9 START-UP FUNDING MISTAKES TO AVOID AT ALL COSTS
Securing and managing funding can be one of the most exciting—and nerve wracking—parts of being an entrepreneur. Often, the financial and legal implications may seem overwhelming.
But fret not. You don’t need to be a lawyer or a CPA to negotiate a good funding deal. But you do have to be smart—and careful.
Avoid these 9 start-up funding mistakes at all costs:
Mistake #1: Having an unrealistic valuation of your company
Overestimating your business’s earning potential will not only damage your credibility with funders, but it may also have consequences down the line.
Consider this scenario: suppose you overvalued your company, and your first-round equity funders agreed on a high price. Later, you ask for a second, larger round from a different group (with deeper pockets). These new guys may be more sophisticated, and don’t think your company is worth as much as you thought. They pay less, and your equity value sinks. This is called a funding downround.
Down rounds like this can be disastrous because they anger early investors. The first-round stock is now worth less, your business takes a hit to its reputation, and your ability to raise future capital becomes limited.
Mistake #2: Underestimating how much you need
A tenet among investors is, “When it comes to building your business, things always take twice as long as you think, and cost twice as much money.”
You don’t want to run out of money too soon, and be at the mercy of investors. This is oftenhow down rounds occur.
So be sure you give yourself a healthy amount of padding in your initial ask, so you can be ready for the unexpected.
Mistake #3: Not having a third-party review your contract
You may not need to be a lawyer, accountant, or business consultant, but that doesn’t mean you shouldn’t talk to one.
Many entrepreneurs become overeager to secure funding, and agree to a funding deal too quickly. When this happens, the deal may be more favorable to the lender, or not a good fit for the business.
Also, entrepreneurs tend to overlook negative contingencies on the front end, such as business failure. A good lawyer especially will ensure you are protected in all sorts of circumstances.
Mistake #4: Being unwilling to sacrifice
Giving up equity or taking on debt isn’t always a big of a step backwards as many people think. Naturally, you don’t want to give up too much, but you’ve got to put some skin in the game.
Read up on the numerous factors to consider when deciding how much you need to pony up. Be sure to keep these in mind:
- Your market. How much money is out there?
- Your potential success. First time or inexperienced entrepreneurs may have to give up more, especially if they are not in an incubator.
- Your team. Having a cadre of experts may mean funders will be at less risk, and therefore they will be willing to compromise
Mistake #5: Not considering “un-sexy” funding options
Innovative sources of start-up funding are emerging all the time. But sometimes, new funding sources such as crowd funding are unreliable.
Some new entrepreneurs see debt as something to be avoided at all costs. But in reality, debt is one of the cheapest (lowest cost of capital) ways of raising money (equity is the most expensive).
Additionally, one good aspect to debt is that it’s predictable, and predictability is required for planning.
Mistake #6: Choosing the wrong investors
Equity investors aren’t just piggybanks. They’re people with diverse interests and skill sets. Choosing the wrong ones can pull your business in a bad direction.
Look for investors that will be strong partners in the long-term. When considering investors, ask the following questions:
- Do they have professional skill sets that I can tap?
- Do they have experience in my industry?
- Can they make valuable connections?
What are their personalities? Are they overbearing, stand-offish, philanthropic? Etc.
Mistake #7: Being too secretive
Protecting your intellectual property doesn’t mean wearing a tinfoil hat and passing out NDAs to everyone you meet.
Not only can this behavior lose credibility with funders, but it can also hide important details from people that can help you. Remember: in the entrepreneurial world, ideas are cheap. It’s your ability to execute that funders are interested in.
Mistake #8: Not documenting everything
The devil is in the details, so make sure you have all your details in writing.
One common documentation mistake is not recording contributions to your business from third parties. This could result in legal trouble. Be sure to execute agreements from any funds taken from third parties, including friends and families.
Another documentation mistake is not recording contributions from yourself. If you take $20 out of your pocket for a business expense, make a record. This way, you’ll be able to write off losses easier, if necessary.
Mistake #9: Leaving your investors in the dark
Your funders aren’t just there to get you going. They need to know what’s going on in your business, and they hate surprises.
If you are missing deadlines or sales projections, let your investors know as soon as possible. This way, they can step in and help, and you’ll also be in a better position to ask for more money if you need to. Communicate early and often.
When seeking funding, it’s good to keep your eye on the prize. But don’t forget about the pitfalls, either.
Be smart, take 10-30 hours to educate yourself on finance, and use all the outside help you can. That way, you can focus more time on growing your business and getting the most value for your efforts.