Thanks to a thaw--some would say bubble--in venture capital investing, raising money no longer seems like such a crazy idea. The latest tech IPOs—with the Facebook offering still to come—have raised hopes for more successful exits. 

I’ve raised outside money for two businesses, once in the height of the Internet boom and once again after the bust. Before you get caught up in the idea of outside investment, take a step back and understand what that money – and the investors who come along with it – can and can’t do for you.

What investment capital can do is fairly obvious.  It can:

  • Jumpstart expansion. All of a sudden, you’re no longer scraping by. Instead, there’s now money for spending on lots of things: increased production capacity, opening new facilities nationally or internationally, making hires, etc.
  • Build your brand through expenditures on advertising, social networking and publicity.
  • Expand your network of contacts, increasing your visibility with potential partners, board members, advisors, and others who can give you a boost.
  • Provide mentoring and executive development (with the right investors).

Less well understood is what investment capital can’t do for a business.  A misunderstanding here can mean the difference between success and failure.  So, consider for a moment that outside money can’t:

  • Fix flaws in your business model:  If the market is saturated, the barriers to entry low, or the target audience too small, throwing money at the business won’t change anything.  Ask yourself, is it really the lack of money that is holding us back, or is there a weakness in the model that needs to be addressed?
  • Buy customers and revenue:  While capital can buy brand visibility, it cannot buy customers.  You have to have a product/service that people are willing to pay for. You can give away the razors but you have to sell the blades or the shaving gel…or something.
  • Create a path to profitability:  If your costs are greater than your revenue, you can’t keep raising money to fill the gap.  Remember the joke from the dot com days?  We’re losing money but we’re going to make it up in volume? (Think Eventually, you need to be profitable.
  • Guarantee success, or even that the business will be around in a couple of years.  You have to continue to innovate, provide a good product, or have high switching costs. Otherwise customers will leave you for a competitor.  (RIMM, anyone?)

The bottom line is that fundamentals matter.  Investors know that success depends on a solid plan, a lucrative target market, a good team, a product that solves a problem or fills a pressing need, competitive advantage, and a path to profitability.  Without the fundamentals you cannot succeed. No amount of money will make these things magically appear, even if an investor is willing to invest in their absence.  

With the fundamentals in place, the next consideration is scalability.  Many successful businesses work because they are local.  Scaling is either prohibitively expensive, or the trust of the community is so critical to the success of the business that the business just can’t live outside the community.  Money can’t change that.  That said, there are many businesses that can leverage economies of scale to create national or international businesses.  Know which category you fit in.

Investment capital can benefit your business in many positive ways, but it is not a panacea.  Understand what your business really needs – is it money or is it better fundamentals?  The money follows the fundamentals, not the other way around.