The Truth Behind 12 Common Startup Funding Myths
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The recipe for business success requires a dose of ambition and dedication, and a healthy portion of perseverance, but make no mistake about it, money is the ingredient that will ultimately make it sustainable.
Funding a startup business, however, is a tricky proposition. It is even trickier with young and inexperienced entrepreneurs who mistakenly believe they can outthink a sophisticated business environment or that their business is "different" than other businesses.
So before you set out to develop a pitch and raise money for your new business idea, understand the truth behind a few of these popular funding myths.
1. I will fund my by business with investor money only.
If you have a business idea that investors are crawling over each other to fund, great for you. Skip this article and start planning your retirement. If you are like the rest of us mortal entrepreneurs, then more than likely, you will look for partners to help you get started.
Very few investors will write you a check, however, unless you have a vested interest in the business. Why? Because when times get tough, you are far less likely to bail on the business if you too have a house or kids' college fund tied to its success.
2. I will never personally guarantee a loan.
If you have no cash or assets to put up against a company, then some investors and most banks will ask for a personal guarantee (PG), which is your promise to pay back money against your personal assets. For many, this is frightening proposition.
Why, after all, even go through the trouble of starting an LLC? A PG provides investors security in knowing, again, that when waters get rough, you will captain the ship through the storm. Most PGs are negotiable to some degree and very difficult and expensive to collect on. Be sure to understand the terms and conditions, and remember that in the end all investors want you to succeed.
3. I need a venture-capital partner to succeed.
It is very tempting, especially these days, to first think that venture capital (VC) is the fastest way to success. The truth is that many companies need to develop a working prototype or minimum viable product and build a small customer base to provide proof of concept before considering the sophisticated and potentially equity-diluting prospect of a VC partner. Do your research and understand venture capital before you get started.
4. We can grow revenues to fund the company.
Congratulations! You just found the magic business formula, which I am guessing is located next to the goose’s golden egg. In reality, entrepreneurs often have an inflated optimism and overestimation of how successful their company is going to be from the start. Ask yourself first, honestly, how you will find your very first customers, and if you answer is social media and/or word of mouth, go back to the drawing board and think again.
5. I can survive with only six months of expenses saved.
This number (or any amount of savings) is difficult to estimate. Six months of savings now may be much too little six months from now as your company grows. Most entrepreneurs (and I include myself in this) will ponder better uses for those funds and be tempted to leverage them to grow the business. Instead of looking at a number in a bank account, consider lines of credit or capital partners who are willing to pony up more money when the company hits difficult times.
6. Banks are the best option to avoid diluting my equity.
True, banks are great non-equity partners, especially with their nice lobbies and friendly staff. Unfortunately, banks rarely take risks with startup companies without collateral or a personal guarantee. More important, they have very strict covenants and (go figure) they want to get paid every month. Because of a few bad apples a few years ago, they are much, much less flexible when missing those payments.
Having a business line of credit at the bank is a good backup and will help you to avoid personal debt to finance the business, but until you have regular income for the business, it should be a last resort.
7. I will fund the company with my personal credit cards.
Great idea, except when you consider the 20 percent annual percentage rate or start commingling your personal and business finances and creating a host of liability issues you do not need. Granted, for many entrepreneurs (myself included in my early years), personal credit cards often are the only choice you have when in a bind, but it should be the last line of defense.
8. My family has money, so my startup will be fine.
Indeed, once you have extinguished your own personal startup capital, you will look to your relatives for your next round of funding. Not only is family money typically more friendly and flexibly, it also helps to demonstrate that others believe in you and your business. Just approach this cautiously, as family and business are a sensitive combination that has the potential to make family reunions very, very uncomfortable.
9. I should never touch my 401k.
Talk to any financial advisor, and he or she will tell you horror stories about cashing out your retirement fund early. While the rationale is not wrong, consider that your business is your retirement, so would your retirement money be better served in your business?
10. I can find talent who will work for equity.
First, when you find these people, please give them my contact information. Second, while independently wealthy and brilliant engineers may be overly abundant where you live, they most certainly are not the norm.
Most ambitious and success-hungry talent are looking for opportunities, and while your startup may have the potential to return a fortune in stock later, that promise does not put groceries in their fridge or keep their apartments cool in the summer. Offering equity can get complicated, especially if not executed properly. Keep those vested stock options as a consideration, but budget to pay and retain key talent.
11. I will never give up half of my company.
If you are taking on investor money, more than likely, you are going to have a difficult time negotiating the proper amount of cash you need without giving up some control. Avoiding the 50 percent or more mark requires you to find a valuation that is fair and equitable to all stakeholders. Understand there are plenty of ways to structure investor money and maintain a higher valuation, so be aware of your options and consult an expert when developing your term sheet.
12. I will need to file bankruptcy if my company fails.
Let me say that I am not a legal expert and this by no means constitutes legal advice, and if you are considering bankruptcy, consult your accountant and attorney to understand your options.
With that said, it is my personal experience that bankruptcy should never be your first resort when the company closes. Bankruptcy is in nobody's best interest (except bankruptcy lawyers), and all of your debts are ultimately negotiable. Most of your partners will take some payment rather than none. If you find yourself in this unfortunate situation, before (or in addition to) consulting a bankruptcy lawyer, speak with as many other entrepreneurs who have gone through a business closing. You will find their feedback and advice invaluable.
These are just a few of the common myths I often hear when talking with new entrepreneurs. Keep in mind that many of these funding myths do not apply to tech startups, which have their own completely unique set of funding myths and even legends.
For the rest of us "ordinary" entrepreneurs with great, non-tech ideas, I believe that understanding the truths behind many of these myths will help set the proper expectations when seeking funding and make identifying and securing the resources you need to grow your business much easier.
What other startup funding myths have you found? Please share your feedback with others in the comments section below.