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Why Do I Have to Pay Money to Raise Money?

Every week, Bryan receives calls from early stage entrepreneurs. Recently, one bemoaned, “Why do I have to pay money to raise money?”


“Well,” asked Bryan, “have you tried to raise money for free?”


“Sure,“ she said. “First I attended about six different networking events for entrepreneurs, but they were full of us talking to each other and also service providers trying to sell us their services. If there were any investors in attendance, they kept mum about it.”


“What next?”  Bryan prompted.


“Well, then I paid $40 – 75 to present at several pitch nights and angel groups.  I received some useful advice, but no investment.   I got some compliments on my prototype but several of them suggested that I apply to join an incubator, accelerator, boot camp, and/or take SBA (small business administration) courses to beef up my business skills.  I admit that financials and marketing are not my strong suits. I am really an inventor.”


“That sounds like you got some good advice.  What did you find out?”


“The SBA classes cost about $40 – 50.  I took ones on writing a business plan, developing financial projections, and developing a 30 second elevator pitch.  Of the accelerators, etc, the ones that are free are usually funded by a government entity that is selective, taking only a few companies based on competitive criteria.  I did not get in.  Many of the others run by private companies charge big bucks:  hundreds of dollars for a weekend or thousands of dollars for several months. 


“I am sensing a theme here,” said Bryan.


“Yeah, me, too,” she sighed.  “Everybody has their hand out.  Some say that they have a fund and MAY invest or MAY introduce you to investors, but no guarantee either way.  I did not go with any of them.  Too much money for no sure thing.”


“Do you have to raise outside funding?” asked Bryan.  “Could you grow organically and reinvest your profits or get a line of credit or a bank loan?  Do you have some assets you can sell to free up cash for your company?”


She looked at him sheepishly.  “I did ask my bank for a loan after I maxed out my credit cards, but they said that my credit score was too low to qualify. “


Bryan asked gently, “Do you think this might concern an investor, too?”


She shook her head in frustration.  “I have been working on this part time, outside my day job, plus networking for five years and not making any headway, and I am paying 18% interest on the credit card debt.  Why can’t somebody with money just invest in my great idea and prototype?”


“What would you do with the money?”


“First, I would pay off the credit card debt to improve my credit.  Then I would quit my job and pay myself a salary, and pay for the patent and incorporation. Then I would fund mass manufacturing, sales and marketing.”


“Hmm,” said Bryan. “I understand your frustrations.  Entrepreneurship is hard.  But banks and investors want to hedge their bets, too.  They are taking a financial risk on you.”

“Put yourself in their shoes. There are several reasons why it is hard to meet investors and to secure funding from them.  One is that anyone WITH money is DELUGED with inquiries by entrepreneurs who want some of it.  So they set up gates and gate keepers and criteria."

 

One gate you should anticipate is that you have to have an incorporated business in good standing in your state with its own bank account. Investors will invest in that entity. They will not give money directly to you as an individual."


A second gate is specialization.  Many investors focus their money in industries they know well because they can size up deals and management teams quickly.  Some prefer real estate; others like tech or healthcare.  Some love early state, pre-revenue companies while others only invest in companies making $1 mm/yr.   So you should find out the investor's priorities before launching into a sales pitch. Frankly, I see a lot of entrepreneurs who talk when they should ask questions."


"Another gate is that some investors do not want to be contacted directly by entrepreneurs at all but prefer referrals. People they respect know their priorities and separate the wheat from the chaff before introductions.  If it is from an intermediary that you engaged, the investor may value that you have assembled your business information in an investor friendly form, including pre-revenue valuations, pro forma financials, market analysis, and competitive analysis."

 

“Let’s say that in your industry, there are two similar companies.  One has a terrific prototype and debt.  Another has a track record of increasing sales of a less exciting product, no debt, and a small sales team.  One investor assesses the second company as less risky and offers loans based on the receivables, charging 10%.  The more the company sells, the more money it can borrow to grow its sales team and inventory.  "


"The other investor loves the prototype but recognizes the risk of investing in a pre-money venture. It commits to fund an initial production run because it knows wholesalers to sell it.  However, it will not pay down  the debt and will only pay salaries out of sales, not before. For this risk, though, it wants to own 70% of the company and manage it, keeping the inventor of the prototype as its R and D person for 30% net profits on that and any other products developed. If the sales do not materialize, no one makes money, but the investor puts no more money into the company, and, depending on the contract, may own the rights to the prototype.”


She slumps in her chair.  “You mean that investors put more money into companies that are already making money and that even if I secure investment I could lose the company?  What’s the point then?”


Bryan shrugs.  “Both you and the investor are taking risks with each other.  There is no sure thing.  But you have several options.  You describe yourself as an inventor. You have already devised a great prototype.  I absolutely recommend that you get it patented. This requires hiring a patent attorney but it protects your ownership of your design. Then, you could sell or lease it to a company that does the manufacturing and sales. Spend your time inventing new things, not worrying about payroll, taxes, and marketing budgets.  Or you could look for a job at such companies and negotiate to keep your rights to the prototype if they develop it.  Or you can set this aside for a while, get yourself out of debt, then approach the bank again." 


"In the meantime, I encourage you to check out inventor, rather than investor, networking groups.  Learn from those who have financed or sold their inventions.  Also, every city has groups of mentors, like Silver Foxes, that offer free consulting to entrepreneurs on topics of their specialization.  You might seek out people who can advise you on topics that worry you. You have already learned a lot from those SBA courses.” 


Bryan leaned forward. “There are bad guys that take advantage of naïve, optimistic entrepreneurs.  Research the reputation of anyone who offers you financing.  Ask for references.  Ask knowledgeable people to review the contract.  Believe it or not, I heard last week of an American entrepreneur who flew to South Africa to meet a company that promised to invest.  However, when he got there, they said that he first had to pay a $40,000 processing fee.  He took the next plane home. An expensive lesson.“


“I have also heard multiple stories about vulture investors.  Ecstatic entrepreneurs sign contracts that promise $1 mm investments.  The fine print says that this will be paid out in tranches of $100,000 ONLY IF and WHEN the entrepreneur meets some unlikely milestone, like doubling sales every month.  If the entrepreneur fails for two months in a row, the investor owns the company (including any IP) for only the money paid to that date.” 


“My biggest recommendation to you and other entrepreneurs is to not approach investors too early.  Only about 20% of entrepreneurs who present their businesses to investors secure funding.  Those that do are qualified, prepared, and protected. They may have had to spend months talking with LOTS of angels or firms or they hired someone to vector them to the right people for their deal. Unfortunately, the reality is that you will spend your time or your money to reach investors."


  "I know that I have given you a lot to think about.  Please write or call me in three months with an update on your progress. ”

 

 

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