It’s great to start with a big dream as you contemplate a new business, but finding the money you need takes more than dreaming.
As an advisor to young entrepreneurs, I find that many are a bit naïve about how the investment process really works. For example, I just read an otherwise impressive business plan last week from a first-timer who asked for $10 million to get started.
In my first working session with this entrepreneur, I suggested ways to break this request into stages or tranches, based on showing traction, with the first amount in a more affordable range of $50 thousand or less.
Even with that, you should expect your first seed investment from friends, family, or business associates, who know your capabilities and believe in you more than the idea.
In fact, according to a classic article on Fundable, friends and family are still the major funding source for new ventures, investing over $60 billion annually, more than all professional sources combined.
Of course, the average beginning amount per startup is low, and usually in the form of a convertible loan, rather than an equity investment.
Large amounts from professional investors come later, when you have proven yourself, and are ready to scale the business. To me, this is a logical step function, and confirmation that the right founders are always more important than the right product.
Yet, even with friends and family, as well as professional investors, you need to approach them right to be viewed as the right people:
1. Ask for a specific amount based on a specific milestone.
Shy introverts may be great technologists, but they won’t be entrepreneurs until they learn to respectfully ask for funding, after nurturing relationships, and practicing their elevator pitch.
Waiting for someone to offer you a gift with no specific objective is likely to be a long wait. A good starting strategy is to ask for just enough money to get a first prototype built.
2. Be prepared with a formal agreement and a thank you.
The vehicle of choice is most often a convertible note, which is really a loan with a specified duration and interest, with an option to convert it to equity when professional investors come in later.
Now is the time to consult with an attorney to make sure the terms are fair for all sides. This shows respect and professionalism. Always put the agreement in writing, after the handshake.
3. Pitch your personal investment and commitment to date.
Friends and family are quick to differentiate between a passionate hobby and a sincere effort to change the world.
Show them that you have done your homework with industry experts and potential customers, and convince them you are not asking for charity or a donation.
4. Get started first on your own time and money.
We all know people who are good at talking, but never seem to risk anything or find time to get started on the implementation.
Every good entrepreneur needs to invest some money of their own, as well as sweat equity, to show credibility and leadership to others. Even family investors want to be followers, not the leaders.
5. Be sensitive to the limits your friends can afford to lose.
In other words, don’t be greedy, and remember that you value relationships with these people even if your startup fails.
Ask for the minimum amount you need to reach a significant milestone, with some buffer for the unknown, rather than the maximum amount you can possibly squeeze out.
6. Communicate your plan and the risks up front.
Remember that no investment is a gift, and everyone who buys in deserves to hear what you plan to do with their investment, and expects regular updates from you along the way.
Be honest with naive friends and trusting family members, since more than 50 percent of startups fail in the first five years, according to SmallBizTrends.
7. Focus first on friends with relevant business experience.
A wealthy uncle may seem like an easy mark, but a less wealthy friend who has connections and experience with startups in your domain can likely help you more than any amount of money. Remember that you are looking for success, not just money to spend.
8. Tie investment return to revenue rather than a fixed date.
Rather than set a date-driven repayment schedule, tie investment returns to a percentage of new product revenue, or a plan to convert the debt to equity. Use the minimum viable product concept to get revenue early, and allow market and product pivots at minimal cost.
In my experience, if you can’t find any friends or family willing to take the plunge with you early, or you have none of your own skin in the game, professional investors will likely take that to mean they shouldn’t be risking any money on you later.
In any case, I’ve never seen a new venture yet that couldn’t be started for less than $10 million. The challenge for every entrepreneur is to come up with creative ideas for financing, to match their innovative solution.
Every investor I know believes funding creativity is what separates successful entrepreneurs from the dreamers. First impressions are everything in this business.