Bootstrapping. Friends & Family members (F&F). Angels. Venture investors (VC). These are each viable – and even appropriate – ways of financing your start-up. The question is: which is right for you? There are no easy answers, to be sure. But one thing is certain; angels and venture investors look at early-stage investments through different lenses, and it is important for the entrepreneur to understand the distinction. Further, this is an assessment that often has to be made multiple times, as early-stage F&F and angel-backed companies should or perhaps should not raise VC funding based upon a variety of factors. Choosing the wrong financing strategy can have a profound impact upon the success or failure of a start-up, and given how hard it is to be successful getting this right is hugely important and certainly worth the time to analyze, reflect upon and plan. It is absolutely critical for the entrepreneur to be brutally honest with themselves and unambiguous and candid with their potential investors.
The key variables with respect to financing strategy, as I see them, are:
- Founder objectives and mind-set;
- Business potential; and
- Interpersonal dynamics.
Some founders want a “lifestyle” business, e.g., to generate positive cash flow and to live off that cash flow indefinitely. The Web is a great place to build a lifestyle business because it scales so well and requires comparatively little ongoing investment (time, money, staffing) relative to service businesses. I’m not saying it’s easy, but if you hit it right it can be fantastic. But these kinds of businesses do not subject themselves well to external financing beyond F&F, as “the exit” is not the goal. Most angels and certainly no VCs are looking for a stream of dividends over a long period of time. They want a finite time horizon within which their equity can be sold at a sharp profit; this stands in stark contrast to the lifestyle business mind-set. So bottom line, if the founder’s honest assessment is that their goal is to build a business to live off of for the long-term, then bootstrapping, or perhaps taking a small amount of long-term F&F capital, is the way to go.
Conversely, let’s say the founder wants to build a business and exit in either the public or private markets. This aligns them with perspectives of both angels and VCs. So we need to dig deeper. Part of the analysis necessarily has to address the business potential of the company: Can this be a billion-dollar outcome? Can the company carve out a valuable niche within the current competitive landscape, or even better, can it create or transform an entire market? Will this business require substantial amounts of capital to achieve its full potential? Is the business model such that it could potentially go public (recurring revenue, customer lock-in, etc.) and there are metaphors for successfully publicly-traded companies of scale? Are there multiple potential acquirers if M&A is the desired exit mechanism? If the answer to these questions is yes, then either angel or VC financing (or both) are appropriate for this opportunity.
So assuming the founder is shooting for an exit and the market opportunity is attractive, the specific mind-set of the founder comes into play. Has the founder had a previous exit of scale before? Do they have a bunch of money, or have they taken relatively little from previous exits or their job? This gets to whether the founder has the temperament to “go the distance,” or whether they’ll find an acquisition offer of $20 million, $30 million, or perhaps $50 million just too compelling to turn down, even if they have the belief that they can build a billion-dollar company. Putting $10 million in a founder’s pocket can be truly life-changing, and the marginal value of the years required to scale the business, go through multiple financing rounds and to take on all the associated risks in order to perhaps walk away with $50-$100 million simply isn’t worth it to many when given the real-life opportunity to sell. And you know what? I get it. Totally. As a VC I have to respect and ultimately abide by a founder’s ultimate decision, but this information I would like to have in advance as it has a material impact upon the investment decision. If what a founder is really doing is building towards a nice exit, and is not driven by world domination, disrupting a market or poking a sleepy incumbent in the eye separate and distinct from any financial implications, then taking money from most VCs is a mistake. Unless the VC is very small or has a distinct strategy of putting small amounts of money into many business and is happy with angel-type outcomes, then there will be a fundamental misalignment between founder objectives (sell when the selling is good) and VC objectives (do what’s necessary to build a large, disruptive business with a willingness to spend many years and significant capital doing so). These kinds of opportunities are tailor-made for angel financing, particularly if they are capital-efficient and don’t require multiple rounds of financing in order to build the exit-ready business.
Conversely, if a founder does have the unyielding desire to go big and is pursuing an opportunity and a space that has those characteristics, then having VCs as part of the financing plan makes abundant sense. This is not to say they are a substitute for angels; they can either be used to augment a seed financing or to drive the first larger financing round that follows on from first money-in angels. But really good VCs with domain expertise, experience in scaling businesses and building high-performance teams and with the long-term perspective and resources to support a business through its lifecycle can be invaluable partners for super-ambitious founders. Interests are aligned. Time frames are synced up. All systems are go. The founder can focus on building the best investment syndicate for the long run.
But at the end of the day, interpersonal dynamics plan a vital role in any financing plan for a business of any size. Has the founder identified a mentor and a trusted adviser? Has the founder built good governance practices and processes by attracting and building an experience Board? Has the founder only taken money from people whom they trust, and performed extensive due diligence on potential partners by speaking with their portfolio companies, service providers and others in their ecosystem? This is something that needs to be taken very, very seriously by the founders. It is critical that founders not get blinded by the flattery and pursuit by big-brand firms; it is far more important to identify the right partner and investment team than the right firm. However, it is hard to apply this discipline in the heat of the moment. But founders have to be strong and keep their eye on the ultimate goal: giving themselves the best chance for success.
There is no one “right answer” for how to best finance your start-up, but being honest with yourself and thoughtful about the key drivers of success will get you most of the way there.