Wednesday, November 12, 2008

Identify sources of funding.

The most common way to raise money is to have an individual investor or a venture capital firm give you money in exchange for an equity position. You don’t need to issue additional stock to each current owner to achieve this. Instead, agree on the valuation of the company with your investor and then issue additional shares based on the investor's dollar contribution. For example, if you agree that the pre-money valuation of your startup is $4M and you raise $1M from an investor, that investor just bought 20% of the company ($1M invested / $5M post money valuation). So the company needs to issue new shares to the investor so they now own 20% of the total shares outstanding.

Understand the ground rules for valuation and know the value of your company. Hire a qualified appraiser or investment banker to help you. Never enter a negotiation without knowing the value of what you’re negotiating for. Be able to backup any counter-offer with market data on similar companies. However, valuing the company is the job of the potential investors as well; they’re the ones who should make the initial offer. Only two things can happen if you attempt to give them a valuation first, and they’re both bad: (1) You give them a number that’s too high and mess up the deal or (2) You give them a number that’s too low and that's what you get! And don't just focus only on the valuation. Focus on which investor is going to most helpful to you and do your best to make that deal work. Interview CEOs from other startups that the investors have worked with and find out which were the most helpful in building the companies.

Today, the Web is making it easier than ever to locate sources of funding because it allows people to search outside their geographic boundaries for investors interested in companies like theirs. For example, Venture Capital Access Online ( is a marketplace for the venture capital and private equity industry. It provides online services and tools to entrepreneurs, investors, advisors and service providers worldwide. Its flagship product, VCPro Database, has become the most popular venture capital directory of its kind available today. America's Business Funding Directory ( allows you to search over 4,000 sources of business financing. But unless your venture is in the hottest industry of the moment, don't expect to get much ready money from VCs in the beginning.

Go beyond appealing to obvious targets, such as wealthy people you already know. Create a broader list of people who have money and who are also relatively sophisticated investors. Write to about 30 of them, letting them know that you have an investment opportunity, should they be interested. To those who ask for more information, send them a venture summary. Others are likely to want a formal written business plan.

It’s expensive and time consuming to raise money - factor in the costs of traveling to other cities, for example, to meet with potential investors. Or having various groups spend half-a-day visiting your company, distracting employees. Make sure to ask for enough money to absorb the costs of raising more.

According to Paul Graham, a partner in the investment firm, Y Combinator, “Getting rejected by investors can make you start to doubt yourself. After all, they're more experienced than you are. Perhaps they're right? Maybe yes, maybe no. If an investor gives you specific reasons for not investing, look at your startup and ask if they're right. If they identify real problems, fix them. Don't just take their word for it or simply ignore their rejection. It might mean something. But you shouldn't automatically get demoralized either.”

Raising money from investors is harder than finding customers because there are so few of them. However, don’t let fundraising wear you down. Startups live or die on morale. If you let the difficulty of raising money destroy your morale, it’ll become a self-fulfilling prophecy.

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