Even if you’re bootstrapping, you always have an investor.  You are your business’s first and most important investor.  And you invest something much more important than cash – your life.  You put everything on the line to attempt a treacherous mountain climb, upon a crumbling path that is littered with the tombstones of failed startups.  If you give anything less, quit now. You’ll never make it halfheartedly.

Since you’re the first investor, you must evaluate your business as an investor would. Is the industry good?  Is the market receptive to new entrants?  Can I make enough money to be happy in the long run? Is the reward worth the risk?  Is the go-to-market plan realistic or a pipe dream?  Pretend that an entrepreneur trying to raise money pitched you your company.  Would you invest 20% of your net worth?  Be honest with yourself!  This is one of the hardest things for entrepreneurs to do, but it’s also one of the most important.

If you come to the difficult conclusion that you wouldn’t invest, what holds you back?  Can you fix or mitigate the issue?  If you can’t justify investing 20% of your net worth, how can you justify investing your life?  Don’t rush into a business that isn’t right for you.  Take your time, and wait for the right idea.  It will come.

Think Backwards

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When thinking about how much money you should raise from investors, think backwards. First, figure out which milestones you want to hit. These should be meaningful BHAGs – Big Hairy Audacious Goals. Usually, these milestones are achievable in an 18-24 months timeframe.  Then, you have to build a plan in reverse that is designed specifically to achieve the milestones you created in the future. In this way, you are actually building your plan backwards, starting with the milestones in the future and working in reverse to the present. Building out a detailed financial model of what will be required to achieve those milestones gives you the total amount of funding you’ll need. And be sure to add a small buffer for unknowns along the journey.

Valuation Isn’t Everything

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When it comes to choosing an investor, valuation should be just one of many selection criteria.  The non-valuation terms of a deal are also critically important.  Minor changes in the deal terms can lead to wildly different economic outcomes for the founders.  Work with your lawyer to watch out for terms like the liquidation preference, number of board seats, option pool, founder vesting, and type of security.  Any one of these can be much more materially significant than a 20% difference in the valuation.

Beyond the terms of a deal, bringing on a new investor is the beginning of a long relationship. You will have to work relatively closely for years to come.  Investors can be a major distraction, so working with someone who respects your time can make a big difference.  Also, an investor with the right connections can open doors.  Interview CEOs of the portfolio company to get a feel for how helpful an investor is.

There’s a lot to consider besides the valuation that an investor semi-arbitrarily assigns to your company.  As with anything else in life, you get what you pay for.  Don’t miss an opportunity to form a great alliance over a few percentage points.

What’s the Business Worth?

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“What’s my company worth?” This is one of an entrepreneur’s most frequently asked questions.  It’s also one of the hardest to answer.  It is possible to value a company with a fancy financial model (e.g., Discounted Cash Flow), but the valuation will be based on projections that are little more than WAGs – Wild Ass Guesses.  The dirty little secret is that, regardless of how sophisticated your model is, it’s impossible to say exactly what an early-stage company is worth. This is especially true with pre-revenue companies.  In fact, valuation is so tricky that most seed stage investors prefer convertible debt because it postpones the value question until the next round of financing.  In the end, your company is worth whatever someone is willing to pay.

That being said, there are a few rules of thumb that should help you get to a ballpark estimate.  Valuations of seed-stage investments are usually in the $1.2-$1.8 million range.  VCs typically want to own 20-40% of a company in exchange for a $2-$10 million investment.  To calculate the valuations of established companies with sales and profits, valuations are normally in the range of 2-3 times sales or 8-10 times profit.

If you really need an expert opinion, there are professionals who specialize in early-stage valuations and can give you an “official” estimate of your company’s worth.

Credibility is Key

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Investors are necessarily skeptical of entrepreneurs trying to take their money.  They will doubt your revenue projections, market size analysis, likelihood of key partnerships, or technical feasibility.  In short, they will substantially discount most of what you tell them.  In the end, investors have to ascertain whether you have what it takes to build a big business.  If you can’t convince them that you are capable, nothing else matters. As a result, make sure that much of your presentation is designed to establish credibility.  And the earlier you prove yourself worthy, the better.  Doing this at the outset creates momentum and interest that will carry you through the presentation.  The opposite is also true – if your investor audience doesn’t believe that you can build the business, they’ll check out early.

Credibility is primarily established through experience, which de-risks your business in an investor’s mind.  Be sure to highlight your team’s relevant experience.  If you have a lot of technology risk, but your chief engineer has previously built something very similar, say that at the outset.  If customers are hard to get, but you’ve already created and sold a business in this industry, say so in your opening comments.

Credibility is key, so build it early.

The Day You Take an Investor’s Money

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Landing an investor is always exciting.  Maybe you were running on fumes, only weeks away from missing a payroll, and now you can keep pressing forward.  Or maybe you just nailed your customer acquisition model and this investment will allow you to really take off.  Without a doubt, a capital infusion can open doors and create new possibilities.  But there is one important fact you need to know before you take an investor’s money – the day you cash the check is the day you commit to selling your business.  Whether the buyer is a private company or the public markets, the reason an investor buys a piece of your company is that she thinks she can sell it for a lot more down the road. Investors can only cash out when you sell the business.

What’s more, high return requirements can put investors and entrepreneurs at odds.  In extreme cases, entrepreneurs have been offered deals that would have made them millionaires, yet their investors refused to sell, holding out for a higher offer that never came.

Take on an investor only if you’re comfortable with the fact that you will have to sell your company.  And, when that day comes, realize that your vote won’t be the only one that matters.

The Investor Triad

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Sophisticated investors evaluate three central areas of a potential investment: the team, the market, and the product(s).  Different investors weight the three sides of the triad differently, but all three are vital to building a scalable, thriving startup.

The team is almost universally considered the most important of the three factors.  The reason for this is that the business model will change, probably significantly, as the company experiments and grows.  The people behind the business will have to evaluate the data, and make the decisions that will make or break the company.  Execution is 99% of a company’s success.

The market has to be “big enough” and growing quickly.  A market that’s large and growing makes it possible to build a significant company with a high valuation.  This all translates into strong returns for the investor.  A market that’s “big enough” is usually at least $500 million.

Finally, investors consider the product.  They want to understand its value proposition, the pain it solves, and its long-term defensibility.  Traction with customers is usually the best way to demonstrate your product’s worthiness from an investor’s perspective.

Get investors motivated by completing the triad.

If You Want Money, Ask for Advice

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There’s an old adage when it comes to investors: “If you want money, ask for advice. If you want advice, ask for money.” The best way to set your company up for fundraising success is to build relationships with investors over time.  And the best way to build relationships is to ask for advice.

Your investor bonding formula should follow this sequence: 1) update the investor about your business, 2) ask for advice on key strategic decisions, 3) declare your intention to do something the investor recommends, 4) go do it, 5) report your achievement, and 6) meet and repeat.  The third and fourth steps – declare and do – are the most important.  When it comes to delivering on your promises, make sure that you under-promise and over-deliver.  By out-performing expectations, you’ll build a reputation for making things happen.  Ideally, over time, your momentum will make your mentor/investors excited to join the party.

The more time an investor has to get to know you and understand your business, the better your chances when asking for money.  While there’s no right time to meet an investor, the wrong time is at your first pitch.  Start early and ask for advice.

Money Only Buys Time

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A lot of entrepreneurs mistakenly equate fundraising with progress. They talk about raising a round as if they just hit a major business milestone.  You can tell that an entrepreneur has fallen into this trap when parties are thrown after closing a round.  Or, when asked about the company, the entrepreneur brags about his latest investors.  This is the wrong way to look at it.  Getting a new investor is not a milestone, and additional capital does not guarantee that your company will be successful.  Money only buys you more time to succeed or fail.  Sure, the cash is important.  The number one reason businesses fail is that they are undercapitalized.  But look at the long, distinguished line of startup tombstones that have raised tens or hundreds of millions of dollars and still flopped.  Capital only gives you time to make your business model work or to postpone your death.  It’s what you do with the money that counts.

A Demo is Worth 1000 Words

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With investors, a prototype or demo is worth 1000 words – other than customers and revenue, nothing makes a stronger initial impression.  People are very visual, so a prototype helps your audience immediately grasp your business.  This is a huge advantage, because investors are notoriously impatient with entrepreneurs, especially when they’re pitching.

However, the demo advantage goes much deeper than conveying an idea.  It says things that you can’t easily say.  Through a demo, your audience will get a sense of your approach and your vision.  The more impressive it is, the more points you’ll get on your credibility in product development and user experience.

Most importantly, a demo or prototype establishes that you’re a doer, not a dreamer.  It proves that you get things done.  When you’re unknown to a prospective investor, the main thing he’s trying to figure out is whether you’ve got what it takes to build the business. A demo of your prototype is a big step in the right direction.

Besides, with prototypes being so easy to build these days, why wouldn’t you?