For every dollar that I have available to invest in start-up businesses, there are at least twenty people that would happily take that dollar and promise me big returns in the future. Since the vast majority of start-up businesses fail, I have the overwhelming task of determining which entrepreneurs that want my money will be successful and which probably won’t make the cut. After investing in more than thirty start-up businesses, and turning down countless other “opportunities”, I’ve started to see a lot of the same mistakes made repeatedly. I don’t always know which companies are going to become the next Uber or Airbnb, but there are some red flags that will tell me when a company probably isn’t going to get off the ground. These red flags are immediate disqualifiers for most start-up investors, so avoid them if you are hoping to raise an angel round or other venture capital for your business.
Here’s why I might not invest in your business:
1. You have no traction and no customers. The only two things that you need to have a business are something to sell and a customer. If you don’t have customers, you don’t have a business. You have an idea and start-up investors generally don’t invest in ideas. They invest in established businesses that are growing and give them capital that will allow them to grow faster. There are many people that have great business ideas, but that doesn’t mean they have the capability of turning that idea into a revenue-generating business. A startup investor needs to know that you have more than just an idea. They need to see that you have at least a few people that have already given you money for your products or services before they will be willing to invest in your business.
2. You want me to work in your business. Between being a father to two children, operating MarketBeat, Falls Angel Fund and GoGo Photo Contest, plus the entrepreneurial community building that I do, I’m a pretty busy guy. I simply do not have time to become an operating partner or an employee in your business. If you want me to write you a check and come work for you to help the business grow, that’s just not feasible. Why would I buy myself another job? I am happy to meet with the companies I invest in and give them advice periodically, but it’s their job to execute on their businesses.
3. You don’t have your financials together. If I am going to invest in your business, I need to have a clear understanding of the company’s current financial situation to assess its long-term prospects. I need to be able to see an accurate balance sheet and an accurate cashflow statement at a minimum. If you don’t have an accurate set of books or don’t have your books up to date, that tells me that you are playing fast and loose with your financials and makes me wonder what else you are cutting corners on.
4. You’re launching a local business. The investments that I make are very risky, because seven out of ten companies that angel investors put money into fail. Therefore, the companies that do make it and succeed must provide large enough returns to cover the losses of the companies that don’t make it. Businesses with a single location in a single community will simply never grow large enough to provide the types of returns that start-up investors need for their investment to make sense.
For example, let’s say that you’re going to launch a restaurant and I agree to give you $500,000 for 50% of your business. Your restaurant becomes very successful and makes $2 million per year in revenue and has a profit margin of 5%. Congratulations, you’re making $100,000 per year in profit. This might sound like a healthy profit, but it’s going to take me 10 years to get my money back even if your company becomes wildly successful. Frankly, I can get better returns than that by investing in the stock market.
5. You’re a first-time founder with no experience. Start-up investors are investing in the people behind the companies they invest in as much as they are the companies themselves. If you have no experience in the industry that you are going into or you have never started a business before, you are going to have a very hard time finding an investor. Investors know that a great business idea operated by a person that isn’t a great business person won’t succeed. Investors also know that businesses evolve and the business model you start with is rarely the business model that you finish with.
“But I need money to get my business going.”
One of the common objections I hear from people when I explain why it’s unlikely that anyone is going to invest in their fledgling business is that they need money to buy equipment, lease space, do research, or build prototypes before they can get their first customers. Entrepreneurs think that these red flags do not apply to them because of the type of business they are wanting to start, but that’s not the case. These rules apply regardless of who you are and what kind of business you are going to start.
The reality is that it is extremely unlikely that you will receive investment capital if you are a first-time entrepreneur that is starting a capital-intensive business and don’t have any significant financial resources of your own. I am not saying that this is a good thing or a bad thing, it’s just the reality of the situation. If an investor wanted to start the same business you are starting and they have the same amount of experience in the industry that you do, they probably don’t need you. It might be tough to hear, but it’s the truth.
“Can anyone actually raise money?”
Attracting angel and venture capital money is not easy. Most companies that apply or pitch to receive risk capital do not get it. Falls Angel Fund hears pitches from approximately 1 out of 10 companies that apply and we write checks to 1 out of 4 companies that pitch us. You may think you are checking all of the boxes that start-up investors are looking for and still not get a check. However, there are early-stage, high-growth companies that get funded regularly—even in South Dakota and other “flyover” states. Falls Angel Fund has funded four companies in the last 12 months alone and we are looking to invest in at least 5 more before our fund wraps up.
If you would like to learn more about raising money for your business, I would encourage you to read my article How to Raise Money for Your Business in the Great Plains or the Midwest.