It was April 2014, halfway through a two-year investment deal. I was pitching my investor on why we needed to double the funds we were receiving every month and shorten our runway to 6 months (a fancy term for how long we have until we need to be self-sustaining).
His answer was “No” and he gave me three choices:
- Go to work for him
- Keep going under the same funding arrangement
- Shut the business down
Going to work for him would mean setting out on a career path I didn’t want to go down. Operating under the same funding arrangement would mean we couldn’t execute on our new business model.
So we shut the business down.
The problem was that I had no options left. I had “been in business” for 18 months with very little to show for it and no money left in my bank accounts. I had no credit cards to max out, no revenue coming in, and no prospect of revenue in the near future because my product had failed. My back was against the wall and it was either raise money or quit.
But the real problem goes back to when I started the business. If I had started my business with a better perspective about what it takes to succeed, I would never have been in a situation to HAVE to raise money.
You don’t have to find yourself in the same situation. In fact, in today’s business environment, there is absolutely no reason you need to raise money in order to build a fulfilling, sustainable, and profitable business.
Here are ten questions you should ask before raising money to fund your business:
1) Why are you raising money to begin with?
What made you think you should raise money to fund your business? Are you plugged into the local startup scene, where everyone raises more money than they know what to do with? Have you been reading too much Hacker News?
Or, is your back against the wall and your parents are kicking you out of their basement? Have you pivoted one too many times and now you needs funds to keep you going?
More often than not, we raise money for the wrong reasons.
The best reason to raise money is because you know your audience, you’ve found a problem that needs solving, and you have a growing base of paying customers who want what you’re building. Raising money in this situation is a matter of scale – it allows you to do things you couldn’t do otherwise, like hire people to help you scale faster.
2) How well do you understand your audience?
At it’s core, every business provides a solution to a problem, plain and simple. That solution is designed for a specific audience or customer base.
Facebook was founded as a way to play hot-or-not for Harvard students (I’m only partly kidding). Tesla got off the ground by building high end luxury sports cars for rich people who cared about the environment.
If you don’t understand your audience, you won’t build a sustainable business. You might make some sporadic money, but you’ll suffer from the classic “feast and famine” model of entrepreneurship.
Raising money does not change anything about the need to understand your audience. Whether you have $0 or $500,000 in the bank, you still have to provide a solution to a problem for a group of people who have the ability and willingness to pay.
3) What will this money allow you to do that you couldn’t do without it?
Are you going to hire people? Buy equipment or inventory? Hire contractors to build your app or website?
The minute you hire people, you increase the stakes. Now you have to bring in enough revenue to not only pay your own salary, but also to support each of your employees.
Buying equipment means you have to know how to use it. Just because you have a nice video studio, five top-of-the-line cameras, and an entire control room, it doesn’t mean you’ll be able to make high quality video training.
When the investment money goes away and you’re left with your app or website, will you be able to maintain it? Have you built the ongoing maintenance costs into your business model? What will happen when you have bugs that need to be fixed?
Raising money allows you to do all kind of fun things in the short term. Those short term decisions have long term effects on your business. Sometimes it’s better to start simple with something you can manage yourself rather than get in over your head.
4) What are your other options?
If you don’t raise this money, what happens? Will you go bankrupt? Will you have to find a job? Or will you keep plugging along, doing the tough work of finding your audience and building something they care about?
Sometimes raising money is easier than doing the hard work of building a profitable business. Raising money from investors is the most vain metric there is.
Oh cool, you raised $1Million? How many people have opted to get emails from you every week? Oh, you imported your Gmail contacts? Good luck. How many paying customers do you have? Zero? Hmm, that’s interesting.
If raising money is simply a way to avoid the hard work of building a business, it might be time for a gut check about whether you’re in it for the right reasons.
5) Have you done your math correctly?
Here’s how we decided how much money we would raise… I wanted to hire a person because I was lonely. I found a great person to hire and asked him how much money he needed at a bare minimum to squeak by living on his own every month. Then I did the same thing.
That added up to $5,000 a month. (That’s an average annual salary of $30,000 between us.) So we asked for $120,000 because that would get us through two years of operations, right?
No, that was an idiotic assumption. First of all, the guy I wanted to hire didn’t think about taxes, so he was immediately making less than he needed to get by. Secondly, we had no way to cover business expenses like website hosting, email marketing, etc. We immediately had pressure to start making money even though we raised money to relieve the pressure of making money in the short term.
When you do your math about how much money you need, be sure you’ve accounted for all of the costs in your business. Those costs will go up as time goes on, so build that into your model.
6) How much runway/time will this buy you?
We did our money calculation based on an amount of time. We said, “We need $5,000 a month and we think it will take two years to be making $5,000 a month in revenue to replace our investment. Therefore we need $120,000.”
What we didn’t think about is that we would be earning $30,000 a year for the two years of the investment, plus as long as it would take us to grow our revenue beyond $5,000 per month. We also had no reason to think it should take us two years to be earning that much money. It was a wild guess. Maybe it would take less, maybe it would take more.
It’s tough to know how long it will take to build revenue. Generally speaking, it will take as long as you have left on your timeline. Productivity experts refer to that as Parkinson’s law.
A better question to ask is: if I wasn’t raising money, how long would it take me to make enough money to make the business sustainable if that were my number one goal? Can I make it that long? If not, then you might need to raise money. If so, why would you raise money?
7) How much of your company will you have to give up?
The way you get money out of an investment is by giving up a chunk of your company. I had to give up 40% of my company to get the $120,000 of investment money we thought we needed. That’s a valuation of $300,000 – without getting into ridiculous math, just know that $300,000 isn’t ton of money when it comes to business valuations and it was still probably too high.
Before you decide to raise money, ask yourself how much of your business you’re willing to give up in order to raise the money you need. Sometimes the exchange isn’t worth it and you should consider what other options you have (even if that means getting or keeping a job for a period of time).
The $120,000 we raised was basically an investment in me as a person. And in return for that investment, I was agreeing that I would forego 40% of distributed profits at the end of every year and 40% of money we brought in if we were ever to sell the business.
That brings us to our next question…
8) Are you building this business to sell it?
If you’re not, then it takes a special kind of investor to even consider giving you money. After all, the number one way an investor makes money is when you sell your business.
For us, our investor was willing to make this a long term investment. He didn’t care if we ever sold the business. He would make his money back as we made profits on a quarterly basis after the investment period. Once he earned his money back, he would receive profit distributions equal to his ownership shares at the end of each quarter.
We were lucky because most investors don’t think that way. Most investors want a return and think in 5-7 years intervals. Be sure that you are either interested in selling or aligned with an investor that doesn’t want to see you sell the business. If not, you might want to reconsider chasing down an investment.
9) If you were absolutely not allowed to raise money, how would you build this business?
Usually there is some derivative of your grand vision that you can start on today, right now, from where you are with what you have. Raising money is a great way to convince yourself that you can create your big, badass vision overnight. The reality is that before you can build an empire, you must first build a single town.
Before you can publish 500 blog posts, you have to publish 5.
Seth Godin puts it best in one of his seminars. He says, “In order to be the best in the world, you have to define world the right way.” Defining the world of your business in the right way will inform so many of the decisions you make. Perhaps the best definition of world is your neighborhood. Once you rule the neighborhood, you can take over the city. Once you take over the city, perhaps you can rule your state or region. Then the country. Then the world.
In other words, start with a small, intense fire. That fire might not require that you raise a ton of money. It might just mean settling in for the long-term and doing the work that matters today.
10) What are you afraid of?
Ah yes, ultimately this is what it comes down to. Raising money is a great way to avoid the things we’re afraid of. Chief among those fears for most opportunities is the real possibility of failure.
Raising money means we can delay that possibility for a period of time. For me, that meant delaying failure for at least another two years.
It turns out that the best way to fail is to fail fast. The sooner you realize you’re running up the wrong mountain, the sooner you can turn around to find the right mountain.
So before you go out and raise money as the next step in launching your business, perhaps the better decision is to take the not so sexy step that many successful entrepreneurs take.
At the end of the day, if I had been smarter about defining my audience, understanding their needs, and being more thoughtful about jumping into the business full-time, I could have avoided that tough conversation I started this article with. In fact, I might still be running that business today.
So before you make the same mistake, ask yourself a few questions to find out whether raising money is the right course of action for your business vision. Maybe it is, but my guess is that you could accomplish just as much without ever going down that path.
This post was originally published at Fizzle.co on The Sparkline, a blog for independent entrepreneurs building their thing with heart and hustle.
Photo: Money by Thomas Hawk on Flickr