Startup Mistakes: Premature Seed Funding
Is it possible to accept seed funding from an angel investor too soon?
Angel investors are accredited, usually experienced, investors who commonly provide seed funding for startup companies. If you are lucky enough, you may one day catch the attention of an angel investor. Then, if you are even luckier, the angel investor may offer you seed funding for an equity stake in your company (let’s assume the terms are reasonable). You would be stupid not to accept the offer from the accredited investor, right? Maybe not.
The startup world is extremely fast-paced, and entrepreneurs are under constant pressure to succeed. As a result, it is not surprising that numerous startups seek seed funding as early as possible. Once the opportunity presents itself, many entrepreneurs jump on it immediately. However, simply because an investor thinks your company is prepared for investment, it does not mean that your team and you are ready to succeed using the additional capital to reach the next milestone.
At the time of seed funding from an angel investor, your startup should have the following characteristics: (1) a minimum viable product (MVP); (2) a well-researched target market; and (3) a clear vision for the future. If not, trouble may be ahead of you.
Without the aforementioned characteristics, how devastating could this trouble be? I will illustrate that by telling you a story about TechCo, a startup company I used to know quite well.
TechCo
TechCo (I used a fake name for anonymity) was a software development startup in the Western United States founded by two incredibly intelligent individuals. The two founders, John and Jane (obviously fake names too), shared a vision that was oozing with potential, and they decided to work on it for 20–30 hours per week. Both founders had low living expenses, so they were able to support themselves rather easily by working part-time at a local business.
After months of designing and backend development, TechCo caught the attention of an influential angel investor, who requested a meeting to learn more about the company. Without a doubt, the angel loved the team and the potential of the software. Despite the company being at a very early stage, the angel offered a $50,000 investment at a pre-money valuation of $350,000. A condition of the investment was also for John and Jane to relocate to San Francisco to have more access to valuable resources, including the angel’s network.
After a week of careful consideration, the TechCo team decided that the opportunity was perfect for the company. Deal accepted.
San Francisco
The relocation to the Bay Area began successfully for TechCo, as the team was now able to dedicate 100 percent of its time to the company. As expected, software development continued at a much faster pace. In addition, thanks to the angel investor, John and Jane held weekly meetings with experienced software/technology professionals, some of whom joined TechCo’s advisory board.
Two months into development in San Francisco, the team finally completed the minimum viable product, and the focus shifted to customer acquisition.
Numerous problems ensued.
TechCo simply failed to test the market for their software. Even though the core idea was brilliant, a minimalistic version of the envisioned final product was not useful to potential customers at the time, and the project came to a screeching halt.
Luckily, John and Jane found a possible solution to the company’s struggles. TechCo could create a new product, which would be built using the framework established by the original idea; however, approximately 80% of the work would need to be redone. They were confident that the new MVP would be adopted by potential customers if executed properly.
Product development began once again, and around this time, John and Jane began to notice the bank account balance beginning to inch closer to zero. The team bootstrapped well, but certain expenses could not be avoided. Consequently, the new product development was rushed.
Running Out of Time
After calculating the company’s current and expected future expenses, the team estimated that TechCo had about 10 weeks to survive. John and Jane had less than three months to go, and the to-do list for TechCo consisted of the following: (1) complete a new minimum viable product; (2) acquire customers; and (3) seek additional investment.
How do you think it went for them?
The new MVP was functional, and a couple of customers began to use it as a part of TechCo’s public beta test. However, the MVP was too unrefined, and the company failed to attract more than one or two returning customers per week, despite numerous marketing efforts. Several investors showed interest, but an MVP accompanied by an unclear vision for the future does not exactly urge investors to write checks.
No money. Few customers. No new investors. The stress of the situation caused an incredible amount of tension within TechCo. John and Jane began to turn hostile toward each other; eventually, they could not be in the same room anymore. Not surprisingly, they decided to part ways. TechCo failed.
Bottom Line
Startups fail for numerous reasons, and accepting capital from an angel investor too soon can be a cause of failure. Before accepting capital from an angel, your company should be ready to grow. If you still need time (1) to build your product, (2) to research your target market, or (3) to develop your vision for the future, you probably are not ready to raise capital.
