Friends or family
When you start raising money for your company, one of the first type of investors that you’ll run into is called friends and family. They’re actually often called friends, family, and fools because only fools would invest in very-early-stage companies at the beginning. But that’s tongue-in-cheek. The friends and family dynamic are people who believe in you and are investing in you to get the business up and running. And that’s important because, as a start-up entrepreneur who’s raising the first capital for your business, a lot of times the people that are going to be most supportive of you are not necessarily that interested in what you’re doing, but they’re interested in supporting you.
Now it’s important to treat your friends and family in the same way that you would any professional investor in the context of raising money from them. They’re supporting you, but you want to make sure they’re getting an appropriate deal for the stage that you’re at. And you want to make sure that what they’re investing in is something wherein the upside case where things are successful, they’re going to make an enormous amount of money. And in the downside case where things don’t work out, you won’t be embarrassed by the way that you treated them in terms of the context of the investment.
Now failure with friends and family can occasionally make for some awkward Thanksgivings; but at the same time, as long as you’re being respectful and thoughtful of those early investors, most of your friends and family will be thoughtful and respectful whether or not the company’s success. There are some magnificent stories of outcomes from these types of friends and family investors.
One recent one that made the rounds was Jeff Bezos’ parents, who wrote the very first check into Amazon; and the wealth that they have now as a result of what was a relatively small check, hundreds of thousands of dollars, is now measured in the tens of billions of dollars of value for them. So you can have that kind of outcome in the extreme cases from friends and family; but recognize that, in addition to the financial support that you’re getting from your friends and family, the emotional support from having them involved early can be very powerful.
And this leads to the final key to it. If you take money from somebody, whether it’s friends and family, angel investors, venture investors, or anyone else; make sure you’re communicating with them regularly about what you’re doing in the business, about the status, good and bad, and especially about places where they can help. When things go wrong or sideways, the worst thing you could do, especially with your friends and family investors, is shut down and not communicate about what’s going on.
Because you never know when somebody’s going to be able to show up and help you in a way that goes well beyond just the money they’ve invested.
So another type of investor that you’ll run into very early on when you’re raising money for your company is known as the angel investor.
Angel investors are investors who regularly invest in early-stage companies, at the very beginning, oftentimes in rounds that are known as the seed, or even the pre-seed round. Many angel investors invest alongside friends and family, or the financing just right after you’ve gotten your business started and raised some money from friends and family.
A lot of angel investors are successful entrepreneurs, or they could be high net worth individuals, people that have made a lot of money in other businesses. In some cases, people who have inherited wealth, who are interested in being investors in early-stage tech companies. Angel investors are almost always investing with their own money, versus money that’s from a fund that they’ve raised in some other way, although some angel investors turn into professional investors over time. Other angel investors invest through vehicles like something called AngelList, which is a network or marketplace that allows angel investors to invest together in a syndicate in companies.
One of the things that useful to know about angel investors is that they fall on a spectrum, where at one end of the spectrum, angel investors really are just providing capital, and at the other end of the spectrum, especially with experienced entrepreneurs, they’re adding a lot to your business. They’re able to help you a lot in different ways beyond just the capital they’re providing. The best angel investors are the ones that fall at the far end of that spectrum, where they’re actually able to engage with your business and help you. It’s also important for an angel investor to know the difference between being an angel and a devil. There are quite a few angel investors who are actually devils. They invest in the company, but they don’t recognize that as an angel investor, what they’re really trying to do is help the entrepreneurs be successful, and build value out of the gate, and instead, they start to act as though they control the company, or they influence the company, or, you know, they feel like they have special rights that they shouldn’t necessarily have.
So, as an entrepreneur, when you’re raising money from angel investors, make sure that you actually do some research and do some diligence on the individuals, and understand what kinds of investments they’ve done, and how much experience they have, especially in the context of any of them who are starting to write larger checks. When an angel investor is investing $25,000 as part of a million dollar round, that’s one dynamic, but if the angel investor is investing $500,000 of a $750,000 round, it’s likely they’re going to expect, and want to have a lot of influence on you and your company and the path it goes down, so make sure you understand what those dynamics are.
Last, a lot of times angel investors invest in one round, and then nothing beyond that. Some angel investors will continue to invest in future rounds, so it’s really important to understand, when you raise money from an angel investor, what expectation to have around the type of financing strategy they have, and whether they’re going to be there just for the financing they’re doing, or whether they might be potentially a participant in future rounds down the road.
Another popular source of early-stage financing is crowdfunding. This is especially true when you have a physical product that you’re going to market with and you want to test the market and understand who is interested in your product.
With crowdfunding on websites that have become popular, like Kickstarter or Indiegogo, you’re essentially doing a pre-order or presale campaign for your product. What happens in the context of that crowdfunding activity with a product is that individual customers who are interested in your product are able to pre-buy your product in advance of it being ready. If you clear some threshold in the crowdfunding campaign, say you set a threshold of at least $100,000 raised, you then get that money minus a discount for the crowdfunding site, which is usually five to 10%, and then you can use that capital to actually go physically build your product and get your product to market.
So essentially it’s collecting people who are pre-buying your product in advance. There’s an added benefit, which is that you are rebuilding a community of early adopters for your product. And through the crowdfunding campaign, in a lot of ways you’re able to experiment with what people are going to be interested in.
Now, there are many crowdfunding campaigns that never clear their threshold so they don’t succeed, but even that is useful feedback for you in the context of your product, because if you can’t get enough people interested in the product you’re going to build to have a successful crowdfunding campaign, you should question whether or not you’ve landed on the right type of product and the right type of customer that you’re going after. There’s another type of crowdfunding that’s called equity crowdfunding, which has come out of something called the JOBS Act, which was an act in Congress in the US that was passed in 2012 that changed the way early-stage investors could invest. And it opened wider the number of early-stage investors that could invest in the startup companies and take risks.
Now there are some ironies around this because, in a lot of ways, the fact that the government is regulating who’s able to invest in a company at the earliest stages but isn’t necessarily regulating how much money you can bet on red on the roulette wheel in Las Vegas is a little bit weird. But in a lot of ways sort of the investor protections that exist, exist so that people can’t scam investors.
With equity crowdfunding, it gives startups another mechanism in a way that’s regulated to be able to raise money from certain types of investors who may not qualify for traditional friends and family or angel-type investing. So as an entrepreneur, make sure you’re current on the different rules of equity crowdfunding, but don’t dismiss that as a potential option, because in a lot of ways it can allow you to get access to a much wider group of customers.
And on the product crowdfunding side, especially if you’re building a specific product, in addition to raising money, recognize that it’s a good way to test the market in advance of you going out and actually building and shipping that first product.
Venture capitalists or firms
After you’ve raised some money and you’ve got your business going, as you raise a little bit more money, you’ll often start to encounter venture capital. If you’re raising any sizable amount of money, usually over a couple of million dollars, you’ll typically be targeting venture capitalists, not just for that first financing but ongoing financing through the life of your company, including into very late stage and very large financings.
One of the mistakes entrepreneurs make all the time about venture capitalists is they view them as a singular archetype. So you often hear entrepreneurs talk about VCs and say, VCs, as though all VCs were the same. It’s the wrong way to think about it. Think of them as a bunch of characters in Lord of the Rings. What you’ve got is you’ve got some wizards and you’ve got some elves and you’ve got some orcs, and you’ve got some dwarves, and you’ve got some trolls, probably a lot of trolls actually in the venture industry, and these characters are all different, so a VC could be one of these characters with different experience levels and different number of things in their toolkit.
A venture capital firm is usually a collection of some of these characters, so instead of thinking about a venture capital firm as a singular archetype, you’re actually dealing with a collection of personalities and experiences and styles all within the context of venture capital firm. The importance of this is to recognize that when you go to raise money from venture capitalists, it’s really important to understand what they are like and what they are motivated to invest in.
Understand how they work with companies and make sure that their value systems and how they want to approach your business in good times and bad times are going to be consistent with what you are interested in. Venture capital funds almost always are a combination of institutional capital that the venture capitalist raised, combined with some of their own capital.
One of the reasons that they raised additional capital from institutions is to have a larger pool of capital to invest in your company. A venture capitalist has control over all the decision-making around that capital, so when a VC invests in your company, what you’re really getting is a long-term partner that typically owns a significant portion of your business. You might often find a venture capitalist owning anywhere from 10 to 30 or 40% of your company. It’s useful to know that VCs generally don’t want to control your business, but in a lot of times, they exert a lot of control over your business and the direction you go.
So understanding, again, what their motivations are and what the characteristics of that individual, as well as the firm, is critical to knowing whether or not you’ve got a good VC for your company or not.