Entrepreneurs struggle with the idea of seeking outside capital and for good reason. An entrepreneur must weigh the risk vs. reward for taking on investment capital. There are 2 types of companies: Market Participants and Market Makers. Market Participants are those entrepreneurs that want to buy a franchise, open a restaurant…you get the idea. These companies can make a good living for their owners but do not usually bring innovation to the market or grow very large to produce a big return on investment. The Market Makers on the other hand are the companies that make the headlines. They have invented a new product or way of doing things that has potential to move markets, change lives. They have the potential of being very big or at least big enough to be acquired by another company that can continue the momentum.
Both types of companies will often seek outside capital to get started or to grow their business. And in both cases, entrepreneurs need to have the right expectation on what the expectations and responsibilities are to that investor or investors. They types of investment they attract may be different but in all cases, the investing party generally expects to get a return on their investment. Unless the entrepreneur is leading a non-profit charity, the investor rarely knowingly gives money to an entrepreneur with the expectation that the money is lost, gone forever. The very notion that they have enough money to invest large sums into another company means they are savvy enough to usually make money when they invest.
The types of investors that invest in Market Participants are investors that aren’t the typical angel investors looking for big returns. They are “silent partners” in an entrepreneur’s business that usually know the entrepreneur well. They believe the entrepreneur can succeed and will work hard. They generally are looking for a steady flow of income from the investment. They’ll share in the revenue or in effect be the landlord in financing the construction of the franchise. They may have an earn-out provision to their investment over time so as the entrepreneur succeeds and the investor gets all their capital investment back, the entrepreneur begins to gain greater share of the company. The risk with this type of investor is that they typically aren’t as “savvy” as the stereotypical “angel investor” or venture capital firm. They do not have an expectation or a tolerance for the company not generating cash flow very quickly. They can make life miserable for an entrepreneur that doesn’t have experience running a business and falters, and avoids communication with the investor to get guidance or help to make the company profitable. This type of entrepreneur can be blinded by the money and desire to get their business started, and not consider the personality and business style of the investor. The “silent partner” can rapidly become a very vocal and active participant in the company.
Investors that invest in Market Maker type companies are what the industry typically calls “Business Angels”. Yes they are angel investors, but to more clearly differentiate from the angel investors that are called “friends and family”, business angels are angel investors that are in the business of investing. They look at many deals in the expectation that they will find 1 that meets a specific criteria to be worthy of the risk in the investment. They are all to aware of the risk in angel investing. Because they have chosen angel investing as a method to diversify their portfolio and increase their wealth, they most likely have made at least a few investments that they lost all their money. Therefore, they aren’t as easily influenced to invest based on an emotional buzz that an investor that has an affinity connection to the deal, or as a friend and family investor might.
The fact is, sometimes investment capital can sink an otherwise healthy business. It isn’t “free money”. The entrepreneur who takes on outside money from investors is taking on a fiduciary responsibility and accountability to those investors to produce a specific result. All is hunky-dory if the company took on the correct amount and has properly planned so they can execute and produce the promised results. So knowing when and whether to ask for money is part of the maze one navigates as a new business takes shape. If the entrepreneur has over committed the potential of the business in a misguided attempt to “sell the opportunity” then the problem with funding becomes in how investors looking for milestone growth rates (or a quick ROI) can influence a company’s direction in the early days of operations. This can place undo strain on a business while it’s just figuring out how to survive. In some cases, if investors don’t give a business ample time and space to figure things out, or if the company didn’t raise all the capital they really needed, the business maybe forced to take unnecessary risks resulting in lost capital without the market results. Similarly, the entrepreneur may make unqualified assumptions or spend money in the wrong places in an effort to show investors that they are making progress.
The recommendation here, before taking on investment capital, an entrepreneur should be certain to do 3 things:
1. Assess your level of competition and uniqueness in the market and determine if you are a market participant or market maker.
2. Make a thorough plan to determine how you would get to market without capital to begin generate self-sustaining cash flow
3. Determine if outside investment capital is absolutely needed, what is the exact use of funds for that to reach key milestones that would grow your business faster and more profitably than the plan you developed without money.
Then based on the outcome of this exercise, the entrepreneur can identify the right type of investors for the business and adopt the mental attitude necessary to start the grueling process of finding investors, selling them on your business and closing them on the sale of the equity. They will be forthright with the investors to establish a clear expectation on what will be accomplished and how with that capital so that the win-win can come not only from the experience of having the investors involved but in the successful outcome of the business to create wealth for the founders and the investors.
Author Info: Karen Y. Rands
Karen Rands is the Founder of Kugarand Holdings, an advisory firm for both entrepreneurs and angel investors. Entrepreneurs gain valuable insight and resources, and a strategic advantage in the marketplace through the LAUNCHfn Access to Capital System ( http://launchfn.com ). Early stage venture capital & angel investors gain access to qualified deal flow and an opportunity to learn, collaborate and prosper with other investors in the Network of Business Angels & Investors (NBAI). Academically trained as an economist and a master of business, Karen shares insights gained through the real life application of business principals relative to building a business, attracting capital, bringing innovation to market, and creating wealth. Sign up to get free reports, tips for attracting capital and announcements about opportunities to meet with investors at http://GetInvestorMoney.com. Follow Karen on Twitter at Karen_Rands
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