Startup School – The funding mindset – capital and partners: Lessons learned
If you know what you are doing and know how much capital you need, don’t move forward until you get it. If you can’t get it, drop the idea. If smart money will not fund you, there is a reason. Either the investors have already seen the model before (somebody is already in your space; the investors have invested in something similar and have lost money or prestige; they have looked at the dynamics and they don’t add up to a reasonable payoff in a reasonable time) or you are lacking what it will take to execute it. Sure, network and references play a role but ultimately a venture destined for profitability will find funding one way or another.
If venture capital won’t fund it, customers will; if customers won’t, your friendly neighborhood banker will. Interestingly enough, it may be counterintuitive, but finding funding is no guarantee of success.
For most entrepreneurs, capital is the initial or ongoing infusion of cash and is generally equal to equity. That is not always the case. Debt convertible into equity, straight debt, personal or family savings, profit reinvested in the business, deferred payments to employees and vendors, and customer down payments on work in progress are all sources of cash.
The last four sources are internal, relatively easier to generate and control compared to external sources, and have no strings attached. In the last 15 years they have been the most reliable and dependable sources of cash I have used or seen used. External sources have information and credibility problems attached which are difficult to address for first-time or fresh entrepreneurs. When they do attempt to solve these problems, the resulting effort and distraction is fatal for the business. A four-man team of fresh entrepreneurs with limited credentials focusing on signing customers will generate cash flows faster than the same team working on pitching business plans or loan applications to formal sources of capital. (Here formal sources include lenders, angel investors, venture capital funds, incubators, and similar institutions.)
When fortunate enough to receive a financing term sheet, entrepreneurs generally misunderstand what the term sheet and the concept of equity represent. Equity only has value if the venture is alive and solvent. As an entrepreneur, you need to solve a riddle maximizing two-dimensional equations. The first dimension is value to owner represented by percentage ownership, market value or fair value of your stake, and control; the second is probability of survival. To do well, you need to maximize the combined outcome of both dimensions. Most founders focus on one or the other but have difficulty tracking the interaction between the two. You can retain majority control and get no funding or you can get funding and ultimately relinquish control. Who you relinquish control to and what value they bring to the table in addition to their cash has a direct impact on the probability of your survival as a business or its owner. Combine the two and you can have a small slice of a fairly substantial exit or a full pie of nothing. Capital pricing is driven by market conditions and your access to capital. In a lender/borrower, investor/entrepreneur relationship end game, whoever has the upper hand in access to capital, wins. (If I was a betting man, I will not bet on the entrepreneur.)
Capital, irrespective of its shape or form, is not free. With capital comes partners; with partners come questions of allocation of ownership and equity. The allocation occurs on the basis of contribution of implied capital—ideas, services, network, relationships, or cash. In failed ventures, implied capital is often not contributed: Ideas are held back, services are not delivered, networks are locked away, relationships disintegrate, or cash infusions come too late.