Investment (Part 5): Don’t Do It
June 26, 2012 1 Comment
Raising funds from Angel and VC investors is a colossally time consuming exercise, and all the time that founders spend raising money is time spent not developing the product, talking to customers or building the team. Most companies that set out to raise investment will not succeed – meaning that this time and effort is wasted.
Assuming a team does succeed in raising money, they will give away a large part of the equity of the company. I have a couple of rules of thumb. The first is that investors in a first round generally take between 25% and 40% of the equity. The second is that pre-revenue companies almost never receive valuations of more than £1m at the moment. These rules of thumb seem to hold true over a pretty wide range of deals, but interact in slightly non-intuitive ways. Usually this means companies give away more equity for less cash than they would expect – don’t just take my word for it, check out this article: Your idea to make millions is worth much less than you think.
As if losing equity wasn’t bad enough, most founding teams also lose control of their business. This is also non-intuitive, since the investors are very seldom taking a “controlling stake” in the business – they control fewer than half of the shares. However, when an investment deal is struck the investors will request modifications to the Articles of Association (guiding rules) for the company, and a separate document called a Shareholders Agreement. Through these, the investors will gain a veto on most important decisions, including future investment rounds, exits, appointments to the board etc. They will very often also gain the right to fire the founders, and may even be able to strip them of their shares. Don’t make the mistake of believing that minority shareholders can’t control a company. Read Angels, Dragons and Vultures by Simon Acland for some scary stats on how few founders retain the CEO job after taking VC investment.
For some companies the amount of cash needed to get started will demand that the founding team accept these compromises and take external cash. If you’re making a new silicon chip that will take years to develop and require millions to make the first samples, you probably need serious VC investment. Many web or service businesses can get started help from other sources.
Other sources of investment cash include Friends Family and Fools and re-mortgaging the house, but there are other ways to approach growth without taking equity investment.
Since growth is costly, slower growth generally requires less cash. If a company can start trading, it can use its own profits to invest in further development and “organic” growth. Even where a company is developing a product that isn’t yet ready for sale, the team very often have specialist knowledge and expertise that can be sold as consultancy. If one or two days a week working on consultancy can fund the rest of the week working on product development, that can be a pretty good model.
There are alternative approaches to getting cash too.
Getting money from customers is always a good idea. Even if your product isn’t ready yet, sometimes an “Early Adopter Program” where they get early access to technology as it emerges in exchange for a discount later can work. Sometimes it is even possible to get a customer to pay for product development where you retain the rights to sell elsewhere, if their need is great and there isn’t a problem with direct competition.
Strategic Partnership or Joint Venture can be formed for customers or supply chain partners, with you bringing technology and a partner bringing credibility, cash and market access. You may still end up giving away equity, but at least it is to a partner who is bringing more than just cash.
In some places in particular (and Scotland is one of them) there is Government money available as grants or soft loans. These can be a vital source of cash in the early days, but beware grant addiction (see my post Are grants bad for business? )
Alternative sources of cash are sometimes seen as leading to slower growth. However, if that growth is more market driven and delivering what the founders want, that may not be a bad thing!