Since 2004, our companies have worked with thousands of entrepreneurs raising capital for their businesses. Over time, this has provided us an incredible vantage point from which to observe how the most successful entrepreneurs prepare for approaching investors. We have also seen firsthand that there are many things most entrepreneurs don’t know about investors, but should. We’ve compiled a list of the 10 things every entrepreneur should know about investors to help prepare them for the process.
#1: There Are a Lot of Investors Out There
According to the Center for Venture Research, there are 8.7 million people who qualify as accredited investors in the United States. However, only a small portion of those people actively invest in deals (approximately 265,000). You may say, “Well, that sounds like a lot, but I don’t know any of them.” The key is to get out there and meet people, through introductions and networking. Your local business incubators can be great sources to connect with successful entrepreneurs and investors who are actively looking to back people just like you. If you need to polish those networking skills that you’ve neglected over the past months, years, or potentially decades, check out Michael Simmons’ Forbes blog that focuses exclusively on that topic, here.
#2: The Leading Investors by Total Volume are Friends & Family
Friends and family members are the largest investors in startup companies, totaling more than $60 billion per year. That is more than angel investors and VCs invest per year, combined. And this isn’t a trend that’s going away. There is a good reason for this too. It’s often your family and friends that want to support you in your success and bet on you before others are ready or willing. This is also a big reason why rewards based crowdfunding has become such a great way to raise capital at the early stages for entrepreneurs. It has provided a mechanism to help facilitate contributions through a personal network. Before, you had to call your uncle, sit down with him, and make an ask that was awkward for both of you. However, you can now send an email and he can back you for whatever he’s comfortable with, all without that awkward convo.
#3: Investors Will Expect You to Put Your Money Where Your Mouth Is
The majority of startups, about 57%, use personal savings & credit to help them get off the ground. On average, a startup team will put in $48,000 of their own money into the company. That means that most of the people raising capital out there are going to be able to show traction and commitment that will stand out against someone who hasn’t put any of their money into their own deal. In general, investors will want to see some of your skin in the game. After all, if you’re not willing to put your own money into the deal, what does that say to potential investors?
#4: Investors See LOTS of Bad Deals
The Kaufmann Foundation reports that 565,000 businesses are started per month in the United States. That is a lot of competition for capital; however, the majority of these ideas never move forward past incorporation or even launch a minimum viable product (MVP). So, the good news is that you can usually differentiate yourself quite quickly by generating traction and social proof. This can include things like getting a minimum viable product built, getting advisors, getting pre-orders, and attracting a skilled team.
#5: An Increasingly Large Number of Investors are Coming from the Crowd
Crowdfunding is the fastest growing source of startup investment, having grown more than 1,000% in the past 5 years, and expected to top $10 billion in 2014. As more people have access to potential deals, the inefficiencies of the investment market will begin to dissipate and there will be substantially lower barriers for both investors and entrepreneurs to connect. If you have a large support network and are looking to raise capital, this is the way to go.
#6: Venture Capital Investors are a Potent Source of Capital
VCs write the biggest checks in the startup ecosystem, with an average investment size of $2.6 million into seed stage companies. There are about 522 active venture capital firms out there and, in total, they invest in approximately 3,700 companies per year. However, VCs don’t write many checks to seed stage companies. According to the PWC MoneyTree Report, only about 2.7% of the $20 billion they invest each year is allocated to seed stage companies. Does this mean you should neglect those conversations? No. In short, it’s best to start your conversations early with investors so you can tell your story, tell them what you’re going to do, and then execute and drive results. This will help build a relationship of trust and help set you apart from 99% of your not-so-forward-thinking peers.
#7: Don’t Overlook Your Local Bank as a Potential ‘Investor’
Banks backed by the Small Business Administration (good old Uncle Sam, the investor) loan money to nearly 100,000 small businesses per year with an average loan size of $143,899.
Debt is primarily useful in the following situations:
With bank loans, you’ll be required to sign personally on the note as well as offer collateral for loans greater than $50K.
#8: By All Signs, Investor Activity is Increasing
Despite some of the doom and gloom out there, recent data from the NVCA reports that 2014 has been the biggest year for venture capital investments since the dot com crash in 2001. That’s good news for entrepreneurs. Overall positive sentiment towards investing in startups tends to translate to more press coverage and opportunities for entrepreneurs outside of the investment hubs to raise capital. It is also a good sign that the investment ecosystem is getting healthier following the 2001 and 2006 recessions.
#9: Your Industry, Not Your Business Plan, Can Determine an Investor’s Interest
Due to growth, activity, and exit opportunities, some industries are much more likely to attract capital than others. For example, the software industry accounted for 31.2% of VC investments last year, but retail and distribution accounted for less than 2%. One of my favorite quotes on this subject is from the co-founder of Flickr, which sold to Yahoo in 2005 for $50 million.
Working on the right thing is probably more important than working hard.
— Caterina Fake (Co-Founder, Flickr)
#10: Investors are Still Heavily Weighted Geographically
Unfortunately, if you’re looking for angel or VC money, where you live does still matter. Last year, for example, California companies raised $14 billion in VC funding, while companies in Iowa raised $5 million in VC funds, and 13 states had less than $10 million in funding. The good news is that this is changing. With the advent of the JOBS Act legislation and growth of crowdfunding sites like Fundable, investors and entrepreneurs are better able to connect despite geographic barriers. As crowdfunding continues to grow, it will have a substantial impact on the democratization of access to capital.
While raising capital can be a confusing and trying process, the important thing is to get started. As you go through the process, you’ll learn quickly. For more resources and tips on raising funding, I would suggest you read things like ‘The Process of Pitching Investors’ and get started crafting your own pitch, today.