Let me tell you a few short hair-raising stories of entrepreneurs who have raised money and regretted it later. Here are some rules that entrepreneurs almost always ignore to their future peril.
Don’t take money from relatives who can’t afford to walk away without remorse. Do take money from experienced family members only after you ask them if they are sure three or more separate times. By the third time you can be sure that they aren’t being overly emotional or feel they can’t say no. Also, if things go south, they are more likely to remember that you weren’t pushy and that you gave them three or more separate opportunities to say no.
There’s a common expectation among entrepreneurs that seed money from family is great—letting close relatives in at the ground floor. The problem, of course, comes if the business fails. Some relatives believe that a family bond is an insurance policy, and that all investments or notes will always be repaid, no matter what the circumstance. Consider whether the family member being asked to invest has the capacity to walk away “happily” from a lost cause.
Don’t take money, especially start-up loans, from unsophisticated investors. I was a co-lender and assumed the chairmanship of a young startup where the entrepreneur’s cousin also loaned money under the same terms. When the business failed, the cousin sued his own relative, me, my wife (who didn’t even know the names of the players), and even my family trust (an estate planning vehicle with no separate assets.) It took several times the value of the cousin’s loan in legal fees and settlement just to extradite my interests from a suit that had no merit—but would have cost hundreds of thousands more just to get to trial.
Related Article: 5 Mistakes That Destroy Startups
Do take loans from sophisticated investors only after you have tried everything to get them to purchase equity and always with clear wording on automatic loan extension if you are making progress but need additional time to meet the full set of goals.
Don’t talk yourself into a high valuation for the first round of financing for any reason, even if your hair is on fire and the idea is worth billions. This lesson is one that is not only hard to teach, but ignored by entrepreneurs on a regular basis. Early investors who don’t have the experience to compare value or ask tough questions accept the word of their entrepreneur as to valuation. Later investors will enter that picture only after insuring that valuation is reasonable and comparable to other opportunities for their money, but often will walk form a deal if the valuation for earlier investments was so high as to cause pain for that cohort. It’s just not worth the effort to argue with early investors when there are so many other deals calling for the sophisticated investor’s money.
Try not to take “dumb money” where the investor or lender supplies nothing other than cash. There are five attributes of a great investor (see my book, “Extending the Runway,”): the money they offer at reasonable terms, their ability to guide you with advice about the context of your business plan in relation to the marketplace, their experience in the process of growing a company, their knowledge of how to best use corporate resource time, and finally, access to their extended relationships with others who can help speed growth. Those four additional assets are worth as much or more than the cash offered.
Don’t walk away from rejection by experienced investors thinking that they are stupid or just don’t get it. Most of us in this world of early stage investing have seen thousands of proposals, good and bad. Even if we don’t seem to get your brilliant idea and buy into its value, we may be comparing it to previous lost investments or industry experiences far beyond yours.
Do ask three sets of progressively deeper questions to get down to the heart of why they didn’t invest. Every contact should be a learning experience. And those with sophisticated investors are doubly valuable. A well-phrased ‘no’ could well be a step toward a correction of course and a later ‘yes.’
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