Startup funding is perhaps the greatest challenge to new companies. Startup companies are faced with many challenges, and one of these are securing funding. Securing and managing funding can be one of the most exciting – and nerve-wracking – parts of being an entrepreneur. Often, the financial and legal implications may seem overwhelming. But don’t be afraid. You don’t need to be a lawyer or a Financial Guru to negotiate a good funding deal. But you do have to be smart – and careful. Avoid these 8 start-up funding mistakes at all costs:
Mistake #1: Having an unrealistic valuation of your startup company
Overestimating your business’s earning potential will not only damage your credibility with funders, but it may also have consequences down the line. I love the following quote by Warren Buffett as it sums up my feelings on business value in a nutshell:
Price is what you pay, value is what you get.
When dealing with potential investors, don’t signal short-term greed and pride while investors want you to be signaling that you’ll prioritise the company’s success over your personal desires and ego. The startup game is a risky business, and for many entrepreneurs navigating the competitive landscape and securing the funding needed to survive is a significant hurdle that isn’t easily overcome. The truth is, there is a limited amount of funding available to startup founders and innumerable new ventures born every day that will be competing for it. Investors simply can’t open their wallets for every good idea that walks through their door. The ones that do secure funding, are the ones that have demonstrated how that good idea will actually come to fruition.
Mistake #2: Underestimating how much you need as a startup
A tenet among investors is, “When it comes to building your business, things always take twice as long as you think, and cost twice as much money.” You don’t want to run out of money too soon, and be at the mercy of investors. This is often how down rounds occur. So be sure you give yourself a healthy amount of padding in your initial ask, so you can be ready for the unexpected. Entrepreneurs looking for investor funding often fail to realise that all money comes with strings.
For example, if you have watched the Shark Tank TV series, you probably noticed that the Sharks always ask the entrepreneurs for their intended “use of funds.” Those who respond with one of the wrong answers, such as “I want to pay myself a salary,” usually go home empty-handed.
You may think this question is just an artefact of good television, but let me assure you that in my experience, it’s a standard “make or break” inquiry posed to every entrepreneur. Here are some guidelines that will help you with the right answers, not only in closing your next investment but in planning when and how much money to ask for:
- Investors are most interested in helping you scale the business. That means they normally only invest in startups with a working product that has already been sold to at least one customer for full price (beta tests, giveaways and best friends don’t count). They are willing to cover marketing, inventory and scaling, but not product development.
- Make your focus and priorities clear. A long list of everyday expenses is not helpful here. I recommend that you simplify your use to no more than three items or categories, with a per cent allocation to each. An example might be 30 per cent for marketing, 30 per cent for inventory and 40 per cent for staffing. Have backup charts for investors wanting more detail.
- Funding for founder salaries at this stage is a red flag. Investors expect you to “bet on the future” with them. You may pay salaries to your team, but your salary should come from earnings when they occur. Taking your cut before earnings exist implies that you are not willing to take the same risk of no return, as you are asking of investors (You must put your ‘own money where your mouth is’).
- Make sure allocation amounts are reasonable. These days, even viral marketing requires real money, for events and promotions. Startups whose marketing budget is trivial lose credibility and most likely the investment. Conversely, a huge marketing budget implies an intent to “spray and pray,” in hopes that something works.
- Use of funds must be tied to projected cash flow negatives. If you ask for 10 Million Rand, your financial projections better show a negative cash flow approximating that number (with a 20 per cent buffer). Investors are not interested in giving you money to keep in the bank for backup, for investing in real estate or a fancy new car. If you want the money, you have to use the money!
- Tie use of funds to real traction milestones. A valid milestone might be closing a specific big-name customer or channel, such as Pick ‘n Pay, or it might mean getting your first 100,000 social-media followers, by a given target date. Building a huge inventory before you have a confirmed customer is not a convincing strategy. Moreover, why would anyone want to tie up their cash in inventory with no assurance that the inventory will sell to yield sales?!
Mistake #3: Not having a third-party review your contract
You may not need to be a lawyer, accountant, or Business Plan Consultant, but that doesn’t mean you shouldn’t talk to one. Many entrepreneurs become overeager to secure funding, and agree to a funding deal too quickly. When this happens, the deal may be more favourable to the lender, or not a good fit for the business. Also, entrepreneurs tend to overlook negative contingencies on the front end, such as business failure. A good lawyer especially will ensure you are protected in all sorts of circumstances.
Mistake #4: Being unwilling to sacrifice and contribute some of your own money
Giving up equity or taking on debt isn’t always a big of a step backwards as many people think. Naturally, you don’t want to give up too much, but you’ve got to put some skin in the game.
- Your market. How much money is out there?
- Your potential success. First time or inexperienced entrepreneurs may have to give up more, especially if they are not in an incubator.
- Your team. Having a cadre of experts may mean funders will be at less risk, and therefore they will be willing to compromise.
Mistake #5: Not considering “unsexy” funding options
Innovative sources of startup funding are emerging all the time. But sometimes, new funding sources such as crowdfunding are unreliable. Some new entrepreneurs see debt as something to be avoided at all costs. But in reality, debt is one of the cheapest (lowest cost of capital) ways of raising money (equity is the most expensive). Additionally, one good aspect of debt is that it’s predictable, and predictability is required for planning.
Mistake #6: Choosing the wrong investors
Equity investors aren’t just piggy banks. They’re people with diverse interests and skillsets. Choosing the wrong ones can pull your business in a bad direction. Look for investors that will be strong partners in the long-term. When considering investors, ask the following questions:
- Do they have professional skill sets that I can tap?
- Do they have experience in my industry?
- Can they make valuable connections?
- What are their personalities? Are they overbearing, stand-offish, philanthropic?
Mistake #7: Being too secretive
Protecting your intellectual property doesn’t mean wearing a tinfoil hat and passing out Non-Disclosure Agreements to everyone you meet. Not only can this behaviour lose credibility with funders, but it can also hide important details from people that can help you. Remember: In the entrepreneurial world, ideas are cheap. It’s your ability to execute that funders are interested in.
Mistake #8: Not documenting everything
The devil is in the details, so make sure you have all your details in writing. One common documentation mistake is not recording contributions to your business from third parties. This could result in legal trouble. Be sure to execute agreements from any funds taken from third parties, including friends and families. Another documentation mistake is not recording contributions from yourself. If you take R1,000 out of your pocket for a business expense, make a record. This way, you’ll be able to write off losses easier, if necessary.
When seeking startup funding, it’s good to keep your eye on the prize. But don’t forget about the pitfalls, either. Be smart, take 20 to 40 hours to educate yourself on finance, and use all the outside help you can. That way, you can focus more time on growing your business.
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