10 Things To Know Before Starting a Company – Financing

By and large, entrepreneurs are far more open about money than the general public. In many ways, they have to be. Just as you cannot go on a road trip without putting gas in the car, you cannot launch any idea — even the best idea — without money behind you.

I grew up in a house where we didn’t talk about certain things. Because of that, I’ve developed a belief that it is overall healthier to be open and transparent about any situation, whether it’s money or depression or anything else. To acknowledge the issue is to give it less power over your day-to-day life, and you also let other people know that they can discuss it in front of you. Every employee I've ever had knows that I funded my company, The Hub, through my trust fund. I don’t make any apologies for that, nor do I hide it. It is what it is, but I also know that not everyone with a good idea has that kind of access. Luckily, they often don’t need it.

In my experience, I've never met a founder who is really uncomfortable about the topic of money with respect to their business. They might not, however, know which questions to ask and when, or they might not like the answers they’re given. The reality is that money over a certain threshold doesn’t solve problems, either – in fact, it can often create new ones, as I’ll discuss. 

We know that 70 percent of startups fail, and that number rises to 90 percent when venture backing is in the mix. A lot of entrepreneurs blame their failures on money, but I don't think it's a fair excuse. You need to not only be willing to fail and lose everything, but to also be open about it and figure out exactly how much you need, when you need it, and where you’re getting it from. Whenever money is involved — whether it’s asking a family member for money or offering an employee equity — do so very carefully and thoughtfully. My advice can help you curb your spendthrift impulses, if you keep it in mind as you go.

From the best way to start spending money once you have some, to keeping a level head when it comes to incubators and venture capital funds, here are 10 of the most common questions I am asked from new and developing entrepreneurs. 

How much money do you need to start a business?

I hesitate to give a hard number, but you do have to be prepared to sort of take losses and make mistakes and give yourself room to iterate. Just as in Blackjack, you should have enough chips where you can play 26 hands because you don’t know if you’re going to win or lose the first four. If you only have enough to last you through a few hands, and if the first few hands are bad ones, then you're done. If you quit your job, have you made sure that you have enough money to last you six to 12 months of taking considerable losses? If not, then you probably shouldn't take the leap. It's almost never the case that things just take off in the first month or two and work miraculously. It's almost always the case that the few months to a year involve a lot of toiling and figuring out what the hell you have to do to get people to not only use your product, but come back for more.

If you follow this MVP protocol, ideally you’ll need  very little money in total. If you're throwing money around to attract customers or to pay your way to some semblance of getting out there, you'll come to find that your money has been wasted because as soon as it's gone. 

The analogy I always give is that of a bathtub: With the water running on full blast, of course there will be water in the tub. But the minute you turn off the faucet, that water will drain unless you have something holding that water in. It's the same thing with spending a lot of money early in a startup: If there isn't a product that people come back for again and again, all of your customers just leave. 

To that end, if you're going to spend money, make sure that it's just enough that you have a little water in the tub. Instead, you should be focusing on the plug, which is to say, make sure that people really like your product and are sticking around. Once you have repeat customers and have found product-market fit, only then would I spend any sort of meaningful money on customer acquisition.

I have money saved. What's the best way to start spending it?

I'd invest solely in the iteration of the product and make sure it’s as close to perfect as possible. Right now, I'm working with a brand that does very little marketing, but their e-commerce numbers, including retention rate and number of repeat customers, is very healthy. The only reason that happens is because the product is so good that it sells itself. It's not because people got a marketing email or a retargeting Facebook ad — it's because they really love the product. 

Spend your savings on getting your product or idea right. Again, ask yourself: Are you solving a problem? Do people really love this? Definitely don't spend your money on trying to get 40,000 people to your website, thinking somehow that's going to solve all your problems. It might be exciting to see all of those people on your website, but the minute you run out of money, those people will be gone and you’ll have to start over.

Should I take on investors before I launch my idea? Will VCs invest?

Broadly, no. When it comes to working with VCs very early on, the work is so speculative that their terms are very predatory and they'll take big stakes in your company. I think it's best to wait until you have proof of concept that they can really chew on. By then, it's not just some idea. You actually have traction and some proof of concept before you go and seek a larger check from an institution like a venture capitalist.

Starting with friends and family money is scary because they're your friends and family, but when they invest in you, they'll see the light in your eyes because you're now doing the thing you love. You can also raise money through financial instruments that are very lightweight, like SAFEs, which move very quickly. Raising or borrowing anywhere from $10,000 to $50,000 from these smaller-scale sources lets you iterate and find product-market fit. 

Of course, when you have friends and family watching you so closely, it's very easy to feel pressure and to listen to the voices in your head telling you that you need to grow and be loud. No friend or family member is going to want to hear that you spent 16 hours on your email nurture sequencing or on your site optimization, both of which are far less appealing than telling them that you got picked up by Whole Foods or that 10,000 people went to your website that month. If you take money from friends and family, you need to avoid falling into the trap of wanting validation.

Asking friends and family for money is typically scary. How do I get over that fear?

It's gotten less scary for me as I have believed in the idea behind my business more and more. It’s difficult to ask for money to back something that you only believe in 92 percent of the way. I was very excited about the idea behind The Hub from day one, but at certain points, I definitely thought that the project could totally blow up and fail. 

Don’t ask to take money from people that can't afford it. If your sister has $2,000 in the bank, don’t ask her to put in $1,500. Don't put people in a position where if they lose the money, their life will change, and make sure they know the money they do give you could go to zero. Instead, ask your rich uncle for $10,000 or $20,000, knowing that if worst comes to worst, he will not be out on the street. If you don't have people like that in your life, there are crowdfunding platforms like Republic that will help you raise from strangers who each put in a few hundred dollars. 

The second bit of advice would be to involve the people who invested and get them emotionally excited about the progress you're making. Bring them in on the entrepreneurial journey. Something I did far too late was bringing my friends and family in on my idea, I think because I didn't want to go back. Two friends and my dad helped me with some of the earliest money I raised for The Hub, so I started holding unofficial board meetings with them maybe two or three years in. Every month I would give them an update, and it was actually quite comforting because they were in on the ups and downs and they could see what I was doing. They got really emotionally invested and that somehow took some pressure off.

How quickly can I sell?

Usually when founders ask me this question, I get turned off or I pity them. It's so hard to be a founder that if you have even 10 percent of your attention towards the door and you're six months in or a year in, you've already lost. It takes 100 to 150% of your energy to succeed, so if you're so eager for an exit, that’s a bad sign. 

That said, once you have some momentum, it's good to occasionally look at the horizon line and ask yourself, “Where is this going? To whom might I sell? What would they want?” I could sell my company to a publisher, or to an ad agency, or to a large corporation. Those sales are different, and my product would need to take on a different candy coating depending on whom I want to sell to. 

It's intelligent after a year or two to consider your exit strategy, but also keep an eye on the broader timeline of things. If you're in CPG, the fastest exit is maybe three to five years to private equity if you're doing 20 million or more in sales a year, or five years to seven years to a company like Coke or Pepsi if you’re doing 40 million or more in sales a year, or you find a way to become profitable and sit above the poaching ground.

It seems like there's a lot to do. Should I hire other people to help?

Trying to find people is really hard. Finding a co-founder quickly is like trying to find a husband or a wife after a date or two. Even finding just like a really good soldier, which is to say an employee who is really bought into the mission, is difficult. You can’t forge a deep belief in a company in a month of working. 

When it comes to finding a good employee, I look for passion, earnestness, and fortitude. I've hired a lot of people who were good employees on paper. They went to good colleges or worked at other prestigious companies. But a lot of those people didn’t know how to do the hard work, nor did they want for something. Every single one of my employees now all want their success really badly. I am drawn to people that have something to prove and are willing to dig in. There needs to be a desire to learn and eagerness to get your hands dirty. That goes so much further, at least in the first couple of years of a startup, than a fancy degree or having worked at Amazon.

It’s also good to set up a kind of trial period: Try to find those people who believe in the idea enough and are excited enough about the startup journey that they'll join you for cheap or free and for a large equity stake so that you don't have to spend a lot of money. Pay them a modest amount for three months, and if they fall in love, set up equity structures that protect you with a one-year cliff, which means that person can’t exercise any of their stock options for a year. If after six months it's not working out so hot, you part ways and you haven't given the person any equity.

How should I think about giving away equity at an early stage?

A lot of founders are so precious about equity, but if you don't get good people on board, your company is going to fail and the 78 percent of your company that you own, because you held onto every little piece of it, as hard as you could, will be worth $0. It’s way better to own 26 percent of your company when you sell for $50 million, then to have held onto it with your talons and not let anyone in. If you're the kind of founder that won't part with even a little bit of equity, it tells me that you don't let other people's ideas in.

It’s very important to get people involved, and to do that you have to be OK with giving away some equity. There’s a mathematical formula for figuring out how much you’re giving away to someone, and countering that with whether or not you believe the company will be worth that much more thanks to their contribution. Do you believe that person can double the company or add 10% of value to offset what you’re giving them? If you protect yourself with a one-year cliff, you’ll know within the first few months if the person's going to pull weight. You will be nowhere near at risk of them having access to your stock options until you're really sure that they're a good soldier. Try them out. What do you have to lose?

What are your opinions on incubators and accelerators? Will they help me?

Don't assume incubators or accelerators will change your life. Some are really good and people have very positive experiences with them, and some are terrible. Be open to the notion that getting into one might not be the best thing for you, and try to negotiate the terms whereby you're not giving away too much of your company when you sign on the dotted line. 

There is a Marc Andreessen quote that says, “There are no silver bullets, only lead ones,” and it’s helpful to remember that. I met with Gary Vaynerchuk very early on, and by the end of our meeting, he said, “I'm going to help you. This is a great idea.” He never helped me. I got into an incubator and gave away 10 percent of my company. They gave me six months to pull out if I wanted to, and in month five, I pulled out because they weren't providing value. The same thing happened with another incubator. I've had big corporate contracts that I thought were going to change the company and they didn't. 

My personal opinion is that incubators and accelerators do not work. In addition to my two experiences, I know 20 founders that have had horror stories. Most incubators take on too many companies and pay attention to their three darlings. When you need them most is when you're suffering, and that’s precisely when you're least promising to their portfolio, so you tend to be neglected.

This isn't working. Can I sell?

No. I get calls like this sometimes, where either someone asks this right out of the gate, or it becomes pretty clear 10 minutes in that their thing isn't working and they want to throw it into someone else's arms. But private equity only buys distressed assets if there's a story or if a company had a good track record but something went wrong and the equity company really thinks they can fix something up.

But if you're a young company, you're an unproven idea. The person that has the best chance of succeeding is you in so far as you thought of it and you have the most passion for it. No one else in the entire world is going to pick it up where you left off on a mangled idea. Your options are to sort of pivot and try to adapt, or to fail, because they’re both ultimately born from the same thing: You run into a wall where it doesn't look like there's any daylight. Failure is telling yourself, “It’s over,” and a pivot is when you tell yourself, “Well, that didn't work. Here's the one little thing that's working. Let me cut everything else away and just build around that little strength.” The only difference between pivoting and failing is when the founder waves the white flag.

 I’m someone who's gone from having 15 employees to four, almost overnight. I know what it’s like to spend almost $300,000 a month at points, and then go to spending $30,000 a month. There's always a way to rethink, to evolve, and to to execute differently. If you're failing, you can't sell. If you're failing, you can give up or you can pivot. Only when things are going pretty well and you figured out how to make it healthy again, will someone want to buy you.

This is working. Should I raise? How do I know when I'm ready?

Entrepreneurs are some of the most confident headstrong people I know, as well as some of the most insecure people I know. A lot of them look for moments of validation, and chase this thing that says “you're on the right track. You're doing great. You're awesome.” They want that article from TechCrunch or press release that says they raised money so that they can tell the world they’re not a loser.

But raising money isn’t a finish line. It’s a starting line. Because when you raise money, the valuation you get is not what your company is worth today — it’s what your company will be worth, hopefully soon. If you raise a $10 million valuation, you might be worth only $4 or $5 million today and you have to get to work very quickly. You usually raise money for 18 months worth of runway, and I invite you to think of raising money not as a finish line or as an accomplishment, but actually as more pressure.

If you hit a golf ball with a putter and you're off by a degree, you'll miss the hole by a foot. If you hit a golf ball with a driver and you're a degree off, you could end up in the woods. Taking money from venture capitalists is like getting a driver in your hands when you've been playing with a putter. So any mistakes you make now, you’ll suddenly have $2 million at your back and people yelling at you to spend it. If you take a big swing and you're even a little bit off, it's going to go in the wrong direction. Spend all of your time failing when you're using a putter and try to get pretty accurate and good at swinging before you get the real club in your hands, because raising money means there will suddenly be higher expectations. 

So are you ready, and did you follow the protocol? If you're pumping the top of your funnel and your growth isn't sustainable, you're going to be playing this game for a long time. You can avoid that by having an authentic product that people genuinely love, as well as product-market fit, retention, and lifetime value. Wait until you have those things before you try to raise.