Tuesday, November 11, 2008

Funding a startup.

The typical funding sequence begins when you put up your own money first. Next, you look for “FFF money” (from Family, Friends and Fools). Then, if you still need more money, you try to attract private investor or Angel money. This is usually followed by additional rounds of funding provided by professional venture groups (VCs).

The funding sequence is typically made up of the following stages:

The Concept Stage – here there’s a business plan and maybe a demonstration product. Money comes from your personal savings, FFF and Angel investors. FFF invest primarily in you, rather than in your business. Angels invest in you and your business.

The Early Stage – here there’s a working product and some beta customers. Funding comes from Angels and some VCs.

The First Pro Round – here the product is being used by some reference customers. Funding comes from VCs and some Angels

Later Stage Rounds are possible after market validation. Here funding usually comes from VCs.

The single most important thing to remember in launching a business is to never, ever run out of money! The most common mistake entrepreneurs make in getting funding is not getting enough in the beginning. Always ask for more than you think you’re going to need. That way, you can focus your energy on building the business rather than spending all your time trying to raise more money.

Try to fund to a series of milestones. If you’re looking for a long-term payoff, you want long-term money. Never take someone’s last dollar. If they don’t have the money to invest in the next round, it may hurt your credibility with future investors. Be careful to avoid the appearance of being turned down by anyone as this usually makes lead investors nervous.

Since the first round is seldom the last round, it’s important not to give away too much equity in the beginning. The First Pro Round often takes 40 - 50% of the equity in the company. Remember, having financing is better than having control. Having half of a big venture is better than owning all of a small one. Raise the money, take the dilution and earn the equity money back some other way. Take the money when and where you can get it - don’t wait until you need it. You’ll never know what dilution means until you need more money and you have to raise it quickly. Avoid having a “down round,” when the price per share drops below that in the previous round of financing.

People who failed in their first business venture usually say they were undercapitalized and while it's true some of the time, more often than not it's because they didn't use their capital wisely. Perhaps they spent money to celebrate when they were told they’d get the order, they celebrated again when they actually got the order, and they celebrated one more time when they completed the order. Remember Sam Walton kept driving his beat-up old pickup truck long after he was wealthy - the truly successful entrepreneurs don't need false symbols of success. Bootstrapping is more than just a response to a financial predicament; it's a belief about how to run your business.

Jeff Bezos, the founder of Amazon.com, was working on Wall Street, studying the Net phenomenon and thinking long and hard about the best possible businesses to build on the Web. He had a big advantage in being systemic and early. So he was able to self-fund Amazon.com into a business with a little seed capital from family and friends. Bezos figured he could grow without VC money, but he’d like their help. This was less about capital than it was about experience and relationships. So he interviewed and auditioned potential venture backers like he was hiring a vice president. He carefully checked references. He talked to entrepreneurs from ventures they’d backed that were successful and also with some that failed. He eventually teamed up with Kleiner Perkins, because, in his words, they were a center of gravity at that time for Internet businesses.

No comments: