Oh, go ahead and ask for a five-million-dollar investment in your startup.

I cannot tell you how many times I have seen executive summaries of business plans in which the entrepreneur seeks $5,000,000 to build the business.

Four reasons you should reconsider.

First, few startups can use that much money today with all the virtual services available and increasingly inexpensive methods of development, prototyping and marketing. Second, almost no professional investor will consider putting that much into a startup until there is proof of market demand, product viability or some other mitigation of failure.

Third (if you’re keeping score), it is not wise to dilute the founder’s ownership greatly in the first round of financing.  The investors want a motivated entrepreneur, and it is certainly more difficult to motivate a twenty percent owner than a sixty percent owner.

Fourth, there is the matter of control.  Entrepreneurs have a vision for what and how to create and build a great business.  Giving control over that vision to others early on often dilutes the vision and is a disincentive to the entrepreneur.

How does this comport with “skin in the game?”

[Email readers, continue here…] Professional investors love to see companies where the first round of financing came from the entrepreneur, showing “skin in the game” and more motivation to succeed because of money invested as well as time and creativity.

There are so many resources for early money to validate an idea, turn it into a product and increase the value of the company before professional investors come into the picture.

A much more rational approach to starting up.

Starting with credit card debt or a personal loan and working through money from friends or family, or simply consulting to earn money for investment, entrepreneurs should consider early resources for capital to produce a prototype, do market research or start to build a team.  Once there is progress in any of these critical areas, raising professional investment is easier and the likelihood of a higher valuation makes for retention of more equity during the first important professional round.

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5 Responses to Oh, go ahead and ask for a five-million-dollar investment in your startup.

  1. Studies have shown that successful entrepreneurs come from already privileged, wealthy families. The tiresome and predictable claim that investors only feel compelled to invest when an entrepreneur has gotten her friends and family to toss in their own money assumes that we all come from the right side of the tracks.

    My response (when I’m amongst friendly investors) is that for my family to invest, they’d have to commit welfare fraud. Gets a laugh out of them and highlights a very real situation.

    If the entrepreneur, herself, has put a load of her own skin in the game, that should be enough for an investor. We don’t all come from privilege and busienss opportunities should not be judged based on how rich our friends and family are or are not.

  2. Mimi Grant says:

    This is yet another brilliant post, Dave. Not only do you share the “why nots,” but the alternatives, and the benefits of holding off going for “professional” investment too early.

  3. Investing in the stock of a startup is foolish if the same amount of money as being sought can be used to buy an agreed percentage of the company’s revenues for an agreed period of time. The money is going to be used by the company to create revenues, so why not buy a piece of the revenues?

    Using our approach the royalty payments are paid whenever the company receives revenue and there are no conflicts of interest with the company’s founders as to executive compensation, profit reporting policies or pressure to sell the company or go public.

    Why would any investor want to invest in early losses, possible profits or benefit from the company being sold, when they can share in the revenues and be paid before anyone else?

    Arthur Lipper, Chairman
    British Far East Holdings Ltd.

  4. Patricia, I empathize with your dilemma, but you really have to look at it from an investor’s angle. There are _many_ pitfalls and possible problems that can cause the initiative to fail, so by waiting for the company effort to have some momentum(by sales, vision and exec team efforts) it reduces the risk to investor and entrepreneur.
    Yes this method reduces risk to you. You have to prove the market and your ability to make the product somehow. The way to do it without $$ is to ask friends to help you. It does not always mean with money. Ask them to help in the marketing plan. Or make the prototype. Then write plan (get help), thereafter finally present with an eye on raising some funds.

  5. Cricket Lee says:

    Thanks, Dave for your great insight. I certainly have appreciated your consulting and it is so valuable now in the middle of my raise. You are a human encyclopedia of investment information!

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