Start-up Entrepreneurs' Blog

Common Misconceptions with Start Up Funding

August 31, 2009

A High Tech Start Up is a Money Machine

What does it take to get funded?  A unique product concept? A stellar business plan? Industry expertise? The right team? Yes, those qualities and many others.  Luck doesn’t hurt either. It’s not something that happens overnight. No potential investors will be in love with your concept and business plan, all will point out flaws and pitfalls. In the end, investors vote with their dollars.

Money is like air. People can’t live without air and start-ups can’t live without money. Capital allows a start-up to bring its product to the marketplace. Without the capital, it doesn’t matter how good your plans are or how fabulous the product concept is because you’ll never be able make it a reality. Start-ups may not succeed even with the capital, but certainly can’t succeed without it. Many start-ups focus too heavily on developing the technology and funding takes a back seat to development, which leads to disastrous results.

The first time would-be entrepreneur or the outsider often believes venture capitalists are risk-loving people. This is not true. They may not be as conservative as banks in lending to businesses, but they are not a group who throw caution to the wind and invest in every new product concept that comes along either.  Too many would-be entrepreneur concentrate their attention on the product concept, but there’s a lot more to making a company successful than the idea or technology.

Just as in capital markets, timing is everything with funding. What was yesterday’s hot technology to be funded is not likely to be worthy of investment today. All of a sudden a funding wave happens and there are a very large number of start-ups dedicated to one particular concept. Every venture capital firm needs to have its play in a hot technology. Most of these start-ups will flare up and flame out quickly. There were dozens of WebTV start-ups, but only a few had any success at all.  Just search on solar start-ups and you’ll find a plethora of them today.  Sometimes a concept is revived because the original was ahead of its time. Social networking may seem be the latest craze with the likes of Facebook and LinkedIn, but the concept and first start-up funded was back in 1997 with Six Degrees.  Find a niche, innovative or unique product, but don’t fight a trend.

Each venture capital firm has its criteria for investing in a start-up. I used to work for a major corporation with the traditional spring and fall planning cycles; one dedicated to funding projects, and the other dedicated reviewing progress and diverting funding to the higher priority projects. Every year the criteria changed for funding a new program or continuing an existing project. And like a major corporation, the venture capitalists change their criteria for funding projects all the time. It’s difficult to get funded if you don’t know what they are looking for in a company today.  And it’s not easy to get the venture capitalists to tell you what their criteria are today.

My recent discussions with venture capitalists regarding funding have been interesting. Most have spoken about the need to reduce risk in the venture capital business. Their plans have included not investing in seed rounds which they felt were more appropriate for angels or private investors, not investing in emerging technology standards that have no market today, and investing in companies that can show market validation in less than a year.  I’ve been involved with many start-ups and only two came close to demonstrating market validation within 12 months. It is difficult for a hi-tech start-up to go from ground-zero to any customer revenue or early adoption in such a short period of time. Hi-tech products can spend several years in development alone.  In speaking with the angels, they have also expressed an interest in reducing their risks. Their plans include only investing in companies where the capital will be used to expand existing operations or product lines. These angels feel the initial seed funding should come from an entrepreneur’s network of family, friends, and fools (The FFF Network); who I suspect are also not willing to fund ideas due to the current global financial crisis.

I know a founder of a privately-held company that has been in business for 10 years and he likes to tell the story of how he dreads the family Christmas party every year.  He initially received funding from his family and every year they ask him when they are going to see their money back. 

So an entrepreneur may be wondering these days whether funding is possible at all. Funding is still possible, it’s just not easy.  It often takes many months to secure a round of funding.  Cisco Systems had to meet with 77 venture capital firms to secure its first round of funding from Sequoia and the company already had hundreds of thousands of dollars of revenue per month. The story of Colonel Sanders and Kentucky Fried Chicken is a legendary story of perseverance; Colonel Sanders endured more than a thousand rejections before he obtained his first deal. Persistence matters.

If a start-up is lucky enough to hook up with a leading venture capital firm then money may find its way to the start-up. I’ve been involved in start-ups funded by the likes of Kleiner Perkins, USVP and Sequoia, and it’s the connections and capital supply chain of the venture capital firm, not the management team’s efforts that bring the funding to these start-ups. At one such start-up, the management team was told when and where to show up for an investors’ meetings and instructed that as long as they presented themselves well, they money was theirs.   Those start-ups not funded by these giants of the venture capital industry have a lot more difficulty in obtaining funding rounds.  Several CEO’s I know have been completely exhausted by the constant need to be searching for funding, and some start-ups have even decided to hire a person whose is dedicated to this task. One creative start-up hired away a managing partner from a venture capital firm and as a result, the start-up was able to locate the necessary funding.  

Many times I have seen companies rest on the laurels after they received a round of funding, thinking they have finally made it. Start-ups close all the time due to lack of funding in subsequent rounds, even those that have revenue can be shut down due to their lack of potential for return on the investment. Once you get funded, the next step is to stay funded.

Personally, it took 6 to 9 months to obtain the initial funding for the two companies that I founded. Success is most often the result of repeated failure and sometimes it is luck. The first time I raised money it was easier than the second time. I had hit upon the right combination – an expert team with engineering and marketing skills and a product in a hot technology area. The second time it was more difficult. It was only on the second that I looked back and realized how lucky I had gotten the first time.

Even in the best of times, funding is never easy. It’s just harder now.

Filed under: Management

Tags: business plan, funding, high tech, start up, Team Building