Before soliciting external sources of funding, ask these four questions to ensure that you’re well prepared for the changes ahead.
How do you know when it’s time to seek outside investment? The question arose recently when we received a query from one of our regular readers, which we will paraphrase here:
I just read "3 Characteristics of a Great Investor." I really enjoyed it and it made me think that I need some direction. I have a start-up and it's growing nicely. I've bootstrapped it to date but I realize that in order to compete I'm going to need to build out the software and do a better job of marketing. It's time to raise money. What should I do next?
We don’t really have enough information about his business to provide a direct answer, but here are four questions we would ask to help the business owner decide what to do:
1. Why do you need money at all?
This is probably the most important question. It sounds like, in this case, the owner has provided capital to fund the business thus far. He is also implying that the business is profitable, or at least generating cash that could be used to fund investments. If you have the ability to fund the business yourself or with existing cash flow, you should continue to do so–this is almost always the right choice. Outside investors will dilute your ownership, bring competing objectives, and increase your workload. Only when bootstrapping growth is no longer viable should you begin looking for outside investors.
2. What will you do with the money?
Any investor, whether it be a founder or external capital provider, should ask this question. The typical answer–“funding operations”–is not very popular among investors, because it implies that the business is not clear about the returns it is receiving from various investments. It’s important to have a clear view of how new money will be put toward specific investments that dramatically change the value of the company.
3. Who are your ideal investors?
We talked about this in depth in 3 Characteristics of a Great Investor, but the short answer is that you need to look for an investor who is uniquely suited to help your business and get more value from the investment than other investors. For most businesses, the ideal investor is not just anyone with money.
4. How will your investors receive a return greater than they would through other options?
When we raise capital for our portfolio companies, we prepare a detailed business case that outlines the expected return on investment in various future scenarios. It’s important to show an investor the math on why they will receive a return. Further, it’s important to lay out the strategic case on why further investment will help the company grow and create value for both existing and new investors.
KARL STARK AND BILL STEWART are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree. @karlstark