Startup 101

To Fund or Not To Fund

Many startups don't need funding; but if yours does, do your homework.

• By Patrick Foley
• 07/08/2012

Why to Get Funding
Let's get one thing straight -- you do not need funding to create a startup. There are countless successful startups created with no outside funding, and many of the people I respect most use this "bootstrapping" approach. I have many friends who built startups on nights and weekends while working a full-time job. When you build a startup "on the side," your full-time job is essentially funding your new business. There's nothing wrong with that, so long as you follow the policies of your employer and don't cheat them out of being the employee they deserve.

If you have an idea that can get to revenue fairly quickly, bootstrapping is probably the way to go. If you want to go that route, then read everything you can by my heroes Rob Walling, Jason Cohen, Patrick McKenzie, Ash Maurya, and others who teach you how to roll up your sleeves and Just Do It.

The fact that many startups can be built this way does not imply that all companies can be built this way. Building a microchip fabrication plant requires many billions of dollars -- I'm not sure even Mark Zuckerberg could start a new microchip business on his own.

Hardware is obviously harder to bootstrap, but when is it difficult to bootstrap a software company? The short answer is when you don't have a quick path to profitability. If you read TechCrunch, you'll notice countless stories of companies getting funded, some of them very early stage, some later. The early stage ones often need funding for the simple reason that they require a fair amount of resources just to get to meaningful revenue.

Later stage financing is easy to understand -- the job of any startup is to achieve "product market fit": to reach the point where your product fills a hole in the market so clearly that all you have to do is let the market know about it via your sales channels. When you know that every $1 you spend will return $1.20, why not spend $10 million or more? You've created a money machine, and it's time to grow. That's what later stage financing is for, even if you bootstrapped your company to get to that point.

Early stage funding (often called seed funding) is trickier. It's very possible to have a great business idea that takes a while to get significant revenue -- yet often such an idea can be made even better by focusing your business model to get to revenue sooner. Even if you plan to seek seed funding, it's a worthwhile exercise to think about how you would build your company if you bootstrapped instead. Besides, a lot of ideas that take a while to get to revenue are just bad ideas (remember the dot-com bubble?)

But if you're confident you have a good idea, and you're confident it will take a while to get to revenue, and you're confident you have a great team, but you're confident that you don't have enough money/energy/skills to bootstrap, then you should seek outside funding.

Where to Get Funding
So where do you get funding? There are lots of possibilities for tech entrepreneurs these days.

For starters, there are the three F's: Friends, Family and Fools. You can ask people you know to help you get your business off the ground. However, there are some obvious (and some not-so- obvious) caveats to doing business with people you know. You should only do business with people who love you if they can afford to lose the money.

Accelerators like TechStars and YCombinator are probably the best source of funding for tech entrepreneurs. Accelerators provide just enough money to get your startup off the ground while providing something even more valuable -- mentorship. Better accelerators tend to be run by smart people and are highly competitive, so getting into one is also a great validation that your idea has potential (validation != guarantee).

Accelerators are popping up all over. My friend Greg Svitak just landed his startup, flock-d, in a top-10 accelerator, The Brandery in Cincinnati, Ohio. Even Microsoft is hosting them now! Check out the upcoming Microsoft Accelerator for Windows Azure, powered by TechStars. It's an awesome opportunity for Microsoft-focused developers.

I recently got to speak with Ben Yoskovitz, who has written extensively about accelerators and even started one. He notes that accelerators tend to do better in areas with high entrepreneurial density like Silicon Valley, New York, Boston, and Boulder (a community that worked hard to create entrepreneurial density).

For communities that haven't yet achieved high entrepreneurial density, like my home of Grand Rapids, MI, it's important for the community to be creative. Innovative investors in my home town recently created StartGarden, and I recently visited the incredible Youngstown Business Incubator. Have an open mind (yet a critical eye) about new possibilities that emerge in your area.

There are also state-sponsored ways to get funding. Some countries have it better than others. Bob Walsh and I interviewed Enterprise Ireland, a state-sponsored $500 million investment fund and one of their successes, SkillPages. Almost makes me want to return to the land of my ancestors.

If you live in the United States, most governmental funding opportunities appear to happen at the state level. In Michigan, we have the SBTDC, which is focused on helping entrepreneurs succeed. My SBTDC contacts in Grand Rapids and Lansing tell me that all 50 states have something similar.

You pay taxes to support them, and they have smart people (at least in my state) to help, so you might as well talk to them and figure out what programs are available to you. They likely will give you useful feedback on your business and connect you with great contacts outside government as well.

Finally, there are angel investors (and VCs, Angel groups, Super Angels, etc.) If you want to learn more about this world, read Do More Faster by David Cohen and Brad Feld, and if you get to the point of participating in an investment, read Venture Deals by Brad Feld and Jason Mendelson. While we're on a Brad-fest, if you're even thinking about being an entrepreneur, start right now by reading Burning Entrepreneur.

I've mentioned various possibilities for getting funding, but if you're serious about it (or even if you're taking on cofounders), I implore you to read The Founders Dilemmas by Noam Wasserman, a Harvard professor who has researched these issues extensively. It's not an easy read, but it's required. Think of it as a homework assignment, and just do the work.

One more thing: thanks to recent changes, crowd-sourced funding is now legal in the U.S. This is new territory, but it might be worth investigating sites like Fundable and Motavi.

How to Get Funding
So you've decided you need funding and know approximately where to get it. How do you go about getting it? The easiest way to get funding is to have already succeeded at building a startup in the past. Investors bet on people even more than they bet on ideas.

If you haven't already succeeded, then I strongly recommend applying for an accelerator. They're designed to help you succeed throughout the whole process. Heck, fill out the application for TechStars, even if you don't intend to apply. If you're seeking funding, you'll need to have answers for all the questions they ask.

If you're going to seek investment directly from angels or VCs (venture capitalists), then you need at least one of the following five things:

• Proven track record
• Significant charter customer
• Unique, Ph.D-level research
• Gilded advisory board
• Product

I put these in a particular order; if you have a proven track record, you might be able to get funding with nothing more than an idea. In fact, it's even possible to get funding without an idea. A highly successful friend of mine had investors approach him out of the blue with an offer of $1 million to build a specific kind of company they wanted to invest in. He took the offer, and his company was recently acquired for a hefty sum -- the investors made a good bet.

If you don't have a track record, the next best thing is to have customers. This is the essence of Lean Startup -- get customers on board before you even build. Kickstarter is built on this very principle.

Research can get you funding if it has unique and significant value. Some investors work with universities and researchers to take promising scientific findings and turn them into businesses. This is a specialized business path for academics.

There are some advisors whose recommendation will cause other investors to back you. If you're a friend of Steve Wozniak, and you convince him that your idea for a mobile accessory is going to be a hit -- and he's willing to vouch for you -- then I suspect it won't be difficult to find investors with nothing more than drawings on a napkin, whether or not Steve himself wants to invest.

If you have none of these things, then you'll probably not get seed funding with just an idea, at least not from smart investors (and why would you want to work with dumb ones?) In that case, you'll need some semblance of a product. Even if you weren't intending to bootstrap your company, you'll still have to do a heck of a lot of work (i.e., bootstrap) just to get to the point where you can ask for seed funding!

Be smart about that work. Yes, you need a product, but don't build a product that nobody wants. Do customer development. Talk to customers. Get customers to pay ahead if possible (possibly obviating the need for funding, especially if it's an enterprise product with a hefty price). And then-- and not before -- build an embarrassingly small MVP -- Minimum Viable Product -- that you will use to validate two things:

• Your assumptions about customers were correct (Did they really know what you were talking about? Do they actually like your idea once they can interact with it, even if it's just a rough prototype?)
• You know how to build things -- if you don't have a track record, investors need to see that you can move from an idea to something concrete. It might not be "done" or even "ready," but at least it's more than just arm waving.

The whole time you're working on an MVP/prototype/demo/version 1, you should also be working on a pitch deck and practicing your pitch. Talk to as many investors and entrepreneurs as you can to get their feedback. And don't forget to talk to customers, too.

When to Get Funding
The process of getting funding is like a courtship dance, and there are cultural norms that go along with this courtship. Most importantly, don't dabble. Don't dip your toe in and ask, "hey, I was wondering if just maybe you might be interested in investing in my startup -- if not, no big deal …" Until you have a solid story and you believe an investor will be fortunate for the opportunity to invest in your company, you're not ready. And once you start, the clock is ticking. Startups that spend too long asking for money without getting it will lose the confidence of the investing community. It's a small world.

Find a Problem and Solve It
Again, there are many startup ideas that don't need funding. In a recent talk by Noah Kagan, he wondered why so many developers build something cool and then look for people to buy it. Why not just look for an obvious problem that somebody has and solve it? Noah even suggested doing searches for "I HATE" and "THIS SUCKS" followed by a domain you're interested in or a product you'd like to improve. Talk to the people who write about their frustrations. When your idea solves a problem so directly, you're more likely not to need funding at all.

But if you do need funding, do your homework. Some people lash out at the investment community when it doesn't recognize their genius, but it doesn't do any good. Instead, learn how the investment community works. Learn what they want from investments and meet their needs as well as your customers' needs. As a good friend of mine said recently, "investors are ultimately customers, too."