Raising cash: The myths and the magic

Every business will need to get together a lot of cash at some stage, either to grow or to start-up a new venture. But a lot of misinformation has gained traction in these straitened times. Mythbuster AMANDA GOME filters fundraising fact from fiction.

By Amanda Gome

Raising money myths

Every business will need to get together a lot of cash at some stage, either to grow or to start-up a new venture. But a lot of misinformation has gained traction in these straitened times. The SmartCompany mythbuster filters fundraising fact from fiction.

Two years ago I decided to leave Fairfax, where I had been a journalist of too many years, to start SmartCompany. I had to raise money to fund the development of the website and the first six months of the business.

I thought we would need half a million, but ended up needing far less. Not bad.

Was it fun raising the money and negotiating the shareholder’s agreement? No.

Was it easy? No.

But it certainly was not the most difficult part of starting SmartCompany. One of the reasons for that was the research I had done with RMIT University into how fast growing companies raise money.

Learning from other entrepreneurs about what worked and what didn’t helped make the fundraising much easier. But it struck me at a recent conference on how to raise money for SME growth that there are many myths that need addressing.

There is another reason; given the current credit crunch, appalling IPO market and high interest rates, more companies might be looking to raise capital from angels or VCs.

So here are the top 13 myths on raising money for SME growth. If you have any more, send them in and we’ll add them to the list.

Myth 1
Raise more money than you need

The thinking is this; it takes ages to raise the money and who wants to do that again anytime soon. Good point. In fact, many fast growing companies say their biggest mistake is that they did not raise enough money when they last went to market.

But in some ways, having too much could blunt your entrepreneurial skills.

It depends on your business model, but companies starved for cash chase every cent. They keep costs low. They come up with new ideas, they don’t pursue ideas that are costing them money with no return, they over service their clients, they don’t get distracted, and they build very sustainable, profitable businesses.

It is not fun, but in the long term you emerge with a better business – and a larger shareholding.

Myth 2
Don’t discuss the exit of your business with potential investors. They think you are a greedy tosser

I couldn’t believe this when I heard it recently at a VC conference. I was in the audience and couldn’t resist raising my hand to say that of course you should discuss your exit plans with an investor. I then asked for a show of hands (annoying the event organiser even further); half the respondents thought that you should talk about the potential exit, half that you shouldn’t.

Ten years ago business owners didn’t discuss exits. Now most savvy start-ups have figured out who will buy them and what they need to do to get bought.

Don’t get me wrong – potential investors do want to know you are a greedy tosser and will fly first class and drive a better BMW than they do.

But discussing the potential exit not only displays knowledge of the market and provides an investment opportunity for all shareholders, but also because it will shape the business.

I talked to a business recently that had only just started to monetise their website even though they had heaps of traffic. The prompt had been an investor whom had offered to buy the site and then pointed out (very kindly, I thought) how he would monetise it.

They decided not to sell but followed his suggestions. Imagine if they had done that four years ago – they would have been far more profitable.

Myth 3
I’m the founder. It will always be my business

When negotiating the shareholder’s agreement, fight for every share. Ask IT nerd Karl Sablajak. Never heard of him? He founded RealEstate.com.au, valued at half a billion dollars.

In 1995 he invested $16,000 from his dad to co-founded the online real estate classifieds site. By 1998 the company was close to collapse and he and his partner sold 51% to Macquarie Bank. He ended up being diluted further to 12.5% and being tossed off the board. The company listed on the stock exchange on 1 December 1999, leaving the two founders with equity of 6.6%. Then the business hit the skids again and News Corp stepped in taking a 58% stake, leaving them 4% equity. Sablajak ended up working as a customer service officer before retiring in 2006.

In the book 50 Great Businesses and the Minds Behind Them, author Emily Ross says that while Sablajak is a multi millionaire through good investments, there will always be a slightly sour taste in his mouth.

The lesson? While it is great to have a small piece of a big pie, you can easily end up with crumbs. So fight for every share.

Myth 4
Faster revenue growth leads to increased shareholder value

No, it doesn’t. Ask Tim Pethick, founder of Nudie. He chased revenue and ended up owning less than 1% of the iconic company that he poured $3 million cash into. His mistake was to take on more investors, which kept on diluting his shareholding instead of reining in growth.

“Slower, steady growth allows you to fund the business as you go. It is a slow burn and a slow build,” says a wiser Pethick. He argues there should be a class of shares for founders that can’t be diluted and that is performance based. Good idea if he can find investors to agree to it.

Myth 5
Fight for every share

I just told you to do that, didn’t I? And now I’m saying it’s a myth. Why? Because founders can get too greedy.

Often startup entrepreneurs are the worst. Their maxim is: “You sink several million into my high risk venture and you can have 20%.” That’s not fair.

Pretty soon both of you are fighting for every share without thinking about what’s fair for both parties.

You need to take a load of things into account. What services can the investors provide? Do you want a salary? (If you want a small salary, you’ll end up sacrificing shares.)

How to find out what’s fair? Ask experienced investors. When I shopped around my “confidential” deal, all the entrepreneurs I took into my confidence took one look at my deal and said: “Yep. That’s fair.”

After you strike the right deal, don’t revisit it and wonder “what if”. Strike the deal; move on.

Myth 6
Investors are looking for positive vision and big profit forecasts

Guess what? Big numbers don’t impress investors. But realistic forecasts that are achievable can send them into a frenzy.

There are two phrases that completely turn me off when listening to a pitch from a company: “We’re going to be bigger than Google” (no you’re not) and “this is going to be a multi-million dollar business soon” (when?).

It is far more impressive to hear projections, time frames and strategies that are believable. So strip emotive language out of pitches and stick to the facts. Your passion for the business will still shine through.

(Oh and can I proffer one more expression that drives me nuts? “Blue sky”. What the hell does that mean?)

Myth 7
We don’t have any competitors

It is astonishing how many companies when asked about the competitive landscape report their company is so innovative that they have no competitors. If you truly believe this, then think about who your potential customers are using now.

If you do know who your competitors are, then build barriers to entry. Always have a competitive analysis. I recently sat in on a pitch for a product that was a great idea. But it was so easy to copy and the inventor, who had no competitors, had no barriers to entry. No one was interested.

Myth 8
Potential investors will steal my ideas

Several years ago I watched an inventor of a new hair dryer stand up before investors and get them so excited they were ready to have a fight over who would invest. Then he got to the end of the pitch and refused to show the prototype of the hair dryer.

There is nothing worse when trying to raise money than to come across suspicious founders who want to shroud the whole process in secrecy. After all, you are asking them for money.

Myth 9
Investors are only interested in money

Yes, they are very interested in money but that is by no means the only reason they invest. You see, they already have money. Usually lots of it, and while they want more it is not why they want to be investors.

What they want is excitement, novelty and the thrill of the chase. They want to enjoy the investment, be excited about it, be consulted over the growth.

In fact, one of the saddest emails that Aunty B received was this: “Dear Aunty B: My investor has fallen in love with another company and isn’t paying me attention any more.”

That sums it up perfectly.

Myth 10
Investor money beats bank debt any day

Are you sure? Equity is the most expensive capital on the market. Think of it like this; you might be paying interest rates but you are not giving away chunks of your company and inviting strangers into your bed.

Myth 11
Money is money. I don’t care who invests

Yes you do. The best money is smart money. If you can interest an investor, then chances are you can get the interest of a smart investor, someone in your industry who has access to great networks, can make a great contribution to your strategic direction, open doors and encourage you when things are tough. They exist! Ambitious young entrepreneurs have more power than they think.

Myth 12
All VCs are sharks

A few are. But some just give the industry a bad name because they tip out a founder, who quite frankly was holding the business back.

It is easy to check people out. You Google them and then call people they know. Find out who else they have invested in and ring them up. Ask what they are like? Did they put in their milestone payments when due? Were they decent and fair? Did they help strategically with the business? What; you don’t think they are checking you out?

Myth 13
VCs invest in start ups

Very rarely. Research from fast growing companies shows that the median start-up capital is about $50,000. The start-up capital mainly came from savings and family friends (82%). About 10% comes from banks, just 5% from VCs and only 2% from business angels.

Second round funding was a different matter. Banks provided 35%, VCs contributed 19%, business angels provided 10%, an IPO provided 13%, and friends and families provided 17%. Looking forward, bank funding will fall and the IPO market has already dried up. So businesses needing money to grow may well be forced into the arms of angels and VCs.

 

Read more on start-ups and raising money

 

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