Discussing “Chapter 9 of The Founder’s Dilemmas” by Noam Wasserman

Written By Lance Hillis

Financing Your Startup

There are many ways to finance your startup, with varying degrees of challenges, sacrifices and degrees of need. The option that retains the most equity and control is to self-fund; however, most founders don’t have this luxury. That said, 77% of founders use their own cash in some capacity to supplement the growth of their business. One of the options not discussed as self-funding in Wasserman’s “The Founder’s Dilemmas” are through debt, or bank loans. This is due to his focus on tech and life science startups, who are high-growth potential startups, which represent a much larger risk profile for banks, which he reaffirms as only 2% of startups in his dataset used debt financing. Banks are also not in the business of taking equity stakes in companies in exchange for loans. In Lara Vukelich’s article regarding SBA vs. conventional loans, she explains that conventional loans are the most common offered to businesses, and are entirely funded by the lender, as opposed to the more competitive SBA, or small business loan, which is funded by the government through a guarantee, and carries a lower interest rate than the conventional loan. This guarantee is between 50 to 90% of the loan amount, and up to $5 million. SBA loans also have repayment terms of up to 25 years, while conventional loans have terms of up to 10 years.

Self-funding, especially for a high-growth startup, may not be an option either. There are scaling dilemmas, better funded competitors, and a litany of other considerations that make self-funding not the optimal choice for everyone. When it comes to external financing, family and friends are the most likely to provide some financial support compared to angel investors, and especially venture capitalists. However, many people do not want to risk this, as these risks relationships being strained if the business is not successful. One CEO argues, if you know with a high degree of certainty that you’ll be able to pay that money back from your family and friends, take it. If you don’t, you probably need to rethink your process. Sometimes, you don’t have the luxury of not taking this investment. Scott Cook, the founder-CEO of Intuit, had pitched to 25 investors unsuccessfully, before giving in and taking money from his friends and family, including his parents’ retirement, co-founders’ friends, and maxing out his personal lines of credit and life savings. Cook was then less motivated by passion, but rather by fear of disappointing those who had invested in him, and carrying this enormous amount of personal risk in failure.

Angel Investors, on the other hand, may take a larger portion of equity and require a member on your Board of Directors; however, they will likely have valuable input and bring forth experience that your friends and family don’t have. For angel investors, there are many factors in play that differ from investments from your family and friends. Typically, angel investors are much more financially motivated and act as a farm system for early startups, linking themselves to founders before they go into later rounds of funding with venture capitalists. They are also much more difficult to get on board, approach, and gain their trust than family. According to Wasserman’s data, 58% of angel investors are put in touch with founders through a mutual contact, while less than 11% were put in touch through cold calls or a service provider. Now, founders can often fund a much larger amount of capital through angel investors than friends and family, and act as an intermediary between them and venture capitalists, with an average of $450,000 raised per company. Additionally, angel investors are usually only apart of the first round of funding, but may fund additional rounds, and are typically the contact that introduces a founder to a venture capitalist. While VC’s are also generally more well known, angel investors fund many more investments per year.

Usually, the last stop in the road (and usually after previous rounds of funding) is through a venture capitalist. Venture capitalists are typically a partnership between limited partners, such as foundations, university endowments, and pensions, who focus on capital intensive, high potential startups (typically in the life science and tech industries). While they may provide larger amounts of capital, this usually comes at the cost of control. The loss of control comes in the form of extra equity versus angel investors, majority board control, and complicating exit plans for founders. Founders typically give an additional 10 percent of equity when partnering with VCs, and sometimes even more with more prominent VC firms. However, there are a number of benefits you can expect through partnership with venture capitalists. Many VCs invest with the intention of multiple rounds of investment (stage a, b, c+). Founders also report more professional procedures implemented throughout their partnership, and even with the larger equity stake taken by VC’s, companies will hold out or partner with VC’s as they receive higher initial valuations when going public.

Reflecting on Potential Investors in my Business

Upon reflecting on all of the various investment vehicles for my business, I can immediately rule out a few. I’ll likely avoid friends and family, for a couple of reasons. I don’t come from any sort of wealth. In fact, I’m probably the wealthiest of my extended family, which is not a fruitful sign. On the other hand, my wife’s family has some resources, and many of them are industrious. I don’t think I’m currently confident enough at this immediate moment to work out an investment arrangement with them, but I could definitely see a few of them in an advisory role. Next, it likely doesn’t make sense to work with venture capitalists. Buzzkill is not a tech or life sciences business, and likely not a capital intensive or high-growth potential business. It’s a high-fidelity earplug distributor. We’ll be working with smaller margins on merchandise for a very niche product. There would likely be no reciprocal interest in a partnership.

Now, the more likely financing options begin with self-funding. One of the reasons I found Buzzkill to be a feasible business was its supposed low cost of entry. I purchased my initial wholesale order of 500 for a reasonable amount of money. The thought was that I could cash flow easily with a handful of established customers since the net margins were good, so I self-funded. I used my personal credit for branding and package design, a Shopify subscription, manufacturing, packaging and a number of various expenses. Then, I received my first order, which revealed a number of issues with branding, package design, and font that I didn’t think looked professional enough and e-commerce regulation on packaging requirements that I hadn’t known about. I’m pretty risk tolerant when it comes to investing, but to fix the issues I knew I’d have to correct before moving forward with any sales would immediately double the cost of what I’ve spent to this point. I had also wanted to improve upon the product packaging, moving from cardstock packaging to tin, which I thought was instrumental in differentiating myself from the competition. However, these improvements would cost more per unit, and opened up a new set of issues such as scratch resistance on the tin paint, EVA foam die cast carving, etc. While the possibilities excited me, the capital wasn’t there to work through mistakes repeatedly. Rather than exhaust my personal line of credit moving forward, I’d likely pursue a bank loan. This would provide adequate capital with defined and predictable terms, while I work through the various issues I may run into.

Next, are angel investors. With the potential to scale Buzzkill nationally and internationally through music venues and retailers across the planet, having an angel investor would be a feasible option. According to Joan Corwin in this CGAA article, angel investors provide up to 90% of outside equity raised by startups, excluding friends and family. I would weigh the risks and benefits between bringing on an angel investor versus taking a conventional bank loan with serious contention. First of all, I can sell an angel investor an equity stake in Buzzkill, which completely eliminates the debt I would acquire through a bank loan. Next, an angel investor would provide substantial network benefits to other investors and business owners, who would expand the growth of Buzzkill. However, between Asheville not necessarily being the Silicon Valley of the East Coast, Buzzkill being a traditional B2B merchandise distributor, and the difficulty that it takes to build trust and even get an angel investor on board, I’ll likely put extra thought and consideration into financing through debt.