There is a widespread myth in the startup world that you need an investor to be successful. Those struggling to secure investment often feel their ideas aren’t good enough or they have failed as founders.
Investors are happy to keep perpetuating this narrative to keep startups clamouring for money, rather than thinking of other ways to grow their business.
There are many ways to grow a business without venture capital, which I have written about before. But, if you believe that investment is key to your growth, there are a few important things to consider:
- The smartest way to leverage investment;
- Risks and red flags; and
- Green lights and good matches.
Using investment wisely
You should take on investment to build an asset, not just to grow your company by hiring more people and spending more on marketing.
An asset can be a piece of technology, a patent, a network of people on the platform, or a piece of equipment that puts you ahead of the pack and allows you to charge less than competitors for a similar service. It’s something foundational and tangible that allows you to have a competitive advantage down the track.
Here are two examples.
Famed investor and entrepreneur Reid Hoffman attracted a lot of attention for the method of hyper-growth he describes in his latest book: Blitzscaling. He says this method is the way to go when there is a large market that has ‘network effects’ that make it hard to compete with once scale is reached.
This basically means ‘when more people use it, it becomes more valuable’.
Think about Facebook. If someone created a rival Facebook 2.0, would it be valuable after a few sign ups? No. The value of Facebook is that everyone is on it.
The same applies for LinkedIn, which Hoffman co-founded. When LinkedIn first started, there were a few companies with a similar offering but most were focused on user engagement, rather than the total number of users. LinkedIn focused on developing a viral referral strategy with the goal of attracting the most users, in the fastest way. Once it had the most users, it became the most valuable platform, and now that everyone is on it, it’s extremely difficult for a competitor to come in and displace them. The value of the platform is the network; hence, the ‘network effect’ is strong.
If you are creating a business where the value is in users or membership, using investment to ‘blitzscale’ may be wise.
2. Creating an asset
Industries that have high entry costs might need an initial investment to get off the ground.
For example, you might need an expensive licence to operate your technology. You may need to build an electric vehicle charging network throughout an entire city so people have confidence they can ‘fill up’ anywhere. I’ve even heard of a startup building a giant algae growing facility to prove a new method works.
When big money is required to get started, investment is a logical approach.
Think to yourself: ‘If I were given a big pot of money for my startup, how would I use it to create assets and worth, rather than simply expanding?’
Investor red flags
Make sure you know the risks of getting in bed with an investor. There are plenty of dirty tricks and sneaky tactics you should look out for.
1. Accelerator programs
These are companies that take a portion of your business to help you get set up and secure investments. Most provide mentors that help you refine your business idea. But, there are some that substitute mentorship with exposure.
What a lot of people don’t realise is that accelerator programs take a percentage of your business regardless of whether you secure investment or not! Be very wary of this.
2. Investors wanting personal guarantees
This means if your business doesn’t go well, the investor can come after your personal finances to get their money back. This is often the case with ‘convertible notes’, which is basically a loan to your business that can be converted into shares at some point, or during an investment round.
3. Investors that want you to be ‘all in’ until you sell the company
‘All in’ meaning they want your house completely mortgaged, no money in your savings and living a very basic lifestyle. These investors will have complete control. You may be forced to sell for whatever price they demand, or risk losing everything to your name. Running a business is stressful enough; a fear of losing everything can be far more debilitating than it is motivating.
4. High targets and takeover clauses
‘You can take this money, but if you don’t hit X numbers then I can remove you from the company and insert my own people.’
This will often be written in very vague language, but it basically means if the investor doesn’t want you there anymore, they can kick you out.
5. Vague ‘company damage’ clauses
Similar to the above, but instead of missing a target, there will be a clause relating to something that damages the company. For a chief executive, this could be a media article about a scandal (true or not) that can be seen as hurting the company and can trigger the option for the investor to kick you out. Again, these clauses tend to be vague with the intention of giving the investor an ‘out’ whenever they want it.
6. Investors that might try to squeeze you once they know your financials
This can happen in the due diligence process. For example, you’ll agree that they will invest $X for Y% of the company, subject to a ‘due diligence’ process. This is when your new investor will go through all your financials, and therefore know exactly how much time your company has before it goes bankrupt. Then they wait. Once you are about to run out of money, they offer you a bad deal, knowing you will have to take it to keep the business going. You are at their mercy.
Avoid getting into the trap of raising money when you are about to run out, because you’ll usually get squeezed like this. Raise early and have a backup plan where you can continue to exist without investment. Once they know that you can survive and sustain yourself without their money, they don’t have the leverage to pull these kinds of squeeze tactics.
If you make it past the red lights, look for the green lights
1. Investors that fill your gaps in knowledge
You might be great at sales and marketing, but not know much about how to expand into international markets. In this instance, a perfect investor would be someone who has scaled companies into international markets and sustained that growth over time. Make sure you find investors that fill your gaps, not overlap with areas you already have covered.
2. Investors that are strategically aligned
Strategically aligned in business, that is. For example, if you have an organic farming company, it would be ideal to have an investor that owns a chain of organic supermarkets. They could easily connect you with a large network of aligned buyers for your product.
3. Investors who want fair involvement in the decisions of the company
It’s reasonable to give an investor a seat on the board so they can influence the direction of the company. However, they shouldn’t have a controlling interest, or more than other stakeholders.
For example, if they hold 20% of the company, they shouldn’t expect to be the chair of the board and make final decisions. If they want to have an active role in the day-to-day decisions of the business, you could consider offering a director role or advisory position.
Investors may seem like the key to unlocking a successful business, but that doesn’t mean you should be at their mercy. Be careful not to sell your soul. Understand what they are offering you and what you could stand to lose. Money should be the last thing you want from an investor. Instead, focus on ensuring they will propel your business forward in areas money can’t buy. If all you really need is money, get creative rather than getting trapped.