Most entrepreneurs who dream big simply don't have access to the kind of money it takes to realize their aspirations. Enter the professional investor community. But, in order to get investors to open up their checkbooks, you'll need to convince them that your idea is worthy and also be willing to subject yourself to increased scrutiny and give up a percentage of your company.
That's why it's a good idea to first ask yourself whether you really need a professional investor at all, says David Henkel-Wallace, a serial entrepreneur who has raised $60 million from VCs. 'If you're starting a web software or mobile software company, you might be able to bootstrap it, which has the advantage that you get to keep all the money you earn,' says Henkel-Wallace. 'You could also look into borrowing from friends and family – or even take out a second mortgage – for the same reason.'
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Understand What Investors Want
If you decide your business can only get to the next level with the aid of a professional investor, then you need to figure out what a potential backer looks for in a budding company, says Martin Babinec, who raised six rounds of funding through the business process outsourcing firm he founded, TriNet, which now boasts annual revenues in excess of $200 million.
For one, he says, many entrepreneurs mistakenly think talking to investors involves loans or debt. 'It should be clear that when you talk to an equity investor, you're trading shares of your company that an investor can later sell,' he says.
To that end, you need to show how your company is on a path to a 'liquidity event,' industry parlance for an IPO or acquisition where the investors get a return on their money.
Since not every company will actually go down such a path, 'many investors use a portfolio approach, where they hope to spread their risk among several bets,' says Babinec, who now heads up Upstate Venture Connect, an organization that connects emerging technology companies in upstate New York with investors. 'An investor may, for example, invest in ten companies, knowing that more than half of those companies will fail to capitalize on their potential. But, if just two of those bets pay off, and pay off big, then everyone comes out ahead.'
Babinec says an investor will evaluate a company's potential along four key criteria:
1. Does the company's product or service address a large and growing market need?
2. Can the company scale quickly enough to take advantage of that market opportunity?
3. Does the company have a defensible competitive advantage?
4. Can the management team execute on the potential outlined in the first three criteria?
In other words, the risk of investing in your company must be offset by the potential reward that can be delivered when your company experiences a liquidity event. 'If you want a lot of capital, you'll need to demonstrate that your company has rocket-ship growth potential,' says Babinec.
Look for the Best Fit and Make Connections
If your company passes those four tests, your next assignment is to prune down the list of investors who might be interested in your company. To do so, you'll need to understand that the private company equity markets have become very fragmented, says Healy Jones, a former venture capitalist who now heads up marketing at OfficeDrop, a start-up that offers digital document scanning and filing and raised venture capital late last year. 'There used to be just venture capitalists, now there are angels, super angels, micro-VCs, VC, and growth investors,' he says. 'As an entrepreneur looking for capital you need to know where on the spectrum of investors your business falls - and target the right potential investors.'
VCs, for instance, typically look to invest $3 million to $5 million. Angel investors, on the other hand, may invest just a few thousand dollars. Private equity groups may have tens of millions to invest.
So how do you know what the right fit for your business is? Start by networking and building relationships even before you set out to acquire funding as a way to both determine who investors in your area might be as well as to develop connections to them. 'VCs highly prefer introductions to new ideas from people they trust as opposed to receiving cold calls from companies looking for money,' says Jones. 'The best introductions come from successful entrepreneurs, especially ones that have worked with the VC before.'
Your networking should include professionals working for companies similar to yours, says Marc Wright, a serial entrepreneur, VC investor, founder of an incubator and an advisor to early-stage companies. 'Look for news in your industry about investments and acquisitions involving companies in the spaces closest to yours,' says Wright. 'The goal should be to target investors and even large companies who look for opportunities in your space.'
Another suggestion from Babinec of UVC is that you can research who originally backed the public companies in your space. 'This is a multiple step process that works you back to the investors who have made money in the space,' he says.
This is essential because investors like to invest in areas where they have developed expertise, says Eric Lefkofsky, the co-founder of Groupon who, in addition to founding two companies that went public, has now started a venture fund of his own called Lightbank. 'We only look to invest in early-stage tech companies,' says Lefkofsky. 'If you had the best idea for a new restaurant, I'm the wrong guy to approach about it. We focus only on the things we know.'
Investors, especially in early-stage ventures, also tend to place their bets close to home, according to Don Rainey, a general partner in Grotech Ventures, a VC firm in Washington, D.C. 'Being closer geographically is better, but it also differs on where you are,' says Rainey. 'In Silicon Valley, you might need to be 15 miles from your investor. In Dallas, it might be 300 miles.'
And don't be bashful about using social media tools to boost your networking efforts, says Wright, who is the CEO of Martinez & Wright, a business media and market data company in Laguna Beach, Calif. 'I frequently use news sources and LinkedIn to find people who are connected to an investor target and then tap them for feedback and input on the business and ask what they think investors or buyers might like and dislike,' he says. 'If the chemistry is right I'll ask them for an intro. And if it's really good, I'll mention the possibility of a formal role as an advisor.'
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Share Your Vision
Once you've finally made some connections to investors who likely understand the kind of company you're trying to build, you then need to whittle it down to those who share your vision of what's possible. 'As an entrepreneur, you need to find investors that buy into the assumptions you have made about the future,' Rainey of Grotech Ventures says. If you don't share the same common view of what's possible, an investor won't invest with you.'
The Internet contains many websites dedicated to helping entrepreneurs navigate the investment community. Here are a few of our favorites:
Startable: A blog penned by Jones of OfficeDrop which focuses on the early stage VC and angel environment and the Internet start-up market.
Venture Hacks: A good source for fund-raising advice that also includes a list of active angel investors.
StartupCFO: A source of advice from a veteran CFO.
VC Ready Law: A blog with good resources for entrepreneurs looking to raise capital.
Angel Capital Association: A great resource for understanding what an angel investor looks for as well as for finding angels near you.
The following blogs written by investors also provide worthwhile information to capital seekers:
Fred Wilson: A well-known NYC-based VC.
Brad Feld: A good source on angel investing, venture capital and term sheets.
Mark Suster: A VC and former start-up CEO, offers advice on raising capital and pitching VCs.