The Myths and Pitfalls of Raising Money
Free Book Preview Money-Smart Solopreneur
Risk-averse entrepreneurs typically have a huge desire to seek third-party funding. This is especially true for individuals who come up with a good idea but have no other viable solutions for financing their business.
Two typical sources of startup financing are venture capitalists (VCs) and angel investors. VCs are groups of investors that hire experts to manage their funds. Angel investors are individual investors with strong cash reserves.
However, there are some important differences between the two. Angel investors tend to be more personal and care a great deal about who the person is behind the idea. In many cases, they are family members, close friends or former colleagues. VCs, on the other hand, care about having a winning business concept. They want to join the process later when a foundation has been laid and your business is ready to start exploding.
Unfortunately, the common wisdom about looking for funding is usually wrong. I am biased, of course, as my team and I have bootstrapped Amerisleep over the better part of the last decade and built it into a leading manufacturer of eco-friendly luxury mattresses.
But I've also had plenty of experience along the way. And, given that experience and the anecdotes I've collected from fellow entrepreneurs, I'm here to explain why seeking investors is not everything it’s cracked up to be, and why bootstrapping may be your best bet.
The myths about third-party capital
When a business exchanges equity for cash, the founders relinquish a lot of control over how they'll expand their idea and grow their company. Sometimes, this can even doom an otherwise promising venture before it has a real chance to take off.
To illustrate exactly why raising capital from investors is a bad idea, consider some of the most common “advantages” attributed to seeking investors for your business:
Provides a simple, quick way to fund your business
Helps you build the foundation for long-term growth
Offers your business valuable mentorship and an outside perspective
Taking a deeper look, however, reveals problems with all of these potential advantages. It's important to realize that just because raising capital from investors is a simple solution to your money problem, it isn’t necessarily the correct one. In fact, it can be more harmful than helpful in the long term.
Most investors demand preferred stock in your company, which means that in the event of an acquisition or IPO, they can redeem a fixed dividend first before all other common stockholders cash out, assuming there is any money left for the remaining equity owners.
Making a decision between what is right and what is easy can be difficult. But think about how investors view your business versus how you do. You are looking to build something that succeeds and prospers over the long haul. You want a huge success that lets you retire early.
Investors, on the other hand, view your business as just another opportunity to make a return. And their goals will often come into conflict with your vision for your business.
Finally, it is impossible to even count on their mentorship and perspective. Many investors are so disconnected from the businesses they fund that they do not even bother to respond to founders' emails. If they do respond, their answers may not be as thoughtful as promised, and their advice may not even be applicable.
Startup investors juggle dozens of active investments at a time, and often are able to allocate energy only toward the one or two portfolio companies they believe will yield them the highest return.
Bootstrapping as an attractive alternative
The term "bootstrapping" implies hard work, and that is exactly what bootstrapping is. Instead of raising millions of dollars for your business, you may be forced to dip into your personal savings, cut back on your living expenses and liquidate your 401K.
So, to start, you will need a more conservative growth plan, spending only what is absolutely necessary to stay operational. Once you start making money, those funds should be reinvested back into the company.
The good news is that your hard work can be rewarded. I would argue that the return on investment for your effort and time is better when you bootstrap your business versus when you sell large chunks of your business to outside investors. Several advantages to being a bootstrapped founder include:
Teaches you how to run a lean operation. Bootstrapping is all about finding ways to stretch every dollar as far as it can. You will quickly figure out what you can handle by yourself, versus what needs to be outsourced, and what you never needed at all. If you are flush with cash from the start, it may be hard to build those skills, which will be necessary to manage the business years down the road.
Maintains your vision. A successful entrepreneur has a clear vision of what his or her company looks like and stands for. Every time somebody else is added to the equation, that vision become murkier. Bootstrapping allows founders to stay laser-focused on their strengths instead of trying to adopt somebody else’s vision, too.
Keeps you nimble. As a startup, your company can move much faster than larger corporations. If you see an opportunity, you can pivot and seize it immediately. When you require investors to sign off on these decisions, you lose your biggest advantage.
One way to look at this debate is by asking yourself: Would you rather put your company’s fate in somebody else’s hands? Or would you prefer to gamble on your ability, instinct and resolve to build a successful business?