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What if I told you that, if you want to build a startup, fundraising might be a bad idea? Many entrepreneurs believe that pitching investors and raising money will help build a better startup. Well, there are at least six reasons why fundraising may not be beneficial. What’s worse, it can be even harmful. Today, you will learn about what these reasons are. And, you will learn how to avoid them if you want to raise money for your startup. Use fundraising to accelerate your startup!
No.1: Fundraising is not a way to test your product
Do you want to build a successful startup? Then, one of the things you have to do right is creating product or service people want to buy. This may sound like a no-brainer. However, many entrepreneurs make the same mistake. They sometimes misinterpret successful fundraising with product validation. They think that raising money is the indicator of having viable product. Don’t make the same mistake. Fundraising and product validation are not the same.
Let’s say you approach a number of investors. It doesn’t matter whether they were venture or angel investors. They were willing to invest in your startup. You think this is a good indicator that your idea has legs. And, it might have. However, there is another question you should ask yourself. Are these people the ones who will actually pay for the final product or service? Those investors gave you their money because they expect it will be worth it.
“Invest” is not the same as “pay for”
On the other side, it is less likely that these people will also go and buy your product. In a fact, many investors don’t care about it at all. They want to make some profit. This is the one thing they really care about. You are only a way to achieve that goal. Sure, there are examples of both, venture and angel investors, who care about the product. Does this mean they don’t care about the viability of your product? No, that would be nonsense. Product has to be viable to make profit.
However, it is something different to just “think” people will be willing to pay for X and actually find people who willing to pay for X. In order to validate your product, you need the second. Fundraising can give you only the first. When investors give you money, they think there is potential market for your product. The problem is that this is not necessarily the truth. It is just another assumption or hypothesis, like your product. This is something you need to understand.
When you come up with an idea for new product, you assume there are some people willing to pay for it. Until you test prove this to be right, it is only assumption. The same is true in case of fundraising. Great, you now have a bunch of people thinking your assumption is valid. Although they all put some money on the table, their motivation is making profit. They are not doing to enjoy your product or service. Again, there are exceptions. However, this is often the harsh truth.
Validate your idea before raising money
My suggestion is simple. Before you decide to pitch your idea, sell your product to real people. I guess that some of you will argue that building the product requires money and time. And, you may not have the first or the second. That’s why you are interested in fundraising. This is not true. Who says that you have to build the whole product? Have you ever heard about lean startup? And, what about MVP? In addition, who says you have to build anything?
The truth is that you don’t have to write a single line of code, or whatever. All you need is a stack of pictures or slides. Isn’t actually this what you want to use for fundraising? Well, good news! You can use the same material to validate your product. What do I mean? The truth is that you don’t have to sell your product in order to validate it. You can pre-sell it. This will do the job as well. It will show that there is at least tiny market for your product. If not, you can try a different idea.
Why fundraising is better with validated idea
Another reason why you should validate your idea before fundraising is that it puts you in a better position. Imagine two entrepreneurs pitching their ideas to investors. The first entrepreneur has no clue if someone will pay for his product. He only thinks that someone will. The second entrepreneur did his homework. He validated his idea by approaching few dozen people and pre-selling his product. Who do you think will have a better chance to close the deal with investors?
This will be probably another no-brainer. However, I have to say it. Idea that is validated is always more interesting for investors. In addition, validated idea can help you get more money for giving up less control. This is non-negotiable. If you want to get some money from investors, you have to offer something in exchange. This usually means giving up a stake in your company. In other words, you are giving up some control over your company.
How much you have to give up usually depends on two things. First, it depends on how much money you want to get from fundraising. The more you want, the more you have to give up. Second, it depends on how risky your business is. Risk is a relative concept. It can mean different things. Let’s say that something is risky when there is a high chance it will fail. Idea that is not validated is riskier because there is nothing solid behind it.
So, when you validate your idea before fundraising, you can make your idea less risky. Then, you can use this validation as argument. You can then ask for more money while giving up smaller stake in your company. Smaller risk, smaller piece of cake for investors. Also, smaller risk increases your chance to get money from another investor.
No.2: Fundraising costs you time
When you decide to give fundraising a go, you have to understand this. Fundraising is similar to a full-time job. It is very unlikely that you will succeed on the first try. And even if you do, you may need to do another round to get more money in the future. If you want to do this, you have to take into account that it will cost you a lot of time. You may have to approach dozens of investors to get the amount of money you think you need. And, you can’t spend this time doing other things.
If you are a solo founder, you have to think about every minute of your time. You can spend it either on building your product, selling it to customers or pitching your idea to investors. Sure, you probably have team of people to help you. However, that doesn’t really change as much. You are still not there helping your people and working on your vision. You are in some office pitching your startup. As a founder, you are probably the best person to sell your idea.
The problem with fundraising is that you are not selling it the most important people. The people you should pitch and infect with your enthusiasm are your customers, not investors. Although your investors may pay your bills now, your customers are the ones who will do it in the future. Also, remember that successful fundraising is not the end. Yes, you got the money. However, you still have to find people willing to pay for your product. You still have to pitch your customers.
No.3: Fundraising can blur your focus
Potential downside of fundraising is that it can distract your focus. Instead of focusing on building your product, and startup, you start to focus on how to get money. Have you ever heard about the proverb that “person who chases two rabbits catches neither”? The same here. What is your main focus? Are you working on your product? Or, are you working on your pitch to impress investors? Although you can work on both at the same time, one of these things has to be your top priority.
Before you decide for fundraising, you should think about what your priorities are. As we discussed, fundraising costs a lot of time. It is not a matter of just a few days. Chances are that it will take you a number of weeks, if not months, to raise the amount of money you want. So, what is your number one priority? Before you answer “both”, think about this. When everything is a top priority, nothing is top priority in the end. You focus is blurred. Multitasking doesn’t work.
Think about your focus as a magnifying glass and your work as light. If you target it on just one spot, you can ignite a fire. Now, try to do that with multiple spots at the same. Still, what if it is possible to split your effort somehow? For example, dedicating 80% of your time to building a product and company and 20% to fundraising? Well, you can try it. However, it will take you much more time to raise the money. Isn’t it better to focus on product and let investors come to you?
No.4: Too much money can be a problem
Money is a problem that is nice to have, right? Well, not always. When it comes to fundraising and startups, money can actually become a problem. What do I mean? Imagine two startups. First has plenty of cash. They don’t have to worry or fight for their survival. And, they can take as much time as they need to build their product. In other words, this startup doesn’t have to rush things. They don’t have to “move fast and break things”.
Let’s talk about the second startup. These guys have just enough money to pay for the servers they need. They can’t even afford to rent office for their startup. What’s worse, even the money for servers are already starting to wane. As a result, these guys can afford to rest on laurels. They have to move fast, break things, fix them and ship. Otherwise, they will not survive. Their company will become just another item in statistics of failed startups.
Which startup do you think has real competitive advantage? I would choose the second startup. Why? These guys have to hustle. They have their back against the wall. If they don’t deliver, they will go bankrupt. Is there any stronger fuel for drive and motivation than bare survival? Let’s also not forget that these guys have probably nothing to lose. Since they don’t have large funds, they can go all-in and risk everything. Well, the question is, how much is that “everything”?
Fundraising doesn’t mean that you will not succeed or that you will be less driven. Many startups could prove this to be wrong. Still, it is easier to rest on laurels and become comfortable when you have a lot of money. If you want to try fundraising, just make sure your people will stay hungry and driven.
No.5: Fundraising can hamper innovation
Have you ever heard about skunk works? This is a concept that was developed at Lockheed Martin. It is not a secret that, as company gets bigger, it tends to play it safer. As a result, big companies are often less innovative than those smaller and more nimble startups. This is why we sometimes hear about some giant being disrupted by a newcomer. The goal of skunk works is to avoid this. The idea is that you take a small group within your company and give it full autonomy.
You task these people with working on some secret project. And, you gave them only small amount of resources. Then, you let them do their job. It is important that the “parent” company has no influence on this group. Remember, these people must have full autonomy over their work. If this sounds a lot like building a startup inside the company to you, you are right. This can be a good description of skunk works. So, what has skunk works to do with fundraising?
Do you remember when we talked about money? And, that having too much money can make your team too comfortable? And, that being comfortable can make you move slower? Well, fundraising, or having too much money, can be detrimental to innovation. Why should you try to reinvent the wheel, and build something better, if you can buy as many wheels as you want? Or, if you need X and you have money to buy it, you don’t have to look for other options.
Many great products are results of scarcity of resources. Because someone couldn’t afford that, he had to build it by himself. And, he found a way to make it better through the process. Don’t think that scarcity of resources is bad. In a fact, not having enough money can be your biggest advantage! It will force you to be more innovative. You will have to look for and try ideas and approaches nobody ever tried before. This is how innovation happens.
Again, this doesn’t mean that fundraising and innovation are mutually exclusive. It is just more common that availability of resources hamper innovation. Fortunately, sustaining innovative spirit is relatively easy. If you have a successful round of fundraising behind you, act like you wouldn’t. Pretend that all those money don’t exist. Think about them only as your last resort. Don’t spend them on things you or one of your teammates thinks you need. Find another way. Be resourceful.
No.6: Investors measure progress differently
The concept of lean startup is built on build-measure-learn feedback loop. In the world of startups, progress is about testing your hypothesis and learning from the feedback you get as a result. This is usually not true in the world of fundraising and venture capital. It is great that you are testing different ideas and learning from the feedback. This is necessary to build product people want to use. However, investors want to see your company grow.
This doesn’t mean that you want your company to stay small. Well, maybe you want. Anyway, what I want to say is that testing and learning is usually not the most important thing for investors. I said this in the begging and I will say it again. Investors care about their profit. They want to see your company to make money and grow. As a result, the value of their investment will increase as well. This is often the reason why many startups wait with fundraising and even becoming profitable.
Think about startups such as Facebook, Snapchat, Twitter or Instagram. All of these companies didn’t rush to raise money from investors. They wanted to get the product right first. They wanted to spend some time experimenting with different ideas and see what works. What is one of the first questions investors will ask you? Are you profitable? How would you answer this question. No, we focus on running experiments to polish our product before we become profitable?
In case of many investors (especially VCs), this will not work. They want to see you are in black numbers. This is what they see as a progress, not number of successful experiments. However, there are some exception to this rule. I hope you find one because it can help you build your startup faster.
Closing thoughts on fundraising
So, is fundraising inherently bad? Not necessarily. In the end, it is all about asking the right investors. When you find a good fit, you can accelerate the growth of your startup. So, don’t let this article discourage you from raising funds if you wanted to try it. Instead, use it as a list of tips on what you should pay attention to. Remember that every investment you accept will have an impact on your company. With every investment, you are giving up some control. So, chose wisely.
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