The most common entrepreneur's question I hear is “How do I raise money for my company?” Before I can respond a second question is often immediately fired off, “And how do I do it fast?”
This second question sounds off a siren in my head. A company that needs money immediately is usually a company that is struggling in some way. And a struggling company is a sign of mismanagement, whether that be in money, strategy, customers, personnel or all the above. In these situations, money is simply a small bandage on a major wound.
Know Before You Go
Before you go out to raise money, understand exactly why you are doing it. If you need money to fix problems, you are unlikely to find funding, and if you do, it just extends the inevitable. A company that needs money fast to fix mismanagement will be far better served simply hunkering down and fixing those problems. Then, later, you can raise money for the one and only good reason to do so: expanding on a proven opportunity.
When your company raises money to build on something that is already working, it points to a win-win. The investor will likely get a return (win 1) and your company will likely see growing profits from the investment (win 2).
A Common Mistake
In my experience, once an entrepreneur is clear on why he needs to raise money, he rarely asks me where to get it because to him the answer is obvious. Go to the four Fs (founders, family, friends and fools), a bank, or max out the credit cards. This is a mistake. There are alternatives that few consider—options that provide both a cash infusion and some huge side benefits.
One disclaimer before we get started. Here I am going to give you five tips on raising money through equity. In other words, selling a portion of your business for cash (and intangibles). There are unexpected and highly effective ways to do debt financing, too, but I will save those juicy tips for a future piece.
1. A competitor. It sounds crazy, right? Who in his right mind would go to a competitor and say, “I need money?” But there is gold in them thar hills. The key is to not go to a direct competitor, but instead go to the juggernaut in your industry (ideally an indirect competitor who is big and would see an opportunity in what you are doing). Negotiate a deal in which that company invests in your startup in a small way initially, raising funds for you and allowing it to test the waters. Not only will you be positioned for an acquisition down the road, the investor is likely to help you going forward (since it has a small piece of your business).
2. A complimentary vendor. Similar to approaching that big-boy competitor, a vendor that serves a similar customer base may be looking to expand. Approach the vendor with the same strategy as you would the competitor. Negotiate an investment in your company in which the vendor can provide you with the needed cash and still just dip its toe in the water. You will get both money and a vendor committed to helping you out. As part of the negotiation, the vendor will likely want the right to buy you outright in the future for a discounted price.
3. The customer. This one can work wonders, but needs to be approached very, very tactfully. You know that favorite customer of yours who depends on your services in a big way? He may be interested in becoming an investor in your business in exchange for discounted services. And in certain cases he may want to invest and continue to pay full fair (tax advantages, people, tax advantages). But before you approach your client, be mindful of a presentation gone bad. If the customer thinks you are approaching him because you are struggling, that may be a signal for him to find a new vendor.
4. The employees. You surely have heard about an ESOP (employee stock ownership plan). Typically this is a method of giving a company's employees an ownership in your company. One primary objective in an ESOP is to motivate employees in the growth of the company and the equity is granted, typically, at no cost. But there is an additional option in which you can offer equity to employees in exchange for a cash infusion or for “sweat equity” (reduced compensation in exchange for stock). But this out-of-the-box approach can work only if communicated well and under the foundation of a growth opportunity. To seek funds from employees to save a sinking ship is like asking more passengers to come for a cruise on the Titanic while it is sinking.
One final word of advice: When it comes to raising funds via equity or selling your business outright, experience has taught me that a business broker or investment banker is an invaluable partner. Emotions can run high in these circumstances and knee-jerk reactions often replace logic. A buffer in the middle with experience and no emotional attachment is worth every penny (um, percentage point).
Mike Michalowicz is the author of The Pumpkin Plan and The Toilet Paper Entrepreneur. He is the founder of three multimillion-dollar companies, is a nationally recognized speaker on entrepreneurial topics and consults for companies whose growth has plateaued. You can read his blog by clicking here.
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