Many startups make mistakes when it comes to securing funding. This is not surprising — fundraising is tricky for founders who have done it before, let alone founders who are doing it for the first time.
We constantly hear about successful funding rounds. Startup funding has also reached record levels in the past few years. Both 2017 and 2018 were very strong years for VC funding and in 2019, there have already been 34 new unicorns raising more than $8.3 billion in funding.
The downside is that all this excitement and activity adds pressure to startup founders and if they are not careful, they can get overwhelmed and make major funding mistakes that will jeopardize the future of their companies.
To increase your odds of success, let’s look at the 5 common startup funding mistakes that first-time entrepreneurs make and how you can avoid them.
1. Equating funding with success
Many new startups see fundraising as not just a necessary part of running a company but as a marker of success. This leads them to focus on chasing investor money instead of doing more important things that can grow their business or solving major issues — such as the company not making money yet and not having a solid plan on how to do so.
This mindset also causes some founders to miss the fact that their company does not need millions of dollars in investment upfront, and that they might already have enough capital to sustain and grow their startup while retaining complete control and ownership of the business.
While companies like Tesla definitely needed a huge upfront investment, there are also a lot of companies that gained critical success despite being self-funded, such as the shapewear company Spanx and the protein bar business RXBAR.
How to avoid this mistake:
Think long and hard if you really need investor money to grow your business.
Will you be using the additional capital just for things that are nice to have (such as a fancy office) rather than essential? Are there major problems you need to attend to first before pitching investors? Are you looking for investors just because that is what the other startups are doing or just for bragging rights?
2. Underestimating the challenge of raising funding
Success stories about startups closing their funding rounds usually gloss over many details, such as the time and effort founders spent preparing their pitches and how many meetings it took to convince the investors.
Unsurprisingly, many startups begin their fundraising efforts with much enthusiasm, but with unrealistic expectations and not enough preparation. Many try to just wing it, thinking their passion and confidence will be enough to sell their idea and get the money.
Many founders also underestimate how long it takes to finish a round of funding. They think it only takes a couple of months, when the reality is it takes a couple of months just to prepare, then another half a year (or more) to finish the fundraising.
How to avoid this mistake:
While you do need to inspire confidence in your potential investors, that won’t happen without a solid pitch deck to back you up and the ability to answer the investors’ tough questions, even if that means showing them the areas of your business that need improvement. Your pitch deck also needs to include adequate financial and accounting pieces detailing your company’s financial status, plans, and projections.
In addition, understand that raising funds is all about creating relationships with investors, and building relationships takes time. These investors have to do their due diligence too, so they may want to meet with you multiple times so that they can ask more questions or probe deeper on some issues.
Having a mentor is also a big help when looking for funding. Someone who has successfully done what you’re trying to do can provide valuable feedback, guide you in your preparations, and help you manage your expectations.
3. Having unattractive investors or too many investors
Not all investors and not all investment money are equal. There are some that can make running the business or doing subsequent rounds of funding difficult, so it is better to be wise from the start in choosing your investors.
When it comes to funding, having more investors is not necessarily better. First, the SEC’s guidelines limit an LLC to only 99 investors — and sticking to well below 99 is still no guarantee that your startup will be appealing to major investors.
In fact, having dozens of investors is a turn-off for VCs and private equities, as they won’t be interested in doing so many individual closings or transacting with so many counterparties. At this point, you may have to recapitalize the business and buy out many of the smaller investors.
Accepting investment money from your friends and family members, meanwhile, can put you in a sticky situation. It is not a mistake per se; after all, many startups got off the ground mostly through investments from the founders’ loved ones. Around one-third of startup founders have received money from their friends and family — more than $60 billion dollars each year — and these investors provide more financial help than VCs and angel investors combined.
Nevertheless, mixing your personal and business lives can introduce complications to your company later on. Business decisions can sour personal relationships and personal considerations can hold you back from making some decisions that will be beneficial to your startup.
In addition, major investors are not going to be impressed by investments from people close to you. On the other hand, if your startup is backed by large investors, it signals to other important financiers that your company really has potential and should be taken seriously. The support of influential figures affects the decisions of investment bankers and other entities within the investment community.
Also, because friends and family are usually the ones that entrepreneurs first ask for investments when the startups are still at an early stage, such investors get larger equity shares than the ones coming in later, which further makes your startup less attractive to potential investors in the future.
How to avoid this mistake:
Before taking on investors, consider how they will affect the valuation and direction of your startup. A few large investors will do more for your fundraising efforts than many small ones, now and in the future.
Also, be extra careful with your initial investors. Because they are getting equity when your startup has the least value, each dollar they invest buys a bigger stake compared to later backers.
4. Pursuing uninterested investors and taking on incompatible ones
Your startup is your baby, so it can be tempting to try to win over any investors who do not believe in your company’s potential for success. However, doing this can just be a waste of time and a source of frustration. It will be more productive for you to raise funds by finding the investors who already believe in what your company has to offer. They can be your biggest allies.
Also, because investors are people too, some of them have preferences. Some, for example, may be partial to startups founded by Ivy League graduates while some may be inclined to support minority-owned businesses.
It is worth noting that a significant number of investors only back startups that have two or more founders. This is because it is close to impossible for one person to be good at every business aspect, so investors want startups that have a team of founders who have complementary strengths.
Some investors also want startups with at least two leaders so that the co-founders can countercheck each other’s ideas and morally support each other during stressful times. Lastly, some investors also interpret having a single founder as, “If that entrepreneur’s own friends — who know him best — do not have enough faith in his character or ability to successfully run a business, why should we?”
Another common startup mistake is to accept investors that are not compatible with the founders. These financiers may have values, visions, or appetites for risk that are not aligned with those of the founders.
Entrepreneurs who take on incompatible investors sometimes end up obsessing over ownership percentages. Diffusion is more acceptable if you and your financial backers want and value the same things but if your financiers want to do things differently or take the company on a different direction, you can end up losing control or even being replaced as leader of the company that you worked so hard to build.
How to avoid this mistake:
Meet with investors long before asking for any financial support. Do adequate research on their background to see if their values and vision are compatible with yours and to gauge if you and your startup will appeal to them.
It also helps to befriend the founders they have invested in. Not only can they help you set meetings with the investors, they can also give you a good idea on how the investors behave, especially during problematic times — as an investor can be nice when everything is going great but a nightmare to deal with when times are tough.
Lastly, choose only investors that you get along with and genuinely respect. Remember that investors are not just money sources for your business; your relationship with them will affect the future of your company.
5. Raising too little or too much money
Another funding mistake is raising funding that is not enough. Obviously, if you raise too little money, you won’t be able to pay for the things that can grow your company at a healthy pace. Hiring and retaining top talent will also be difficult.
You might also be tempted to forego paying yourself, which is not a wise decision. Once you do this, investors will expect to continue not paying you. You might also be tempted to do side jobs or businesses in order to make a living, which will take your focus away from the startup. And even if you don’t, some investors will still wonder if you are multitasking instead of focusing all your efforts on the startup that they have invested in or are thinking of investing in.
Worse, a business has expenses every single day, so if you have not raised enough funding and the company is not earning enough yet, your business will run out of money and you’ll have no choice but to pack up and leave.
On the other hand, raising too much money can also be problematic.
An influx of excess money can cause you to splurge on shiny new things that are a luxury rather a necessity for your business, or to grow the company too quickly — even before you have fully understood what customers want and are willing to pay for.
Founders will also experience more pressure from investors. Once a supporter gives you several millions of dollars, there is the expectation that the startup will immediately put that money to work, not lounging in a bank deposit while the founders continue taking things slow.
Having a lot of money can also change the company culture and the founders’ mindset. Moving into a nice office and hiring more people will change the startup from having co-founders who are committed to succeed to being mostly made up of employees who need to be told what to do and are less invested in the company’s success.
Bootstrapping startup founders are also forced to get creative in their strategies to grow the company; having a lot of money can cause them to just throw money at the problem and take shortcuts that will only have short-term results. You also lose some of the flexibility because you now have more people to take care of and investors to satisfy.
How to avoid this mistake
To avoid raising too little money, ask yourself: are you doing all you can to reach out to and impress investors? Once you find investors, ask for more than you think you’ll need, but not too much, so that you will have a buffer in case of emergencies and unforeseen delays or expenses. If you are not sure how much to ask, consult a financial advisor or a mentor.
Also note that some VCs will offer you a low valuation just to see if you have the guts to ask for more money. This is where investor research comes in. If you find yourself dealing with such an investor, don’t be afraid to negotiate the valuation.
Building and running a startup is no easy task, especially for first-time entrepreneurs. For every successful startup, there are several that do not make it.
Trying to secure funding as a first-time entrepreneur can be intimidating, stressful, and time-consuming, but it’s all worth it as that capital you will raise can propel your startup to levels you won’t be able to achieve with your money alone.
As a newcomer to fundraising, there will be a learning curve, so you shouldn’t be afraid to make mistakes. However, you can avoid some of those mistakes by learning from other founders. By knowing about the five common startup funding mistakes discussed above, you can now avoid making them.