Whenever you invest money in anything you are of course looking to invest in something that will increase in value (or in the worst case, won't lose value). Most any investment involves some risk which as an investor, you attempt to minimize.
Mapping those ideas to start-up investors they manifest in familiar ways. For example, you'll often hear founders complain that they can't get investment because they have no traction and that they can't get traction because they need investment. Well, sure. In investor terms we could re-word this as, "You might have an interesting idea. And you might be the right person/team to execute it correctly. But I can't tell, and I'm smart enough to know I can't tell. But if you had traction then at some level, you've proved all that stuff. You'll have then taken out a lot of the risk associated with this investment."
|Again as an investor, you're trying to buy value that you're betting will increase. No matter what though, it is of course a bet. As a founder, you are selling some of your company, but you're also selling some of that risk. If you raise money you can start drawing a salary, build up the team, and overall increase your chances of success.|
If you're thinking of growing on revenue alone, the road is surely much harder. Sure you own the whole company and thus own all the upside, but you also own all the risk. Even a few hundred thousand in the bank can make a lot of little problems go away. And sometimes, enough little problems can kill an unfunded start-up.
The primary reason I hear someone not wanting to raise money (by the way, not being able to raise money is wholly other topic I'm not addressing here) is that they don't want to be diluted on their big idea. I think they're looking at things the wrong way.
Assuming your big idea is pre-product or pre-customers, then as far as companies go - that's all it is, a big idea. At that stage, those entrepreneurs were worried about dilution of something that currently had no actual value. I imagine what they meant when they said that was that they didn't want to be diluted once their start-up hit it big. Because who cares right now, diluting zero is still zero.
The question I usually pose next is to ask "What in the best case (but realistic) scenario will your start-up sell for in a few years?". Let's say that number is 100 million dollars. If you're a sole founder (which has it's own host of problems that lessen the chance of this great outcome) you still know you'll probably need some help to get there, so you will dilute a bit for some employees. Let's say on that grand exit day you still own 90% of the company. Hence, ignoring taxes, you get a cool 90 million. Nice. The day after that you buy your Bentley, a couple of drones, and spend probably another million on things you thought you always wanted. Great.
Let's consider the other scenario. Let's say you take some investment. Let's say you take a million or two in reasonable deal. Let's say you give up 33% of the company for that money. Again by the way, the investors will insist on a 10% option pool for employees so you get diluted 43% total. Wow, that sounds devastating. And compared to your original 90%, it surely is.
But hey - remember our cool outcome? Our blue-sky exit is happening at 100 million. Between monetary support and your investor's connections, this outcome was likely to be more likely. Instead of 90MM however, you only get 57MM. Ouch. Usually while the entrepreneur I'm talking to is now wincing at all the pretend money they lost, the question I ask next is "So as far as life change goes, how does 90MM change your life differently than 57MM?". Surely, large sums of money will change your life. But at these levels, would 90MM fundamentally change your life differently than 57MM ? Would you just get the base-model Bentley (is there a base-model Bentley?) at 57MM where you would have at 90MM? I find it's hard to pinpoint big exit numbers where reasonable dilution changes the fundamental outcome to your life.
That was the deal. You sold some risk, you sold some value, and its not unheard of that you made a darn good deal. What you sold helped the endgame. My point is that at least at an initial round of funding, the amount of dilution you are likely to experience does affect the numbers but it is marginal in the affect it will have on you.
When you have no investors, you own all the risk. When you get some, you've sold some of the risk. That's the game. Well, at least on your side. For the investor, before they invest you own all the potential value, after they invest, they bought some. Two ways to look at the half-full glass.
Taking investment allows you to take a salary. There goes the obvious part of the risk you've sold. Secondly, you've now proven you are funding worthy. That's a big point - if no one will fund your start-up idea, that should tell you something. Great ideas rarely happen in a vacuum. Being rejected by 10 different investors will invariably gain you useful feedback. Any investor will tell you that it's ridiculously hard to pick winners. But as it turns out, dead-to-rights losers aren't that tough to spot. You don't need to be a great poker player to spot bad poker.
Simply exposing your idea during pitches will shape your thinking going forward by people that see the industry in a bigger view than you. Will they steal your idea? Heck yes they will. And guess what - you stole your idea from someone anyway. You got your idea by seeing 2 or 3 or 5 synergies among disparate products that formed something you feel the world needed. Sadly, you're not special. A hundred other people had the same idea you did at the same time you did (and 1000 slightly less clever people will have it next month). Of those hundred, 95 are busy off doing other things, 5 of them however are now just like you. Thinking about how to execute on it. Two of the 5 have strong VC connections and having coffee with them tomorrow. You are already behind.
If a few of those other 5 got funding, you won't know about it just yet but they're going to eat your lunch. Not because they are smarter, or faster, or better looking than you - but because they have breathing room. Room to tweak, try, experiment, and fail. You're out shopping for Ramen value-packs while they have 5 engineers trying slightly different tangents trying to find the perfect recipe for users. Of course, you might find it before them. It is after all a game of statistics fraught with luck and peril. But their chances are better.
Now keep in mind, most of the above discussion is about when things go great. I started there because that's where entrepreneurs start with me but the usual case is that things don't go great. Things usually go bad. Selling some of that risk should sound even better now.
If you don't take money and things go bad, you simply fail. You shut the doors and walk home. Now of course failing fast should be a skill you get good at. It's critical to your success, but if your idea did have merit and you were simply hitting it at slightly the wrong angle, you'll never know. A few educated people with skin in the game might have steered you into a better direction. They might have helped you pivot to somewhere that worked. They might have been able to make a few calls to prospective partners or customers that put you on the right track. Of course they might not too. They might be utterly worthless but at a minimum, you and them are in this together for better or worse.
Money or no money, it's more likely you're going to fail than anything else. With no investment you simply cower back into the shadows. No one will have ever heard of you or your company and you'll get zero credit for trying what you did.
With investment your resume now says you previously got an investment for idea, tried it, and you're a big fat failure. As it turns out, future investors often find the fact that someone previously was willing to bet on you more interesting than the fact you went off and blew it. It seems amazing how someone can go out and blow millions of someone else's money on a failed start-up then get investment immediately when they go out to raise for their next try. In a way though, there's some sense in there. Investors truly have little to go on for a new pitch. A track record that at some point in the past someone believed in you (the real investment product) enough to invest in you says a lot.
This other reason I hear for not wanting funding is that you could get screwed. You could pour your heart and soul into this start-up that you love and have it all taken from you. Yep. Could happen. Does happen. Happens all the time.
Most cases of this however is when things are going bad - or at least not great. A high percentage of CEOs are removed by their investors at some point. Surely that CEO is rather upset but for the health of the company this isn't always a bad thing. Truth is, most anyone is capable of being a CEO of a fledgling start-up. A good portion of those people suck at it if things get moving or if things start to falter. This isn't terribly surprising, every person starts out with zero experience at being a CEO of a fast-growing company. You might learn it on-the-job fast enough, you might not.
Getting ejected as CEO won't make you happy, but hopefully it happened for a good business reason. As the saying goes, do you want to be rich? Or, do you want to be King? If your board thinks someone else could do a better job than you, they might just hate you - or maybe they really do care about their investment.
Bottom line for me is if you're dead set on not taking money make sure your reasons make sense. Getting investment in your company brings an incredible level of validation to your company (and you), not to mention better odds, better ideas and more resources. At the end of the day you're not selling part of your napkin-idea'd company, you're simply selling risk. And who wants to own too much of that?