We’ve been sharing a series of blog posts and videos here about how an idea is just that: an idea, and how there are some basic, critical things a high-potential start-up technology company founder must do in order to make any idea worth having and building upon. The fact is, as I have said more colorfully in earlier points, most ideas are not very good. So a founder needs to be sure this idea is worth making it the most important thing in her life for the next months or years.
My fourth suggestion for the immediate post-idea step is: Decide Where You’re Going to Try to Get Money
The founding team of a high potential technology startup needs to think realistically about how the company is going to survive financially until revenue exceeds expenses.
In 77% of high potential startups, at least one founder contributes seed capital early in the life of the startup. This is great, and certainly a reflection of enthusiasm and motivation, but money tends to run out quickly at the early stage of such a startup. In startups that had not raised outside money, the median monthly burn rate – the amount of cash being used by the startup – is $75,000 per month, and the average startup is a little more than four months away from running out of cash. And needless to say, The less liquidity a startup has, the higher the chance that it will disband.
Plainly put, money buys time.
So where to get it?
The choices are:
- You and your fellow founders. (savings, credit cards, retirement accounts, home equity….)
- A bank.
- Friends and family.
- An angel.
- Venture capital firms.
Let’s dispense with bank funding right off the bat. Only about 2% of technology startups obtain a loan from a bank early in their life. This is because this sort of company has no collateral – no accounts receivable, no equipment or other capital assets.
And a VC firm, unless you’ve just cashed out and have a big name, is not an immediate option.
So you are down to where are you going to get cash. Do you dig really deep and put it in yourself, or do you try to get it from other folks?
And if you are going to go to others for money, the real question is, do you want dumb money or smart money?
It’s about “dumb money” and “smart money.”
Dumb money can come from people who aren’t dumb at all, like your Aunt Emma, who’s done really well in the stock market with her investing club, or from that CEO friend of your father’s who heard about what the kid is doing and liked what he heard because he read something about your industry space in the Wall Street Journal.
The usual good thing about dumb money is that the providers of dumb money aren’t going for as much of the equity of the company, if they want to structure it as an equity deal at all, and won’t feel like they have the right or expertise to stick their head into your affairs all the time.
The meaning of “dumb” in the phrase “dumb money,” though, is that it is likely you aren’t going to get access to any social capital, human capital or additional financial capital from dumb money. You are getting what you are getting – money, and probably not enough to take you very far.
This is not to say you shouldn’t take friends or family money. Part of me says, “Gosh, take it and run, even if it might make Thanksgiving a little awkward if your venture fails.” One commentator said that if a founder is willing to take money from friends and family it must mean that they really must have a good sense the thing is going to work.
But because of the personal relationship, it is “playing with fire.” It could stink if it goes south. Think of your mother or father in law. Wow.
Smarter money is “smart” because at the same time you getting the money, you are probably getting some amount of human capital and social capital as well.
The two general categories here are angels and venture capital. Let’s focus on the angel investor. An angel is generally someone who doesn’t know the founding team and is investing his or her own money at a slightly later time and who is more financially driven than a friend or family member.
An angel is also someone who might have more of a positive substantive impact on the venture than any normal friend or family member ever could.
- An angel might have a helpful role on the Board of your startup, keeping you accountable to all of your stakeholders, and offering excellent connections to customers and potential hires.
- A well-chosen angel might even introduce you to sources of larger funding.
- Maybe most importantly for the attention-deficited among us, an angel might keep you from going too far down the road with marginal ideas or flights of fancy.
- Angels participate in about 34% of later rounds in early stage companies, which means they often have a long-range vision for your company and an inclination to not just throw money at something that’s shiny.
Angel money is also harder to get. The statistics show that if you want to reach an angel investor, you will almost certainly get there by way of a common contact. 58% of startups with angel investment found their angels by an introduction by a mutual acquaintance. Only 7% got the angel by way of a cold business plan submission or cold call. So that’s another immediate action: start networking!
Smarter money leads to a number of good things, and a thing or two that a founding team won’t find so wonderful, namely dilution and unpleasant phone calls that cause anxiety in the middle of your Sunday picnic.
Let’s focus on dilution for a moment. Dilution is the process of being a smaller and smaller owner of your company as money comes in. Dilution is real. In and of itself, dilution is unpleasant, and it snowballs. At some point the gratitude for getting this money and for the affirmation of professional investors begins to recede in the distance.
So it puts the pressure on choosing the smartest smart money possible, to help make it worth the dilution.
The decision of whether you go after smart, intrusive and dilutive money is a now decision. It is completely tied up with
- how you spend the cash you have now,
- how much you pay your people (if at all),
- how you incentivize your hires and your founding team, and
- quite frankly how late you stay up at night leveraging and bootstrapping your most valuable personal asset, which is your time.
If your business model and burn rate are such that you know you will need to raise money, take action now to enable you to put that off as long as possible – unless you need access to some of those extra smarts sooner.