New businesses can be divided into 2 groups:
- Those that can be started with virtually no infrastructure or technology investment and;
- Those that need significant investment in infrastructure or technology from the get-go.
I’ve heard the latter referred to as “technology first startups” but it could also refer to something like a cafe or restaurant which needs a certain amount of equipment prior to being able to generate any revenue.
Regardless of which type of business it is, there is a trend towards seeking investment at the very early stages of a business and I would like to posit that the “angel/seed/series X” path (aka. the “book of graham”) is almost always a bad choice.
If you are starting the first type of business, you shouldn’t need investment at all.
The reasons you’re looking for investment probably fall into one of these common categories:
- You think that getting investment from someone with more money than you validates your idea because people with more money than you are smarter than you. This is rarely the case and the only validation that counts is those of your customers.
- Despite the fact that this is not a “technology first” business, you are more interested in/excited by the technology than you are by the business, so that’s what you want to build first. In that case, you should go get a job building technology for some other business and forget being an entrepreneur.
- You think that you have the opportunity to gain first mover advantage so you need to go big and go hard quickly in order to corner the market before you get too much competition. If you feel this way ask yourself: in 5 years time, will the market still be there? Do you imagine that at some point in the future you would gain competitors and they would sucessfully steal some market share from you? If the answer to either of these questions is “no”, then what you’re looking at is a fad and your business plan is a ponzi scheme aimed at duping investors. If the answer to both of these questions is “yes” then you needn’t be impatient: if you’re not the first mover, you can be the competitor and do equally well (in fact there is a track record of first movers being the biggest losers in a range of tech sectors).
If you’re building the latter type of business then you’re probably seeking investment for all the same reasons but since you’re probably a tech geek I’ll add one more reason into the mix:
- You’re desperate to quit your job and you’ve fooled yourself into thinking that you have a shot at long term success if you get 6 figures in the bank, hole up building product for 6 months and do a big hollywood launch.
All of these things are terrible reasons to take investment.
Regardless of which type of business you’re building, the right time to take investment can be determined very simply by looking at how you sacrifice pieces in a game of chess.
In Bruce Pandolfini’s “Every Move Must Have a Purpose” he looks at what a sacrifice in chess is.
If you are forced to lose your queen in order to avoid check mate, that is not a sacrifice. You had no choice: if you had kept your queen, you would have lost the game.
A sacrifice is willingly giving up material because you have calculated that you will achieve a net gain in future moves.
There is still some risk in that you may have miscalculated the timing of the moves, or you may have missed something and wind up having made that sacrifice in vain, but basically you are choosing to give up material because you have some reasonable expectation of winning an advantage further down the track.
In the case of business, the material you sacrifice is usually in the form of equity in your business. Unless you have a very good strategy to win back advantage with a high level of certainty as a result of that sacrifice, it is a foolish move.
When do you have that level of certainty in business?
Some examples are:
- You have found a way to buy customers profitably via AdWords. The expected payback period is 24 months. The more money you can put into AdWords, the more money you will get out.
- You are profitable but finding it hard to cope with demand due to operational inefficiencies. Investment in technology and infrastructure will allow you to service demand and will have a predictable impact on revenue growth.
In both of these cases it makes perfect sense to give up equity in your company in exchange for cash: your part ownership in the company in a couple of years will be predictably worth more than your whole ownership is now.
So what if you want to build a company that requires significant investment in technology before generating revenue, but you don’t have the money to fund it (or a spare 3 years to work on it before it becomes profitable)?
Easy: build a different company. Become financially independent, then build the company you always wanted to build.
If you can’t bear the thought of starting some boring business in order to fund your technological fantasy play, chances are you should be working for someone else!