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2017

This is the second article of a three-part series on  capital-raising mistakes you can easily avoid.  If you missed the first post, can check it out here.

 

Mistake #5: Underestimating How Much Time it Takes to Raise Capital

Almost everything in business, particularly those things outside of your control, takes more time than you expect.  Raising capital is one of those things.  This is especially the case when raising money from individual investors.  Even when people tell you they are going to invest in your business, it is difficult to get them to write the check.  Getting people to part with their money is like trying to get food away from me when I am hungry; a tough task!

 

People will wait as long as possible to part with their “Benjamins.”  Just ask the federal government what percentage of tax returns get sent in at the last possible moment (on or around April 15th) and how many taxpayers file for an extension.  You may have to pry that investment check out of your investors’ hands.

 

Even with loans, documents need to be put together, processed, reviewed, put through bureaucratic processes and ultimately signed.  This takes time and lots of it.

 

How to avoid this mistake:

 

  • Take whatever timeframe you think is needed to raise capital and increase it by 50 to 100 percent.  If you have budgeted six months, it will probably take nine to twelve months (and if you are thinking one month, wake up, because you are dreaming).

 

 

Mistake #6: Assuming Your Business is Fundable by Sophisticated Investors

Most business models aren’t big enough to attract the attention of sophisticated investors like angels or venture capitalists.  These investors want to invest in businesses that have the ability to give them a 30% – 50% return (or sometimes higher) on their capital, on average, for every year they hold the investment.  They use this benchmark because they know a large percentage of their investments are going to fail (as most new businesses do) or be limited in the scope of their success, so they need the one that really succeeds to make up for the nine others that flop.  These investors also need a way to get their investment out of the business, so they expect that in some realistic timeframe (usually five to seven years) the business will be big enough to sell or to take public in an IPO.  30504271_s.jpg

 

Based on the above, there are many more venture capital firms focused on industries like technology, rather than consumer or service businesses.

 

This set of criteria means your business may not be a fit for an angel or venture capital investment.  Venture capital firms only fund a fraction of one percent of all businesses in the U.S. each year.  Sophisticated angels also fund a tiny portion of all businesses.

 

If you are one of the few that do have a business that meets the potential criteria of venture capitalists, it will still be tough to get funded.  Every venture capital firm gets hundreds to thousands of business plans submitted for review each year.  They dismiss most plans that aren’t introduced by someone they know and can vouch for them.  So, if you are not in the inner circle of the venture capital community (and if you need the money, you often aren’t), your plan may not even get a glance, even if your business has merit.

 

How to avoid this mistake:

 

  • Be realistic on whether you have a business model likely to scale quickly and be of interest to venture capitalists or sophisticated angel groups – if not, don’t waste your time going to them for funding and look elsewhere.
  • If you do have a plan that meets the above criteria, try to get an introduction through someone who has a relationship – spend time with your network seeing “who knows who,” as a direct introduction will keep you from the bottom of the business plan (or pitch deck) pile.

 

     Learn more about investors and your business: Why Investors Avoid “Ground Floor” Opportunities

     You can read more articles from Carol Roth by clicking here

 

Mistake #7: Taking Investments from “FFFs,” “DDLs” or “the Crowd” Lightly

If you don’t qualify for an investment from a sophisticated investor group, you may turn to folks who you know—friends, family and acquaintances—who may consider investing in your business.  Two acronyms are usually used to describe these investors: “FFFs- friends, family and fools” or “DDLs- doctors, dentists and lawyers”. These are generally people in your network who may have some extra cash lying around.

 

With technology, and the passing of the JOBS Act, you can raise money in various forms from strangers via crowdfunding.  For the purposes of this mistake, I am going to focus on investments vis-à-vis crowdfunding (not the kind that gets you a perk).

 

Typically, FFFs, DDLs and the Crowd don’t truly understand your business, but they invest either because they believe in you, they have some infatuation with your business idea or because of peer pressure (someone else is investing and they invest alongside them).  As investors, these people can become co-owners or lenders to your business.

 

Going to FFFs or DDLs is challenging.  It is hard to ask people you care about or who are in your social circle to give you money.  Once you accept it, you make a deal with the devil of sorts, because now your relationship with this person has gone from its existing form to also being business partners.  Sometimes you will have to make decisions for the sake of the business that will not make your friends and family happy.  This makes for some seriously uncomfortable future interactions.

 

Because they don’t work with you on a daily basis and yet, you are using their money, your FFFs/DDLs may now:

 

  • Want to get updates on a regular basis
  • Want to put in their two cents worth of ideas (e.g. telling you, “don’t you think the store would look so much better with a singing plastic fish on the wall”?)
  • Want to come and hang out at your office or place of business
  • Demand free or discounted products and services
  • Ask you to employ their lazy cousin Nick, or
  • Ask you for a million favors in return

 

You will have to answer to these people, who are now your co-owners or lenders and therefore, people you can’t ignore.  These people, based on their lack of business sophistication, can take up a lot of your time at best, and at worst, will make demands from you and the business.

 

How to avoid this mistake:

 

  • Think about both the pros and cons of taking an investment from a friend, family member or acquaintance.
  • Make sure you don’t take any money from someone you have a relationship with that cannot afford to lose 100% of the investment.
  • Make sure that you discuss the implications on your relationship with the other party if the investment is lost in whole or in part and decide if the relationship can endure if a problem occurs.
  • Think once again if you can handle an awkward birthday party or family dinner if things don’t pan out as planned.

 

 

Mistake #8: Not Achieving Milestones First

Everyone thinks they have a great idea for a business and many try to raise money for their business idea.  However, a serious letdown about businesses is that the ideas behind them aren’t worth anything (see my previous article on this subject here).

 

Ideas may have had some value back in the day when there were very few businesses in any given sector.  Now that almost everything has already been thought of, not only is it hard to be innovative, but extracting value comes from executing your thoughts into reality.

 

You have to invest time, money and effort to achieve key milestones, such as developing a technology or securing purchase orders, before you raise capital.

 

The more you do, the more value and credibility you create.  Investors really don’t like to take risks.  The more milestones you have achieved, the less risk for the investor. Plus, you will have more confidence in the success of your business.

 

How to avoid this mistake:

 

  • Focus on achieving milestones – get past the idea stage by building a working prototype, landing paying customers or filing defensible patents, to create value.

 

Be sure to check back soon for my final post on capital raising mistakes to avoid.

 

Related Content:

 

About Carol Roth

Carol Roth Headshot for post.png

Carol Roth is the creator of the Future File ® legacy planning system, “recovering” investment banker, billion-dollar dealmaker, investor, entrepreneur, national media personality and author of the New York Times bestselling book, The Entrepreneur Equation. She is a judge on the Mark Burnett-produced technology competition show, America’s Greatest Makers and TV host and contributor, including host of Microsoft’s Office Small Business Academy. She is also an advisor to companies ranging from startups to major multi-national corporations and has an action figure made in her own likeness.

 

Web: www.CarolRoth.com or Twitter: @CarolJSRoth.

You can read more articles from Carol Roth by clicking here

 

Bank of America, N.A. engages with Carol Roth to provide informational materials for your discussion or review purposes only. Carol Roth is a registered trademark, used pursuant to license. The third parties within articles are used under license from Carol Roth. Consult your financial, legal and accounting advisors, as neither Bank of America, its affiliates, nor their employees provide legal, accounting and tax advice.

Raising capital for businesses is hard and often misunderstood.  As a “recovering” investment banker, I have helped my clients raise 10-figures in capital over the past 15 years, and have witnessed many individuals who failed to present a compelling, fundable story about their businesses (and themselves).

 

In my unscientific but thorough poll of entrepreneurs, 99% rank raising capital amongst their five least favorite business activities. Hopefully, I can help make sense of the capital-raising process to make it more tolerable – and valuable – for you.

 

To start this three-part series on raising capital, I’ll focus on the key mistakes you must avoid to save time, money and energy while increasing your chances of success when raising money for your business.

 

Mistake #1: Putting all Your Eggs in One Basket

 

The very first capital raising mistake relates to not raising outside capital at all.  Statistics show that the typical start-up business in the U.S. is self-funded from the entrepreneur’s own savings and supplemented with some personal credit card debt.  However, part of balancing risks and rewards is using diversification.

 

It is important for you as an entrepreneur to show your commitment to your business by investing some of your own capital.  This is a safeguard to ensure that you are incentivized to do everything you can to make the business successful.  However, if you are putting every last dime into your business, all of your eggs will be in that one darn basket.

 

How to avoid this mistake:

 

  • Don’t bet the farm on your business.
  • If you don’t have enough money to live on and invest in your business, then: (I) wait until you have more money saved, (II) see if you can revise your budget or (III) consider taking outside capital.

 

Mistake #2: Undercapitalizing Your Business40556715_s.jpg

 

A large percentage of businesses close because they don’t have enough money to survive the rocky first couple of years of business.

 

I have found that early-stage and new business owners underestimate the cost of starting and running the business virtually every time (usually by a factor of 3).

 

In each early stage business I have seen, entrepreneurs say their financial projections are conservative in terms of revenue and expenses (and then I roll my eyes).  They also tend to claim they are raising more money than they need so they have a cushion. When I tell them that their projections, as with all entrepreneurs’ financial projections, are too aggressive, they lecture me about why they are the “exception to the rule.”  Then, a year later, after revenue estimates fall short and expenses were greater than expected, they give me the reasons why they missed their projections.

 

There has yet to be an exception to this in my personal experience.  Note: seasoned investors know this and it is why they always take a “haircut” to the projections; they assume that they are overstated on the revenue line and/or understated on the expense line when they evaluate investments.

 

Another issue arises when you don’t raise enough capital upfront and you start to run out of money.  It is much more difficult—often impossible—to secure capital to stay afloat when things aren’t going so well.

 

How to avoid this mistake:

 

  • Do yourself a favor when you do your projections: Revise them so the amount of money you actually need is three times the amount you originally planned.  If you think you need $10,000, you really need $30,000.  If you think you need $1 million, you probably need around $3 million.

 

Mistake #3: Not Understanding Valuation

 

When you raise money for your business, you are usually dealing with one of two types of capital: equity, where you give up an ownership stake in your business, or debt, where you can take on an obligation for your business that you agree to pay back instead of giving up ownership.

 

There are hybrid scenarios that incorporate both equity and debt (as well as options and warrants), but at a basic level, you need to at least understand equity and debt.  If you raise equity, you end up setting a value for your business, which is based on the stage of your business, the milestones you have reached and the ultimate potential of your business.

 

However, many entrepreneurs don’t understand valuation.  Imagine that your business is symbolized initially by a small pie. You have 100% of the pie and then you give up a slice (or percentage) of that pie in exchange for equity capital.  The hope is that in the future, your business becomes a huge pie, so that even though other people have pieces of the pie, your piece is bigger than when you owned 100% of the small pie (i.e. your stake is worth more in terms of absolute dollars).

 

Often, entrepreneurs don’t understand how the pie works.  They will say that they have a business idea and that they need to raise $200,000.  Then arbitrarily, they will decide that they only want to give up 10% of the equity. However, that establishes a value for the business (and a big one!).  If 10% of the pie is worth $200,000, then 100% of the pie (the whole pie) is worth $2 million!  That $2 million number includes the $200,000 in cash the investor is giving you, so that means before you raise any money, you value your company at $1.8 million ($2 million minus $200,000).

 

Most established small businesses aren’t worth $1.8 million dollars, let alone a brand-new business.

 

Setting unrealistic valuations can increase the amount of time it takes for you to raise capital, prevent you from raising money altogether and create credibility issues for you as an entrepreneur.  Even if you can find a fool to invest at your crazy valuation, beware: You may have to raise capital again in the future and having a silly upfront valuation can impede your ability to raise capital in the future (again, credibility issues). It can also damage the relationship with your investor who is now, in effect, your business partner.

 

How to avoid this mistake:

 

  • Make sure you understand what you are implying in terms of valuation – if you need help, ask a professional.
  • Think carefully about the pros and cons of a high valuation, even if you can get one.
  • Consider an investment structure using debt that either doesn’t require you to set a business valuation or sets one in the future based on achieved metrics and benchmarks.

 

Mistake #4: Being Greedy

 

Let’s say there is a treasure chest of gold located several hundred miles away from your house. If you are the first to get to the treasure chest, you can claim it as yours.  The problem is that you don’t have a car.  You could walk or ride your bike, but by the time you got there, someone else may have claimed the gold.   So, you ask a good friend if they can drive you to the gold and you will share some of it with them if you get there first.

 

In this analogy, the gold stands for the potential upside rewards of your business, and your friend with the car is the investor and investment capital, respectively, that you need to build your business  and reach the treasure chest.

 

So, how much do you give your “friend” for driving you there?  Now, many entrepreneurs take the stance, “well I came up with the idea,” and offer to give their friends a token amount, say 10%.  However, the reality is that you can’t get to the gold in enough time to claim it without your friend and his car.  So, what if you gave him 30%, 40% or even split it? There will still be enough value for it to be worth both of your whiles. True, the friend wouldn’t have known about the gold without you, but you can’t get there without the car.

 

Valuing a business is an art, not an exact science, and splitting hairs over percentage points is often missing the entire point!

 

How to avoid this mistake:

 

  • Other than understanding valuation implications (from Mistake #3), don’t get too caught up in the percentages that you give up for raising equity capital.  Capital is a necessary component of growing a business which is also a great deal of risk for the investor.
  • Be fair and realize that if the opportunity is large enough, there will be enough to go around for everyone – if not, then you should probably rethink the opportunity

 

Be sure to check back for my next post on capital-raising mistakes to avoid.

You can read more articles from Carol Roth by clicking here

 

Related Articles & Pages:

What is working capital – and why is it important?

 

Infographic: Building Credit for Your Small Business

Bank of America Small Business Financing, Loans & Funding

Tips on How to Finance Your New Business Venture

 

 

About Carol Roth

Carol Roth Headshot for post.png

Carol Roth is the creator of the Future File ® legacy planning system, “recovering” investment banker, billion-dollar dealmaker, investor, entrepreneur, national media personality and author of the New York Times bestselling book, The Entrepreneur Equation. She is a judge on the Mark Burnett-produced technology competition show, America’s Greatest Makers and TV host and contributor, including

host

of Microsoft’s Office Small Business Academy. She is also an advisor to companies ranging from startups to major multi-national corporations and has an action figure made in her own likeness.

 

Web: www.CarolRoth.com or Twitter: @CarolJSRoth.

You can read more articles from Carol Roth by clicking here

 

Bank of America, N.A. engages with Carol Roth to provide informational materials for your discussion or review purposes only. Carol Roth is a registered trademark, used pursuant to license. The third parties within articles are used under license from Carol Roth. Consult your financial, legal and accounting advisors, as neither Bank of America, its affiliates, nor their employees provide legal, accounting and tax advice.

 

Bank of America, N.A. Member FDIC.  ©2017 Bank of America Corporation

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