2 Essential Questions When Raising Capital for Startups
Raising capital for startups is notoriously difficult. It seems as if many entrepreneurs spend more time presenting to potential investors than they do running their nascent businesses. But it doesn’t necessarily have to be that way. Often investors don’t go forward because they are not convinced about the answers to just two questions.
Why You Need to Raise Startup Capital
Before you even get to those questions, the starting point is understanding why you need outside capital in the first place (presuming you do). Most startups do need to raise capital. Rarely do entrepreneurs have the resources to bring an idea forward to its full potential on their own. And even when they do, they often still use outside capital.
Many businesses bootstrap their way to success. Generally, this is how the mom-and-pop shops in your neighborhood got going. But as often as this is how local businesses get started, it’s rarely how larger businesses come into being today.
Businesses need capital in order to scale. While bootstrapping can be great to get a business started and to demonstrate proof of concept, going big requires capital.
It takes a lot of money to scale up, market, and build whatever systems and infrastructure you need to grow. Trying to bootstrap into prominence is really just leaving the door open for a well-funded competitor to eat your lunch.
Types of Capital
Basically, it comes down to a total of four types of capital. It can be your capital or someone else’s. And it can be debt or equity. There are only four boxes in that matrix.
To raise equity capital, you give up a portion of ownership interest in exchange for funds. You give up some control in exchange for the resources that allow you to grow. This can make a lot of sense for a business with great potential; your share of something very big can be much larger than all of something small. The outside capital allows you to make more than you could by using only your own funds.
That said, be careful about using personal debt. Some entrepreneurs may be tempted to borrow significantly before starting a business, using their work income to justify the loans. But then they quit working a day job and begin their business. The debt puts a heavy and immediate drain on the scarce cash a startup may be generating. Using personal debt can strap the business with a debt load it can never escape from.
It is hard for a startup to raise capital via debt. If you can find someone to lend you money, it’s likely to be at exorbitant rates.
For most businesses, there is one viable box: outside equity. You need someone else’s money to maximize your business’s potential. You will have to cede some control and a portion of ownership.
Sources of Capital
There has been a lot written about this, and there’s not a great reason to rehash it all. So I’ll be brief. The U.S. Small Business Administration has some good resources.
Your list of potential investors includes family and friends, angel investors, crowdfunding, and venture capitalists. And you’ll quite likely raise capital more than once. Some to get going; more to scale.
But no matter what source you pitch to, there are two questions you need to address. These are the questions investors need to answer for themselves in order to invest. They may not even know it, as they may think of them in another form. But if you’re struggling to raise capital for your startup, failure to adequately address one of these issues is likely what’s causing you trouble.
Raising Capital for Startups: The Most Important Questions
The first question is the somewhat obvious one. It basically boils down to, Can this idea or concept be turned into a profitable business venture?
This is the piece most entrepreneurs put all their effort into explaining. This is the passion piece. It’s the why consumers or customers will want or need the product or service. How it will be created, packaged, delivered. What it costs to make and what the margins are.
It’s kinda funny, as you might get the idea that this is the only question. Hence the problem.
The Oft-Forgotten Question
After you’ve established the viability of the product or service, the second question is, Can you, the entrepreneur, successfully turn this concept or idea into a successful business venture? Please don’t take it personally.
Your family and friends may readily give you money because they believe in you. They have a bias in your favor for this second question.
Strangers, on the other hand, have no bias in your favor. Nor should they. They really need to know if you’re the individual or team to make this happen.
If you’re a likely unicorn, they may be willing to bring in their own talent. But for most venture capital investments, the investors need to believe in you.
Your background is a factor. If you’ve developed several businesses from concept to market and success, investors can easily buy into your track record. If you have a strong background in running a business or businesses — even someone else’s business — you have a track record for them to use.
But let’s say that’s not the case. Maybe you’re an engineer. Or a mechanic. Or a groundskeeper. It doesn’t matter. If you don’t have a track record of success in running business enterprises and you fail to address this in your presentations, you’ll have a hard time raising capital.
Most would say you’re going to have a hard time, anyway. Raising capital for startups is challenging. But if you fail to demonstrate, to the potential investor’s satisfaction, how you’ll run this operation in a way that will result in a profitable business endeavor, you’re going to have a particularly tough time.
The solution is to understand how you’re addressing these two questions. Most entrepreneurs are at least getting close on the first one. This is the nuts and bolts.
But you need to be very clear. You should have a detailed business plan. And you should have contingencies. For example, you should know what will happen if you lose a major supplier. You need to be prepared.
Many entrepreneurs aren’t doing the job they need to do on the second question. It helps if you’re past the first round. If you’ve established a track record of increasing revenue and preferably some profitability, that’s also a big help. But either way, you need to address the question.
As a business owner, you need to show the potential investors how you can manage and bring this to profitability. You may need to address things like outside counsel, accounting and bookkeeping, when you’d bring in a CFO, and how you would go about getting one.
There are a number of issues to address, depending on where you are and what your plans are. But focus your presentation to answer how you will run the organization and bring it to its potential, and you’ll remove a major obstacle to raising capital.