I often have discussions with people who have a great idea and are thinking of quitting their job to pursue it. However, they have fixed costs (rent, car payments, etc.) and can’t afford to work for free. Instead, they want to raise some venture investment to fund their new company and pay them a salary. Inevitably, they are surprised at how hard it is and rarely succeed.
The problem that these potential entrepreneurs fail to see is that investors are looking for investments to make a return, not to fund your lifestyle. If an investor is going to invest in you it will be for one of three reasons:
- Investing in people (you). An investor might invest in you because of who you are and your track record of success. However, unless you have started and sold companies for tens or hundreds of millions of dollars, it is unlikely that investors will invest in you for who you are. The risk for new companies is too high for someone inexperienced who doesn’t have a product or a plan.
- Investing in your product. Investors will invest in products that have no plan (or revenue) but are growing like wildfire (Snapchat is a good example). The investor might not know you and you might not have a plan in place, but they see the product succeeding in the market and have faith that you can come up with a plan when necessary. This is exceedingly rare because the product needs to be so amazingly successful as to forgive the higher risk of not having a plan.
- Investing in a plan. The vast majority of venture investment is in a plan. A plan includes all of the other elements including people, products, marketing/growth, financials, etc. When an investor invests in your plan, it is because they see how their investment will help you achieve your plan and in doing so, produce a return on their investment.
Now, before you spend weeks writing a 50 page business plan, it is important to understand what an investor looks for in a plan. The best plans are not determined by length, but whether you can answer the following questions:
- What problem are you solving? Explain who your customers are, what problem they have and how much money can be made by solving it. The bigger the problem, the bigger the market opportunity.
- How do you solve the problem? There are many ways to solve the same problem. What is your solution, and how is it unique? In many cases, this is a demonstration of your product.
- Why hasn’t the problem been solved before? There are reasons this problem exists, and one of them is that no one else has solved it. Why not? Are there difficulties that you have overcome?
- Why are you (and your team) the ones to solve it? While this is your plan, you need to give investors confidence that you can execute the plan.
- How will you beat the competition? Even if you don’t have competition today, you will at some point. How will you win when the competition attacks?
- How much money will you make if everything goes well? This is the most important question. Investors want to see a business that will become very valuable, very quickly based on the money it can make.
- How much money do you need? The final question is how much it will cost for you to build the business to a point where you’ve removed a significant amount of risk. Your plan, no matter how well formulated, has a lot of risk. Instead of giving you $20M now, they would rather give you $1M and see if you can eliminate some of the risk in the plan and then give you more. It is up to you to set realistic goals and estimate costs accordingly, and the investors will evaluate the risk profile from there.
Note that these are the questions for a seed level company, one that is just getting started. As your company grows, the questions you need to answer in your plan will change. Even public companies need to have a plan for their shareholders, who are their investors.
So, if you are looking to raise money for your company be sure you have a plan that justifies the investment. And quit your job first. No one wants to invest in your plan if you don’t believe in it enough to go all in.
This article was originally published at Sean on Startups, a blog about starting and growing companies.
Image Credit: CC by Tax Credits