Editor’s note: Investor and entrepreneur David Gardner is founder of Cofounders Capital in Cary and is a regular contributor to WRAL TechWire.
CARY – I have received many emails after my latest article on bad advice for entrepreneurs. Mostly it was from entrepreneurs sharing with me some of the bad advice they had received over the years. It seems that at least one more bad advice article is in order.
Bad advice
- Your first round should be from friends and family.
No! The problem with getting money from friends and family is that it is just too easy to get.
David Gardner, General Partner, Cofounderes Capital. Cofounders photo.
Most often, these are not sophisticated investors that will give you critical feedback but rather those who just believe in you and want to support whatever you are doing at face value. I encourage entrepreneurs to go after smart money i.e. those who will tell you “no” anyway. Entrepreneurs rarely get their model right the first time.
Most successful entrepreneurs will tell you that they had to pivot, monetize differently or even sell to a totally different market before things started to take off.
A sophisticated investor will help you think through the fundamentals of your business and avoid a lot of lost time, money and equity. I’ve said many times, when parting with equity you should always get more than money. Fund raising should not be viewed as a problem but rather an opportunity to align the right people with your success.
It’s great to have friends and family that believe in you but generally they are not the best place to raise your seed round. In fact, if you can’t find sophisticated investors who like what you are doing then you might want to seriously rethink your venture.
As an entrepreneur, I grew to like hearing investors tell me “no”. I would respond, “That’s great now please tell me why.” It’s all about the “why.”. This iterative process is what shapes and forges a great venture.
Short cut it at your own peril.
The other big problem with F&F money is that these folks are often not emotionally prepared for the ups, downs and losses associated with early stage investing. They often invest money they can’t afford to lose, or they anticipate getting their money back in an unrealistic time frame.
Sophisticated investors know that they will often lose money on a good plan even after very careful due diligence. They don’t like it, but they typically aren’t going to hate or disown you over it. It was Warren Buffet who was once asked if losing his money was the worse feeling in the world to which he responded, “No… losing a friend or family member’s money is far worse.”
- Avoid creating a board for as long as possible.
We often hear entrepreneurs tell us that they have been “advised” (sometimes by their attorneys) to raise initial money on a convertible note or other structure to avoid having to form a board, have governances or deal with investor rights.
As an entrepreneur with seven of my own startups behind me, I always wanted a board of directors from day one. Besides having trusted advisors, I liked the credibility and weight that the board gave to my decisions. This was especially true in areas where I was obviously conflicted, such as, setting my own salary.
I often asked my board to vote on high-risk decisions even if those decisions did not require board approval because if things went bad and people lost money, I liked the protection of knowing several reputable people were consulted and with the information at hand, supported with my choice. Having a board discussion in the minutes indicates that major decisions were not made in a knee-jerk manner or in a vacuum.
I would seek advice from my board frequently asking, “What am I missing here” or “Help me see this from a different perspective.”
A well-managed board protects the entrepreneur from law suits and appearance-of-evil criticisms. As entrepreneurs look to future rounds of funding, a well-functioning board communicates to potential investors a desire to socialize and discuss major decisions. Setting regular board meeting creates a cadence of accountability needed in an early-stage startup environment.
- Your first step in starting a business is to create a legal entity.
Wrong. That’s your last step.
A legal entity in necessary when you need a vehicle for taking investment dollars, establishing a stock option pool, paying taxes, etc. The things listed are not something that you need when going through the process of figuring out if you have a viable venture or not.
Entrepreneurs often think that the trappings of business are the business. They focus on creating logos for business cards, office space and running up legal bills. These things are not the business.
They are administrative check boxes. The heart of the business is your value propositions and the assumptions your model is based upon. Validating these assumptions is what the startup process is all about so focus your time and money on that and not the administrative stuff that you may never need anyway if things don’t pan out.
