In December, we reviewed non-dilutive funding sources in a two-part article, including bootstrapping, friends and family support, grants, debt financing, and alternate funding approaches. This month, we are examining dilutive funding in a two-part series. Part one described dilutive financing in general terms and reviews the commonly available funding stages. Part two covers how to search for investors and prepare for the challenges that intensify once you embark on an equity financing path.
For the first part of this series, we looked at the basic steps of equity (dilutive) financing, its legal requirements, and the different sources accessible at various company development stages. In this article, we’ll dig into a couple of complex topics – finding the perfect investor and preparing yourself and your company for the journey.
Finding the perfect investor
You’ve decided that your business strategy includes one or more instances of equity finance. However, this decision only raises more questions in your mind. How do you find your investors? What criteria should you use to evaluate their offers? When will you know the fit is right? By understanding their goals, experience with your business model, and their character and values, you will find the investor(s) who best fit your business. Here are three questions that will help you uncover this information.
Q1: What’s Their Target Return on Investment (ROI)?
All investors are looking for returns. These returns are principally financial, but other benefits may also be valuable. For example, your friends and family will be interested in your business success due to the familial social contract. Angel investors typically fund startups or early-stage companies to help shape the direction of the business. They frequently invest locally to give back to their communities. People with accredited investor status may be close to retirement and seeking creative ways to use their lifetime of skills and knowledge in less intensive encore career roles. Investors may also be interested in developing the niche of your business because it supports other companies in which they invest. Incubators, accelerators, and “excubators” provide cash, working space, and advisors to help startups at early stages in specific geographies or industries speed up their growth in exchange for a small stake in the company (and possibly some of the IP). Incubators also support companies arising from colleges and universities to bolster entrepreneurship and employability. Once you start working with funds, the emphasis will shift toward the total financial return.
Q2: Do They Understand Your Business Model?
Investors who understand the model for your type of business will improve your support and chance of success. In my field, drug and medical device development differ in timelines, stage gates, and regulatory requirements. Software development, business-to-business services, or consumer product development have business models with widely varying capital needs, sales and marketing strategies, and potential growth trajectories. Perhaps your business model is an unusual combination of these sectors. Your investors will mirror these differences in their approach to your business, their engagement in your success, the timelines they are looking to fund, and whether they invest in bringing the product to market or just for the exit. Review their online presence, and use warm introductions and networking in the right places to help you find investors with the experience, knowledge, and interest to help your business succeed.[2]
Q3: How Do They Handle the Relationship?
Establishing and sustaining investor relationships takes time and effort, yet this work is necessary to leverage the non-capital advantages of a funding raise. Therefore, it makes sense to evaluate the character and values of your investors before committing to a new relationship. Preserving the relationship is one reason you should use contracts when your friends or family invest in your business. A legal agreement helps to protect your social bonds in the event your startup is less than successful. Your investor’s resume and LinkedIn profiles allow you to assess their professional expertise and previous experience in your business industry. Consider the value their network has for your business growth. Measure their reputation by interviewing founders and leaders from other companies they financed. Ask them how involved they want to be in the business, at what levels, and how often and through what modes they would like updates. An experienced investor will not be offended by detailed questions about their values and goals; instead, they will be impressed by your thoughtful approach to ensuring the right fit and stability of the relationship. Trust your instincts if something doesn’t feel right. Thank your potential investor for their time and attention, and explain why you think the partnership is not right now. A professional and respectful end to the conversation leaves the door open to referrals and future opportunities.
Dilutive Funding and You
I believe no discussion of financing (dilutive or non-dilutive) is complete without a look at some of the personal challenges you may face along the founder’s path. Securing funding isn’t the only or the most significant difficulty, and you should prepare for the possibility of managing your own and others’ expectations better. Managing the founder’s journey involves understanding your goals and values, thinking about and preparing for situations that don’t align with your business vision, and pivoting when necessary.
Your Goals and Values
Your long-term goals and values should be a thoughtful part of every strategic discussion. You will likely reassess your goals as you go, but taking time to visualize and document them at the start gives you and your team clarity. The perspective you gain determines what will be acceptable to you and will be critical when discussing relationships with partners and planning your business tactics. For example, you may be most interested in starting the company and looking for a relatively quick acquisition. Maybe you’ve dreamed about taking a company to IPO. Or perhaps you are a technical expert and want to remain focused on the features and delivery. You may also be very passionate about seeing your product or service to market, whatever it takes. Understanding your preferred role(s) and personal goals will help clarify your path. Pitching to investors always involves evaluating you as the founder, which Omri Drory explains in this excellent article.[3] Understanding why you have built this startup and what you want to achieve is the first step in preparing for those questions.
What If?
Envision and prepare for possible business situations, particularly those misaligned with your business vision and values. These situations will require choices, and not all are easy to make. Your trusted advisors will help you identify and rank potential scenarios. Aligning each option with your goals and values should help you make consistent decisions over time and build trust with your employees and partners. You may also find that you need more information to understand the risk and impact of the situation. Pre-evaluating potential scenarios increases your available options, minimizes unproductive deliberation, and increases confidence within your team. Whether the situation involves money, personnel, or client and partner relationships, thinking in advance about how you might handle it will help you quickly adjust if it occurs.
Things Rarely Go as Planned
You should always be prepared to pivot. Your incredible idea may be too early to attract more than a few innovators and early adopters. Serial entrepreneur and investor Daniel Isenberg maintains that an idea is not truly a breakthrough unless it has been summarily rejected at least three times by industry experts.[4] Customers may tell you they want something different than your original idea, so you must adapt to fit the market. Early and robust customer discovery work can minimize these pivots. Technical, physical, legal, or regulatory barriers may affect your product features and the size of and approach to your market. They may also impact the long-term interest and stability of your partners. Adapting could mean changing your product or service, target customer, or business. Pivot points are frequently a source of conflict with your original vision and values, but they also provide natural stage gates, places where you can change, expand, or hand off your role to others. Clearly understanding your business and personal goals will help you make choices with the most significant benefits for you and your team.
The Takeaway from Dilutive Funding Part 2
Once you have chosen an equity step in your financial strategy, your next challenge is finding the right investors. You must take the time to evaluate each of them for their value and ability as future partners because part of the funding activity is establishing a long-term relationship with your investor. By learning more about each other’s goals, experience, and character, you and your investors will have a better basis to start a healthy and valuable relationship that will benefit your startup. Similarly, the many potential challenges of founders are not always clear from the start, and they can multiply after adding investors to the team. The quality of your experience will depend on a clear understanding of your values and personal goals, consideration of the possible situations that may arise, and your ability to pivot when necessary. Your awareness of the potential and assessment of your own capacity early in the process should help you manage each challenge consistently and with more significant benefits for yourself, your partners, and your business.
References
[1] Anna Vital, How Funding Works Infographic. Accessed October 11, 2024. https://annavital.com
[2] Bryan Janeczko, “Building Your Own AngelList: 4 Expert Tips on How to Network to Find Investors for Your New Business. Entrepreneur.com, September 28,2020, accessed December 23, 2024. https://www.entrepreneur.com/starting-a-business/building-your-own-angellist-4-expert-tips-on-how-to/356276
[3] Omri Drory, “The ‘Intangible’ Game: How VCs See You.” December 2024. Accessed December 23, 2024. https://www.nfx.com/post/how-vcs-see-you
[4] Daniel Isenberg with Karen Dillon, “Worthless, Impossible, and Stupid: How Contrarian Entrepreneurs Create and Capture Extraordinary Value.” (Boston: Harvard Business Review Press, 2013.