Many entrepreneurs are faced with a classic dilemma as they finance their emerging companies: How do you raise needed capital for growth without giving away too much equity (ownership)?
I am aware of two local businesses that are in the process of raising funds for their emerging firms. One is a relatively new startup that needs $500,000 to finish its product development. The other is a more mature organization that is looking for $4 million for market expansion. The newer firm is prerevenue (no sales to date) and faces the challenge of a low valuation, as the investors are worried about how the market will ultimately perceive the product and how fast the company will be able to gain traction, to build market share and create a sustainable cash flow.
The second company will most likely need to raise additional funds beyond the currently needed $4 million as it attempts to become a major player in the Internet market and, therefore, cannot afford to give away too much equity at the current time. The owners know that a further round of equity dilution will lessen their equity stake.
What are some of the strategies that a firm can employ to reduce the need for outside capital and the resulting dilution in ownership while not sacrificing the ability to fund a plan for aggressive growth? Following are four ideas for the emerging enterprise:
Build prototypes and experiment in the marketplace: This will produce valuable information at a lower cost than would have occurred in a full-scale rollout. In technology companies, a beta version of the product allows a few users to experiment with the product prior to the company making a major and costly release in the marketplace. Contacting a small percentage of customers through a mailing, the Internet or in a direct-sales effort will allow you to test a marketing plan prior to making the commitment for a costly marketwide campaign.
Change fixed costs into variable costs: In today's "flat world," entrepreneurs have several options to create variable cost opportunities including using sales representatives vs. hiring full-time sales people; outsourcing production to other firms for manufacturing as opposed to building production capacity and acquiring equipment; and for high-tech firms, contracting with outside programmers (sometimes in foreign lands) versus hiring technicians who might need to be laid off at some future date. The advantages of this strategy typically includes a reduced time to market, ability to cut costs or to rapidly change and adapt to movements in the market, an ability to minimize up-front resource requirements and a reduction in the cost of failure if the company needs to change direction.
Raise outside funds in stages: Acquire the money as you need it. Each time you raise equity capital, you will be required to give away some ownership. The more progress and traction in the marketplace and with your product, the greater the valuation that you can expect on the next raise.
Accept the fact that you will need to adapt: Develop the attitude that you will make mistakes. Most businesses will adapt both their marketing and product strategy within the first six months after funding the company. Too many entrepreneurs hang on to a failing strategy too long, draining the resources from a new enterprise.
Another common problem is assuming that the product must be 100 percent complete before taking it to market. Allowing innovators and early adopters to buy the product will not only give you some early revenue but will also be an invaluable source of market intelligence as you adapt to the ultimate buyer.Using these strategies may have two noticeable impacts on your company. The first is to reduce the amount of needed capital. The second lies in your ability to delay the need for capital without hampering your growth. Both will help you hold on to your equity!
Gary Williams is affiliated with the BYU Center for Entrepreneurship. He can be reached via e-mail at firstname.lastname@example.org.