(Links to presentation, video, blog, and event feedback here.)
In our 15th TechTea, Luboš Vopasek gave us a clear-headed view of the essential, yet often misunderstood and inflated world of startup financing. If you’re dealing with your own startup, or want to better understand how mistakes are often made with financial decisions, this piece and accompanying video are a good start.
Angel phase
Here you define your idea, validating with potential users. With the first money you raise, you will create a prototype to show to investors. At U+ we deal with this by making clickable prototypes, which are a great advantage when you get the chance to meet an investor.
And so you were able to get the attention of people with money — now what? Founders often underestimate questions that investors will ask them. They may have a great idea, but they are unclear on how they are going to get people to pay for their great idea. It’s good to be positive and enthusiastic, but remember to keep it real. Do your market research to make sure you understand what percentage of the market you could be taking up, but be wary of the following mistakes:
Financial mistakes made by new entrepreneurs
(Video).There are too often no contracts in the early phases, which causes blurred lines in agreements between partners. Maybe they finance it on their own, but the casual nature of an early-stage startup can lead to legal grey areas that can come back to bite you down the road. Aside from legal stuff, it helps to clarify roles and ideas and anticipate future problems. Look, people always roll up their sleeves and take on multiple roles in the early stages, as they should, but you should make sure this doesn’t lead to destructive confusion within your company and when trying to inspire confidence in investors. The more financially and legally sound your early setup and model is, the better for obtaining the trust needed from investors. This is especially true if your pitch contains inflated projections of how much you’re going to crush the competition in the future.
People rather unconsciously use something that can be called illusionals. During planning and pitching, they don’t have the right idea of how much of the market they will take up. They promise investors they’ll get 1% of the market, when they don’t realize 1% means millions of clients, so their business plan and strategy is unrealistic.
Another problem is that many pitch decks just assume that people will buy or use something and don’t consider the distribution channels as much as they should, which, in this oversaturated economy, is something that every company struggles with.
You assume people will pay X. Would you pay X? Really? Take a hard look at your startup and ask yourself how it would be if you were the user. How much would you personally pay? You are probably not that different from the average prospective end user. Create a business plan based on this.
Thought experiment
If you want a more in-depth look at a how a hypothetical, problematic startup might realistically present itself, Luboš offers a rundown in this video.
Seed phase deliverables and mistakes
(Video). Having an MVP (a minimum viable product) to sell here is crucial. You might have a flawed product, but this is the first time at least a few users will actually pay for it. You also need a sound business plan and a fully dedicated and motivated team of full-time employees.
In the MVP stage, the founders often start to make a lot of changes or crucial pivots. This is kind of risky. In many cases the founders want some catchy new features in the MVP and don’t understand that ‘M” stands for “Minimum”, and they start to demand a lot of extra features and they run out of time and budget. Conclusion: it’s better to have something more functionally complete and less ambitious and vast.
You might think lack of interest in your product is a lack of marketing. But your test users need to be presented with a useful product to fill their needs, so don’t spend a lot on marketing until you’re sure you’ve got something good that users actually want to use.
Think big but keep your feet on the ground
The exaggerated optimism of founders leads to inflating of expectation of investors with an incorrect growth schema. This breaks down the trust between you and investors.
It might be surprising to hear, but many times founders highly underestimate the cost of their startup because they don’t realize that if they are successful, it will require, for example, more team members answering phones and bigger teams, marketing, accountants — more of everything. To prepare for the happy chance that your startup does succeed, you need to conceive of a detailed plan for your potential growth.
Finally, startups often don’t understand the implications of their valuation. People think that the number arrived at is actually the value of the company, but it isn’t because it’s based on estimates and assumptions or is simply the result of a negotiation compromise .
Fundraising valuation myth
Remember, valuation is all on paper. It’s important to be aware of the hypothetical. You might have a business plan that projects your startup as a billion-dollar enterprise a few years into the future, but don’t let it get to your head: in reality your value is still basically zero.
Series A/B financing
The point of this stage it to get the first big investment in, hopefully, millions of dollars, and move you into the realm of a serious business as you get funding from more traditional or conservative sources. Here you should be seen as less risky by investors. You should have a growing client base, and if you’re not exactly turning a profit, your profit-loss factor should be under control.
