I was on Mark Raffan’s podcast, Negotiations Ninja, recently and had an in-depth conversation with him about the common misconceptions surrounding raising money. And are there ever many of them! Let’s dive in because we have a lot of ground to cover to dispel all of these myths.
The first misconception I mentioned was the common misbelief that when entrepreneurs are raising money for a startup, they’re making money on a personal level—lining their own pockets if you will. This is not the case. In fact, it’s the total opposite: Rather than raking in any cash while fundraising, an entrepreneur’s ultimate payday doesn’t occur until a final liquidity event such as an acquisition or IPO, and even then receipt of cash might be delayed due to lock-ups. While fund rounds are celebrated, they are only a step towards the final destination.
Mark summed up the actual premise of the process perfectly when he stated: “The goal, at least from the outside in, for me, is seeing a venture fund invest in a company. It has to be a symbiotic relationship because they’re both going to make money on the exit. The idea is to help that company grow as much as possible, as fast as possible, to be able to get that exit.”
The subject of exits brought another common misconception into the conversation: That venture companies are a fast and easy payday, with entrepreneurs and investors able to make a direct beeline to the finish line (exit). Again, this is not true. The average venture-invested company requires 6–7 years of growth before an exit—and that’s when you’re talking about a really successful and good one. Let’s face it: The harsh truth is that building companies is very hard, and it takes a lot of time.
More bad news for those expecting a fast and easy payday/exit is that there’s no guarantee you’ll even get an exit. After all, it’s not like the stock market. If you do not generate high growth and you’re of a certain size, there may not be any buyers for what you have.
So, if it’s not like the stock market, what is the venture market like, really? Simply put: The overall venture market follows the power law. For instance, if you invest in 100 companies, only one of those companies has to make it for you to get a big return—a return that will cover and account for the other 99 losses.
But another harsh reality is the chances for success are low. Sure, raising money is a major milestone and validation, but it isn’t the end result. Not by a long shot. So, after raising money, feel free to take a moment to celebrate (as you should!). But don’t party too hard. Why? Because you can’t stop there. This is a dangerous trap all too many entrepreneurs make.
These entrepreneurs let themselves be fooled and start to believe their own press. It’s an easy lure to fall prey to. After all, you’ve just raised a fair amount of money, and everybody wants to celebrate with you. Your whole city says, “Great! You’ve just raised $10 million or $15 million. This is great!”—only to find out several months later you’re out of business.
You don’t want this to happen to you. Don’t get too overconfident or comfortable and rest on your successes, thinking you can coast once the initial funds are in the bank. Hence, the name “initial” because that’s only the beginning. We have to be reminded that there’s a cost to that money—there’s always a cost to that money. It’s not free money.
While we were speaking on fundraising and investments, I shared my opinion that the best type of investment is customer revenue. Think about it: If you can get customers and not have to raise any money, that’s ideal.
And before you start thinking that it can’t be done, there are actually about 38 to 40 companies that I know of right now that are “unicorns” that didn’t raise any outside money, proving that this impressive feat can indeed be accomplished. One such unicorn company that comes to mind right away is the wildly successful MailChimp.
The lesson here is this: You don’t have to raise a bunch of money to be successful. In fact, the more capital efficient you are, the better. I can’t tell you how many times I have seen entrepreneurs who are so focused on this goal of raising all this seed money, but what they don’t understand is that they raised that money because they could, not because they had to. I’ll say what I termed the first law here, which is capital follows growth.
For instance, say during the seed round, you get friends and family or whoever to fund your great idea, largely because you’re a great entrepreneur. However, not too long after that, the inevitable thing is: People are looking for metrics, and if you have good metrics, and if you’re capital-efficient, you’ll find it’s relatively easier to raise money.
This knowledge is largely why I’ve never really had any difficulty raising money—I knew all along it was all about the metrics. And I saw this proven time and again throughout my career. One example is when I was working with the entrepreneurs at Cintrifuse. I could call an investor on either coast and walk them through the metrics of a company that is growing quickly, and they would be on a plane the next day to any city in the country to check out that company. The next day. The investor might not even fully understand what the company does at this point, but they recognize growth when they see it. Again, it’s all about those almighty numbers (metrics).
Keeping this in mind, this is why you can’t raise that initial money and just sit back and pat yourself on the back and celebrate: Your execution and your growth have to support the fact that those investors are going to expect an up round from you in less than 24 months. And if you fall behind on that, they have to go back to their investors and explain why that company is underperforming. And that is one situation you just don’t want to be in.
Bottom Line: You have to think and have this hyper-growth mindset from the start. Understand the risks and unknowns associated with each round and how any new investor is going to help you ensure that you overcome those risks or fill those gaps before the next round.
Although I’ve given you a pretty good rundown of what Mark and I discussed, there is so much more we dove into in-depth. For more tips and engaging conversation on all things negotiation, head over to hear the full podcast.