The Verdict on Raising Venture or Angel Money "Pre-Anything"

This is part of my Series on Venture Capital and Angel Investing.

I have the privilege of meeting a lot of entrepreneurs in my dual role as technology investor and university entrepreneur-in-residence. Many of these entrepreneurs are first-timers and are out looking to raise capital for their fledgling companies which very often have no product, no team and no customers. A good number of these folks are also under the illusion that there are investors out there that would be interested in providing them with seed capital nonetheless. This is simply not how things work in the overwhelming majority of cases.

Here are a few quick thoughts for those of you out raising money pre-revenue, pre-customer, basically pre-anything:

• At this point you need to realize that your sources of funding are limited to either grants, friends and family money or your own money. 
• Without some traction in the form of a product, customers, revenue and other proofs of concept, very few investors in the world will even consider investing in your company.
• The sooner you accept this reality, the better off you will be, because you will be spending your time achieving these milestones as opposed to wasting your time trying to pitch investors.

Are there exceptions to this? Of course there are.

• Biotech/Drug Discovery is one of them. For example, if you are a world class scientist in biotech and make a break-through discovery in an area with a huge market and demonstrate this with animal studies, investors will be breaking down your door.
• If you are a serial entrepreneur with a big success or two under your belt, you will be able to raise capital, oftentimes from investors who have backed you before, even if you are at the idea stage.
• Lastly, if you have what I call the X-Factor, then there are no rules. You will be able to inspire certain adventurous investors to bet on you and help you make your vision a reality.

For the next post in this Series, click here.

Comments

[Jay Levy]

At times we provide a small amount of funding (i.e. $25k) in conjunction with a very early stage team raising a friends and family round. We do this when the idea is strong, the market is apparent and the team rocks.

Overall i agree; vc's we want to see some sort of traction whether that people customers or product (ideally both).

[Dave Lerner]

That's great to know, just checked out your site. It seems like you have your own variation of the X-factor in mind in order to be motivated to step-up early. What sector do you focus on Jay?

[Ming Jack Po]

"if you are a world class scientist in biotech and make a break-through discovery in an area with a huge market and demonstrate this with animal studies, investors will be breaking down your door."

I think that might be a bit optimistic. Animal study is way too early stage for most investors, and even then a great deal of other things would still make the deal highly unattractive (but I guess I'm a pessimist).

[Dave Lerner]

Ming- I think for the most part you are correct... the thing is, I have seen this happen a number of times first-hand- where the scientist is world-class, the science is absolutely break-through and it's working in animals- sort of a perfect storm- and then the biotech VC's are flying in from all over the country...

[Mike Wilke]

Excellent, reality based advice.

I work with great people with great business ideas everyday. Unfotunately, there is a widely spreading rumor going around that all that entrepreneurs need is to have is a great idea in order obtain millions in start-up funding. This belief is probably rooted in pre-2000 boom. Those boom years were really something here in Austin at that time.

Thank you,

[Dave Lerner]

Yep Mike- things have certainly changed... I've heard Austin is a great start-up community by the way... true?

[Creative Financing]

Financing for the Rest of Us

So what are your chances of attracting capital from outsiders?

According to VC firms only one in 500 companies seeking venture capital gets any. When it comes to angel investors, we don't know what the success rate is. It's possibly closer to one in 250 because the amounts sought are much smaller.

So how wise is it then to rely on a business model that can't move forward an inch unless a kind stranger gives it a lot of money first?

Learn alternative methods of financing and creative entrepreneurial strategies for overcoming startup challenges.

[Andrew Koopman]

David, I would add that having "skin" in the game certain adds to the legitimacy of an entrepreneur's convictions. As they say, "bacon and eggs".

[John]

Thanks for the post and also for linking to your prior "X-Factor" post. It's a nice sobering explanation of how tight the VC/angel funding funnel is. Not surprising in view of the times and the number of startups out there.

So what remains surprising is some of the large VC funding that goes forward with some startups. For example, online music seems pretty saturated, but you see massively funded startups in that space. Or, Palm getting $100 million despite the iPhone, Blackberry & the then looming Android. Doesn't always happen, but sometimes you see funding that appears to be either (a) good money following bad, (b) a herd mentality kicking in, (c) VCs suckered in by a good sales pitch from the startup (perhaps an inherent risk of focusing so much on a startup founder's pitch - the google guys got turn away often before getting funding) or (d) something else.

In view of how tight funding is, it's surprising to see both the smart tight decisions and the "acting like drunken sailors" loose decisions coexisting in the same VC landscape.

Of course, I'm a bootstrapped startup so a little biased.

[Dave Lerner]

So true... it's hard to back someone who won't put their own money in as harsh as that sounds... it's a big signifier to the level of commitment involved.

[Dave Lerner]

John- I guess it's slowly dawning on the collective consciousness that vc's are people too and subject to the same human behavior as the rest of us... my guess is that in five years time only about half of the funds in existence will still be in business....

[Jay Levy]

Dave -

The X Factor for us is a feeling, its tough to explain. We get it when all planets align correctly, team, market, concept, execution ability, etc. You know it when you see it and you feel it in your gut, and we are generally ready to jump when that happens.

[Dave Lerner]

I love it! "You know it when you see it".... "You feel it in your gut"..... great stuff Jay.... thanks for weighing in....
dave

[Rick Coplin]

Well said, David. I see young entrepreneurs particularly taken with their idea and convinced that all they need to do is talk about a concept and the money will flow. They generally have a lack of knowledge about how funding and venture capital works, to their detriment. VC money flows to experienced entrepreneurs (those with both successful and less than successful ventures) closer to the idea stage. For neophyte entrepreneurs, VC money flows when an idea has become reality and sales are beginning to grow. At this point, we can make a reasonable guess as to future growth and ROI. VCs also wait for earlier stage investors (founder, friends/family and angels in that order) to bake some of the early stage risk out of an idea, allowing the initial investors to prove that an idea is a good one and that the founder can navigate the early challenges of building a business. Entrepreneurs’ lack of knowledge of how money flows is typically coupled with a lack of knowledge of how that same money works. VC investment frequently comes with implanted expertise and buys close involvement if not control. It also comes with expectations of large returns and of an exit. Inexperienced entrepreneurs more often than not are loathe to “give up control” – holding on to a grape when a corner of the vineyard will be much more lucrative. The best thing an inexperienced entrepreneur can do is invest in learning all they can about how investors and investment works prior to seeking money for an idea. Finding experienced entrepreneurial mentors to guide this learning journey will pay great dividends.

[Dave Lerner]

Well put Rick.... First time entrepreneurs now have the advantage of there being a ton of great information online for this learning process you describe, whereas even 5-6 years ago there was hardly anything available... also, totally agree with the mentor comment... I'll be blogging about mentorship soon as I think it's critically important to first-timers... (go tech columbus! by the way...)