Would you join in and play a game when you didn’t know the rules? The biggest reason most entrepreneurs don’t get start-up funding is they don’t know or understand the rules of the start-up game.
Imagine … You arrive at a friend’s house and everyone is playing a new game. It looks like fun. Everyone seems to be enjoying themselves. So you ask to play too, only no one bothers to fully explain the rules. You just start playing. You lose. You couldn’t figure out the rules fast enough to play effectively against the players who knew what they were doing.
One more question … if it wasn’t a party and the outcome of the game was your career or future, would you just start playing without knowing the rules? When put this way, you wouldn’t, but this is exactly how most entrepreneurs start their new companies. Sometimes, they are fortunate and beginner’s luck shines upon them, but if doesn’t happen often.
The unfortunate truth is only one percent of the business proposals receive funding from angel investors or venture capitalists or private equity. It’s really a self-filtering process. Any seasoned investor is like the seasoned game player – they quickly recognize a new player that doesn’t know the rules of the game – and don’t invest.
If you have a brilliant idea for new product or service, and the next thought that flashes into your mind is getting funding, ask yourself if you know the rules of the start-up game.
Every entrepreneur has heard the terms seed stage start-up, early stage start-up, series A, Series B, and on and on. Ignore all those terms, not many new entrepreneurs understand them and they are meant for the investment community. Right now, with just a pie in the sky idea, your new business is an experimental start-up. It’s a business experiment and just like a scientific experiment, you’ll probably need to try a few different approaches or test different hypotheses before you find out what works. And yes, it requires patience to work through the process.
What investors want is simple. They want to maximize profit with the least amount of risk. If they are equity investors, they want to buy into the new company at a low price, and sell it at a higher price. They want to flip their investment as soon as possible. Debt investors want assurances that they’ll get their money back plus a great return. It’s your responsibility as an entrepreneur to make the would-be investor believe that your start-up can achieve their expectations of return. So how do you do this?
As much as start-up investors have an image of being care-free and risk takers, they’re not. They are quite conservative. They want the proposition to be obvious. They want to be able to connect the dots. Above all, what they want is proof of a viable business. The first equation is simple: startup = product + customers + revenue. Now, most entrepreneurs come from a technical or skilled background. As such, when ‘proof of concept’ is mentioned, they immediately think of building a prototype of the product. But investors want proof of concept of the business.
Now, you may be thinking that you’ve heard of start-ups funded on just an idea. It’s rare and only becomes common during boom times such as the dot-com era – and there’s usually more to it than just the idea. Start-up funds are managed funds, similar to mutual funds. Most venture capitalists and the ilk are fund managers. They are investing other people’s money. They have an obligation to invest the money, not keep it on the sidelines. In boom times, it’s difficult to place the money in start-ups and so they are willing to fund ideas. We aren’t in boom times now and it’s back to the basics.
As a side point, entrepreneurs should realize that as a funded or venture-backed start-up, they are a portfolio company in the fund – not any different than when a mutual fund holds stocks in Coca-Cola, IBM, Motorola, or General Electric. A mutual fund manager may sell their holdings in IBM and divert the funds to GE because they believe they will get a better return for their shareholders. IBM may not be a poor performer; it’s just that GE may be a better performer at that moment in time. Likewise, a start-up fund may shutdown a start-up to divert funds ear marked for later rounds into another portfolio start-up with greater return potential.
Most of the start-ups that get funded know these rules. To get the attention of investors, you first have to prove the simple equation of product, revenue and customers before seeking funding. And once you obtain funding, most entrepreneurs must realize that they now have an obligation to the investors and start-up fund to perform.
Post contributed by Cynthia Kocialski, who has founded three start-ups and has worked with numerous other start-ups and entrepreneurs, and also is the author of the books Startup from the Ground Up and Out of the Classroom Lessons in Success. She can be reached through her website www.cynthiakocialski.com