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Why Raising Capital Is a 4-Step Process

Entrepreneurs care most about turning their vision into a real business, but often lack sufficient capital. Yet going hat-in-hand to investors asking for money could lead a startup CEO to lose control of their company. Sell a big stake in your business to an outside investor and that investor may decide your vision for the company is wrong or that you lack the capabilities needed to realize that vision.

Is it possible for an entrepreneur to both raise the capital needed to fund their startup's operation while retaining control of the business? In order to achieve their full potential, startups must evolve through four stages -- seeking a different source of capital at each one. Let's look at each of these stages:

1. Prototyping. In this stage, entrepreneurs listen to potential customers, develop simple and cheap prototypes, get customer feedback and try again. At this point, it is best for the venture to be financed through the founder's cash, credit card borrowing or invested labor.

Trying to raise venture capital at this stage would unlikely produce any interest unless you can show that you have previously made a significant profit for investors. Even so, without establishing a clear business model, you are in a weak bargaining position with venture capitalists.

2. Customer base. Once you've found customers who want to use and pay for the final version of your prototype, you may want to seek capital from friends, family or angel investors who would generally buy a small stake in the company.

At this stage, an entrepreneur can often raise money from many individuals -- none of whom own enough of the venture to oust the founder. While some entrepreneurs raise VC at this point, it is generally better to wait until the third stage in the venture's development.

3. Expansion. Once you have gained a significant share of a market segment and your growth there has begun to slow down, you may want to expand into new markets, countries and customer segments while updating and developing products.

In this stage, a startup CEO is in a stronger position to negotiate with a VC because the venture is profitable and could continue to grow -- albeit more slowly -- without taking in outside capital. At this point, if you can make a compelling case for how your venture can achieve higher growth with the help of a VC investment, you could receive significant funding while still maintaining control of the way your business is run.

You should think of raising VC as similar to hiring a boss. That's because the partner from the venture firm is likely to be joining your board and exercising some control over your business decisions in the future.

In that case, how can you hire the right boss? Make sure the VC partner shares in your vision for the company. Check with other CEOs who have worked with this partner in the past to find out how a particular VC reacts when a startup is under stress.

4. The exit. Few startups actually reach this point. Here, the entrepreneur sells the company to an acquirer or leads an initial public offering. While startup CEOs I have interviewed talk about an IPO as a relatively minor step in the company's development, the reality is that most entrepreneurs leave their business soon after the initial public offering is made, bored with the challenge of administering a slower-growing publicly-traded company.

So while you may want to raise as much money as possible right away, in order to balance a need for cash with a desire for control, you need to match the right source of capital with the proper stage in your company's development.

The author is an Entrepreneur contributor. The opinions expressed are those of the writer.

Peter Cohan is president of Peter S. Cohan & Associates a management consulting and venture capital firm. He is the author of Hungry Start-up Strategy: Creating New Ventures with Limited Resources and Unlimited Vision (Berrett-Koehler, 2012).

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