Chapter I – The business of money
Yes, you’re right, funding IS broken
If you’re an entrepreneur or have been thinking of becoming one, you must be aware that funding, to a certain extent, is broken. You may have heard it before and yes, it’s true. It’s not a popular thing to say but more and more experts are saying it.
Now, don’t get me wrong. There are awesome people out there, across banks and financial institutions, various innovation and research funds, angel investors, seed investment and venture capital, doing a wonderful job of finding rare talent and accelerating those teams to a life-changing success that benefits all of us (by brewing the Facebook, Airbnb, Uber, Snap and WeWork of this world). And for every giant success, there are also thousands more that we’re less familiar with but that are delivering incredible goods and services thanks to the funds that allowed their business to grow and thrive.
I am certainly not pointing a finger at the individuals that are part of the current systems that fund businesses in America. I am, however, pointing a finger, just like you, at the flawed logic that underpins it all.
3 little pigs?
So what’s wrong with any of it? Well, if there is one thing I learned back from my years in sales (and more recently through studying Game Theory) is that “incentive is behavior”, meaning that people will act according to where the incentives are. In other words, if you want something, don’t reward something else. Sounds self-evident, right? It sure is, but yet, in the world of smoke and mirrors that our economy can sometimes be, it eludes many of us on a regular basis.
There are essentially 3 ways to fund your business.
- You can really bootstrap and fuel it solely through your revenues. It’s challenging as hell for many reasons but sometimes feasible (if you’re in no rush). That includes some of the entrepreneurial funding that means well and comes with not too many strings attached. There is not much of it and it’s a jungle of programs out there but you can top off your coffers with some decent grants and loans if you’re diligent about the process. It also includes love money from your close circle of friends and family as well as any angel investor who might be in it for more than a financial return.
- You can try financial institutions, banks or otherwise. They’re, as you know, in the interest business. Their game is to lend our money to other people, at a premium. For that business to be sustainable and profitable, they need to make sure whoever gets the loan won’t default. Since about 80% of new businesses don’t make it past the 5-year mark, they don’t love lending to unproven businesses. So, unless you have tons of solid revenues, a mountain of collateral and an undeniably bright future, the banks and such won’t do much for you.
- Which leaves us venture capital. Venture capital is a wonderful thing. It’s this thing where a group of people with means (called limited partners) put money together to create a fund. That fund is then invested in different ventures. When the ventures sell or go public, 7 or 8 years later, they get a great return on their money (for funding it in the first place). That’s an amazing invention and it has certainly done a lot of wonderful things for many start-ups to date (and many of their customers).
What’s in it for me?
So, what’s wrong with that picture?
Well, bootstrapping is a fine way to grow a business. Natural and organic growth make for one of the best ways to build a business. If your revenues allow you to capture the opportunities you need to go after in your market, it’s fine and dandy. If on the other hand, you need to grow faster, expand or scale rapidly, then cash flow sometimes turns out to be a challenge.
Banks and other such institutions are fine when you fit the profile. – (They are also an increasingly unnecessary middle man in the rising peer to peer world we live in, at the dawn of the fourth industrial revolution, but that makes for a whole other story.) – If you fit the bill, banks are great to fund your growth and operations. If that’s your case, you might be wondering what we could possibly think is broken. If, however, banks have not been the answer for you, read on.
So, if you’re not a proven business yet and if you need to scale faster than your revenues allow for it, you might benefit from venture cap and similar deals. And if you’re able to assemble a great team, build a minimum viable product, get hundreds of paying customers, prove your marketing strategy, and get a warm introduction to the right people, before you run out of time, energy or funds, your idea is fundable.
As demonstrated in this video from One Million by One Million (1M/1M) – a global virtual accelerator for startups by the inspiring Sramana Mitra.
Great! You now have about 1% chance of being funded. So, if you’re part of the other 99%, you might feel like something is broken. It might be your idea, your team, your business model, you or otherwise. But many investors will tell you over and over that many solid projects just can’t get funded. It’s the nature of the game.
Furthermore, even IF you are in the 1% that do get funded, here’s what you’re looking at… Your venture capital investors want to see a great return on the money they invested in the next 7-8 years. Typically, about 5 out of 10 businesses they chose won’t ever really sell or go public. Out of the 5 that do, about 3 will return a bit of money but it essentially leaves the last 2 to make enough money to pay for 8 years of investing in 10 businesses. The math is compelling. Since most investors want a healthy return of something close to 20% a year, those 2 businesses need to return something like 20 or 30 times the initial investment for the whole thing to be really worth it.
OK, venture cap wants me to be wildly successful? Cool!
What does that mean and what’s wrong with it?
Well it means that when you ask yourself why companies nowadays seem to be so set on growth at all cost and focus so much on revenues without always making sure they are returning a healthy profit along the way, this is your answer. In the first 1-2 years, your venture capital investors will want you to find your legs as you ramp up, then will push you hard for 3-4 years of aggressive growth and will clean up shop in the last 1-2 years to show a good profit on the books so going public or selling can be done at a super high valuation.
Aggressive growth, as I’m sure you have noticed, doesn’t always mean delivering real value to the customer or taking care of the people that make the business run along the way. Furthermore, when it comes time to show a profit, an easy way to accomplish that is often to cut back on things that might deliver value to customers or to push out the people that built the whole thing in the first place. – (It’s much more nuanced than that and am always happy to get into the specifics if you’re up for that discussion.) – But let’s just say for now then when you have a system that rewards aggressive revenue growth and cost slashing, that’s what you get. If we wanted funding that grows local economies, provides steady employment and delivers incredible value through stellar products and services (and we all may be better off for it), that system would need to reward exactly that. Incentive is behavior, right?
So how do we do better?
The answer to that question has been 20 years in the making and takes us back to 1996… (To be continued)
Send me an email at email@example.com if you’re interested in reading chapters 2 and 3.