Getting your start-up off the ground and scaling it up usually requires an injection of capital to ensure that you can get past the lean years. Many a start-up has been left to starve in the proverbial desert seeking the promised land of an equity funding raise and many start-ups have drunk from the poisoned chalice of a poorly aligned investor relationship. It is important that you don’t treat equity funding lightly. A few key points are discussed in this article for you to consider.
Hold onto your equity, it is precious
Equity may seem like an attractive way to raise funding for your business, it is easy to “create” and it doesn’t really require that much effort to exchange it for funds, but remember that with each share you give away, you are giving a little more control and value in your company away.
At first, this may not seem significant, but the more funding rounds you go through, the more you are going to wish that you had held on to more equity, especially if your company’s growth is in line with your aspirations! Ideally, an equity raise should be one of your last options for raising funds until you have at least developed your ‘minimum viable product’. An equity raise should only be used if you are really in need of funds to keep going or to jump your production to the next level; even then, only give away as much equity as you need to.
Know what stage your business is at
This is really a simple principle. If you are pre-revenue and trying to create a minimum viable product, if you have to raise funding, you should seek out “Angel” or “friendly” investors who are willing to give you very favourable terms generally at a high valuation (meaning you give away less equity and control), these are often friends or family members. If you are post-revenue, you may wish to seek out venture capital funds or institutional investors to invest in your company.
He’s just not that into you
Make sure that your investor is serious about investing into your company. For institutional investors, the way that you will know when they are serious is when you receive a letter of intent or “term sheet” from them. It’s the venture capital equivalent of asking you on a date. They are trying to say that they’d like to see how things go, but they are not committing to anything serious just yet. If after a few months of discussion, you do not get a letter of intent, move on, there are more fish in the sea.
Know who you are doing business with
It is better to struggle through months or even years of bootstrapping than it is to have an investor relationship with someone who is completely incompatible with your business or who is going to add no value other than money.
An investor relationship can make or break your company. Don’t simply hand over your equity to the first bitcoin millionaire with a Colgate smile who approaches you.
Look for investors who want to invest in your industry and who have good connections in that field, this can be more valuable than the money that the investor is putting into your company.
Get good legal and commercial advice
It’s important to remember that an institutional investor is just as much a business as you are. They are always going to be biased towards getting the best return on their investment no matter how altruistic they may come across. This means that the commercial and legal terms, if left to them alone, will be weighted in their favour.
You may be tempted to avoid the expensive lawyers and commercial advisors, but too many startups make the mistake of being penny wise and pound foolish here. Unfortunately, commercial investment terms can be very complex and it is always advisable to have someone on the commercial and legal front sitting squarely in your corner.
In short, equity is an effective arrow in the start-up’s quiver to use when raising funding, however, it is not the only one available. If you do decide to let it loose, don’t do so aimlessly, pick a target and aim it in that direction. The more strategic you are in negotiating your equity fundraising, the more likely you are to get favourable valuations and investment terms.