. Every entrepreneur wants others, particularly investors, to see what they see and to understand why they believe their start-up venture is so valuable. At the same time, many of them have difficulty boiling down the core of their business value proposition to one or two phrases. When you live with your business everyday it is easy to lose the ability to see the forest through the trees.
Investors, especially in the current market environment, receive so many business plans that they cannot possibly review them all at a level of detail necessary to make informed judgments. As a result, they don’t even try. When you get the attention of an investor, at most, you will have it for a few minutes and more likely it will be only a few seconds. As such, it is critical to be able to communicate what your business does and its value proposition in 30 seconds or less. If you are successful in doing this, you will significantly increase your chances of attracting legitimate interest in your business from potential sources of financing.
- Telling an investor that you know the answer to a question you really don’t:
One of the bigger mistakes I have seen entrepreneurs make is to answer every possible question that is asked of them whether they know the answer or not. The problem with answering a question you don’t know the answer to is that if and when it does become apparent to the investor that you’re “spinning” it is nearly impossible to regain the lost credibility that results. There is absolutely nothing wrong with saying “I don’t know, but I will find out and get back to you on that”. I believe that investors look for realism and some measure of humility in their management teams. For them, it’s a red flag when that’s missing. - Failing to identify and pursue “strategic” investors:
When you raise capital from “strategic” investors, i.e., those who not only understand your business but who are also deeply ingrained and connected to your industry and target market, you get a lot more than just money. Strategic investors can be immensely valuable and function as a catalyst to help your business get traction and grow in your target market. Conversely, “non-strategic” investors who do not have the depth of contacts or understanding of your business expect to take on a role in your business that is at best focused on oversight and at worst passive. They can often become an impediment to long-term success since they don’t fully understand the implications of decisions you might make and tend to react to circumstances, particularly negative ones, through a filter that can be best described as “protecting their investment”. That can lead to sub-optimal outcomes for your business. - Failing to raise enough capital to sustain the business for at least 18 months, if not longer:
Ideally, entrepreneurs would like to lead their businesses to success without the injection of outside capital. When a capital infusion becomes necessary, entrepreneurs often think they will need to raise capital only once to get to a point where the business becomes self-sustaining. Unfortunately, that rarely happens. It is difficult to anticipate a whole host of external and internal factors, e.g., where the next revenue generating opportunity will come from, that will change the capital needs of the business over time. It is rare that the initial “go to market” strategy of a start-up survives for very long.
Most businesses have to adjust and adapt to changing market dynamics and conditions as they mature thus requiring maximum flexibility. As I mentioned earlier (#1 above), it can take up to a year to complete a successful capital raise. The entrepreneur, responsible for raising capital, ends up dedicating so much time to the task that their ability to focus on the job of running the business takes a back seat. That slows down overall progress towards critical milestones. It is very important that each time you make the necessary effort to raise capital, you raise enough to give yourself ample time before the next capital raise to be able to focus on growing your business.
Raising capital can be a daunting task. However, being able to succinctly communicate your business’ value proposition, engaging potential investors with a degree of humility, targeting appropriate “strategic” investors while anticipating both the amount of capital you will need and the amount of time it is likely to take will significantly enhance your chances of completing a successful capital raise.
