5 Reasons a Young Entrepreneur Should Raise Outside Funding

Investor Peter S. Cohan gives us the lowdown about scenarios when a young entrepreneur should turn to investors for funds.

learn more about Peter S. Cohan

By Peter S. Cohan

blog.popephoenix.com

Opinions expressed by Entrepreneur contributors are their own.

Many entrepreneurs cringe at the idea of seeking outside financing, as a deal will most likely require giving up control and equity. They want keep their business under lock and key and forgo investor scrutinizing their every move.

But there are times when you have to look outside for financing because you're quickly running out of cash or your goals for your venture's expansion exceed its capital resources.

If you need to turn to venture capitalists, don't wait until the last minute. Instead, you should start the process of talking to potential capital providers at least six months before you actually need the funds.

Here are five situations when you should kick into capital raising mode:

1. You can't convert users to buyers.

If you are a startup using a freemium model -- one that offers free basic services but requires people to pay for added features -- and you're not getting any conversions, you are going to hit a revenue wall. Depending on the rate at which you are burning through cash, most likely you will need to go outside to raise capital before you run out.

This situation can be tricky, as investors aren't going to want to put their money in a sinking ship. Do not approach those investors until you have a clear idea of how many potential customers might be willing to pay for your product, what price you can charge and the details of the additional features you'll need to persuade future customers to pay.

Related: 5 Tips for Customizing Your Pitch for Every Investor

2. You lost a big customer.

Big customers can cause big problems when they decide to cut ties with your startup. If your company is getting a big percentage of revenue from one customer and one day they say sayonara, you better act quickly.

When approaching investors, any potential outside capital provider is going to need to understand why you lost the big customer. You'll also need to explain how you are going to use that capital to make your business even bigger and more successful than it was before.

3. You have intense price competition from rivals.

If your startup offers a product with high profit margins, you could be inviting in competitors looking to cash in on the market. And they may offer consumers the same product at a much lower price, igniting a price war.

Related: How to Speak the Language of Venture Capital

If this happens, your company is in imminent financial danger. You can hold prices and risk losing customers or you can match competitors' lower prices and watch your margins shrivel. Either way, you are going to suffer lower cash flows and outside capital may be your only option.

But you can't launch a capital raising campaign until you have good data on why customers are taking their business to competitors and what new products would be required to win back customers.

4. There's been a rapid change in technology.

Technology is continually changing, resulting in startups needing to constantly upgrade or risk losing their market position. To stay competitive, you may need to turn to investors to front your technology investment.

Before you go to potential investors, make sure you can explain why customers will perceive the technology as important, how you will need to change your product to incorporate the new technology and how much it will cost to build the new product.

5. You want to expand into new markets.

You may reach a point where your growth has plateaued in the market you are selling in, and you are looking to offer your products or services in new countries or industries.

Related: 10 Ways to Generate Your Own Startup Capital

If you're at this point, you most likely have a cash-flow positive business in the current market, which puts yourself in a good position when approaching investors. Nevertheless, you should have a good answer to investors who will wonder what it will take get into those markets.

Raising outside capital is no walk in the park, but the alternative could be worse.

What reason did you offer for raising outside financing? Let us know if it worked in the comments below.

Peter S. Cohan

President of Peter S. Cohan & Associates

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 (Berrett-Koehler, 2012) and a full-time visiting lecturer in strategy at Babson College in Wellesley, Mass.

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