When to take the seed – Answer the “knowables”

A question I often think about is when to take outside money. It can be tricky. Taking other people’s money, no matter from whom it comes, entails a set of risks and responsibilities. Furthermore, once you take money, your venture is “on the clock.” That said, ultimately you need to fuel the tank to accelerate the business, hire top talent and be legitimized in the eyes of prospective customers and partners.

So, the question becomes how to decide when to pull the trigger and raise seed money?

Before taking anyone else’s money, I like to identify the short term “knowables.” In other words, what key pieces of information can be understood in a matter of weeks or months with effort, without too much capital, and in most cases without leaving one’s primary employment. I think typical start-ups have a handful of knowables – say 3-6 key ones that can validate the business hypothesis. If you can’t think of any in the short-term or have too many, the business may be too risky. Most knowables should cost less than a few thousand dollars (if anything) and take no more than 3-6 months to answer.

As an example, a company I’m advising needed clarity around if/how its product would be regulated by government. (you may be thinking … talking to the government … that must take decades … not so!) First we ventured out to find the most capable regulatory advisor we could find with strong knowledge of the area. We contracted for a limited engagement and spent only a few thousand dollars. Amazingly, in just a few weeks, we had an email exchange with the exact people in government that will regulate this product and got the information we needed. While there remain long-term risks (unknowable’s), we now have information directly from government that clarifies our capital needs, timeline and data requirements.

There are many types of knowables. Some knowables are business development related. For example, some upstarts will want to know that they have a critical beta-test partner lined up from the start. Other short term “knowables” involve relatively straightforward web experiments that test customer adoption, web marketing tactics, click through rates, or pricing. 

I advise start-ups to answer the knowables before taking money. There are too many examples where a start-up took capital only to hit a roadblock that could have been identified early and cheaply.

Due diligence for the entrepreneur

The question I’m most frequently asked (and most frequently ask myself) is how to validate and size business opportunities. Is a particular start-up or concept the next Google or doomed for failure?

I’m rather lucky. I’ve been able to spend the past year or so acting as entrepreneur, angel investor and early stage VC at various times. I think one’s process depends on whether you’re an investor building a portfolio of bets, or an early employee or founder with a portfolio of one.

First the similarities …

Evaluating businesses at its most fundamental level is really an exercise in understanding, measuring and trying to minimize risk. I’ve often said that entrepreneurship is like having 10 playing cards all face down, with the goal to turn as many over as quickly and cheaply as possible. It doesn’t matter if you’re an investor, entrepreneur or thinking of joining a young company.

In all cases, one must assess the ability to raise investment from quality investors. Capital is the venture’s fuel and the fuel has to be high quality and most importantly, you don’t want it to run out. Additionally, it’s important to feel that you’re being rewarded for the risk – the equity received should correspond to the level of risk in the venture. This can be hard to quantify, but there are some rules of thumb that experienced entrepreneurs and VCs use. Trading off some amount of equity for lower risk is generally a good idea given that the nature of start-ups is inherently risky.

Market size is also important, but can be elusive. Simply put, the venture should be attacking a hard and large problem. All ventures are hard, so if you’re going to invest money or “sweat equity,” you better be going after a significant opportunity and not an incremental innovation. I gain comfort by talking with folks in the target industry and making sure their eyes light up when I talk about what I’m doing.

People. So much of the success of a start-up comes down to the team. Does the team have a track record of success? Does everyone bring different skill sets? Does the team have good chemistry?

And the differences …

Time. My experience having founded 2 companies is that it can take many months (or more) to validate a business plan. An investor or employee can make a decision in a week with only a few calls, but the entrepreneur should make at least ten times as many calls. The entrepreneur needs to become an expert in the field in which he/she is thinking of entering.

As an investor, you can rely to some extent on other’s research. As an entrepreneur, you have to do all of your own research. You should hear directly from end customers. You also need to candidly assess whether your previous experience and your own skill set enables you to be uniquely valuable to the venture. In essence, you should feel as though joining the company improves its probability of success.

Finally, there’s the big intangible difference between investing and operating. As the operator, you have to wake up every morning and spend all day working on a single cause. To be successful, you have to believe in the mission. Without passion, it’s not worth it. Like much of life, wait for your spot. But when you find it, jump in with both feet.