Founders are the first to place a bet on their company because founders are investors. These investments come in a few forms; seed capital, sweat equity, partnership or in-kind contributions. Regardless of the structure, one truth remains – if you want to grow your business from a side hustle into a scalable, full-time operation, you need capital. You’ve put in the sweat equity to-date, and moved your idea from notes on paper to a business plan or working prototype. Now is time to show investors you’re serious by putting your money where your mouth is.
Why smart founders invest in their startup
You need to put money into your startup if you want to build your product, land critical sales and grow into a sustainable business. After the initial idea-inertia, founders tend to run right out to fundraise, assuming that with their shiny deck they are ready to chase investment. However, few are equipped to present investors with more than just an idea. If you’re standing up there, tossing out a business without fully costing it out, or even ensuring there’s a product-market fit, just wastes the investors time. Usually, It ends worse the founder. If you’re pitching without something concrete to present, like a prototype, your chance of landing an investment is basically shot.
As talk with investors, they’ll want to know how much cash you put in. Making the commitment of putting your money on the line shows investors that you’re serious about this idea and you are willing to take the risk as well. When you put your own cash in, you’re demonstrating that you expect to see a return and you have faith that other people will invest. Bottom line; if you plan on asking others for money, you have a far better chance when investors know that you invested in your startup first.
When I was actively fundraising for my businesses – meeting with private equity investors and doing the well-rehearsed dog and pony show – without fail one of the earliest questions was, “what’s your investment?” Proving that you have skin in the game, that you’re not only working off the sweat equity, is a critical component to securing investment. That’s not to say that you can’t pitch sweat equity alone, simply that you should be prepared for a tougher raise and to see a higher equity requests from investors who are taking the larger risk.
Should you find yourself in a sweat equity position, it might be in your best interest to carve off a larger employee option pool and have it written into your term sheets that the founders get first shot at the options (up to X amount) to help top up their shares should the company reach its initial stages of success and is proceeding towards a Series A or B. This route allows you to give up more at the start, but saves the opportunity to gain back some equity once the agreed upon metrics of success have been proven.
If you are ready and capable of making an investment then you’ve already planned out the initial growth and know how much you should be putting in to give yourself enough runway to reach either initial sales, MVP, government grants or fundraising. When investing one big cheque into your new bank account remember the business plan, and make sure you have build a strong set of financials so you know exactly where every dollar is going, and when. As long as spending doesn’t get out of control and threaten cash flow, the business should grow along.
It would be wonderful if every founder was already independently wealthy and could self-finance their startup but short of that, there are other ways to get your proverbial skin in the game.
Credit Cards/Line of Credit
Google’s founders, Larry Page, and Sergey Brin, famously maxed out their Amex cards racking up over $15,000 in credit card debt. Just like you at the start of your company, they didn’t know they’d be building Google, they simply had a vision and used what limited resources they had to bring it to life. This is not to advocate racking up unsustainable debt or putting yourself or your family in a precarious position. If you are in a stable enough position to start drawing upon credit – with a plan to pay it back – then credit might be a solution for you.
Friends & Family
Imagine having a network of friends with deep enough pockets that they can drop five digits (or more) into your startup to get you up and running? Not so far fetched as most serial entrepreneurs run in circles with other serial entrepreneurs who would want to invest in the next big thing. Even if you’re not rolling with an exited friend or two, it’s always worth practicing your pitch on friends and family and asking for a small sum to help get up and running. If you can match to make it a ‘friends & family & founder’ round, you’ll look more committed to potential investors down the line. If you’re not willing to take the risk with your friends and family’s money, why should an investor take the risk?
Crowdfunding
Everyone’s favorite counter-culture party game, Cards Against Humanity, launched via an incredible Kickstarter campaign that showed how bang-on the creators knew their product-market fit, along with a complete understanding of their end-users. With crowdfunding platforms the name of the game is marketing. If you or your co-founders have a marketing background, especially advertising, this is where you can let it shine. Crowdfunding is great for smaller-scale prototypes and favors more physical product-based startups.
In-Kind Contributions
Your startup is focused around what you know, and how to do it better. Chances are, you have some equipment or other types of contribution from your previous career or hobby that you can give to the company. Whether its computers, machinery, lab space/time, vehicles, etc… these can all count as an investment. Your accountant will need to know about this, so they can track depreciation and factor that into your financials. Vice’s three founders made their initial investment in thirds. Co-founder Suroosh Alvi spoke on NPR’s How I Built This. “I borrowed five grand from my parents, Gavin borrowed five grand from his parents, and Shane got $5,000 worth of computers from his dad. His dad worked in IT or something. And so it was with the ten thousand dollars Canadian that we started Vice.”
At the end of the day, you’ll need to keep track of your investment to show for tax purposes initially, but to also use as a point of reference as you go forward. This is where your accountant comes in. Don’t have one? Now would be the time to find someone trustworthy and affordable. If that really isn’t an option, using software like Wave Accounting or QuickBooks is a bandaid alternative. Your accountant will structure your business using the Generally Accepted Accounting Principles (GAAP) to ensure that you’re not only set up with the Canada Revenue Agency (or your national tax collector) but that you are following standard business practices that can be showcased when fundraising. When it comes to taxes, your accountant will thank you for keeping track of where the money is going so that it can be correctly reported to maximize your returns (and save you hours on your accounting bill). Additionally, with funding allocates in streams, you might be able to claim additional tax breaks, or apply for government grants, loans, and incentives. When approaching investors, having the ability to show them where the cash went and a full accounting from day one will be a requirement from you and absolutely part of their due diligence.
When you’ve reached the point that you’ve brought on other investors, it is good to have a plan on what to do with your investment as the company grows. Most founders will roll their money into their existing equity stake to grow their ownership back up to stem the tide of dilution. Others offer the cash as a loan and treat it to similar loan conditions. A note of caution with the loan route – this is something you’ll want your lawyer involved in. They can make sure you have the proper terms regarding repayments and consequences of a default. These term sheets will need to be included with your investors due diligence package so there is a clear understanding that their investment dollars could be used to pay you back. Expect this to come up during negotiations! Either way, if the business does not succeed you will not get a return at all and either have to write off the loan or write off the investment. Make sure your accountant has a plan for either scenario when tax time comes around.
How much to put in depends on your personal situation and your tolerance for risk. Some companies have gone on to incredible success, launching will as little as $10,000.
Startups are risky. If you don’t want to bet your own (or your friends and family’s) cash, your prospective investors might not want to either. The bottom line is, if you want your startup to be successful, you should invest in it. However, like any investment, don’t just roll the dice and hope for the best. Know what you’re trying to do, understand the market and the chances of success. This is an investment into yourself, so plan diligently and make a smart investment.