Thoughts on startups by investors that
fund them & entrepreneurs that run them

Don’t Make It Personal

For 97.5% of aspiring entrepreneurs, the issue of when and how to turn down funding isn’t a problem…because they never get offered it in the first place. For the other 2.5%, it can be agonizing, because it seems to violate the first rule of entrepreneurship: “Take money whenever it’s offered!” In reality, however, the reasons to pass up an offer of financing fall into five distinct categories: personal, strategic, operational, control-related and economic.

Personal. By far the largest source of non-founder startup funding in the U.S. is from friends & family, accounting for more than $60 billion annually. For many entrepreneurs this is the beginning and end of their capital raising, because of the 600,000 companies that get started every year, fewer than 10% raise any equity capital at all from unrelated third parties. But while funding from those close to you may be the most accessible, it’s also the most fraught with danger. On one hand, there is the ethical (not to mention legal) issue of taking a significant percentage of the assets of an unsophisticated investor and putting it into a risky startup.

So even if your pensioned grandfather or loving Aunt Edna were willing to mortgage their home and invest their life savings into your venture, you would do well to politely decline the offer…regardless of whether it was the only money available. On the other hand, there is the long-term family relations issue. Even if your parents or siblings can afford to lose their entire investment, how comfortable will you be at Thanksgiving dinner every year if you lose all their money? As Polonius warned Hamlet, “Neither a borrower nor a lender be, for loan oft loses both itself and friend.”

Strategic. When faced with a choice between a financial (venture) investor and a strategic (corporate) investor, entrepreneurs will often find that the strategic player appears to have a seductive offer: A higher valuation for the company (which means less dilution for the entrepreneur), industry expertise, access to large markets, support with distribution, development and marketing. This may well be true, but there is something else extremely important to remember: While a financial investor is motivated solely to increase the company’s economic value (usually a good thing for the entrepreneur), a strategic investor by definition has some other agenda (that’s the “strategy” they’re following!) This can sometimes mean that the entrepreneur finds him- or herself forced (or at least urged) to move the company’s product path in a certain direction, or enter into exclusive contracts with the investor — or even concentrate marketing in certain cities or among certain demographics.

While none of these requirements are necessarily wrong when taken individually, together they can turn a strong financial offer into something a company should refuse.

Operational. When an investor purchases equity in a company, the usual inclination on the part of the entrepreneur is to breathe a sigh of relief and put the whole fundraising process behind him (or her). Wrong! Taking in an equity investor means taking on a partner…if not a spouse. Like a roach motel, once an investor has a toehold in your company, there is no easy way to ignore your new family member. You can often get an idea of what the long term relationship will be like from the way investors deal with you during the courtship phase of the relationship. Did it take ten meetings to get them to commit? Did they ask to see reams of documentation during the process? Did they want to sit down individually with each of your senior managers and ‘deep dive’ into detailed spreadsheets and forecasts? Did their process take up so much of your own time that it had an impact on your ability to run the company? While these actions may well be among the hallmarks of a knowledgeable, careful and value-adding investor, they may also be a harbinger of what your relationship might be like for the next several years. If you are an experienced CEO in a lean, fast-moving business, if you have multiple options, and if you believe that a particular investor may ultimately be more trouble than he or she is worth, that may be a legitimate reason to walk away from the money on offer.

Control-related. With few exceptions, every time you exchange money for equity, you are transferring a few more shareholder votes from you to someone else. For a typical seed or Series A financing round this will rarely change control of the company, but eventually the numbers (including votes at the board of directors level) add up. Combined with the protective provisions that are invariably a part of any professional investment, taking in significant funding means giving up some (or all) of your flexibility to manage your venture as you see fit. And once you pass the tipping point, those investors who end up with control will ultimately have the ability to end your operational involvement with the company you founded. For most high-growth startups, this is a clear choice made by the entrepreneur in exchange for the funding necessary to grow the business. But if you have the option of taking in money or not, and like Lucifer you would prefer to “reign in Hell than serve in Heaven,” then turning down available funding might be a choice you would knowingly make.

Economic. Finally, the decision to take in funding or not often comes down to a cost/benefit analysis, also known as risk vs. reward, or, in its most bald and honest expression, fear vs. greed. Taking in funding means agreeing to part with a share of all the good things that will no doubt happen with the venture, in exchange for protecting yourself from failing by running out of money. So if you are the rare entrepreneur who can successfully bootstrap your business to profitability, you may well have the opportunity to turn down funding in order to keep all the rewards for yourself. Alternatively, you may at least be able to delay taking in funding until further down the road. By that point, if the business has already achieved a high enough valuation, the smaller economic dilution of your equity may well be worth taking a penny-pinching, lean startup, approach of your early.

 *Original post can be found on Wall Street Journal Blogs @*
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Written by David S. Rose

user David S. Rose Founder and CEO,

David has been described as "the Father of Angel Investing in New York" by Crain's New York Business, & a "world conquering entrepreneur" by BusinessWeek. He is a serial entrepreneur & Inc 500 CEO who chairs New York Angels, one of the most active angel investment groups. David is also CEO of Gust.

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