How to Find the Perfect Investor
Introducing the Capital Opportunity Framework
Raising money is hard.
It’s hard if you have an innovative tech startup and it’s hard if you have a non-profit organization. Whether you’re appealing to prospective donors, pitching venture capital investors, or running a crowdfunding campaign, convincing someone (or, more often, lots of people) to open her checkbook and back your work is a tough slog with lots of rejection on the road to success.
When fundraising is so difficult to begin with, it troubles me that so many people make it even harder than it needs to be by focusing on the wrong targets for their appeals.
I’m unusually well-positioned to identify this matchmaking problem. For the past 20 years I’ve run a non-profit organization that, in addition to raising money for its own programs, also operates the largest fiscal sponsorship program in the country. In other words, I’ve had a front-row seat to literally thousands of funding appeals every year.
On top of that, I’ve recently transitioned into a new role as a venture capitalist with Exponential Creativity Ventures. In the last few months I’ve spent about 100 hours listening to scores of creative tech startups pitch us on angel or seed investments in their companies.
Setting aside the underlying quality of the ideas and execution, the number one fundraising mistake that I’ve seen in both of these contexts is approaching the wrong source of capital for the opportunity you’re offering.
One of the more memorable examples was the time a brand new theater company, founded by a handful of actors fresh out of NYU, tried to ask the Ford Foundation for a $4 million grant so they could buy a building and launch a school.
Or consider the arts organization that wanted to raise venture capital dollars for an avant garde art project that they acknowledged had no prospects for revenue or growth beyond an (admittedly cool) initial exhibition.
Then there were the myriad business startups that wanted to raise charitable dollars for their unambiguously commercial projects (e.g., sitcom pilots, mainstream pop music albums).
These are just a few of hundreds of examples that I’ve seen over the years. They make me cringe, not just because the appeals themselves are embarrassingly inappropriate, but also because the projects themselves would be 100% totally fundable with the right sources of capital!
The number one fundraising mistake is approaching the wrong source of capital for the opportunity you’re offering.
With this problem in mind, I decided to create a simple new tool for thinking about capital-opportunity matchmaking. It’s called the Capital Opportunity Framework.
The Capital Opportunity Framework plots a source of capital funding based on two basic variables: risk tolerance and motivation.
If you understand (1) where your work lands on this chart and (2) how these factors apply to a given source of funding, then you should have a pretty good idea of whether it’s worthwhile to make your pitch.
To be clear, these two variables by themselves are not enough to determine what might attract money from a particular source. The framework presumes that there is already a fit based on content filtering and dollar amount. By that I mean that you’re talking to a tech investor about a tech company or an environmental funder about a conservation project and the amount of money you’re looking for matches what the backer is able to provide. But risk tolerance and motivation are fundamental factors and the biggest pitfalls so they’re the focus of the model.
Let’s try some examples:
Foundation — The primary job of a foundation is to give away money to charitable organizations so they can do their work. Not only are they not motivated to make money from their grantmaking, but there are even legal prohibitions against doing so. As such, a foundation’s grant programs generally have a strong non-financial motivation. But what about risk-tolerance? I’m not talking about financial risk — they know with certainty that 100% of the grant is gone and not coming back — but about the risk of success or failure based on the goals and metrics of the work itself. Many foundations talk about supporting “responsible risk-taking” by their grantees and being comfortable with the possibility of failure. (This is, in fact, how they should behave.) With very few exceptions, the reality is quite different. In my experience, foundations tend to be extremely risk averse in their grantmaking. There are lots of reasons for why this disconnect happens, but they’re beyond the scope of this post. For now, suffice it to say that this is where most foundations land on the chart:
Individual Donor — Every individual is different, of course, but donors are similar enough that we can generalize for present purposes. Like foundations, donors tend to be motivated by non-financial factors. (Note that these may be totally different from the motivations driving a foundation’s grantmaking! In particular, individuals tend to be more motivated by the social capital that derives from philanthropy, as compared to foundations that generally have formal priorities and strategies. Regardless, neither expects a direct financial return from their contribution.) Many major donors, however, owe their wealth at least in part to entrepreneurship, and therefore have a higher intuitive comfort level with the risks that new ventures must take to succeed. In my experience, they’re near the center of the risk tolerance axis, with a slight bias toward risk aversion.
How about a bank loan? We have now exited the world of philanthropy and are dealing with a source of capital that is entirely motivated by financial reward. However, a loan officer’s first responsibility is capital preservation (i.e. minimal defaults), so they tend to be very risk averse.
Okay, let’s find someone for that top-right quadrant, which is the land of startup investors. Both angel investors and venture capitalists live there. The differences between the two are matters of degree. Compared to professional VCs, angel investors invest earlier (i.e. when a new venture is riskiest) and are often motivated partly (even if unconsciously) by non-financial factors (e.g., a personal relationship with the founder or a desire to be affiliated with some cool new technology).
You get the idea by now, so let’s go ahead and plot a few other common sources of capital — crowdfunding backers, impact investors, and corporate sponsors:
Boy, that’s a lot of empty space down in the lower-right quadrant! That’s not because I ran out of time; it’s because this is a serious gap in the capital markets. However, I am aware of one category of funding that is both highly risk-tolerant and motivated entirely by non-financial goals: federal research agencies. When DARPA, NIH, or the like makes a grant to support a research project, they often do so with the explicit understanding that they are facilitating important, moonshot work with huge potential to benefit society but so much uncertainty that private philanthropists won’t touch it.
So what’s the point of all this plotting and graphing? It’s a waste of scarce time and energy to focus on the wrong quadrant for your business or organization. Beyond that, it’s probably worthwhile to study a prospect’s past activity in detail to understand with even more precision where they fall. Once you’ve done that, you can target your appeals at the funders or investors who are most likely to match your own risk/return profile.
It’s a waste of scarce time and energy to focus on the wrong quadrant for your business or organization.
Plotting the sources of capital is only half of the matchmaking equation. You also have to know where your own project or company lies. That means answering two questions with complete intellectual honesty:
- If I succeed, what will my supporters get as a reward? Money? Prestige? Mission impact?
- How likely am I to achieve that success in reality?
If you can answer those two questions, and you understand the motivations and digestive fortitude of your prospective backers, then you’ll never again waste your time on a hopeless appeal.
Now let’s revisit those poor misguided souls from a few paragraphs back:
The Brand New Theater Company with Big Ideas — Outside of Broadway and Las Vegas theater is a money-losing enterprise, but these guys are starting a school, so let’s focus on that. An acting school can make money, especially in a market like New York. However, even a wildly successful school won’t have the scale that a venture capital investor needs to see. Angel investors might be a possibility, if they can find some with enough of a personal connection that they have a bit of non-financial motivation as well. Under the right circumstances a crowdfunding campaign could also work. The tricky part here is the risk. This isn’t a super risky business, but there’s a lot of team risk, since they’re first-time entrepreneurs with no formal business education. Unfortunately, that kind of risk tends to drive away investors, since it doesn’t result in a corresponding increase in return expectations. As such, I would advise them to start small, build a track record over a few years, and then start looking for some individual investors to fuel a reasonable growth plan.
The Avant Garde Art Exhibition — This one’s guaranteed to lose money, so investors are off the table. The organization has a strong track record of success, however, so there’s relatively little risk that they’ll pull it off. Foundation grants or individual donors are a definite possibility. Corporate sponsorship could also be worth pursuing, depending on whether the exhibition is likely to attract enough attention that there could be some indirect financial benefit to the sponsor.
The Commercial Media Startups — These projects all intend to make money (and to prioritize making money over making “art”) so charitable dollars are not a good fit. Risk is a little nuanced. There’s very little execution risk; with enough capital, the film/album/pilot will surely get made. But there are no guarantees that it will find a big audience at that point, so there is a lot of financial risk. Assuming the team has something of a fan base, a crowdfunding campaign could be the right approach. Crowdfunding backers care a lot about whether or not a project will happen, but generally expect nothing beyond that. So for them, this is a relatively low-risk investment with exactly the right return (i.e. a front row seat).
It’s anyone’s guess whether or not these misguided souls ended up finding the right capital opportunity matches to launch their ideas. I’m hoping they did, but if not, then at least they’ve made for a great teaching tool!
Adam Huttler is the CEO of Exponential Creativity Ventures, an investment firm supporting startups at the intersection of technology and human creative capacity. Prior to launching Exponential Creativity Ventures, he founded and spent 20 years as the CEO of Fractured Atlas.