In this latest instalment of “Ask an expert”—a blog series that seeks to address common mistakes that entrepreneurs make—Angelo Casanas interviews Shirley Speakman, investment director for MaRS’ Investment Accelerator Fund (IAF).
A wise old maxim states that you have to spend money to make money. Consider fledgling company ABC Ventures. The company raised money through bootstrapping and five months later has three million customers eagerly awaiting its revolutionary widget, the 123-pad solution. The company will certainly need more money now—say, $3 million—apart from what friends and family have already contributed. XYZ investors swoop in, hoping to capitalize on this profitable opportunity and a partnership begins.
It’s a complex situation to be in, says Shirley Speakman. “There’s a natural friction between the investor and the entrepreneur,” she explains. The former thinks he or she is paying too much, while the latter believes he or she is getting very little.
This is coming from a seasoned investment director who has 23 companies in her IAF portfolio and more than a decade of experience dealing with early ventures and startups. I sat down with Shirley to find out her thoughts on what entrepreneurs should consider when financing their startups.
What common mistake do entrepreneurs make with regards to financing their startup?
The most common mistake entrepreneurs make is underestimating what it actually takes to get from where they are to where they want to be. Usually, an entrepreneur’s best-case scenario never takes into account the inevitable snag in the business plan. Such things can cost the company six months in its development or may even tilt the balance between the life or death of a company.
It happens because entrepreneurs, by their very nature, are optimistic. That’s who they are. They really believe that they can build a company with a million dollars when you can’t. You can build a company with a million dollars with revenue or a million dollars with follow-on revenue, but it will take twice as long and cost twice as much. If you think you’re going to spend $40,000 in six months to get to where you want to be, you’re actually going to spend $80,000 and a year to get to that point.
What happens to entrepreneurs who make this mistake?
Entrepreneurs can end up with limited opportunities. They may run out of cash before meeting their milestones, which ends up disappointing their investors—and is the worst place to be for an entrepreneur. They’ve overpromised and under-delivered, which is the worst situation a startup can be in.
What you really want is to under-promise and over-deliver. It’s far easier to tell your investor “I promised you six customers, but instead I have 10,” than to tell your investor “I was going to get you six customers, but I’ve only got three.” What a different story that is. You want to get enough money from your investors at the outset to tell the first story and not the latter.
Also, investors can now say that, because you’ve missed your milestones and need more money, your stake in the company will decrease to 40% or 30%, as opposed to 60%, at the end of the last financing. Since you haven’t proven yourself and you haven’t created value, your venture is not worth what you originally said it was.
Any of these situations could happen or, worse yet, you could get kicked out as CEO!
What should startups do instead?
Always think that there are three other CEOs out there working on a similar type of product in a similar type of market. Meet them, talk to them and ask them how long it took them to get to this point, how much it cost them and what difficulties they faced. There will always be a risk, but educating yourself in a very detailed and pragmatic way is how you mitigate that risk.
Also, twice as much and twice as long is a good rule of thumb. If you’re going to be a good entrepreneur and fund your company, you have to make sure that you have a buffer and that you’ve taken contingencies into account in case things don’t work out. There are a lot of moving pieces that can get off track, but money can solve all that. If you don’t get the right amount of money [to get to where you want to be] at the right time, everything else is moot.
Angelo is the associate for corporate services at MaRS. As a recent convert to innovation, he assists the many moving parts of the MaRS ecosystem to meet the demands of both internal and external stakeholders. See more…