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.
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
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.
About Carol Roth
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.
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