In the early days of a business, it’s common to spend a great deal of your time and energy trying to raise investment. Unfortunately, this is the stage when you can least afford to do so, as building your company will be demanding 100 per cent of your attention.
What can you do about this? The simple answer is, don’t try to raise investment yet. Grow the company organically in the early years, sacrificing growth possibly, but the upside is that you are not suffering massive dilution or losing control of your business.
For companies in some sectors, this approach will be easier than for others. For those of us in the software world, the real investment is intellectual horsepower, not expensive equipment or premises. But for nanotechnology or pharmaceutical start-ups, where a physical product needs to be prototyped, raising that early investment is often a necessity.
While I don’t have all the answers, I have taken my company Nimbus through four successful fundraising cycles. Of these four, we have only taken two rounds of investment. Twice we got to term sheets and decided it wasn’t right for the company, so pulled out. The key is knowing when investment is good for the business.
If you decide that you absolutely need investment, you’ll want to get it for the minimum effort at the best price. These are the best sources of capital, in order of their cost to the business.
Clients
Selling a product to a client is a double whammy. It generates money and it also builds a track record, so that when you do need to go to a VC you can raise money more easily at a better price.
Credit card
A number of businesses were started with a credit card cheque – expensive but quick and simple.
Bank loan
I believe the reason taxpayers invested heavily in buying (bailing out) banks was so they could continue to lend to businesses. Although early-stage ventures will still struggle to secure finance without the directors offering personal guarantees, there are government-backed schemes which reduce the risks for the banks to a level where they may consider lending.
The three Fs
Family, friends and fools, as they are traditionally known. These are the people closest to you who trust you and will support you in your new venture. They are less likely to be picky about the fine detail, the investment terms and the legal implications.
Venture debt
This is essentially a loan from a specialist lender which is prepared to accept higher levels of risk. But for that they will ask for an eye-wateringly high level of interest and a small percentage of stock – so not a long term funding route, but useful as bridging finance whilst you arrange VC investment or an exit. Venture debt providers often invest side-by-side with VCs.
Venture capital
This is what most people think of when they think about raising investment. Venture capitalists (or vulture capitalists, as they are often unfairly called) will invest cash in exchange for a stake in the company and whatever else they can get: interest, dividends, the founder’s recipe for Lemon Soufflé. They have invested as they are expecting the company to have a ‘liquidation event’ whereby they can sell their shares for three to five times the price they invested at. This event could be that a secondary investor buys them out or the company makes a trade sale or floats.
If you’re considering approaching a VC, it’s important to ask yourself why. The answer needs to be very clear, as it will be the most expensive money you will ever take, and you may regret it in years to come. The VC firm will be a partner and there is no option for the ’quickie divorce’ that seems so popular with celebrities. You are stuck with them and the terms you agreed. And if you want to change these terms, expect to pay for it – big time.
Also ask yourself if the funding is for product development, expansion or growth, an acquisition war chest or simply to strengthen the balance sheet. Will taking venture capital increase the credibility of the company, giving clients confidence in you and your product? If you’re simply looking for funding to pay yourself a salary, you might as well forget it.
In the second article in this series, Ian Gotts shares his experiences of raising venture capital.
