In my work, I see a lot of companies looking for investment. At the AIF (Angel Investor Forum) where I’m president, we screen a few hundred companies per year, ask a couple dozen to present to us and actively pursue diligence on 10 or so.

And what’s new since Elon Boms paid attention to AIF is we just closed our first fund a couple of months ago. It has already made 2 investments, and AIF members have added on to those investments: in one case more than doubling what the fund put in.

Plus I mentor or judge at a couple of startup weekends each year and go to 5 or 6 accelerator demo days. As I said, there’s a lot going on in Connecticut. And I agree with Elon, that we still need more angel investors. To that end AIF has already scheduled a training session on September 19th open to anyone who’s considering becoming an angel investor. Details here.    End of shameless plug.

But I also have my foot in another camp. I’ve been an entrepreneur since 1979 starting and running companies – none you’ve ever heard of. They’ve all been bootstrapped – companies that I grew and profited from with no outside funding. And I’ve been consulting since 1994 primarily to people who run such companies. The difference between bootstrapped companies and those with outside investment is quite stark.

The Entrepreneurial World is Changing

The problem I see is that everyone thinks starting a company and raising money go hand in hand. They don’t, but you’d never know it from reading the press. Until now. But from my perspective, with a foot in each camp, I see things changing. Or rather changing back. You see, there was no venture capital industry before the late 1940’s. And some pretty big companies were started back then. Many are still around, like IBM, AT&T, GM, Xerox. Even into the 70’s and 80’s when companies like Microsoft and Oracle, and Dell were started – they didn’t go after outside investment first. They first went after customers.

Only in the last 20 years or so has raising money become the first thing entrepreneurs think of. But in the last few months, people are starting to see the error of that approach. Don’t get me wrong – there’s a place for angels and VC’s in the entrepreneurial ecosystem. I’ll get to that in a minute. But here’s what people are missing.

The kind of investment that’s right for your company is not up to you – any more than the size of your shoes is a fashion choice. The style of  your shoes is your choice, but not the size.

I hear from entrepreneurs all the time why they need money. They’ll grow faster, hire more sales people, get new features added etc. But investors don’t invest to grow your company. They invest to get a return on their investment. If people sold products the way they ask for investment they’d be saying “You should buy my stuff because then I’ll be able to upgrade my internet service to a faster line.” It doesn’t matter whether investment will make your company better – but whether your company makes a good investment. And in my work I see a whole lot of really good companies that are lousy investments.

A Good Company is not the Same as a Good Investment

The idea that there’s a difference between a good company and a good investment is starting to gain traction. Have you heard about the Series A crunch? Companies that got some early seed funding, now can’t get funded when they need to raise $1 million or more. Maybe they should have gotten their seed funding from selling their product to customers rather than selling their concept to investors.

Did you read this profile of 2 companies in the same industry? RJMetrics got started with $10,000 of bootstrapping money and got their first customer in 3 months. GoodData went for funding first and has now raised $75 Million. The founders of the RJMetrics own 80% of their company. Not so for the founders of the GoodData. And the money quote:

…if RJMetrics were to sell for, say, $50 million, the founders would be set for life financially. If GoodData were to sell for $50 million, it would be a disaster.

And just today, arrived in the mail, a copy of INC magazine with an article about a company – ESRI – that does almost a billion dollars in revenue, and has grown for 43 years without a layoff or downsizing. Here’s what Jack Dangermond, co-founder says.

 One thing that has made us so successful is that we’ve never taken outside investment. That means we can concentrate on what our customers want – not what the stockholders or VCs want. That’s a strategic advantage.  

In the last 10 years or so, the cost of starting many types of companies has come way down. Between cloud computing, hardware getting cheaper, open source software being more powerful. Hell, you can even get a 3D printer for under a thousand bucks. That reduces much of the cost and risk of getting a product to market.

Add to that the newly discovered concepts of learning entrepreneurship. The phrase “business model” is not just a change in terminology replacing business plans and competitions. It is in fact a new way to start a company with less risk. Customer Development, Lean Startups, Business model canvases – these are all new ways to help entrepreneurs earn their craft faster and better. So they can start companies more rapidly, with less capital and with less risk.

Bootstrapping is Becoming more Well Known

So why aren’t more companies bootstrapping? They are. And I think you’ll see the press reporting on it more and more in the next few months. Things work differently when you bootstrap a company. You focus on getting cash in fast from customers. You learn quicker what customers want to pay for. You grow slower, but when it works, you end up owning more of your company. And all that time that others spend raising money? You can spend it growing your company.

According to Chris Dixon (himself a VC with Andreeson Horowitz)

There are lots of tech companies that are very successful but don’t fit the VC model. If they don’t raise VC, the founders can make money, create jobs, and work on something they love. If they raise VC, a wide range of outcomes that would otherwise be good become bad.

The numbers support this concept. At least 500,000 companies get started every year in the US. Many people are surprised to learn the VCs only fund about 3,000, angels probably fund another 60,000. These numbers are approximate, but the order of magnitude is right. That leaves a lot of companies to bootstrap. Why? Not because they can’t find investors, but because their model isn’t right for equity investment.  

What is the right model for raising money from equity investors? When you can generate the kind of returns investors need. At minimum that means being able to sell your company and returning to investors 10 times their money in 5 to 7 years or 3 times their money in 2 to 3 years. Minimum. That generally happens when one of the following is true.

• You have a market that’s large enough to create a billion dollar company.
• Your market is large AND is such that there will only be one key player (like eBay) so you have to grow very fast to annihilate all the competition.
• You have invented some technology that’s protectable and desirable to an acquirer for strategic reasons.

These returns generally don’t happen when several others are pursuing the same idea, when your technology can be easily replicated, or when your success depends on the whims of fashion. In those cases you can make a very good bootstrapped business by executing well, but it’s much harder to have an exit that gives investors the returns they want.

A strong ecosystem emerges when there are companies at every level and scale: Those that should be funded by angels and VCs and those that should bootstrap. But equally important is that entrepreneurs learn what it takes to make a strong company and learn which kind of funding is right.

Worst Place #1 – Investors! Why? it’s the most expensive money and it takes more of your time and energy to secure it. Plus they almost never tell you no so you waste a lot of energy pursuing deals that are never going to happen.
Worst Place #2 – Lenders. It’s cheaper than investor money but it’s still hard to get (almost impossible for start-ups). Not only do you have to pay it back with interest but often at the most inconvenient times that don’t account for dips and fits that all businesses (especially young ones) go through.
Worst Place #3 – Friends and Family. Why? It can be easy to get, and if you’re a success you probably won’t mind paying it back. But if you aren’t a success you can mess up some important relationships. Seriously.

THE BEST PLACE? Customers.

Not only are they the best place, customers are actually the only place to get money. Here’s why. Your business is like a car. It has to get a lot of power. Power to go, of course, but also for the power steering, power brakes (did you forget cars didn’t use to power those things?) And you need power for the windows, the AC, the audio system, even the GPS and the DVD player for the kids. All that power has to come from the engine. All of it. There are no solar panels (not yet) no gerbils or even rubber bands under the hood. Every single bit has to come from the engine.

But the engine can’t start itself. In the olden days it was started by muscle power with a crank. In my younger days I had a car that had to be started with a push down a hill. Modern cars get started with power from the battery. But that battery needs to be recharged, and the charge comes from guess where? The engine.

Your business is like that. The customers are the engine. All the money has to come from the customers. Sure you may need a jump start, and you may look to some of those worst case sources I mentioned for that jump start. But if you haven’t built a business model that shows how your customers will ultimately pay your cost of goods, plus all the costs of selling to them, plus the cost of keeping the lights on PLUS paying back the lenders, investors or friends and family your company will sputter and die. In many cases you won’t even get the jump start.

I say this as an ex-entrepreneur who is currently an angel investor. I love it when my investment can jump-start a successful company. But I don’t get to do it enough. Why? Too many entrepreneurs think getting my money is closer to the end not the beginning.

Too often I see pitches from entrepreneurs who don’t really get that my money is just a jump start – and an expensive one at that. So expensive in fact, that there are a lot of good companies who will never get going fast enough to pay me back enough to make me take the risk. Too often they waste so much time trying to pitch to people like me when they could be selling stuff to customers and actually making money.

Many would be much better off to start with a little push, and grow slower but more profitably, with customer’s money.

photo credit http://www.flickr.com/photos/neubie/2273635564/

[tags] start-up, entrepreneur, financing, investors, VC, angel investor [/tags]

It will be helpful to have some documents to do this. But a typical business plan is not usually the right document. The right ones capture what you thought would happen, and more importantly, why you thought it would happen that way. Then they make it easy to compare what did happen and why to what you were thinking at the time.

Here’s an example. In the marketing section, most business plans cover who the market is, how fast it’s growing etc. They often get this information from generic research reports that talk about market segments. But market segments are irrelevant to a small company (and all start-ups begin as small companies). Then the business plan makes some guess at what percentage of that market they can capture. The guess seems to be based on what number will look like they can make a lot of money, while not make investors think they are smoking crack.

But this evades the more important questions about your market: how you’re going to find them, educate them about your product and ultimately sell to them. And how much time this will all take, and how much it will cost?

Here are some better things to document about your market:

Rank your market in order of the cheapest / easiest to sell to. For each group estimate the following:

• What it would cost to sell to a customer in that group?
• How long it would take?
• What’s the average size of a purchase?
• What’s the average life-time value of a customer in that group?
• How many people there are in this group?
• Give examples of what you base this information on?

Never forget that a customer is a person. It’s not a company, a family, a household, or a demographic. It’s the person (or people) in that organization who actually decides to pay the money. Say you want to open a family restaurant. Yes, you need to know how many families live within a certain distance from your place. But don’t stop there. The time and cost of marketing a meal to a kid (think Chuck E. Cheese or McDonald’s happy meal) is different from marketing a meal to an overworked Mom or to a grandparent. Who is going to decide to spend money at your place and what will it cost to get them to do so?

Document your thoughts on that. Then you can regularly compare what your actual sales are, and what it actually costs to make a sale to what you were thinking. If you’ve been open a month you have enough data to start the process. The actuals won’t match up (trust me on this) but the point is to get better at projecting so that by month 6 you’re doing a better job and by month 18 you’re doing a good enough job to know if you should stay in business, close the doors or raise more funds. And if you do need to raise funds, that kind of detail will convince investors yours is a business not just a product.

Takeaway:

• The purpose of planning is not the plan – it’s to get better at predicting what the future will bring and how to be in the best position when it happens.

[tags] small business, entrepreneur, business plan, planning , CEO Skills [/tags]

The idea is “believers” aka investors invest $10 in a share of a new band. When the band has raised $50,000 (5,000 investors) SellABand helps them produce and promote a CD – the investors get one copy of the CD for “free”. Money is split between the band, the investors and the company. Any time before the band raises 50K an investor can get their money back or switch it to another band.

Seems to me that $10 is a really cheap way to “own” part of a band for people who like to be early adopters of new music and a way for a band to raise money but more importantly get 5,000 folks promoting their music from the get go. For the investors, it’s like paying $10 to be a promoter of an idea virus. And you get a CD for the price.

UPDATE: Slice The Pie has a similar concept.

Takeaway:

• The real power of any technology is not to do the same old stuff quicker, better, or more accurately, but to allow you to do things that could not be done before. The web is no different in that it’s real power lies in the uncharted.

[tags] entrepreneur,record label, Music Business, business model [/tags]

I’m finding a huge disconnect between investors and entrepreneurs. And not just their needs – their entire outlook on the process. It seems like they both believe they’re doing the other a favor by offering them an opportunity to be in the deal. That may sound like a win-win but it’s really a situation where each won’t accept the other’s point of view. So it makes coming to an agreement difficult.

The other problem I’m seeing is that angel investors seem to believe they are just mini VCs. So they are looking for companies they can cash out in 5-7 years for 20-plus times their investments. The chances of that happening are not strong, so VCs hedge their bets by being in a lot of deals, and trying to cut their losses when things go south. But that’s not usually what the entrepreneurs want. Especially the large numbers of entrepreneurs who have viable companies that aren’t venture companies, yet need some investment. As Paul Graham has said VCs prefer a 20% shot at making 100 million over an 80% shot at making 10 million over 100% shot at making 1 million. Entrepreneurs prefer the opposite. [I can’t find the exact quote, this is a paraphrase.] I found the quote: “The founders, who have nothing, would prefer a 100% chance of $1 million to a 20% chance of $10 million, while the VCs can afford to be “rational” and prefer the latter.” It’s from The Venture Capital Squeeze

Takeaway:

• I’m looking for a model where I can invest in a company (20K, 50K maybe 100K) and contribute my experience and advice in helping the owner grow the company. Then get a healthy return. Sure I’ll take a percentage if the company gets sold to Google for a billion and a half. But if it’s merely “profitable” and not saleable, I’d like a decent income stream from the profits. Some way to insure it doesn’t get wasted on fancy company cars, extravagant off-sites etc. If you know of such a model drop me a line.

[tags]Angel Investing, Finance, Raising Money, Capital,  Small Business, Entrepreneur[/tags]