Why do startups make mistakes while looking for outside investors? To answer this question, we must start from inside the head of the startup promoter. He thinks all he needs is funding, and then he will be off to a flying start. These views are based on the experiences I have had as an entrepreneur
Why do startups make mistakes while looking for outside investors? To answer this question, we must start from inside the head of the startup promoter. He thinks all he needs is funding, and then he will be off to a flying start. These views are based on the experiences I have had as an entrepreneur and also what I had observed during my career. Let us take a closer look at the funding problems and the typical mistakes startups make.
The biggest mistake is taking money from anyone who is willing to invest, without seeing whether there is alignment of goals of the investor and the startup. The right investors will add value in many ways – from generating new business leads to suggesting technical improvements. Sometimes, after several pitches to investors get rejected, desperate startups settle for any investor. This is a big mistake.
The second big mistake is related to the first one. And this lies in signing investor agreements without studying them. Most startups do not have the experience to understand the implications of innocuous-looking clauses. Even if they sense that a particular clause is likely to cause trouble, driven by their optimism and desperation, they still go ahead. Big mistake! These are the very kernel of such agreements, and should be understood well by discussing them with experienced consultants.
A third mistake is seeking outside investment too early. What may not be apparent to a startup is that it is probably better to manage for some more time on one’s own funds raised from the ‘3 Fs’ (Family, Friends and Fools!) and get the revenue stream stronger before going in for outside investment. This will depend on a great deal on the nature of the venture but, as a general rule, it would be pertinent to say that the promoter group should include those who could help raise resources.
A fourth mistake startups make is not paying enough attention to what happens if the venture fails. It is true that entrepreneurs are incorrigible optimists. But they must be aware of the fact that most startups fail. While the entrepreneur is probably willing to lose what he has invested, the same cannot be said of most investors. It is important to pay attention to the terms of the agreement that deal with the failure of the venture. It is necessary to put in place clauses that will ensure that a fair process of dispute resolution is followed when disputes arise between investors.
Another mistake is to raise too much funds too early without adequate study of the funding needs. This is something that may lead to sloppy decision making. For a startup that was struggling on bootstrapped finances, the infusion of funding is a big relief. But with funding no longer becoming a problem, expansion plans will suddenly be advanced and scaled up, with little regard to the capability of the organisation to deliver. This will lead to available funds getting quickly used up.
I am concerned when I listen to young people talk about their plans to raise funds. But today we have too much money chasing too few projects. In such a scenario, it is important for startups to consult experts. They must have a financial consultant familiar with the capital market and having a good track record in arranging funding. They must also consult a good lawyer having experience in advising businesses.
There is a feeling that even if you have the capital to invest, it is better to get an investor from outside. But I feel your own funds are the best source of funding. Going in for outside funding must be done to accomplish certain clearly defined goals. This must be defined in terms of revenues and cash flows, and one must convince the investor that reaching that pre-fixed milestone will help the venture launch itself to the next stage of growth. Going for outside funding because you are running out of cash means you have done a bad job.
Finally, don’t be afraid to look at other options to raise money, especially debt. This will turn out to be a lower cost option than others. Given the penchant of the governments to promote a favourable startup ecosystem, there are likely to be various schemes under which a startup could get funding with easy terms. These should be fully utilised along with own funds.
When seeking funding, keep your eyes on the prize, but don’t lose sight of the pitfalls.