Capital is the lifeblood of companies, especially in the early growth stage. Unfortunately, too many entrepreneurs have been given a limited view of what are the best ways to get financing for their companies. Especially in a time of economic downturn, when equity financing might be scarcer than it was during the end of the last cycle, it’s more important than ever for entrepreneurs to understand their options and make fundraising decisions that are in their financial favor.
Here are a few of the biggest myths about equity financing, and why entrepreneurs need to ask some tough questions to make sure they’re getting the best possible deal when raising capital for their companies.
Myth: Equity financing is the only way to get capital for your business.
Reality: There are other options to raise capital besides equity financing. You don’t have to give away equity in your business if that’s not the right fit for your goals; instead you can raise venture debt, royalty financing, convertible debt or a myriad of other structures that may be better matched with your goals. If more companies thought this way, there would be fewer blow-ups (like Wework) that come from misaligned expectations between founders and investors.
Myth: Equity financing is necessary because startups are so risky.
Reality: In the early days of the tech startup boom, VC investors were often backing unproven, high-risk/high-reward technologies. That was the 1980s. Today, the venture industry has grown to over $140B invested in the US each year – that is 10x bigger than the industry was in the early 2000s! As the industry has grown, investment risk has shifted from financing research and development to financing more traditional areas of a business such as sales and marketing or inventory. These are areas that can be financed non-dilutively.
Myth: You need Silicon Valley connections to get equity financing.
For years, the equity financing process has been somewhat mysterious and often seen as unpredictable. Entrepreneurs have often been prompted to approach the process as if they should be grateful to be in the boardroom at all and that if they don’t have Silicon Valley connections, they won’t get very far with raising capital.
While it may help to get a meeting if you have the right connections or are in the Valley, smart investors today are funding companies based on business performance data, the quality and expertise of the founding team, the company’s big idea and the business’s potential. Today’s capital allocation process is modernizing to become more about businesses getting funded based on their performance and potential, not the color of your skin, what you look like or where your company is based.
Myth: Having a high valuation is good! Everyone wants to be a unicorn!
Reality: Having a high valuation can have some big risks and downsides. Sometimes a highly valued company’s founders will start believing their own headlines and lose discipline and focus, or the company will turn out to be overhyped and overpriced, leading to rapid dilution and financial pain. Some companies are better off moving under the radar without the attention that comes from being a unicorn. Raising too much equity financing at too high of a valuation can sometimes take away a company’s options and make it harder for the company to make smart strategic moves and grow.
~Novel Serialisation: Heavens Fire~
If your company is in the early growth stages, don’t assume that equity financing is the only solution to help you grow. Equity financing imposes costs and risks upon your business that other forms of capital do not require. Don’t give away too much equity for too little in return – afterall, the average company in our Capital Machine pays over a 50% cost of capital for equity. If your bank charged you 50% on your credit card, your banker would be in jail. Know the facts, know your options, and own your power as an entrepreneur.
What are some lessons you’ve learned about raising capital for your business? Leave a comment and let us know!
By Blair Silverberg, CEO, Capital
Blair Silverberg is co-Founder and CEO of Capital, a financial services company using technology to accelerate the fundraising process. Prior to founding Capital, Blair was a principal investor at Draper Fisher Jurvetson where he sourced and managed venture investments during his four-year residency.
