You can be on Entrepreneur’s cover!

Everyone Pays to Raise Money One way or another, entrepreneurs always pay to obtain capital.

By Scott Shane

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

Pexels

An entrepreneur I know recently told me he wouldn't raise money through angel platforms that charge a placement fee because he wouldn't pay to fundraise.

That statement surprised me. One way or another, entrepreneurs always pay to obtain capital. And if an entrepreneur gives up time or equity to avoid an online platform's fees, that's a bad bargain.

To understand this point, you need to understand how many curated accredited investor angel platforms work. Take SeedInvest as an example. This platform charges entrepreneurs 7.5 percent of their fundraise as a placement fee and a small amount of warrants.

While that might sound like a lot, it's less than the cost of raising money offline. Individual angels or angel groups aren't likely to charge a placement fee or ask for reimbursement of expenses, but an entrepreneur will likely spend more time and give up more equity raising money from them.

Related: What Slow Exits Mean to Startup Investors

Let's first look at time, which is arguably an entrepreneur's most valuable resource. SeedInvest currently has more than 14,000 accredited investors on its platform, while the average angel group has 43 accredited investor members, the Angel Capital Association (ACA) reports. In fact, the membership of all angel groups that comprise the ACA have roughly the same number of accredited investors as SeedInvest.

To raise money from members of all 220 angel groups that the ACA comprises would take an enormous amount of time. Even assuming that all the groups would talk to a founder (far from a given), the entrepreneur would need to travel around the country making presentations. Moreover, he would need to negotiate terms with 220 different entities, and go through 220 different due-diligence processes.

Suppose it takes 40 hours to present, negotiate, and go through due diligence with an angel group, and 400 hours to do the same on a curated angel platform. Raising money from the ACA member groups would take an additional 8,400 hours – four more years of fundraising – to get in front of the same number of investors as are on the SeedInvest platform. Even an entrepreneur who values his time at only $30 per hour would spend more than triple the SeedInvest fees in opportunity cost to raise $1 million.

Related: Why Angels Are Moving Online

An entrepreneur is likely to give up more equity by raising money from individual investors and angel groups than by using online platforms. If the entrepreneur doesn't know a lot of angels already, she will need advisors to make connections with them. Those advisors often get incentive compensation, such as warrants, in return for their help. Moreover, to bring on board first investors, the entrepreneur will likely need to provide warrants or other equity incentives. As a result, bringing individual angels or angel groups on board could easily mean giving up more equity than the warrants that a platform like SeedInvest will take.

With an online platform, an entrepreneur can set the terms of his deal, which isn't always the case with an angel group or individual angels. The difference in those terms could leave the entrepreneur with far more equity in the business than she would have had from raising money offline. For example, an individual angel or angel group might demand participating preferred stock, cumulative dividends, redemption rights, or full ratchet anti-dilution, all of which are entrepreneur-unfriendly investment terms. Or the offline investors might set a lower pre-money valuation for the company than the entrepreneur would set on the platform, causing the founder to give up more equity to raise the same amount of capital.

In financing a startup, there's no free lunch. Trying to avoid the fees charged by an online platform could easily cost entrepreneurs much more in terms of time and equity.

Related: Why the Number of Accelerators Is Accelerating

Scott Shane

Professor at Case Western Reserve University

Scott Shane is the A. Malachi Mixon III professor of entrepreneurial studies at Case Western Reserve University. His books include Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live by (Yale University Press, 2008) and Finding Fertile Ground: Identifying Extraordinary Opportunities for New Businesses (Pearson Prentice Hall, 2005).

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Side Hustle

This Dad Started a Side Hustle to Save for His Daughter's College Fund — Then It Earned $1 Million and Caught Apple's Attention

In 2015, Greg Kerr, now owner of Alchemy Merch, was working as musician when he noticed a lucrative opportunity.

Business News

Yes, You Can Buy a Foldable Tiny Home on Amazon — And Now It's Selling for Less Than $12,000

The waterproof and flameproof house was listed around $35,000 a few months ago.

Starting a Business

4 Common Mistakes That Will Spell Doom Your Ecommerce Business

It's hard to spot a success story before it happens, yet it's easy to tell if a business will struggle. With that in mind, here are the four most common mistakes people make that you should avoid when starting an ecommerce business.

Business News

This One Word Is a Giveaway That You Used ChatGPT to Write an Email, According to an Expert

"Delve" has increased its presence in written work since ChatGPT entered the scene.

Business News

This Futuristic Wearable Smartphone Alternative Projects a Screen on Your Palm — And It's Now Widely Available

Humane's Ai Pin fastens magnetically to clothing and becomes a voice-activated AI assistant that can make calls, send texts, take notes, and find answers to complex questions.