Reuben BuchananFollow on twitter www.wholesaleinvestor.com.au
Should I ask investors to fund 100% of my start-up, or stump up some cash myself?
This week’s Secret Soloist is answered by investment advisor Reuben Buchanan:
Investors are definitely more likely to fund you if you have invested your own cash. It’s a common question they ask.
Here are some of the reasons:
1. They like to know that you are fully committed. A lot of ventures fail because the entrepreneur runs out of enthusiasm and goes and does something else or gets a job. If the entrepreneur is fully committed, the chance of this happening is less.
2. If the investors think that the entrepreneur has funds but won’t commit them, no matter how small they are, in principle they may not invest.
This is because if the entrepreneur doesn’t believe in it themselves, then how can they expect the investor to?
3. It’s not uncommon for entrepreneurs to try to start ventures without using any of their own money and use investors’ money instead.
Investors are wary of this and will often ask, “How much have you invested in this?”
The answer they like to get is, “I have invested everything I have into this business”. Now it may not be wise for an entrepreneur to put all of their assets on the line (house, kids’ school fees, etc) and investors understand this.
But they want to know that the entrepreneur has financially committed to the business as much as is practically possible before they invest.
4. It’s unreasonable to expect an investor to say, put in $100,000 for 10% of a venture, when the founder has contributed no money and retains 90%.
From the investor’s perspective they have more to lose than the entrepreneur because the entrepreneur can always go and get a job if the venture fails. The investor will lose all of their $100,000.
There is no ratio of what the investor will contribute compared to what the entrepreneur may have contributed.
Look at Facebook. I don’t believe that Mark Zuckerberg contributed any funds to the venture – just a lot of time and intellectual capital.
The first raising was $500k for around 12%. But don’t forget they had about 500,000 members at that stage, and were growing like crazy each week.
When I’m dealing with this situation as an entrepreneur, I like to explain to the potential investor how much time, money and effort I have invested into the venture.
An example might be:
- Capital: $10,000 to start-up from my own personal savings.
- Time: 12 months full-time (equal to say $100,000 lost income if I went and got a job).
- Effort: Working 60 hours per week.
- Focus: Not working on anything else, highly committed and focused on this venture.
If I’m seeking, say, $100,000 from an investor after only 12 months from start-up, I’d be pitching the investor to have around 20% to 30% stake. Maybe up to 50% if I think the investor is strategic.
Now this depends on a lot of things but this might give you an idea. This is a good starting point and won’t immediately turn the investor off.
I see many start-up businesses offer the investor only five or 10% after just 12 months – and they wonder why it’s so hard to raise funds.
The bottom line is many entrepreneurs value their young, risky, start-up business at a very high value compared with what else the investor can invest into, and the risk associated with it.
Don’t forget – if you are raising capital, you are competing with every other investment option out there.
An investor might rather spend $100,000 on another investment property which is lower risk, provides a tax deduction; they own it 100% and can be renovated to increase value. This is the sort of thing you have to keep in mind when fund raising.
Finally, if you say to an investor that you have put in $X, then make sure you can prove this with bank statements.
Don’t just make something up, because if they check up on you and you are lying or “stretching the truth” then they won’t invest in you, period.
If someone says to me, “I’ve put $500,000 into this venture” my next question is, “Show me – send me your P&L’s that reflect this”. So be careful what you pitch to investors. Your word and credibility is very important. Investors do not back entrepreneurs they don’t trust.