A lot of entrepreneurs ask me when they should start looking for investors and my advice is to start very early. Get out there before you need money.
Basically, start looking at the time you’re starting your business, and get to know people. Go to industry conferences, go to investor meetings, introduce yourself and ask people for advice. Tell them you’re working on something exciting. Don’t mention that you’re looking for money so that when you come back later, it’s now a warm introduction rather than a cold call, and that’s very important.
I always say the first thing you should consider is whether you need an investor at all. In fact, some 90% of new businesses start with what’s called bootstrapping.
Related: How to Bootstrap Your Business
They start with their own money but if you need investors or you anticipate that you need investors, you have to do it in a very kind of structured sequence. In other words, there are friends and family, there are angel investors, there are venture capital investors.
A lot of people come to me and say “well I need $5 million to do this, so I think I’ll go directly to a venture-capital firm I’ll get the $5 million in one time.” Wrong! It doesn’t work! No one is going to invest if they think you have no skin in the game. If you ask any investor for money, the first thing they’re going to say is “how much did you put into this?”
Friends and Family
So once you have put your entrée, then friends and family are first. Maybe that’s $50,000 or less. Those are the people who invest in you very early. They’re not looking for a product. They’re not looking at you to have a prototype or a customer. They believe in you and so you can go and ask for small amounts.
Then once that kind of alternative is exhausted, go to angel investors. Angel investors are people like myself that invest their own money.
They might invest $25,000, $50,000 $100,000, but they expect to see a prototype. They expect maybe to even see a dollar of revenue. They expect something because there are not looking at the product, they’re looking at the whole business.
A little further down the road, you might need $5,000,000 or $10,000,000. That’s venture capital territory.
Those people, though, will expect maybe a couple million in revenue and good traction. They don’t even want to invest a small amount like $25,000. They start at $2,000,000 or so. They expect a good bit of equity for that as well, so your valuation better be up there.
So you need to think this way: I’ll start myself, start with friends and family, then with angel investors and even venture capital if I need that much.
Do You Need a Business Plan to Show Investors?
There’s a popular myth going around these days that you don’t need a business plan, that the VCs don’t read business plans and so why even do it. Well let me tell you, it’s wrong!
There are venture capital people who never read a business plan and those are the ones who have been around a long time. They only deal with people who sold their last company for $800 million. They exclusively focus on people that are already successful.
Related: Sample Business Plan
If you’re like the rest of us and maybe this your first entrepreneurial venture, you need to convince people that you have understood and dealt with all the details of your business like how to market, how to incorporate the business. All the things that are in your business plan.
So if somebody comes to me as an investor and says “oh I haven’t done a business plan,” I say “I’m not ready to talk to you, you’re just wasting my time.”
You Need Credibility
In your business plan, you should talk about the top three executives in your company like the CEO founder, maybe the CFO and two or three advisors that are not people that have equity but are industry connections. If I’m in the software business, for example, I’d love to have Bill Gates on my advisory team because that gives me credibility.
Related: Why You Need a Board of Advisors
How Much Should I Ask For?
Do you ask for enough to last you forever or do you ask enough to get you through a few months? I say look at the next 12 months. maybe 12 -18 months, and see how much you’re going to need. Don’t ever ask for more than that.
What you asked for determines how much of the business you need to give up and so, if you asked for $1 million and your business is worth a million dollars or less you just sold your whole business! What you ask for has to be enough to be meaningful but not so much that it scares away investors.
The Amount You Should Ask For Depends On Your Valuation
You should expect to ask for an amount that it’s going to cost you 20 to 30% of your equity. So, if your business is worth $1,000,000 in your view at this stage, you might ask for $200,000 or $300,000.
Related: Fast and Simple Business Valuation
So if you watch popular shows on television like Shark Tank, potential investors ask “how much do you want and how much you are you willing to give?” So if the entrepreneur says “I want $100,000, but I’m willing to give 1 percent,” that implies that he has a valuation that’s 100 times that. In this case, the first thing the Sharks would ask you is to justify a million-dollar valuation. If you have revenue of $1,000, 000. that’s certainly fine.
Do Your Have Any Revenue, Customers or Intellectual Property?
Typically, what investors will give you is two or three times your current revenue, so if you have some revenue, multiply it by two or three or maybe 4 or 5 and start from there.
If you don’t have revenue, then they will probably ask how many customers you have. If you have 1 million customers that are free, that’s still something so it might be worth $1,000,000.
If you don’t have that either, they might say “well, do you have any intellectual property?” If you have a patent, I might give you $1,000,000 in valuation just for the patent.
If you have none of the above, then it’s all about you. Have you done this before? Have you sold your last company? Have you been successful? Have you been the CEO of a small company? If it is your first rodeo, then your valuation is essentially zero. That means that you probably can’t get much money from investors and that you’d better be talking to friends and family at that stage.
Crowdfunding: A Viable Option For Consumer-Oriented Businesses
The fact is that crowdfunding is a very, very popular approach and it’s one that I recommend.
This approach doesn’t require much of anything out there. In other words, you go out on the Internet and you say “I need $50,000,” you’re looking for people that have some faith in you.
The reason it’s such a good approach is that if you can get the money that way you probably don’t even have to give up any equity. On the other hand, if you get no interest at all, then you should be rethinking your idea. I don’t recommend it for large amounts like multimillions because online contributors don’t usually want to give more than a few dollars.
You also need to consider the industry. Crowdfunding is best for things that are kind of consumer-oriented because you’re talking to a large number of people. In the other hand, if you’re looking to build a new chip factory to manufacture computer chips, you probably won’t find people up in the crowd that are willing to invest in that business.