“Show me the money”-Investor Dilemmas

20131121_081754-2

Sacristain

People sing about it, write about, marry over it, divorce over it, lose friends over it, take a job because of it, leave a job because of it and some even end up in jail over it. Money-Money-Money! This is one of the biggest dilemmas that a founder will face with his or her startup. Where to get it? Who to get it from? What are the costs and risks of where the capital comes from? How will the source of the capital change relationships now and down the road? But, it is not just the founder with dilemmas–there are dilemmas for the investor(s) too. The investment needs to be structured in a way that reduces the risk for the investor. (Wasserman)

It is important to look at the different avenues to raise capital and their benefits and costs. Similar to hiring, the decisions made on how the startup is funded can have an impact on the future growth and the control of the business. There are two ways to fund the startup: self-funding or investors. Investors could be friends and family, angel investors, or venture capitalists.

Self-funding would be any and all savings that the founder has accumulated and is ready to put into the business. In Wasserman’s research, 77% of founding teams committed seed capital in the beginning, but they run out fast. (Wasserman) At that point or even in the beginning the founder may choose to go to friends and family. Some of these people may be your biggest cheerleaders and want to back the idea. It is good to ask if it is a wise decision for them to invest with you. If the business does not succeed and they do not get back their investment, will the relationship suffer? Also, if friends and family give capital but have no knowledge of your business, they may not be able to provide any of the social or human capital that is necessary for the startup. That may or may not be important. The opinions on this seem to range from “take it — you have to start somewhere” to “only as a last resort.” Similar to hiring friends and family, this needs careful deliberation and thought before accepting.

Angel investors are another option for founders. Angel investors do not necessarily know the founder and oftentimes are investors before the venture capitalists get involved. Whereas friends and family may want to help a founder get off the ground, an angel investor’s motivations range from mentoring startups to helping build the next generation of companies. Angel investors also are more financially driven. (Wasserman) Their interactions with the founder and company are also different. They usually bring social and human capital because of their previous business experience. At the beginning they may counsel as well as sit on the board of the company. Their investments are smaller than venture capitalists, which decrease their risk. They do have risk because they are willing to invest in a variety of industries and if they don’t do their due diligence, there presumably will be costs and losses to them down the road if the startup fails.

When I was reading about the last type of investors, venture capitalists, they scared me. Perhaps it was my imagination of a group of people sitting around a huge conference table deciding about a founder’s future with only the thought of how much money they could make off his/her idea. I recognize that these are professional investors whose main job is to focus all their time and energies on investing in high potential startups. Maybe it was the quote from Mark Suster — “The auto industry is $1.6 billion, and you want to f*ck with bars and restaurants?” — that made me feel like I am out of my league.

Do we all have to be in billion dollar industries? I know they eat at Google and Microsoft. When I worked in Seattle I used to make pastries that were delivered to Microsoft five days a week. I digress, back to the VCs.

Venture capitalists make much larger investments than angel investors. They also invest in fewer businesses because of their large investments. What the founder needs to be well aware of when taking capital from venture capitalists is that they expect a return on investment and, therefore, will be quite involved with the company. Like angel investors, they may offer not only counsel, but perhaps their own CEOs or CFOs depending upon their investments. They will definitely have a seat(s) on the board. If they continue to invest, the founder’s equity share will diminish and some of the control may also be given up.

Richard Harroch, a Venture Capitalist says “It’s almost always harder to raise capital than you thought it would be, and it always takes longer. So plan for that.” Recently Bill Gates was named the wealthiest American for the 23rd year in a row. I know that he and the others on that list would have no trouble finding capital for a startup. Unfortunately, for many of us it will be harder and take longer. Just remember that Bill Gates and Paul Allen had a vision and a belief back in 1975 and they, too, had to find capital. Who is to say that in another 41 years someone might not see your name on the Forbes list because of your vision and belief?

Resources and Links:
Wasserman, Noam The Founder’s Dilemmas. New Jersey: Princeton UP, 2012.

“The startup dilemma – cracking the code.” Sanjay Modi, Yourstory.com, 2016

Web 24 Apr. 2016
“The Social Entrepreneur’s Dilemma.” Rohan Potdar, Startupgrind.com, 2015
“11 Candid Truths About Entrepreneurship From VC Mark Suster.” Businessinsider.com, 2011.
Web. 6 Apr. 2011.

 

 

 

2 thoughts on ““Show me the money”-Investor Dilemmas

  1. You make a great point with how friends and family may not be able to provide any social or human capital that is necessary for a new startup. I think friends and family are a great source of capital during the startup phase, but only as a one-time investment to be paid back as soon as possible. Mixing family and business is always a risky judgment call. It could also prove to be a very wise choice depending on their level of venture capitalist experience, which may lead to more familiar networking opportunities!

    Trevor Hollis Ottaway

Leave a Reply