Newbie entrepreneurs with their first “million dollar idea” for starting a new business are often cash-strapped. This frequently makes third party startup funding a misplaced top priority.
Pretotyping Not Payola
As a practical matter, the first issue should be validating whether or not your idea is worth pursuing.
For the aspiring entrepreneur with a limited budget, your first investment should be buying and reading “Pretotype It: Make sure you are building The Right It before you build It right” by Alberto Savoia.
Even if you’re convinced everyone needs what you plan to build, save your time, money, and energy by testing that theory through applying the tactics described in Savoia’s book at little or no cost.
According to Texas Business Lawyer Mike Young, if there’s no market ready, willing, and able to pay for what you have in mind, it’s time to regroup before trying to fundraise for a startup no one wants.
After you’ve proven there’s a sufficiently profitable market by pretotyping, only then is it time to consider how you’ll fund the next steps for your startup.
Your Own Money
Before approaching friends, family, or third parties to raise capital, look at your own assets. If you’re not willing to risk part of your assets, why should anyone else?
That being said, think twice before looting a retirement plan (e.g. IRA or 401k) for your new venture. This is particularly true the older you get with limited time to make up any losses before retirement.
If you can’t afford the down side of a 100% loss of the funds, you shouldn’t be using them in your business.
Don’t go into debt to fund your company. Mortgaging your house or running up credit cards rarely results in business success because it creates a sense of desperation that leads to very bad business decisions when debt payments come due but money is tight.
Business Bank Loans For Startup Funding
Unless you have significant assets to use as collateral or a proven track record of building successful companies, banks are unlikely to give you the time of day for a business loan. In other words, banks are rarely interested in loaning money for startups unless you really don’t need their money in the first place.
Friends and Family Startup Funding
Want to ruin a good friendship or having family members never speak to you again?
Borrow money from them or sell them equity in your new venture.
If you insist on doing it, make sure the loan is done in writing (e.g. promissory note), collateral given if requested, etc. And honor the repayment terms of the debt.
Be careful when fundraising from acquaintances, such as co-workers or friends of friends.
Because there are federal and state securities laws that must be obeyed if you’re offering equity in exchange for startup capital. The regulatory compliance costs often exceed the amount you’re able to raise by this method…and these people are likely to sue you if your company goes bust and they lose their money.
Angel Investors and Venture Capitalists
Although some angel investors are adrenaline junkies who invest primarily for the rush of being involved with a startup, you should assume both angel investors and venture capitalists are solely interested in a high monetary return on investment (ROI) with the ability to cash out on their terms.
If you are one of the “lucky” few to get this type of funding, understand there are many strings attached.
One of the primary strings invariably is control. To protect their investment, they will throw you out of your own company if you fail to deliver to expectations. These investors don’t assume every investment will pay off. However, they show little tolerance for founders who drop the ball through laziness, incompetence, etc.
If your primary reason for starting a new company is to work for yourself, giving up a large chunk of equity and expecting to run things as directed by your investors is a recipe for disaster. You can’t fight those who control the purse strings and expect to win, particularly when they’re in the business of making money from your efforts.
Despite the hype given in the media, your new venture is unlikely to become the next Google, Uber, Amazon, etc.
After testing the concept through pretotyping, if you decide to proceed, seriously consider a model where the business’ incoming revenues fund its growth rather than incurring debt or giving up equity.
And if your startup does have the potential to be the next billion dollar unicorn, investors will be knocking at your door rather than you begging for help when starting a new business.
What if you need a serious injection of capital for the startup because of the nature of your new widget is technology that requires hundreds of thousands or even a couple million dollars just to get off the ground?
If pretotyping shows there’s a hot demand for your idea, consider using a crowd funding site like Kickstarter or Indiegogo to get the money you need. Just understand there are strings attached to this startup funding too. Whatever you promise to those who crowd fund your company, be prepared to deliver.