The Right And Wrong Times For Investment
A lot of entrepreneurs are convinced that they want to take on investment.
The idea makes sense at first – you get to use someone else’s money to grow your business.
But there’s a catch; you’re going to be paying your investor a lot of money in return.
You’re either in debt and have to pay back what you borrowed plus interest, or you sell ownership in the company and will be splitting profits forever.
Your investor is going to want to be careful too; they risk lending out money they never get back, or own a portion of a company that no longer exists.
For this reason, investors are good at doing their homework.
That’s why I encourage entrepreneurs to pre-empt their investor’s questions.
By grappling with these ahead of time, you’re able to give clear, confident answers when asked, and can start looking to fix any red flags that pop up.
Wisdom From A Shark
One of my favourite Sharks is Robert Herjavec, who is razor sharp and also seems to be a genuinely nice person.
In an episode from season six of Shark Tank, he makes an insightful comment to a social enterprise who are seeking investment to grow their sales team:
“You want to invest to support the sales, not to invest ahead of the sales”
This might seem like a bland statement, but look at it more closely.
Investing to support sales is a very compelling argument.
It’s where you say to an investor:
“I have 3,000 people lined up outside our factory gate who are waving their cash at me.
If we can buy more machines, we can serve them quickly and reduce our costs”
What a great offer.
The sales are there, customers are ready, the only thing that’s left is the funding.
It’s essentially the premise of crowdfunding; if we can get $50,000 of pre-orders, we’ll go ahead and make this thing.
Investing ahead of the sales is much riskier.
It’s where you say to an investor:
“I want to buy more machines so I can start experimenting, and then later we’ll go and find some customers”
This is not such a great offer.
There are a number of things that can go wrong – be it at the back end or with making enough sales.
It’s essentially “Build it and they might come, but we’re not fully sure who they are”
When you’re trying to invest ahead of the sales, you’ll encounter one of two problems:
1. Investors aren’t prepared to take that risk, so they politely decline
2. Investors are willing to take the risk, but their valuation of your company will be a lot lower, since there’s so much uncertainty.
In both scenarios it is massively in your interest to remove risk ahead of investment.
By eliminating the uncertainties of a new business model, you can demonstrate the potential for growth to investors - and to yourself.
This means being confident that you can consistently deliver something great, to a deep enough pool of customers, at a price point that earns you a surplus.
Again, crowdfunding campaigns do this brilliantly.
They are a fast way of testing out your value proposition and price point.
If the market slaps you down, at least you haven’t invested in the wrong thing.
Presales gives you a great foundation for approaching investors – be they banks, wealthy individuals, or even your own money.
Better yet, the money you make from presales may reduce the need for investment altogether – which means less debt or that you keep more of your company.
It also gives you a higher valuation, since you can now prove that people want what you’re selling.
Investment vs Respite
At this point, entrepreneurs tend to feel conflicted about my suggestions.
They’re relieved that they don’t have to take on a burden, but they were also hoping that investment would somehow “free them up” from their current issues.
The truth is, investors hate uncertainty, and are going to factor it in to their decision making.
It’s probably better to remove that uncertainty in advance, since it’s cheaper, faster and teaches you more about your market.
It seems that what entrepreneurs really want is financial respite.
They’re sick of funding everything themselves, shouldering all the risk, being alone in the uncertainty.
The idea of investment sounds so appealing because it brings extra eyes, extra dollars, and a sense of assurance.
Unfortunately, investment itself won’t solve your problems, it tends to highlight and magnify them.
Perhaps you’re not really after investment, but rather a mentor, coach or advisor?
These people won’t give you money, but they will give you the support and guidance to remove the risk from your business.
Then further down the road you can hunt for investment – to support the sales, not to create of the sales.