In your journey to start your own business, you have reached step 3. Great work. You are doing your research and you are learning the skills necessary for your business. Now you worry about the money necessary to start your business, don’t you? You do not have the money to bear the initial cost and you also have no idea how to arrange for it.
I will mention different ways to solve the investment problem. I will not discuss any budgeting areas here. Budgeting will be covered over a separate lesson in itself. In this article, we will discuss various ways you can finance your venture.
I am writing a set of posts that will help you start your business step by step. You are
Before we discuss the way, you must consider a few things. Let us go back to Adam and see what he did. If you haven’t followed Adam’s story, here is a recap.
Why do you need money?
Adam had a plan to quit his job and start a huge restaurant with a seating arrangement for 100 people. For such a setup, the initial investment was huge and there was no way he could start the venture without any investment. His current savings were nowhere close to the number required.
But Ben made him rethink his decision. He told Adam “Knowing the Food industry well, why don’t you start with a smaller investment to test the market? Since the world is moving towards a delivery model, a huge chunk of orders are placed online. Why don’t you try a dark kitchen?”
“What is a dark kitchen,” Adam asked. Ben replied “A dark kitchen is a restaurant for only online orders with no walk-ins or seating arrangement. Such an arrangement will cut down your initial investment by over 60%. As an icing on the cake, you do not even have to quit his job. You can run the dark kitchen with some help from your wife and a cook, by catering to orders only in the evening for dinner.”
Ben saw Adam’s eyes gleaming. He continued “Sure, your profits would be lesser, but you would feel a lot safer due to the reduced risk, a job in hand and also know if the market liked your dishes.”
Before you think of the investment required as a number, think why do you need the money? Do you need the money because you plan to quit your job right away? If the money is necessary to cover your expenses, ask yourself if you should not quit your job. If you think hard, you might find a way to start your business without quitting your job.
If you need help on how can you start without quitting your job, leave a comment or drop me an email via the form. I will try my best to help.
Do you need a big investment up front?
Adam analyzed the input from Ben. He realized that the dark kitchen satisfies both his reasons for starting his own restaurant. He wanted a place of his own to innovate his own continental dishes and heard good feedback from the foodies. A dark kitchen could serve that purpose with much lesser investment. “Why couldn’t I think of it? I order food online myself quite often,” he exclaimed to himself.
Adam was planning a fancy restaurant because he wanted to go big, grow famous and gain money. But his actual reasons for beginning his venture were something else. He had forgotten to consider the most important why of his business and was chasing something which did not matter much to him.
When starting off, every new entrepreneur wants to go big. While thinking big is not always bad, testing the waters adds a layer of safety. Your assumption that your idea will click could go wrong.
No matter how brilliant of an idea you have, the market may not buy it at all. Checking if the product sells in the market at a small scale is a great way to validate your idea.
If your idea is a software product, you can build a Minimal Viable Product and ask your potential customers for their feedback. As simple as the approach seems, almost every product that has fallen flat on its face, did not bother to build an MVP to test their idea.
If your product sells in retail stores, approach one retail store where you believe your target audience is. Convince them to place your product on the racks and check the response from the market there.
There are enough and more ways to validate your idea if you think hard enough. Do not be blinded into building a massive product waiting for glory, based on your own assumptions without any validation from the actual customer. Many failed entrepreneurs have done that before. I am one of them.
If people tell you that your idea is great, it means nothing. If people tell
By now, you must at least be thinking if you need the investment or not. Give it some time. By hurrying, you could trip on the first mistake and end up with a bruised arm and broken teeth.
Let’s say you decide, you have no other choice but the investment route, what are your options?
Let’s get back to Adam to find out.
Different fundraising ideas
Adam had almost decided that he would start a dark kitchen. But out of curiosity, he decided to ask Ben how could he raise the investment if he wanted to.
Ben replied “Today, you can raise investment from random people off the internet. We call it crowdfunding. Crowdfunding is a model where you raise money online for your idea by people all around the world. The model works like a donation where you have to prepare an interesting pitch of an idea and state the amount that you wish to raise.”
Adam seemed confused. He asked, “Why would anyone do that?” Ben continued “People donate any amount they like if they like the idea or have followed your activity or want to support you. Rewards are provided to the people who donate towards the idea.”
Ben noticing how confused Adam was, continued, “Crowdfunding does not always take place over donations alone. Some crowdfunding models involve equity too. “
2. Raising money from investors:
The crowdfunding model of raising money from unknown people surprised Adam. “What are the other ways I can raise money?” he asked, now curious to know more methods.
Ben replied “Multiple companies exist who make profits by investing in companies. Their business model involves identifying the ideas/products which have the potential to grow big. On finding one they invest a large sum of money in exchange for equity. Such funding is called Venture Funding or Series A, B, C depending on the stage of the business.”
Adam asked, “So can I approach those companies now?” Ben sensed Adam’s urgency and replied “Such funding occurs after a company has shown potential and revenue. Since the money involved here ranges from a few million to tens of millions, venture funding looks at the current revenue of the business before investing.”
“The purpose of venture funding is to help a proven business grow and scale faster.”
3. Seed Fund:
Adam realized he was too early for venture funding. He probed further “So how can I raise an investment given that I am too early for a venture fund?”
Ben sipped on his coffee and answered “You can try for a seed fund. Seed funding is the investment during the early days of the venture in exchange for equity. For example, if you have an idea of skates that can be used without any balance practice, a seed fund will help you build the necessary product. A seed fund helps you get the business from an idea to a product stage with some sales. It sets the tone for the next rounds of venture funding.”
Adam looked confused “Isn’t that the same as venture fund?” Ben realized he had not mentioned enough detail. He added “Seed fund is smaller. It can start with a few ten thousand to multiple hundred thousands. These funds can come from individual investors, known contacts, mentors, friends, and family. The purpose of the seed fund is to take the business off the ground. Once you generate enough revenue, you can approach a venture capital fund.”
4. Bootstrapping or self-funding:
Adam was more curious now. “Are there any other ways to kick start your business?” he asked.
Ben mentioned “The other method is stating the obvious, which is using your own money. In the startup world, we call it bootstrapping. This method works well when a small investment is required for moving from an idea to a sellable stage.
How much you can fund yourself depends on you. Some startups had 0 funding from the founders while some have invested millions from their own pocket.”
Adam felt he had received a load of useful information which he would spend some sleepless nights over. Adam thanked Ben for his inputs and headed back home.
So what do you understand from Adam’s story? So far you have understood the various way in which you can raise money. Before you think further on the topic, you understand the pros and cons of raising investment.
Advantages of getting an investment:
Whether you should raise an investment or not is a frequently asked question. Unfortunately, one answer does not fit every situation. I will present the advantages and the disadvantages. As the owner of your business, you should use your best judgement.
You can grow faster:
Let us say for example you own a restaurant. You invested a sum of 100,000 $ when you started off. Your restaurant is receiving a great response and you are making a profit of 10,000 $ a month.
You have identified 3 more locations where you can open an outlet. The new outlets will need more investment, let’s say 250,000 $ in total.
At the rate of 10,000$ profit a month, you need over 2 years to accumulate the funds. You might think of taking a loan. Well, the banks may not approve a loan of a quarter million dollars when your business is new.
Reduces your risk:
Let us say you plan to raise the investment yourself. If you have a 100,000$ in savings over different investments such as savings account, 401k, bonds, etc, you might need to sell them all to gather the money for your investment.
If your startup fails you have lost all your savings. Having an investor invest his money would reduce the risk on your shoulders.
Increases your confidence:
When an investor invests money, it indicates they trust in you or in the idea or both. The willingness of another person or a company to invest money in you tells you that you are headed on the right track.
You will have further motivation to do better.
Covers your expenses:
If you are funding your venture without an investment you might face trouble paying your bills if you quit your job. Your salary will have to come out of the profits your company makes. During the early days, the income may not suffice to pay your bills.
With an investment, you can draw a reasonable salary to cover your expenses.
Gaining mentorship and business knowledge:
If you are raising money from venture capital firms or angel investors with a proven track record, you also gain mentorship and knowledge. The industry experience they carry leads them to suggest valuable changes and avoid pitfalls which you grow faster.
For young founders or those with no prior experience, the business knowledge and mentorship adds as much value as money, if not more.
Additional services such as legal, tax:
Most investors already have a successful business. They are familiar with all the nuances of the legal formalities, the taxes, the accounts books and so on. Their existing team can handle your books too or they could suggest a trustworthy set of people at a reasonable price.
Improved network reach:
The venture capitalists and investors are well connected with the other big guns in the market. For example, if your product sells in retail, the investor can set up a meeting for you with Walmart at a snap of his fingers.
You, on the other hand, might have to knock on a hundred doors to get there.
Loss of ownership:
The investor looks for a certain share or equity in the company for the money he invests. For example, Peter Thiel invested 500,000$ during the early days of Facebook in exchange for 10.2% equity in the company.
With equity, the investor also becomes a partner in the company. You no longer run the business only by your own rules. Though many investors allow the founder to run the company, you do not have the comfort to take any decision you like. The bigger the investment, the more involved the investors are.
Any investor puts in money with the intent of making more from it. Therefore, once you receive the funds, targets and milestones become the norm.
As a founder, your passion could lie in the growth of your idea. The investors might have a different perspective and expect you to target profits first which can cause a tug of war many a time.
With the industry experience the investors possess, they force some changes to foster growth and increase profits.
For example, if your product sells to a niche audience like adventure motorcyclists, you could be forced to tweak the product and cater to the mass market normal motorcyclists too.
Your Equity Reduces:
No investor invests money into your venture as a charity. In exchange for the money, you have to forgo a percentage of your company. Through the various stages of growth of your business, chances are you will need to raise more money and thereby have less equity.
Every round of investment you raise stimulates faster growth but leaves you with less ownership of the company. Mark Zuckerberg currently owns about 28% of Facebook. It is not a bad thing in terms of money because the overall net worth of your company increases with investment.
The process of looking for investors, preparing a pitch, following up and negotiating will consume time. If your product has gained fame in the market already, the process becomes much easier though.
But for most ideas in the early stage of their growth, you will have a lot of running around and convincing to do before securing the first investment.
Even after receiving the investment, regular updates, discussions, targets, and milestones will consume more of your time.
The feeling of “not my money”:
Have you noticed how employees visit expensive restaurants for corporate lunches? You would have. The same people would never visit the same restaurant if they had to pay on their own. Spending someone else’s money seems easy which spending your own money makes you feel the pinch.
Similarly, spending investor’s money is easy. If you have invested your own money you will take more careful decisions. You may not splurge the investors’ money, but your mind might think different. You might spend more than necessary on marketing, promotions or hiring just because you have the money.
Raising money from friends and family:
Raising money from friends and family is the easiest way to get your feet off the ground. But for every easy way out, you have a possible cost to pay.
Friends and family invest because they trust you, not the idea. You must live up to that trust by stating the truth upfront. Do not hype up the potential of the idea and create false dreams. You must state the reality and help them understand what is your road map and when can they expect the return on investment.
Bring your investors on the same page as you. For example, if your business is making the news, your friends who invested in you might expect the money back. You, on the other hand, might be seeking more funds for growth.
Help your investor friends and family know how your business works. Their knowledge on the subject will be limited.
Most entrepreneurs do not lie to their investors but keep some part of the information a secret. One such example is hiding the risk of losing money.
Be upfront. Do not hide the truth that the possibility of the business failing exists too which would mean their investment could go down the drain like a paper boat in rainwater.
Communicating all the possibilities clearly. Help your friends and family make a thoughtful decision. When every piece of information on risk and reward is placed on the table beforehand, you will not hurt relationships in the future when things go wrong.
I know quite a few entrepreneurs who raised their initial investment from friends or family and the idea failed to take off. The investors still believe that the entrepreneur owes them the money. You do not want to be in such a situation, do you? So be crystal clear and honest upfront.
Conclusion with an exercise:
Raising money is easier than before. At the same time, raising a huge investment seems rosy from the outside. You must take into account the disadvantages of raising capital too.
Ask yourself a few questions before you raise an investment:
- Do I need the investment to start or am I thinking too far ahead?
- Can I start small to prove the model before I try raising a big investment?
- Can I handle the changes in the business that can arise due to the decisions of the investors?
- Can I grow my business without investment? Will an investment speed up the scale of the growth of my business?
Raising investment is not a bad idea. In fact, it can short cut your growth at a pace you cannot fathom. At the same, you must digest the fact that external people will also participate in decision making.
There exists no right answer if raising investment is good or bad. The answer comes down to your line of business, the current stage you are at, your style and your vision.
Be aware and make the right choice.
What I am not:
What I am:
Continuously improving self-learner
Productivity/Time Management Obsessed