Everyone Pays to Raise Money
One way or another, entrepreneurs always pay to obtain capital.
By Scott Shane •
Opinions expressed by Entrepreneur contributors are their own.
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.
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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.
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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.
