If you think you can just go out there and get your company funded, think again. For every 100 entrepreneurs, just 1 will succeed in getting funded. According to Forbes, “garage to riches” stories and popular reality shows like Shark Tank present a false narrative of what access to venture capital actually looks like. In reality, the chances of getting funded by a VC fund are less than 1%.
The fact is, the world is overcrowded with entrepreneurs and the economy is shaky at the moment. But you’ve worked hard, your business has a great story, and you’re ready to reach out to potential investors.
However, have you done your due diligence and is your strategy on point? Have you considered all of the consequences, both pros and cons, that could come from bringing in investors?
If you don’t want to be in the 99% of businesses that never receive any external funding, we suggest you avoid these 5 common mistakes founders make when bringing in investors.
1. Thinking it’s all about the money
Investment is a partnership and a huge opportunity to be guided and learn from the VC. What many founders mistakenly believe is that fundraising is only about one thing – money. We see a perfect example in the comedic series Silicon Valley. In urgent need of funding to save his company, Richard Hendricks accepts a large investment from a VC with a less-than-stellar reputation. This hasty, desperate decision leads to endless issues, and later ends with Richard being fired from his own company. The lesson? Once you have a suspect investor on your cap table, they’re there for life––plan accordingly.
Even well-meaning investments can take an ugly turn when the focus is solely money. Take the McDonald’s story. In 1954, the McDonald brothers famously let Ray Kroc into their business. His conflicting vision for the company led to him purchasing exclusive rights, promising the brothers a half-percent royalty on all future McDonald’s proceeds. According to the family, he never paid them a cent.
Good investors will mentor, open doors, and help you grow without micromanaging. They’ve been in your shoes and can help you avoid costly mistakes and pitfalls. Not only that, mentors will also have strong networks they’re willing to make you a part of, thus connecting you with potential future investors, employees, or customers.
2. Failing to properly vet investors
Ben & Jerry were an imaginative duo full of wacky ideas with flavors like Cherry Garcia, Phish Food, and Jamaican Me Crazy. However, their lofty goals and alternative management style clashed enormously with their investors, leading to a $300m takeover by Unilever. Unfortunately, Unilever took a very “vanilla” approach with much cost-cutting and bland PR. Luckily, Ben and his buddy Jerry finally convinced Unilever to allow them to maintain an independent board of directors and the brand regained its character. Years later, they’re still butting heads.
One way to avoid a nightmare investor pairing like the above? Research. Think of it like applying for a job. You wouldn’t show up at an interview without researching the company extensively beforehand, or making sure the company’s direction and values are aligned with yours. The same applies with your investor. Do your homework to make sure your vision is aligned with the investors’ objectives. Do you feel they are a good personality match? Are they going to micromanage you?
A good match will save you major headaches and could even lead to more growth than you expected.
3. Failing to balance control and capital
Understanding your right valuation and then balancing the desired capital versus how much company control you give up, is crucial.
Some founders are so busy making sure that they don’t lose strategic and creative control that they lose focus on their goals entirely. Plus, there are the founders who believe themselves to be the next Elon Musk or Mark Zuckerberg, with a controlling share plan.
Zuckerberg ensures his shareholders will not change the way Facebook manages itself by owning the majority of voting rights. He and a small group of insiders control almost 70% of the voting shares through a dual class structure. Unfortunately, due to his relentless pursuit of the Metaverse, the share price has dropped and angered numerous shareholders, causing him to have to rethink his plans. Then we have Elon Musk, who has just bought Twitter and is bound by no fiduciary constraints, and the future of the platform is unknown as employees continue to exit.
In yet another cautionary tale, Sam Bankman-Fried of FTX famously refused to form a board, assuming he and his young team knew it all. Now he’s filed for bankruptcy and is in debt to the tune of billions. All three CEOs went to extreme lengths in the pursuit of full control, with results varying from questionable to straight out disastrous.
In contrast, when Jeff Bezos purchased the Washington Post, he ensured that “the duty of the Post is to the readers, not the owners.” So far, there doesn’t seem to be evidence that Bezos is driving its editorial agenda. Since 2013, he has secured the paper’s future with the staff having nearly doubled. A very different story at Facebook and Twitter, especially considering the recent mass layoffs.
Ensuring adequate capital while keeping hold of the company you created is not always easy. How important is control to you? Do you plan to be Zuckerberg, Musk, and SBF, or Bezos?
4. Not having a clear capital allocation plan
So, you’ve secured the funds. How will you use that money effectively? It’s not just a matter of getting funding from the right people or in the right amounts. You have to have a plan for how to use it (this is referred to as Use of Funds) to grow your company and avoid burning it on unimportant things. If the best you can come up with is a hockey stick graph with all of your growth in year 5, go back and try again.
Consider WeWork, a unicorn that raised $12 billion in equity and $9 billion in debt. After a series of poor investments, impulsive purchases, and outright excessive spending, how much is left? At their lowest, just $600 million, and currently their market cap is around $2 billion.
Many entrepreneurs underestimate how much capital they will need, and they don’t start with the end in mind. They think they’ll know how much money they need when they get there, but they don’t know what “there” looks like until much later. Make a reasonable and intelligent plan and stick to it. This way, you can stay on track and avoid lighting cash on fire (and you’ll keep investors happy, as well).
5. Not having an exit strategy
What is your long-term plan? Will you eventually sell the company or take it public? These are questions your investor will most certainly have. Be prepared to show your partners how they’re going to make money. At the end of the day, they don’t want to be your partner for life, they want to invest and make a return.
BrewDog, the UK’s largest craft brewer, has darted around this subject for a number of years now. In 2018, they raised £26 million through crowdfunding, having tempted customers to invest with benefits such as beer discounts. Having received numerous private equity approaches, they have so far turned them down in favor of a future IPO. However, with a listing on the stock exchange looking unlikely and evidence of an increasingly toxic workplace, crowdfunders are starting to lose faith.
Trying to secure funding can be intimidating, stressful and time-consuming. Then again, it’s not supposed to be easy. It’s a learning curve where mentorship is key. If you choose the right investor and remain smart about money allocation and your goals, then your choices may prove to be very fruitful.