This week I will discuss some of the common mistakes made by the entrepreneur in raising money for their business.
You have a great business idea. You’ve done the market research, tested your product and potential customers like it and say they would buy it. You just need the money to get started. So how do you find the money if you don’t have it sitting in your bank account? Well, very simply, you go where the money is and ask for it…but you had best be ready for the questions you will be asked before you make your request.
Where’s the money?
Most good business ideas don’t even get off the ground because the novice entrepreneur does not have enough cash themselves and does not know where to look to find it. You might first try turning to friends and family, who tend to be the least demanding, but if that is not an option, then where do you go? How about your bank? A bank may require significant collateral before they will loan you money, such as your house, if you own one and this may not be the best approach. Don’t despair, there are other sources of funds you can turn to which includes angel investors, venture capitalists or private equity. I will focus in this blog more on raising money through the private investors.
Are you properly prepared?
Another one of the common mistakes for the entrepreneur is not knowing how to best prepare before asking for an investment in their business. You usually only get one chance, and you don’t want to blow it.
The expectation with a bank, angel investors, venture capitalists, or any other sophisticated investor, is that you will have done your homework before you enter their doors. The minimum requirements going into such a meeting, are:
- A clear business plan.
- Projected financials of the business.
- A definite amount of money you are asking for.
- What you intend to do with the money.
- Your contingency plan if the business does not go as expected.
The Business Plan
Again a common mistake of the novice entrepreneur is not to have a business plan when asking for money. But without being able to show that you have thought about how your business will function, defining your product and value proposition, and how you defend against competition and create a return for the investor from whom you are seeking money, it is unlikely anyone will invest.
The business plan should explain the business opportunity for your product and what it is that makes your product unique and better than what is already out their; in other words your value proposition. Make sure you have market research to back up your assumptions including data that supports what you expect people will pay for the product. You need to explain how you will acquire sales whether through marketing and advertising locally or globally, social media, print or word of mouth. In my experience, most of the questions you will receive will focus on your understanding of the market place and how your product will compete with what is out there already and the products that are in development. It is also important to make sure you can answer how easily it would be for others to replicate your product or service. In the technology spaces it is customary to have patent protection around your invention to stop others copying your idea.
Investors like numbers and unless you can show them how you will make money, how and when you will be profitable, and what type of return they can expect to obtain from an investment in you, they are unlikely to invest. Your business plan should contain financial projections based on how you see the business growing. You should have at least 3 years projected with the first year broken out by month. I recommend you create a profit and loss statement, a cash flow statement and a balance sheet. If you are not familiar with financial statements you may need the help of an accountant. My advice is that you are not overly optimistic with the revenue projections. You could even consider creating an optimistic and pessimistic projection as well as the most likely projection so you can explain what you would do if the business takes off more quickly than you think or if the uptake is slower than you believe. This will at least show how you intend to deal with both scenarios should they occur. With regard to your expenses, be accurate. Make sure you think about the type of people you will need, their salaries and benefits, the equipment you need, the facilities and insurances. Obtain estimates where possible and include all aspects of your running costs. If you are making a product, don’t forget that you will have inventory to consider and a time lag for selling it. Consider when the business will be profitable, watch your margins (gross profit and operating profit), and calculate when the business will be generating cash.
First time entrepreneurs often make the mistake of not asking for enough cash, or asking for too much. To make sure you ask for enough cash, turn to your financial projections, particularly in the case of the pessimistic scenario, just how much money you will need until the business is generating sufficient funds to sustain itself and your future. It is really important to ask for enough funds to see you through as going back for more if you have not achieved your goals or did not estimate accurately, will be very difficult to obtain. I like to look at when the business is consistently generating a positive cash flow. If you are going for a loan, don’t forget to factor in the payments on the loan and paying back the principal. If you are asking investors for cash in exchange for equity, then you will probably have to estimate when they will see a return and how much (I will cover this in a future blog).
Use of Funds
It is fairly typical for any investor to want to know how you intend to use their funds, but again, the inexperienced entrepreneur may not provide an appropriate response. Investors want to see that you plan to use their funds wisely and frugally to build your business, so you may want to avoid showing them some extravagant real estate you intend to lease or purchase with their funds. Stating that the funds are for working capital is rarely a sufficient explanation. Better to have several concrete items you can point to, for example, building initial inventories, establishing a customer base (initial marketing campaigns, website, social media, etc), establishing an office, manufacturing facility, warehouse, etc.
Finally, most entrepreneurs, the first time they seek financing, forget to challenge themselves with the types of questions an investor will ask and consequently stumble around trying to answer, and in so doing may lose the confidence of the potential investor. I think it is really important to challenge yourself, or have someone else challenge you, with what could go wrong with your business, and if it does, what would you do? You may even want to make this part of your business plan. This exercise will help you prepare for criticisms and questions and your ability to answer will help persuade the investor that you are taking your idea very seriously and provide them with the confidence they need in you to make that investment.
The better you prepare, the more chance you will have of successfully convincing others to invest in you. In the case of a bank loan, you will also need collateral equal to what you are asking for. The bank does not want to lose out if your business fails. So, good luck, and let me know if you need any help; I will be happy to advise you.
MP Consulting writes a weekly blog on Social Media, Marketing, Leadership, Business Strategy and other Key Business Topics. Hopefully this has given you something to think about. My goal is to make your life easier and to ensure you are as productive as possible. I hope you enjoyed this and that you will send me your comments, subscribe and link to my blog, and if you need help, go to the question section of my blog.
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Copyright © 2012 Mark Philip