Fuel to the Fire

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To understand the differences between investors and entrepreneurs, think of your startup as a fire. It is the entrepreneur who decides to build a fire, gets the right resources in place by collecting kindling and firewood, and provides the initial spark.  Up until this point, investors are only spectators who watch you run around frantically to get the fire started, and occasionally lob opinions your way.  It’s only when you have the fire burning, and there’s potential to turn it into something much bigger, will an investor jump in to help.  Even when investors get involved, their main function is simply to add fuel to the fire.  By injecting additional capital, they can help you grow the fire faster and burn stronger.

To better understand an investor’s motivations and desires, it’s important to recognize that their main function is to add fuel to the fire.

Realizing that an investor’s main function is simply to add fuel to the fire, you’ll better understand their motivations and desires.  You’ll avoid making mistakes like asking for an investment when you’re not ready, or hoping to get more than capital.

Raise Enough to Get to Your Next Milestone

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Investors want to know specifically what you plan to spend their money on.  Rookie entrepreneurs have vague and confused answers that will leave them dead in the water.  Experienced entrepreneurs have detailed and logical answers that convey the confidence that investors need to see.

To determine how much money you should raise, you have to figure out how much money you need to get to your next significant milestone.  Getting to the next milestone is important because achieving the milestone will set you up to raise additional funds down the road, if necessary.  If you only get halfway to a milestone without much to show for the last round of funding, investors will perceive you as a risk and you’ll take a hit on your valuation (if you get any interest, of course).

After you’ve determined how much you need to hit your next milestone, add in a six-month buffer by multiplying your post-investment monthly burn rate by six.  Things always cost more and take longer than expected, so you need a buffer to protect yourself.  Add these two numbers together – the milestone cost and the buffer – to figure out about how much money you need to raise.

On average, the number of months of operations funded is usually around 18-24 months.

Save the Best Pitches for Last

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It will take hundreds of hours of practice and dozens of iterations to perfect your pitch. You’ll discover that things you thought were straightforward are too complicated to explain in one meeting.  In the beginning, you’ll be all over the place as you try to get through all of your material.  Most importantly, when you first start pitching you won’t have a strong sense of what investors will care about.

The only way to improve and get a sense of investors’ concerns is to pitch to real investors.  The more you pitch, the better you’ll get and the more you’ll learn.  As a result, save your best investor pitches for last.  Start with your least favorite investors to improve and get a sense of the investor mindset.  Learn what they’re most concerned about, how they evaluate your opportunity, and what gets them excited.  When you’re ready, blow away your top choice investors with a pitch that exudes confidence, addresses their concerns in advance, and showcases your company as a great investment opportunity.

Don’t Expect To Hear “No”

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Most investors suffer from a disease – the fear of missing out (FOMO). This disease heavily influences how entrepreneurs are treated, especially those hoping for an investment decision.  Most business deals conclude with a definitive “yes” or “no.”  Not so with FOMO, which has struck “no” from most investors’ vocabularies.  They simply can’t say it because they don’t want to miss out on what could be a great investment.  By not giving you a definitive “no,” they’ve left the door open if they decide to walk through it later.  Since you’ll rarely hear “no” outright, FOMO causes a lot of false hope and wasted energy.

Many entrepreneurs think, “They haven’t said ‘no’ and they keep meeting with us, so they must still be interested, right?”  Wrong. They won’t reject you because you might either 1) get a lot of traction or 2) get other big-name investors interested. If either happens, they still have the option to invest.

Fundraising is so time-consuming that it can suck the life out of you, so try to determine as early as possible who is stringing you along and who is actually serious. Don’t waste your time on FOMO investors – you’ve got a business to build.

Part of the Family

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Bringing on an investor is a big deal.  Your investor becomes part of the family when you cash that check.  And vice versa – you have just become an important part of his or her livelihood.  Your new family member will want to meet with you at least quarterly, if not monthly, to get updates on the business, learn about your strategy, and understand the challenges and issues that you’re facing.  And this is if things are going well. If the business turns south, then you can expect much more involvement.

Before taking an investment, ask yourself if you would welcome this investor as a partner.  You’ll be dealing with him routinely for years to come, so it’s not that far from the truth.  If not, think hard about whether this is the right choice for you and your business. Don’t be afraid to walk away if it isn’t.

Get a Meeting

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It’s tough to get a meeting with an investor.  There are good and bad ways to get to an investor.  The path that you take will determine your likelihood of success. Cold calling an investor, for example, will almost always put you in the “automatically reject” category. Investors get inundated with pitches and meeting requests, so they almost always prefer trusted sources to unknown people.  In other words, you need to find a way to get introduced to an investor by one of his or her trusted sources.

A good way to start is with your own network. Ask friends and associates if they have any connections.  If this doesn’t work, a great way to be introduced is through one of the CEOs of the investor’s portfolio companies. Founders usually like meeting other founders, so ask them to coffee and find out about their business, their experience with the investor, and ask advice about your business.  When the time is right, ask for an introduction to the partner they work with.  If you have your act together, the CEO should have no problem doing this.

The Lemmings Need a Leader

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Investors are often compared to lemmings, and for good reason.  Lemmings move together in groups, and blindly follow each other.  Investors also feel most comfortable in packs and follow other investors.  To raise capital from multiple investors, you need to find a leader among the lemmings.  Otherwise, you’ll have a lot of conversations, and maybe even get a few soft commitments, but no one will write a check.  The trouble is that most investors won’t tell you “no” outright, so you need a way to tell if they’re serious.  If you find yourself in this situation, focus your efforts on securing a lead investor who will show the other lemmings the way.  A lead investor will offer you terms that you can take to other investors.  You can take the term sheet to the followers and say, “Here’s the deal – take it or leave it.”  Without a lead, you’ll feel like you’re spinning your wheels.

If you can’t get an investor to step up and take the lead, try sweetening the deal for them by offering extra incentives such as warrant coverage or bonus stock.

Counting Chickens

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One mistake commonly made by entrepreneurs actively fundraising is to oversell their current sales or partnership pipeline.  By advertising that you’re about to close a big deal before anything is signed, you set yourself up for failure.  Investors are necessarily skeptical of whatever they hear, so they’ll probably insist that you close the deal before they fund you.  This puts you in a tough spot, because you might need their money to stay alive and close the deal.  It also damages your credibility if you the deal falls through.  It’s not worth the risk, as too many things can go wrong

It’s a much safer bet to wait until you’ve closed the deal before advertising it to anyone.  The benefit of doing it this way is that, with the purchase order in hand, raising money should be easier and your valuation will go up significantly.

Calling All Angels

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Angel investors, or wealthy individuals who invest their own money, are typically a company’s first source of financing.  They invest for a variety of reasons, but most of the time it’s because they want to give back and help up-and-coming entrepreneurs.  Altruism aside, they also want a return on their investment.  Because they want to help, they’ll probably be active in your company’s day-to-day operations.  There are three types of angel investors, and you should pursue them in the following order.

  • Serial entrepreneur, startup expert
  • Industry veteran, expert in your market
  • Unsophisticated, with little business experience

Ideally, your investor is both (1) and (2) – a serial entrepreneur with a lot of industry experience.  An angel with a lot of startup experience will know how to roll with the startup punches, so he or she will understand when things go wrong.  If you can’t find a serial entrepreneur, the next best thing is someone who understands the industry pitfalls, and has a robust network that you can call on for help.  Unsophisticated angels who have never built a business before, or don’t understand business, can be more trouble than they’re worth.  Other than the money, they add little value.  It’s best to avoid these kinds of investors.

Your angel investors will be hands-on in your business, so make sure it’s a good long-term fit.

The Train is Leaving the Station

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To get investors excited about your business, you have to convey a sense of unstoppable momentum. You have to give the impression that your startup train is leaving the station with or without them.  Investors are notorious for dragging their feet, and too many spectating investors are a recipe for fundraising disaster.

Creating this feeling is much more an art than a science.  Landing an investor is like trying to get a first date: You have to look like a winner, move quickly, be in high demand, and not look desperate. Send out email updates at regular intervals with evidence of your impending success.  An end date on which the round officially closes is a good way to instill a sense of urgency in your investors. But this is also a gamble, because if you don’t have all of the money committed by then, you’ll have to extend the deadline, which is a negative signal.

The trickiest part is that all of this needs to happen quickly – in weeks, not months – to build a sense of urgency.  Moving swiftly creates a fever pitch, and causes investors go to extremes to jump on board.  To do this, you’ll need to start laying the groundwork many months in advance.  Plan carefully, and start communicating with investors early.