While VCs & Angels debate, focus on first principles

There has been a lot of debate lately in the investor community about VCs vs SuperAngels and the best approach to financing early stage companies.  If you are an entrepreneur, you could spend all day catching up on the blog/twitter traffic, which of course makes it hard to focus on actually building your business.  If you do have the time and want to wade in, these posts/comments from Fred Wilson, Brad Feld, Eric Paley, Dave McClure and David Hornik (via TechCrunch) will give you the overview.

Given that 90% of all potential investors will deliver advice that is self-serving to their own particular agenda, in approaching the question of how to fund your business, to me it makes sense instead to focus on first principles.  As a first pass, this entails answering three questions:

  1. How much money do I realistically need?  Put together an overall multiyear plan for your business, assume it takes longer and more money than what the plan suggests, and then determine what that means.  The simple point here is that the financing sources that are appropriate if you need a total of $1 million are different than if you need $10 million or $100 million.
  2. What amount of capital upfront allows me to significantly decrease risk and increase valuation?  While every entrepreneur would like to raise all the capital required per question one in one fell swoop, this is often unrealistic and will result in a tremendous amount of dilution.  Instead, think about determining what allows you to prove you can build your solution, that customers will adopt and it fits a market need, there is a sustainable business model and that you have a path to access the market.  Funding through milestones such as these will allow you to raise subsequent rounds of capital at higher prices.  In the digital media world this often can be accomplished with less capital, in other segments it requires more, but regardless of the segment you participate in reducing risk and demonstrating potential upside will always translate into higher valuations.
  3. Who do I want to work with, what do I expect to get out of them and are our objectives aligned?  When you bring on an investor, especially if they are on your Board of Directors, you will be together for a long time.  So make sure you both enjoy working with them, you see eye to eye in terms of the market opportunity, you are aligned in terms of what you expect from the investor and what they will be able to deliver, and there is agreement on the the ultimate goals for your business.  One of the greatest sources of conflicts between entrepreneurs and investors happens when this alignment is not in place from day one.

In all of this, avoid the trap of telling an investor your strategy is what you think they want to hear.  Instead, if you focus on what is right for you and your business, the answers should come to you.

2 thoughts on “While VCs & Angels debate, focus on first principles

  1. DesmondPieri September 9, 2010 / 9:58 am

    Chip, great advice. Although it seems basic, I’ve seen so many entrepreneurs not follow it. People often shoot for a raise amount that is not tied to their milestones. And people often dismiss the importance of the long-term relationship with the VC. When I’ve gone in to clean up VC backed companies, the problems often go all the way back to a not-well-thought funding round. Des

    Like

  2. just.a.guy September 9, 2010 / 12:22 pm

    Very well and succinctly put, Chip. Far too many entrepreneurs chase the financing source(s) first, and as a result wind up receiving self-serving advice and “help” from investors who predictably try to force-fit the business into the particular investors’ funding models. In my experience I’ve seen this happen with investors of all stripes, from angels to “super angels” to traditional VCs to corporate/strategic investors.

    Like

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