An entrepreneur asked me for $200,000 and I turned him down. From that failed pitch -- I see four lessons for start-up CEOs.
It all started in May 2013, when the entrepreneur, an electrical engineering professor, told me that he was getting back into the start-up game and had started reading my book, Hungry Start-up Strategy.
A few weeks later, he told me that he had a business idea and asked for a chance to pitch it. At a late June lunch - he asked me to sign his copy of the book and started asking me questions: How had I been able to find 160 entrepreneurs who would talk with me for the book? Why was it so important for a start-up to understand its customers? How could a start-up raise capital if it has no product developed yet?
I answered the questions: I found the entrepreneurs through networking at Stanford, MIT and other schools and they snowballed; most entrepreneurs cite statistics of large and growing markets they’re targeting without understanding the customer’s pain and how they will resolve it; a start-up should boost its bargaining power by not raising venture capital until the business generates meaningful cash flow and has a strong customer base.
I also talked about how entrepreneurs should realize that it’s been over a decade since venture capitalists earned investment returns high enough to justify the risk of loss - so they want to invest in start-ups that will double or triple their money in two or three years.
The entrepreneur’s idea: a smartphone App to help people monitor their health. He asked me what I thought, and I told him that he should do an experiment to learn which is more popular: his App or more traditional health Apps.
He should measure how each group of potential customers reacted to each -- counting the number of people that each group urged to try the Apps, how many times they used the App each day, and how long they spent using it each time they visited.
We walked out of the restaurant and stood next to my car. He said, “I just feel that with $200,000 I could hire a team - including an App builder, graphic designer, and big data expert -- and test out the idea.”
I did not address his request for money directly. Instead, I told the entrepreneur that he might consider building a key portion of that App himself to show it to potential employees and customers and get some feedback on whether it would gain market traction.
Here are four lessons to take away from that entrepreneur’s experience.
1. Insincere flattery will get you nowhere.
I was flattered that the entrepreneur had read my book and asked questions about it. But when he asked for $200,000, I realized that either I had done a poor job of communicating or he had not really been listening to what I said.
That’s because during lunch I had tried to make it clear -- as I wrote in the book -- that an entrepreneur should get feedback from customers on a cheap, quick prototype before asking for capital.
But he was asking for the $200,000 just based on a verbal description of the idea - not a prototype or customer feedback.
2. Listen and respond.
I would have been more open to a future pitch for capital if the entrepreneur had acknowledged that advice.
For example, he could have said, “When I came to lunch, I had intended to ask you for $200,000 to hire a team to build a prototype and get some market feedback. But you’ve made it clear that you think investors need customer feedback before writing a check. I will build a quick-and-dirty prototype, get feedback on it, and then decide whether I think the business is worth an investment.”
3. Know how you will spend the money.
The entrepreneur also said that he “felt like” he needed $200,000. Entrepreneurs should go beyond feeling. They should explain the detailed assumptions underlying their request for money and how spending the money that way will help the venture succeed.
4. Make it clear how the investor will get a return.
The entrepreneur also left out an explanation of how he thought I would get a return on my $200,000 investment. If you ask an investor for money, you should have a well-argued and clearly-documented rationale for how you will generate a return that takes into account the big risk of loss.
To boost your odds of capital raising success, put yourself in the investor’s shoes in these four ways.