I want to cover fundraising and investors, and even if you do not plan to raise money, this discussion has important implications for giving equity to cofounders, employees, advisors, consultants or partners.
Investors invest to get a return on their investment, and the predominant way in which they get a return is when their investment is acquired or goes public. But, even in the world of investor-funded startups, both of these options is rare.
it is even rarer for the company to pay the investor back through dividends on profits.
Unless the investment is structured as debt, their chances of getting paid back are small and investors rarely want debt or dividends because the returns are too low. They want 10X return on their investments.
So, how does an investor maximize their chances of an acquisition or IPO? By having their investment take big risks in pushing for fast growth and a “swing-for-the-fences mentality.
And for professional investors who invest for a living, this is fine because they can spread their investment dollars across many startups, with the expectation that in general, 1 out of 10 investments will hit it big to more than make for any losses or missed expectations on the other 9.
Now, as an entrepreneur, you cannot diversify across 10 investments. Possibly years of your work and savings is invested in your startup. So if you take money that causes you to accelerate your growth rate, all of a sudden, those investment dollars might be adding huge risk to your investment. Instead of those dollars giving you breathing room to grow, they may actually be pushing you closer or even over the edge of failure.
So, you really need to know what you are in for when you take on investment.
Investment can be very good, but at the right time, when you have proven that your product and your marketing works. At that point, investment dollars can be good to help you scale, because you have taken out a lot of the risk.
But when you take on investment too early, and go on a growth path without proof of product and marketing, you end up spending a lot of money fast. And if you end up being wrong, the investor may not give you more money, and instead, just invest in your competitor who has chosen a different growth strategy. I know…this happened to me twice and is how I ended up crashing and burning on those two startups.
So, first, before you take anyone else’s money (family, friends, accelerators or venture capitalists), prove your product sells and your marketing works.
If you do not take on investment, but still give equity to cofounders, employees, advisors, consultants or partners, you need to make sure you and they are on the same page so that everyone’s expectations are aligned.
Don’t let them push you towards fast growth and a “swing-for-the-fences mentality until you prove your product and marketing works. And, they need to understand that you might prefer a profitable company and pay them back via dividends, rather than trying to grow towards an acquisition or IPO, which as I said earlier, is rare.