SMB and Outside Capital

devil in suitAll my start-ups after Orbitz were boot-strapped, so I get rather passionate about this topic.  Whenever inquiries come in from small business owners regarding the logistics of getting outside capital – valuation expectations; how much control to relinquish; what changes in operating agreement are necessary; re-classing voting rights and shares; guaranteed distributions regardless of performance (sort of like Jay Cutler’s new deal); etc. – I ask one simple question.  Why do you think you need outside capital?  Often, I’m dismayed by the answers I hear back…  They range from funds for rainy days to taking money off the table for the founders.  One thing you need to realize, it’s irrelevant why you think you need outside capital.  Investors will only invest if prospects meet their investment thesis in addition to meeting a couple of crucial criteria.

  • Management team in place – if it comes down to poorer business model with great executive team vs. great business model with poor executive team, investors will always choose the former over the latter.  There’s no such thing as great business with poor management – it won’t last.  Lesson for business owners – choose your management team wisely as your business grows.
  • Scalable business model – investors will invest if exponential return in COGS investment can be forecasted, e.g. there’s significant operating leverage.  Whether the business is technology-based or processes-based, business owners will have to demonstrate that an investor do not need to continue to spend corresponding OPEX dollars in order for it to grow.

So really think about why you need outside money and what you will use it for before approaching / accepting the capital.  Besides, there’s some truth to old saying – taking VC funds is like making a deal with the devil – do really want or need to do that?

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About Richard Lee
Experienced finance and operations professional. Currently partner in five companies, adjunct professor of economics at Columbia College and executive contributor to a small business blog (www.SMBmatters.com); following corporate finance, M&A and management consulting tenures with Orbitz and Diamond Technology Partners; and six years of service with the United States Army.

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