Checklist: 7 Ways of Raising Money
The big problem your start-up faces is that your dreams are bigger than the capital needed to make them real.
Not only that, but if your start-up gets to the point where it can persuade outsiders to write a check--taking money from the wrong person could mean a one way ticket out of your venture.
In short, taking money from a venture capitalist is the worst way to finance your start-up.
So which sources of capital are better? Here are seven of them--in order of priority.
1. Customer profits
An obvious and frequently over-looked source of cash for start-ups is to sell your product at a price that’s higher than the cost to make it. If the money left over is enough to pay for your rent and other fixed costs, you can maintain control over your venture and won’t need to sell pieces of it to outsiders who might want to manage you out.
Another source of capital is your suppliers. More specifically, if you can convince your suppliers to wait, say, 60 days for you to pay them instead of the usual 30 days, your suppliers have just given you a 30-day loan at zero interest.
Amazon is a big player when it comes to such financing. In 2011, for example, Amazon was operating a $34 billion business with negative $3 billion in what Harvard Business School professor, Bill Sahlman, called operating capital (inventory minus accounts payable plus net plant and equipment). By contrast, Barnes & Noble used $1.3 billion in positive operating capital.
Such operating capital is a complicated form of supplier financing--and you might be able to use it for your venture as well.
Another way to finance your operation is to keep your expenses low. Do you really need to rent office space or can people work from their homes? If you have offices, do you need to buy desks for everyone who shows up there or can you ape Amazon by scavenging doors and propping them up on bricks instead?
Hoarding scarce cash and using it only for things that create value for customers is another capital source for your start-up.
4. Founder’s capital and sweat equity
If you’ve done all these things and you still don’t have enough cash, then you need to dip into someone’s reserves. If you want to maintain control of your venture, the next best source of capital is your own savings and the willingness of your team work for a piece of the company that is currently not going to help pay their bills.
Some of the people I interviewed for my new book, Hungry Start-up Strategy, have accumulated a significant amount of cash to pour into their new ventures. Consider John Xie - he financed Min.us - it lets people share files by dragging them onto a Web browser - through profits from Cirtex, a successful web hosting company he founded.
5. Friends & Family
If you’ve tried all of these things and still don’t have enough cash to run your start-up, then it’s time to tap your friends and family. Here you’re going to have to be prepared to put your closest personal relationships on the line for your start-up.
You’ll need to present a business plan that describes what the company does and how your friends and family will get a return on their investment. You’ll have to give them an idea of how big a check you want them to write, what you will use the money for, and the share of your venture that they’ll get in return.
Then you have to prepare them for the high odds that they will lose their money and keep them up to date on how your company is doing.
If you can raise money from friends and family and have used that money to build a product and persuade a few customers to use it, you are in a stronger position to go outside your personal network for more.
Angel investors are wealthy individuals with an appetite for working with start-ups as a way to get wealthier and to share their expertise with a venture that needs it. But with Angels, you are taking the chance that you will lose control of your venture or at a minimum invite a partner inside your tent who does not share your vision and could distract you from realizing it.
So if you go with Angel investors, make sure your due diligence is thorough on the ones whose money you take. Ask others who have taken their money how they contributed in a pinch and whether they disrupted their start-up’s day-to-day operations.
And if you have to...
If you can use the Angel money to develop a viable business model--customers are paying for your product -- you are in a stronger position to deal with venture capitalists (VC). The key to working well with venture capitalists is to think about the process as hiring a boss.
That’s because when you close the deal with the VC, the partner who worked with you will join your board. If that partner shares your vision, works well with you, and has a track record of helping companies in your industry succeed, then you have yourself a good boss.
If you don’t conduct enough due diligence on that partner and all the surprises are unpleasant, you could find yourself tossed out on your start-up’s pavement.
But if you can tap each of these seven capital sources in the right way, you’ll boost your start-up’s odds of success.
Strategy consultant, startup investor, teacher, corporate speaker, pundit, and author of 11 books, Peter Cohan has invested in six startups, three of which were sold for a total of $2 billion. Before founding Peter S. Cohan & Associates in 1994, he worked with HBS strategy guru Michael E. Porter.