by Tim Jahn on March 11, 2011
I invited her here today to share why venture capital could be good for your business, how to know if your business is even fundable, and common mistakes creative entrepreneurs make when seeking funding.
Tim Jahn: My first question is what makes a company venture capital fundable? Because as you mention in the pre-interview, I don’t think people even thing about whether or not they’re fundable. I think these days, people, entrepreneurs in the text base just run for the funding regardless. So how do you even know, or what makes you fundable?
Carol Roth: Such an interesting question Tim because on fraction of one percent of all companies are actually funded by venture capital each year. But if you were to look in the media you would seem to think that it was every company because everybody tells you, you know how you should go about getting venture capital funding. I mean literally less than half of one percent.
So I think the first thing you have to realize is, is how truly scalable is your company. Venture capitalists only have so much money to invest. So they invest in a handful of companies realizing a few are going to be losers and maybe they get the one homerun that makes up for the rest of them. But they all have to have the potential to be the homerun or the grand slam. So that means 50 to 100 million in revenue on average in three to five years with a, you know reasonable amount of capital, not, obviously not putting in $50,000 to achieve that, but some reasonable amount of capital to achieve that.
And so that’s why you, the technology space has so many more venture capitalists than something like consumer products because it’s so much more expensive to build a brand and consumer and to scale whether it’s a retail operation or a packaged good than it is a software. You know the right software, you can scale that infinitely with a pretty reasonable amount of capital.
So you really, the first thing you need to figure out is do I have a company that realistically could get to this size within three to five years. And then do I have the stomach to be able to go along for that ride. Am I the right person who’s going to help guide us to 50 or 100 million dollars in three to five years? And that’s why so few companies actually get funded by venture capital because they’re just not appropriate for that kind of funding.
Tim Jahn: So the first question you almost have to ask yourself is if I’m a tech company or not because that already increases your chances by a ton, right?
Carol Roth: It does. I mean if you have software, biotech, you know those kinds of things you’re going to definitely be in a different path than if you’re somebody who’s you know making jewelry or some kind of craft. That being said, it doesn’t mean that you can’t attract venture capital. There are certain areas of consumer, particularly of food and beverage which are hotter right now.
Anything in the natural products base, you’re going to have a few more options. But it’s definitely a finite number of options. I mean in consumer there’s probably a couple of dozen of the usual suspects at even at that point in time you’re probably a little bit later on the business life cycle before you can get venture capital than somebody in the technology space. Tech person might be able to do it with a prototype or a couple of customers, the consumer business is going to have to have a little bit more traction in order to attract those types of investors.
Tim Jahn: So to me that makes perfect sense because as you explained it a venture capital, venture capitalists is you know throwing their money on the table and ten different companies. And obviously you’re not going to win ten out of ten.
Carol Roth: No, unfortunately.
Tim Jahn: Yeah. Not yet. What about — so the type of company matters and the industry matters. What about the entrepreneur themselves? Are there types of people that are more fundable than other regardless of their company?
Carol Roth: Absolutely. The number one thing, you know after the size of the company, opportunity, but the number one thing that a venture capitalists is going to look at is you. Are you somebody that they can back? And that is so super critical so you really have to have the confidence, hopefully the track record and really something unique that you are bringing to the table where they feel like you’re the right person and if they supplement you perhaps with a few other team members, that you’re really going to be able to take this to the next level.
Because you have to remember that venture capitalists are sources of capital. Yes they may be able to provide some strategic introductions and they may be able to provide some support and networking, which is fantastic, but they’re not running the business on a day to day basis, nor do they want to be running the business on a day to day basis. And that means you have to run the business on a day to day basis and if you’re not the right person to do that, there better be a team that is the right person to do that because it’s not just about the idea these days, it’s about execution.
There are so many people coming up with the same ideas over and over again that you have to be the one that can execute. So not only does this make sense for venture capitalist, but whether if you go down the pike a little bit to Angels or even friends and family, at the end of the day, they’re backing you. Are you the force that they can win with? And if so, they’re going to put down the money on you. And that’s so critical so you really have to be up for it.
We get a lot of people who are like oh I have that great idea and I want to hand it off to someone else and let them do it. And it just doesn’t work that way. The idea isn’t really the valuable part, it’s the ability to execute it on a day to day basis and really take it to the next level. And at the end of the day get the investors a return on their investment because that’s what they care about. They care about how they’re going to make money, not about you or your idea or your mortgage or anything else.
Tim Jahn: Do you find that to be a common misconception? That people don’t realize how much venture capitalists want that return. That they might think they’re in it for, you know to help somebody along or like you said it’s a great idea. Or is it, I mean is it really just at the end of the day it has to be about the money for those VCs?
Carol Roth: Absolutely. I mean that’s their job. They have a responsibility to their investors who’ve given them the money to generate a return. So the only way they can do their jobs well is by investing in businesses that will produce that return, that have the opportunity to produce that return. So they’re making very educated, risk decisions. And so I think that it’s not necessarily that anyone thinks they’re doing it to be charitable, but I don’t know that enough people really go through the thought process and realize that they have an obligation.
I think there’s this sort of mentality, whether it’s getting money from the banks or from VCs that oh I have this great idea and I’m someone, I deserve the funding. And the reality is that this is business. This is a capitalists system and at the end of the day it’s about achieving the required returns and everybody has a job they’re doing a long the way. And the VCs have a job and they need to have that first obligation be to their investors otherwise they don’t get to raise another fund and they don’t get to keep their jobs at the end of the day.
Tim Jahn: I like the way you put it, yeah, that it’s business and everyone’s got their job to do.
Carol Roth: Yeah.
Tim Jahn: If — so I have my company. It’s the right type of company to attract VCs. I’m the right kind of entrepreneur, so I’m going to seek funding. What’s the most common mistake you see people take next when they’re going to look for funding?
Carol Roth: Okay, so it’s — I don’t know if it’s the rule of two or three, but everything takes twice as long as you would expect it to. It takes, it’s two times as difficult, or three times as difficult to privy money out of these peoples hands once you make contact. And by the way you’ve probably underestimated the amount of money that you need by a factor of two to three. So it’s really not having realistic expectations going in. I think that a lot of companies think that the money is the source of their problem.
If they just had that money, then all of a sudden all of the customers were going to be there and when they launch their business or they take it to the next level, there’s a ticker-tape parade and confetti falls from the sky and you know everyone’s waiting for their product or service. And if they just had that money, that’s the whole solution to the problem. And that really isn’t the case because there is usually a sales cycle and depending on what business you’re in that could be a really long time to engage the customer and to make that sale, which means that your revenue is taking longer to produce and you’re spending a lot of money in the meantime which means you’re eating up more cash, which means you probably need more money.
And so I think that’s a huge area of underestimate, underestimation by most entrepreneurs and then you know when they go out to raise the capital, not understanding how long that process takes. From the first meeting, to the second meeting, to doing the paper work, if you’re so lucky, I mean it’s you know six to nine months on the low side and I know people who’ve been at it for much longer.
So it’s having a contingency plan in place while you’re out raising the capital, what are the things that you’re doing in the meantime? And then understanding that it’s going to take you a long time, you can try and push it as much as you want, but there’s another party that’s involved and they will go at their pace and oh by the way they have the money so they get to set the pace.
Tim Jahn: I guess it seems only natural that a, especially a first time entrepreneur would totally underestimate all aspects of the funding process since —
Carol Roth: Yeah.
Tim Jahn: — it’s just a matter of experience I would imagine.
Carol Roth: You know you would think it’s a matter of experience but I know people who’ve been through the process who still, on a second or third time out then think all of a sudden okay well I’ve been through his before. We’ve, you know, we’ve done these things to mitigate the risks, it’s going to be easier or fast. And again try and push it or force a process and it still doesn’t work.
Capital raising is rarely a one time thing. Its things that companies need to do over and over again during a course of their life cycle. And so, you know yes, obviously the first time out is going to be a huge wake up call, but sometimes it take two or three times before they’re really getting okay, yeah this is really how this works.
Tim Jahn: So if my company isn’t the best option for funding, and if I’m not necessarily the best type of person to fund, what’s the next best option for me in terms of getting some sort of funding to get my business going?
Carol Roth: Okay so you’re, if you’re in the 99.96% of companies out there that are not VC fundable, there are a couple of options. You know the first thing is that most entrepreneurs actually, on average finance the business themselves. They do it out of their personal savings, or off their credit cards. So that’s something that you can consider, you know is it something that you can put your own money to, you know at risk.
Like everything else there’s pros and cons and you want to make sure, my prospective that you have enough money to start the business, to operate it for at least a couple of years because it often takes that long to lay a foundation and get to a point where you can break even. And then to live on, in the meantime because you never want to be in a position between having to choose between paying your mortgage and investing in your business.
That’s a total lose/lose situation. So you really have to be in a position financially to be able to do that. If you want to take in some additional capital, then the next logical step is often what we refer to as FFFs, friends, family, and fools, or I like to call them DDLs, doctors, dentists, and lawyers. People that might logically have some extra capital laying around that you know who might invest in you. And like everything else, there isn’t a right answer. It’s all about pros and cons.
So you know how do you make that decision? Do you want to take a personal relationship that you have and layer on a professional relationship? And I always say, you know people imagine sitting at the dinner table with your mom and you say “please pass the potatoes” and she’s like “no because you just blew $10,000 of mine.” So you really have to kind of make sure your relationship can handle it and that reward from taking the money is worth the risk that you’re going to take on at the end of the day.
So it’s a really, really tough decision and just, you know pros and cons. There obviously is also the option of doing some debt financing and bank financing. I think the misconception here is that the government has a bunch of free money out there and that if you apply through SBA the government gives you money and that is not the case. Basically the government helps banks by offering some extra leverage and matching funds, but it’s still a loan and it’s still done through a bank, not directly through the government.
And at the end of the day you still have to have a credit worthy business or personal history and a lot of times you have to sign for that personally. So it’s not like somebody’s just passing out the free money here, it’s taking on a serious obligation.
So lots and lots and lots of challenges, in this day in age people are trying to find creative ways around that, maybe bartering, boot strapping or doing other things, you know selling some of their stuff, whatever it is to find ways to bring money in to finance at least the beginning parts of the business so that they can achieve milestones, take some of that risk away, say “okay, you know I do have some paying customers. And I have proven the viability.” So it takes that risk away and makes it easier for them to ask, whether it’s a, you know friend or a family member, or a bank, or a doctor, dentist, or a lawyer for some money.
Tim Jahn: I like that, doctors, dentists, or lawyers, DDL.
Carol Roth: Yeah, it’s a bit when I was working for Montgomery Securities back in the big ’90s, that was our big joke in there. So I just kind of swiped it and continued to use it.
Tim Jahn: In all your years of experience —
Carol Roth: Yeah.
Tim Jahn: — helping companies, helping business, helping entrepreneurs, have you — I’m curious, is there any correlation between success and the people who chose the friends, family, fools option? I mean is it, does that just strain your relationship too much or is it just unrelated? I mean you can totally succeed if you’re taking your mom’s ten grand.
Carol Roth: Yeah, I mean you know it goes back to pros and cons and it really depends on your family. You know if you have a really super wealthy family who doesn’t care, maybe it’s not as much of a strain. You know if you have a family where this is a really big deal to them, you know it’s going to be an issue. You know my personal rule is never take money from anyone whether you like them or do not like them if they can’t afford to lose the entire amount.
Because the reality is up to 90% of businesses fail or fail to succeed within five years and so, you know the odds of them not only making a return but even getting that money back are slim to none. So you have to realize a lot of the times they’re doing that because they believe in you and they want to help you, you know fund a dream or you know do something for your benefit that this is your real life MBA and they’re contributing to it, what not.
So you really need to set that expectation up front and say “look mom, you know the likelihood here is that this is just going to get blown. It’s like you know I could have used this to go get my MBA, I’m using this for this instead. Are you cool with that? Because if you’re not cool with that, our relationship is just way too important and I will go find some other sucker to take the $10,000 from.” And I think if you approach it and you set those expectations up front realistically, it always seems to work out better on the back end. I think it’s those who are selling too much of the dream and the promises upfront and don’t set up the reality up front, those are the people who end up paying for it.
But I don’t think that there’s necessarily a correlation between, or at least I’m not aware of any studies between whether you’ve taken your money from friends and family or if you’ve financed it yourself. Different people are motivated by different things. I know some people are actually paralyzed when they take money from other people. That they feel like oh my gosh, you know I don’t want to lose all their money. And I’ve seen this with clients before where they actually are unable to invest in the company and not realizing they’re not spending.
They actually need to invest in order to grow and they’re so worried about it that it actually has the opposite effect of what they’re intending to happen. So that is a huge, huge problem and it kind of goes back to the personality thing you were getting at. I mean there are just some people that don’t have the stomach to be an ent [cut out] or don’t have the right competencies. And if you’re uncomfortable financially, that is a big red flag.
I mean that’s something that you probably don’t want to be, you know if you’re having problems investing your own money or other people’s money and it’s something that’s not comfortable to you, that’s going to be a huge, huge liability for you because you’re not going to be able to make those tough decisions and invest like you need to in order to take your company to the next level.
Tim Jahn: Yeah, I think personality is such a huge part of it and maybe overlooked a lot. Like you said people don’t necessarily realize. What’s your number one piece of advice for an entrepreneur looking to get funding for their business? The one thing you’d have to tell them.
Carol Roth: I would tell them that there’s no right answer. There are a lot of people out there who like to sell “here’s what you need to do” and that’s a bunch of crap. There’s nothing that you need to do, there’s only a range of pros and cons and risks and rewards. And so you really have to look at your own situation and your own goals and objectives.
I think you need to take a step back and say where is it that I realistically think that this could go? Do I want it to go there? And what do I need to do to make it happen? And what risks am I willing to take to make it happen? Because I think too many of the entrepreneurs, particularly creative entrepreneurs get so caught up in the idea and the you know oh cool, creative passion that they never really set that intention or goal for the business and if you don’t have the goal, then you can’t really measure those risks and rewards based on your own goals and objectives.
So I think it’s really important to take a step back and really look at that framework first before you start making decisions about financing. I mean business is very strategic in nature and if you really set out that where you’re, where is it that you want to be, you can come up with road map to get there. And if you don’t know where it is that you want to be, then taking a capital is just going to kind of set you driving and you may not be on the right path at all.
Carol Roth: That’s okay.
Tim Jahn: Definitely. It’s back on now.
Carol Roth: Okay, so I —
Tim Jahn: You got to see your figurine too.
Carol Roth: Yeah, so I just wanted to say you know especially for creative entrepreneurs, you, one of the things that you really need to do is understand the different kinds of businesses that are out there and all the things that you need to do to stack the rewards of success in your favor. And it’s really key because a lot of people are BSing out there. And they’re selling the passion, they’re selling the creativity, but they’re not telling you the reality.
And so you really have to have a nice mix of both. And that is why I wrote the Entrepreneur Equation, I don’t know if you can see here, which launches on March 22 and is available everywhere. And a really, really solid resource I’ve got and you can, you know just Google the Entrepreneur Equation. I’ve had at least three different people say it’s the best book on entrepreneurship that they’ve ever read, so independently verify that this is a really huge value and something that you will get a return on.
And I know Tim wants me to show you — also with you, my little goofiness which is, depending on if you’re female or male, it’s either an action figure or a fashion doll. The men call it an action figure, it’s really a fashion doll, that I did as an incentive and I think, you know as a creative entrepreneur you may be able to relate to this, business is often so boring and when I sent my book out to press I wanted something to help make it stand out and I can guarantee you that they’ve never received any other business books that had a fashion doll slash action figure attached to it.
Tim Jahn: How do you get one of those? Do you get one when you’re buying the book or is it some special give away or what?
Carol Roth: Yeah, so basically I did it for press, but if you go to the entrepreneurequation.com and you click on special offers, there actually is a special offer that if you buy a certain number of copies of the book you can get the doll and that’s going on for a certain period of time and then I’ll probably have you know some of the extra dolls available later on too.
Tim Jahn: So these are limited edition dolls? I mean these are like collector item.
Carol Roth: They are, they are highly collectable, limited edition, absolutely, made by my client at Integrity Toys that actually makes limited edition collectables, so lots of fun and even has a miniature of the book with it.
Tim Jahn: Oh the doll has a little book?
Carol Roth: Yeah, here, I don’t know if you can see it right here but she’s got —
Tim Jahn: Oh wow.
Carol Roth: — her little copy of the Entrepreneur Equation because you know she wants to make sure she makes good decisions in business so she can succeed and not be one of the statistics because you know if there was any other career path that had a 90% failure rate, people would be flipping out. But somehow if you invest your own money, it’s cool. I don’t understand that, do not think anybody should be a part of that.
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