Today, you work, and then you get paid. With little or no delay. So as long as you want to get paid, you have to work. If you want to get paid more, you have to work more.
You are here because you want to break out of this cycle.
You want to be smart. To work more up front and get a delayed, but bigger reward. That is the key mechanism of a scalable business.
Unfortunately, this upfront work can take some time. So you need time, and still need to eat and pay your rent. So how do you fund this phase before the delayed reward start kicking in?
First, ask yourself:
Do I Really Need External Funding?
Many great business—including scalable ones—started and grew without a single dime of external funding.
These are often called bootstrapped companies.
37 signals is probably the most famous bootstrapped company. 37 signals builds super simple software products for small businesses. They boast being bootstrapped in their branding, even feature a list of bootstrapped companies on 37signals: Bootstrapped, Profitable and Proud.
What if you already run an existing business, and are here because you want to scale? Startups may envy your income, but your commitments towards your existing clients – even employees – can make it harder for you to set the time aside. Read on to learn how to get funded, and look for a following lesson on how to make yourself unnecessary.
How do you get bootstrapped?
There are three basic ways, according to this great resource on bootstrapping by Joel Gascoigne. Joel is the founder of Buffer, a smart scheduling service for sharing stuff via social media. Here is the rundown:
1. Work on the side. Spend your evenings and weekends on your project. Or switch to part time work. That’s why I’ve done. I work 3 days a week for money, and most of the remaining 4 days for my startup.
Pros: you can start right away, and keep a steady pace. In addition, you are acutely aware of time constraints, which makes you to be more effective, and focus on what matters. It can force you to rigorously question what is absolutely necessary for the first version.
Cons: there is always so much to do. A constant flood of new ideas for what you need to do next. You will inevitably go slow, and you risk a burnout. You also need to watch out for legal aspects, like clauses in your (employment) contract. You should anyhow keep a record of your activities, so you can always prove you’ve build your new business on your own time.
2. Work in waves: this basically means to work a couple of months and save up, so that you can then quit and work for a few months on your project. You get to build your business in “waves”.
Pros: you can completely focus on your idea for long enough to get a lot done. You also get a “money clock” ticking – a pressure to deliver before the money runs out. And if you are lucky, it may just take one wave to get to your first income.
Cons: again, there’s just so much to do. We are very bad at estimating. Especially under conditions of extreme uncertainty that is inherent to building a new business. You will likely run out of money, and will have to go back looking for work. This will be tough on you. It will affect your productivity, your judgement and your motivation.
3. Get to ramen profitable as soon as possible. This is the term coined by Paul Graham: At YC we use the phrase “ramen profitable” to describe the situation where you’re making just enough to pay your living expenses. Once you cross into ramen profitable, everything changes. You may still need investment to make it big, but you don’t need it this month.
But how to get there?
It first and foremost means to simplify your offering, down to the smallest, tiniest thing you can build. So small that it takes a maximum of a couple of months—better yet, weeks—to build.
Don’t just gloss over these words. Stop and think carefully. This requires a complete mindshift.
My co-founder Jonne told me once: “if we cannot come up with one single killer product feature we can sell, adding other features to the product is not likely to help”. I agree.
Do this:
- Sit down and think hard about that one single thing that is the essence of your product. This is the result: list of users, type of information you need to keep, and basic functionality (e.g. ‘screens’).
- Ask yourself, if I made this, could I charge money for it—knowing that more will come in future? Absolutely need something else? Is there a way to do that part by hand in the beginning? Is there a service out there that already does it, that you could integrate with?
- Now look at it and think: what can I remove? Do I need to support two different types of users in the beginning? Or can I not find a workaround for one of them? Look at every function in turn an ask yourself: is this absolutely necessary? Sleep on it, come back to it, and think again what can you remove. This step is critical.
- Once you have a description, don’t jump in building it just yet. Go out and look for existing products and services you might ‘misuse’ for any of the components of your offer (Google Docs, content management systems like Drupal or WordPress, but also Mechanical Turk or Elance…)
There is nothing wrong in delivering (parts of) your offering manually a first few times.
As long as all of it can be automated or scaled.
If automation is not possible (or is very hard), you have just started building a service business. A business that is difficult to scale. The money you earn this way will not change anything. A few years down the road, you will find yourself right back where you are today.
Bootstrapping also does not mean that you never seek external funding. 37 signals did. Joel from the bootstrapped Fog Creek raised $6M for their StackOverflow product.
Or maybe you simply need funding. Then, this is what you do:
Determine what Sort of Funding You Want
If you want external funding, you need to give something in return to the investor. There are basically three types of things you can give in exchange for money: interest, equity, or something exclusive. Which one you choose will also depend on the amount of money you need.
Interest on debt. Here we are talking about the debt-based funding, or simply put: loans. Most commonly, people loan from banks. Banks typically expect a proven track record or a proven business model. Getting a bank loan to fund an innovative (=risky) project is not very likely. Unless you can provide some guarantees. Sometimes, government have programs to provide these guarantees. Unfortunately, guarantees often include your private property.
Before you take a second mortgage on your house, think about this. An investor such as VC, is in a much, much better position than you. They handle “risk” capital. This means that they know you will likely fail. It’s built in their model: they only need a few of their portfolio companies to succeed to pay for those who didn’t. And still, they are extremely picky in whom they invest (<1% companies that pitch them). So before you take out that loan, at least pitch a few investors first and listen carefully to their reasons why they do not want to invest in you.
The banks are not the only loan providers. You can also loan from: the government, your shareholders, or even from your clients or your suppliers.
Equity. Basically, you sell a share of your company to an investor. How big of a piece will depend on the type of an investor and the size of the required investment. There are five sources of equity-based investors: own funds, friends & family, seed incubators and accelerators, business angels and venture capitalists. They are listed in increasing order of the amount of money you can raise.
1. Own funds: this is simply you taking a chunk of your savings and investing them as capital in your company. You and potentially other shareholders. Some company structures have a minimal capital requirement. If the main use the funds is to pay yourself, this is not the best strategy: you would be paying taxes twice. If you have savings to spend, become frugal and use them to survive.
2. Friends & family (“and fools”). You ask support from your immediate environment. I am personally not a big fan of this approach—unless your family is business-savvy and clearly understand the risk they are taking.
The funds you will raise yourself and from the FFF will be limited. Couple of tens of thousands, rarely above a 100K.
3. Seed incubators and accelerators: acceleration programs seem to be mushrooming all over the world. There are more than 7000 worldwide, according to NBIA. Some, like the Founder Institute, offer only training and mentoring programs, while others, such as Y-Combinator or TechStars also provide seed funding. The funding will range between 10K-150K in exchange for a share in your company (typically in form of an option, warrant or a convertible note).
If you have never started a company before, joining an accelerator can give you that extra push, and the knowledge you need to build a business. They are often designed to get your through the initial phase faster than you would go through yourself (therefore the term “accelerator”).
4. Business angels are wealthy individuals who use their own money to fund early stage startups. Often they’ve already earned their fortune through their own startups.
Their investment bridges the gap between the FFF and VC investment. The size can vary between a couple of tens of thousands up to a million. In Europe, investment size tends to be smaller than in the US. A 2009 UK study estimated an average investment size of £42K.
5. Venture capitalists are companies that manage the pooled money of others in a professionally-managed fund. The investment managers (a.k.a “VCs”) are salaried professionals whose job is to find the most promising high-tech startups to invest the fund money in.
Since the funds VC manage are large (up to a $1 billion) the size of investment has to warrant the considerable overhead that comes with it. A typical VC investment therefore varies between 500K and 10 million.
VC firms often specialize in certain industries. Make sure your project fits the type of projects they typically invest in. Specialization enables them to build the inside market knowledge required to judge how likely a startup project is to succeed.
Both angels and VC rounds represent high risk investments. Most of their investments is completely lost. Therefore, the investor needs to choose projects with high returns. So you’ll need to make a compelling case for five to ten times the invested amount in three to five years. And have an exit strategy—put simply, a promise of being able to sell your company for ~$100 million.
If you don’t have any traction yet, it will be difficult to make a good case to a VC. And you may only get one chance with them, so be careful about going too early. Also, they will see many, many more companies than they will invest in (<1%). This also means you will need to see many, many VCs before you (might) hit a jackpot. It is not uncommon to spend 6-9 months full time pitching a hundred investors before the first one agrees to put the money on table.
Something exclusive. We are talking about crowdfunding, where you raise funds from the “crowd” of people, in exchange for something exclusive they are willing to pay for.
According to Scott Steinberg, this is typically a combination of merchandise, pre-orders and personalized, exclusive rewards. People are buying from you, not giving their money away. So you have to give them value at every investment tier: from $5 to $500.
This will only work well for certain types of product, Most products seem to have a strong consumer focus, and a value that is easy to communicate. Just have a look at the Kickstarter’s 10 Biggest Success Stories.
A Very Interesting Alternative: Business Grant
But what if you do not have a wealthy family, are not ready for an investor and are not building a consumer product that will appeal to large crowds of people?
I didn’t either.
Yet, we managed to get enough money to get us going for a year—albeit with a modest burn rate—using a business grant. And you know what is the best part?
- It’s not a loan, so you don’t have to pay anyone back
- You don’t have to give away any equity
- Your project does not have to lead to a successful business! That is, as long as you honestly carried out all the research work you promised. The work you anyhow need to do in order to validate your new venture assumptions.
Lots of regional or national government have programs to support with innovative projects.
The grant program we submitted, rewards 2 out of 3 requests. All you have to do is prepare a grant proposal. And you know what? Such a proposal is not so much different than a business case you need to prepare for any investor. And it’s a good thing for you too, as it forces you to do a bit of thinking, research and planning before jumping in.
In fact, if you want, send me an e-mail, and I’ll help you out with this.
But how do you prepare such a business case?
Prepare your Business Case
If you have been following this course so far, you should already have most of it covered.
The goal of the business case is to convince the investor (private or public) that you will be able to provide them a return on their investment (ROI).
To do that, it pays very much to understand what the investor cares about. In other words, what does the “R” in ROI really mean for them. A high risk investor (such as a business angel or VC) will look for very high returns: 5-10 times his money in 3-5 years. VCs put lots of money in, so they will look for potential to scale. Government agencies will look for potential for (local) employment.
It also pays to know how an investor evaluates your business case. In their presentation Top 5 Reasons why an Investor will NOT invest in your startup, two finance experts, Martin van Wunnik and Xavier Corman, gave us the very essence: team, business model, scalability, ROI, and exit strategy.
Here’s what you can do right away to put it all together.
Here are 10 steps to a great pitch deck.
1. Name, logo and a 1 sentence summary. Your new product needs a strong name and a logo. Next to that, you need a simple one sentence summary of what your product is all about. This could be your one sentence pitch.
Here are some good ones: Mint is a free easy way to manage your money, that empowers you to take charge of your financial life; UserTesting.com’s online usability testing is the fastest, cheapest way to find out why visitors leave your website. Desk.com, the all-in-one customer support app for small business & teams.
2. Hook. Investors hear tons of pitches. Think about ways you can stand out. A great way to open is by creating an emotional link. Katherine Bicknell did a great job in her pitch of Kindara, by telling a moving personal story of her mother going through an emotional turmoil of not being able to get pregnant.
Or you can just sketch a situation investors can easily recognize. Explainer video of data.com, begins with the word “you”: you have big ideas to grow your business, but ideas are one thing, and executing, well, that’s something else.
3. The problem. What problem do you solve? This is another great place to create a personal connection. In their Chrome OS presentation, Google marketeers explain the frustration of waiting for your computer to start so you can go on the Internet. This is how they create the link: and if you are anything like me, as soon as you see your web browser icon, you start clicking it over and over and over again “let’s go buddy I got some emails to read”.
If you have some proof of the problem (some studies, survey results…), show it.
4. The solution is where you surprise us and delight us by showing us a better way. You found a clever way to solve a tough problem we just identified with.
Your product, the solution, is where you spend most time thinking. And yet—or just because of that—this is the one which many people screw up. There is a huge gap between you (being so deep in it) and your listeners (who hear it for the first time). You need to explain it in terms anyone can understand. Use visuals (e.g. animated screenshots) to show it.
I can’t stress this enough: make is super simple and super clear. And if you already have users, tell us how many, and how satisfied they are with your solution.
5. Business model. How do you make money? Keep this one simple: $X per month, $Y per project, %Z commission. Keep it to one revenue stream, maximum two.
If you have already proven your price point by charging actual customers, don’t miss the opportunity to score big time.
6. Market and opportunity size. How big is the problem – and consequently, the opportunity?
Go back to your market research (lesson #3) and pull out the figures? How much money is made in the market today? How many potential people / projects / licenses can you address?
7. Competition. Analyze your major competitors, and show us how you are different. Again, in lesson #3 of this course you will find hints on how to search for and analyze this information.
A common presentation technique is to show a graph with 2 axes and 4 quadrants. Each axis represents an important competitive advantage. For example, X could be effectiveness of competing solutions, and Y could be their affordability. The trick is position yourself in the top right quadrant (in our example: affordable & effective), and your competitors in other quadrants.
Please, never say you have no competitors. Your audience will form one of the the following conclusions: (a) you don’t know your market – or, (b) market does not even exist. Neither of the two is a good outcome.
And if you are pitching experience investors who see hundreds of presentation, they will surely come up with competitors you don’t know of.
Don’t embarrass yourself, do your research.
8. Go to market. What will be your path to customers? You need a clear, simple and believable marketing plan. Will you offer a free version, and ask people to pay for advanced features? Will you market via established affiliate partners?
Always give more details. Why do you think your free product would spread? Would people pay premium for the extra features? Did you talk to your channel partners? The best argument is existing (albeit modest) success.
Like: we have 100 signed up users, each user brings on average 2 new users via our invitation system, and 2% of them buy $10 monthly subscription. BTW, you know this is completely unrealistic, right? Should this be true, in 2 years you would be earning $33.5B—per month! And half of all mankind would be your user. In month 25, it would be the whole planet.
Watch out for naive plans. Just saying “I will use social media”, or “I will get featured on TechCrunch, and people will flock to my website” is not a marketing plan.
9. The ask. How much money do you need? Take the time to create a financial plan. You cannot answer this question without one.
A common way to present this is using the result of your financial projections. There’s always a cash flow curve: revenue minus costs over time. The lowest point (if it is below zero), indicates the amount of money you need from an investor. Showing this graph allows you also to show your projected revenue, and therefore show the ROI and the payback time.
Make sure to explain how will you use the funds. When someone gives you money, they want to know what this money will help you achieve. Not necessarily how you will spend each and every cent, but what business milestone will the investment enable you to reach.
10. Team. Investor will not invest in a single person. The risk is just too high. In addition, no matter how good you are, building an investment-backed scalable business requires a multidisciplinary team. And if you are not able to convince people to join your team, how do you expect to convince someone to give you money?
Show that you have an A-team. Show why you and your teammates are the best possible people on this Earth to develop this business.
Now take your presentation, go out of the building and show it to as many people as you can.
Get Feedback. And lots of it
You may be afraid someone will steal your idea, so you will avoid sharing it. There are two problems with this mindset.
The first one is, that this is highly, highly unlikely. First of all, as you start explaining your idea, most people will not even understand you. Second, even if they do, most people will not have what it takes to execute on it. Third, even if they have what it takes to execute (and out-execute you), which is extremely rare, you have just met an entrepreneur. Someone already working on an idea of their own. And likely wishing they had more time to execute on other ideas they have. Fourth, if you are so lucky you find someone who likes your idea so much they would be ready to immediately give up the five years of their life to work on it, you have just found a business partner, or a co-founder. Fifth, if the idea is so easy to copy, that all it takes is to hear you explain it, you have a problem whether you pitch it or now.
Here is how Adeo Ressi puts it, in his typical harsh, no-beating-around-the-bush style.
There is one exception though. If you are talking to a startup already exploring the same space, you just may give them an angle they didn’t think about.
The second problem with withholding your idea is that you are depriving yourself from very valuable feedback.
In the first phase, talking with anyone willing to listen will help you fix the basic problems. Most of the times, people will have difficulties with understanding you. More often than not, this is not because they are not smart. It is because ideas tend to start out very vague. Ideas need nurturing and development. And getting feedback and iterating is a great way to start. You want to come to a point where your idea is so clear to you, that you can explain it to virtually anyone in a minute or two.
Soon after that, you want to seek people with experience. Other entrepreneurs, or friendly investors (unless you intend to pitch them for money). From their vast experience, they will be able to shoot holes in your plan, and see obstacles you didn’t think of.
And no matter how hard this may be to hear, it is still way easier than failing a few months / years down the road.
There are also numerous events and pitching contents where you can present your idea and get feedback.
Conclusion
The 20 second summary of this lesson is: first, ask yourself if you need funding. If the answer is yes, choose which kind of funding is most appropriate for you. Then, work on building a compelling business case you will use to convince the investors to give you money.
The main motivation for seeking funding may be to hire people to work on the new venture. In lots of cases, there is an alternative step to take first that may be better for your business. It is finding a co-founder, or a partner, an entrepreneurial soulmate with complementary skills—skills crucial for your business.
But how do you find the right person, convince them to join, and decide how to divide the stake in the new business? Stay tuned, I’ll answer these and other related questions next week, in lesson 9.