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Avoid the Pitfalls of Raising Outside Capital and Know It's not a Necessity for Entrepreneurial Success.

For many entrepreneurs, raising outside capital is, seemingly, just another necessary step in the lifecycle of a small business. Still others think it's the only way they will get their business off the ground. While there is no right answer, those two are both wrong!

Raising outside capital is, at best, difficult, especially for entrepreneurs who have never had previous entrepreneurial success (more on this later), to the point of highly improbable. Pretty negative thoughts for somebody who has raised significant capital both for my own ventures as well for others. Yet, it remains one of the most arcane, underestimated and misunderstood processes that an entrepreneur can undertake. But, most important, it is not a necessity for your success.

For the purposes of our discussion, my definition of outside capital is that from professional investors, beyond friends and family. That means capital from angels, venture capital and private equity firms. I don't include loans from banks anymore, because outside of SBA loans, for entrepreneurs without significant track record, small business bank loans are as rare as full service gas stations. As for SBA loans, that's whole other subject, covered best by my friend, Charles Green in "The SBA Loan Book," now in its third edition.

So, here are 7 key considerations to avoid the pitfalls before you embark on raising outside capital.

First, you have to have "skin in the game!" Many entrepreneurs believe that raising capital is simply something that's part of the entrepreneurial experience and is how a new business is funded. Risk is inherent to that experience and if you as the entrepreneur don't first have "skin in the game," and/or are not at risk, why should an outside investor risk their capital?

Second, it's not for everybody To raise outside capital from professional investors you have to have a well-prepared plan for a growth business that is operating in a growth market, or a growth niche in a very large market.As important, whether it's a growth market or a niche market, somewhere, a reputable research firm is tracking it, even if it's in its early stages.That gives the market credibility. The strategies you define for your business to grow in that market are equally critical, specifically, how you will scale the business. So your plan has to be more than just jargon and high-level strategic directives.If you don't have a well-defined growth market and a plan to scale to capitalize on it, think twice about raising outside capital.

Third, with an investment, you will have a boss (or bosses), no matter their ownership position. I've seen so many entrepreneurs fighting to keep majority control, not understanding, capital always carries the day. No matter how much they own, how many board positions they have, they will "drive the bus," at least at a high level.Some will do it more overtly than others, but they will do it, nonetheless.

Fourth, they don't just want to make a one-time investment.Beyond angels, once they commit, professional investment firms want to invest as much as possible to continue to help and continue to enhance their returns. They can only manage so many investments, so they want to optimize each investment. Often they will invest an initial amount and want to come back, fairly early thereafter, with follow-on investments. A lot of entrepreneurs miss this one and, in turn, lose control of their operation, and I don't mean in the stock ownership sense. Suddenly, they have more capital than they know what to do with and start hiring and spending without a real plan beyond "growth." This happened a great deal during the internet bubble and continues to happen as solid companies start to go south from "growing pains." Unless your business is capital-intensive (physical plant, equipment, etc.), without a really good capital use/growth plan, you can only spend so much on marketing and infrastructure until you reach a point of diminishing returns. If your business is not capital-intensive, you need to take this into consideration before accepting the first investment.

Fifth, they invest in the jockey, not the horse. Of course, you've heard this one, but understand it's more, it's the collective jockey - that is, you and your partners, management team, your business maturity, understanding of your market and belief in how you will deploy their capital most effectively. And if any of you have been part of a company where outside capital was invested, successfully, your odds for successful investment, this time, increase dramatically.

Sixth, it will take infinitely longer and extract much more of your time that you could ever imagine with less than a 25% chance of success. It will take its toll in time and impact on your business, so you must be careful. It is a slow painful process, full of smoke being blown at you at various intervals; promises made, lies told. Some of the firms will behave professionally and tell you, up front, why they can't or won't invest in you. Others will keep you in their pipeline so that they always have activity, but have no intention of getting serious. Know that there are always more deals than there is capital to fund those deals. It is always a buyer's market! Even if you succeed, you will pay a price.

Seventh and last, it probably won't make or break your ultimate success. There are countless successful entrepreneurs who have done so without outside capital beyond friends, family and, maybe, angels. Outside capital comes with many strings as noted above.That has to be weighed against how the capital will help, both short- and long-term.

The Entrepreneur's Yoda knows these things.  He's been there.  May success be with you!  

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