Founding & Funding

You're founding a startup!

I imagine that's a thought you've had at least a couple times at this point.

It is very cool – I won't argue with you – but it's not the glamorous, two-steps-from-riches, lifestyle you're imagining. It's a lot of freaking work. It's hard. It's time consuming. You might fail.

I don't say this to discourage you. Rather, I want you to remember that you've taken on a role in a business, not a cable TV drama about Silicon Valley. Today I want to look at some of the myths, some of the preconceptions, and some of the assumptions about founding a startup and put a few things into perspective.

We're going to look at not only the role of founders, who they are, and how to start breaking out responsibilities for yourself (and anyone who is onboard with you at this point), but your options when you need money for your business.

This is the part that gets the most press coverage and the big headlines – the big infusions of cash and the bigger personalities that get those infusions – but it's only a small part of the reality of owning a startup.

And today I want to share what this particular piece of that reality looks like, what you can expect, what you SHOULDN'T expect, and how to go to the next stage with your business without getting in over your head.

Your Role in the Company

As a founder, you're more than just a figurehead. You're the person doing just about everything that needs to be done until you can afford to hire people.

Answering phones. Testing for bugs. Answering complaint emails. Copying and pasting spreadsheets. Yup, that's all you.

But you're also the guy who gets to make the big decisions. Where will the funding come from? When will you bring other people on board to help you? Will they be employees or cofounders? What's the lifespan of your project?

This is all stuff you need to be responsible for as the person at the top of the food chain for your new business. We're going to run through the deeper role of the founders, the support you can expect (and not expect) as you get started, the funding sources you may or may not have at your disposal, and ultimately which decisions make the most sense for you and your brand new business.

No pressure – this is just the biggest set of decisions you'll make for your business.

Founders

To keep it as simple as possible, a founder is the person who starts the company with their own sweat, blood, tears, and/or cash. If you're investing in the business and getting it off the ground, congratulations, you're a startup founder.

With that out of the way, there are a lot of nuances to this role. Sole founders, cofounders, and people who work in the business vs on the business. It's all stuff you have to think about because it's going to determine how you approach building your business in the long term.

What Is a Founder?

There is no "perfect" founder. Some of them are technical geniuses who literally build the product that they eventually launch and turn into a technology behemoth. Others are tinkerers who like to program and happen to create something that others are willing to pay for. Others still are career business people or sales people and do it strictly for the money – hiring people to do all the heavy lifting of actually building a product.

In the end, it doesn't matter which of these you happen to be – the business will grow and be structured differently depending on your skillset, but in the end, the same things are going to matter when it comes to creating a successful product.

I get this question a lot – what are the right skills for a startup founder? Honestly, it doesn't particularly matter, at least not when it comes to hard skills.

Programming, design, sales, marketing – doesn't matter what you know how to do. You can always hire people to help with the rest.

What really matters are the soft skill and the drive to get stuff done.

Sergey Brin and Larry Page were grad students at Stanford – scientists and programmers who happened to create one of the world's richest companies.

You'll find that a lot – a company founded by someone who excelled in one particular area and who then brought in someone to help with everything else. Most of these companies have a single face – the guy who is more comfortable on camera – but they have multiple founders who pour energy into creating the product and getting it out there.

A common dynamic that works very well is to have both a technical and non-technical founder. Someone can handle the development and building the product without having to spend to hire an outside talent, and the other can handle everything else – this is more of your typical MBA-style business manager.

Regardless of the skill combinations, however, what you need to do is work hard, not give up (until the market tells you your product won't work), and find the most efficient, least expensive way to solve a problem as quickly as possible.

Do these things, regardless of what your own background is, and you'll have just as good an opportunity to find success in your work as anyone else in this business.

Your Role in the Business

Your role in the business will change constantly. From the start, you'll do a little bit of everything. But over time the nature of your role might adjust as you determine you aren't very good at certain things (or as you find people who are better at those things than you are).

At the core, though, there are a few things you should always be doing.

1. Representing the Company – Don't send someone else out to apologize for your failures or make your deals. Be willing and able to go out and push when opportunities for success present themselves. This might change if you get big, but for now, it's all you.
2. Leading the Team – Even if it's just you in your basement with the cat, you have a team and you need to lead. That means making tough decisions (quickly) and being ready and willing to make moves as soon as necessary. No one else is going to do it for you.
3. Recognize Your Failings – You're not perfect. Be aware of where you don't kick ass and be willing to fill those gaps. Find people who do kick ass there and that can help you.

This is the key to being a successful founder – knowing your failings, working hard despite them, and bringing in smart people as soon as possible to help you realize your dream.

Who a Founder Should Be

At the end of the day, regardless of your skillset, you are your company's brand. How many CEO's and Presidents in old school businesses do you know the name of? How many startup founders do you know?

When a business is pulled together by a single person and small cadre of brilliant people in a short time period, that person tends to become the brand of the company being developed.

Elon Musk (PayPal). Brian Chesky (AirBnB). Drew Houston (Dropbox). Daniel Ek (Spotify). Tim Westergren (Pandora).

These people are more than the companies they own. They are brands. And you will be as well if your company succeeds. Even in the early stages, you need to be out there, putting your face forward and willingly stepping in front of any attention you receive – good, bad, or indifferent.

A new company, especially a small one with a single product, cannot succeed if there's no face attached to it. You need to be out there taking action and building your business. If you aren't comfortable doing that, it may be time to bring in a cofounder who can.

Why Have Others Help You?

I've mention cofounders a few times. At this point you may or may not have someone on your side to help get this thing off the ground.

If you do, awesome – I'm about to show you why they are a good person to have on your team. If you don't, read carefully – there are a lot of benefits to having two or more people on board and a handful of cons. Make your decision wisely and don't let the money that doesn't yet exist be a deciding factor.

Strength in Numbers

Whether you enjoy the company of others or not, there are significant benefits to having more than one person working on a project.

After all, you're one person. How much do you think you can do? Especially if you're still in school or working a full time job? It's unrealistic and if you stretch yourself to breaking you'll either fail or meltdown. And if you break, no one is left to pick up the pieces.

So it's good to have someone else or multiple someones on board to help you get your idea off the ground. Here are some of the most substantial benefits of this approach:

• Failing Alone Isn't Fun – If you're committed to the idea of failure, that your idea might crash and burn and that you're willing to walk away without a second thought relatively early in the process, it's a lot easier to do so with someone else on board – at least one other person who is equally invested and can look and agree with you that this is the right decision. Failure is a lot harder to accept when it's just you.
• Pressure to Succeed – At the same time, two people will push each other to try harder and be more successful. The hard times that are inevitable when starting a new company will be easier to push through when you know someone else relies on you just as much as you rely on them.
• Time Off – Want to take time off? Good luck if you're flying solo. Most founders work every day of the week for months or even years. Now imagine if you're the only one – the one guy whose effort will determine the success or failure of your business. It will not be easy to disconnect for even a couple of days if you know you're the only one people can talk to.
• Skill Match – This is where your shortcomings can be balanced out. Maybe you're a kickass programmer but you suck at sales and all that marketing junk. A cofounder who is awesome at talking to people, enjoys getting on the phone, and actively digs into selling your product would be a perfect fit. Do you necessarily need someone to do that? Not right away, but if the fit is good, it can work out really well. Hubspot's founders fit this bill – one the career salesperson and the other a reclusive techy.
• It Just Plain Works Better – Data supports there being a second founder. Of all successful startups in 2010, 47.5% had two founders and only 20% had 1. The vast majority of successful companies had exactly two founders. Not too many cooks in the kitchen, but support between two people to get a project off the ground.

Having at least one other person on board helps startups succeed and keeps founders from losing their marbles in the process. There are plenty of reasons you might still not want to go that route, but keep this stuff in mind because you can't take it back months or years from now.

Funding Benefits

There's one more very important benefit for a startup when it comes to having two versus one founder:

You're a lot more likely to get funding for that startup.

Part of the reason the number of successful one person startups is so low is that they have a heck of a time finding funding, and not a lot of people are setup for self-funding.

Statistically you're much more likely to get funding from any of the sources we're going to talk about with two or more people. It's just good economics – giving a lump sum of cash to one person for their cool idea is riskier than giving it to a collective of people who believe in what they are doing.

Not only does the financial burden fall on more people in the latter situation; there are better indicators of success from past startups.

Imagine you have a big pool of money to invest in startups. Would you trust a company that only has one person and can't get anyone else on board? Even if that person very consciously decided not to bring on cofounders, it's a risky investment.

Does this matter if you plan to self fund or forgo outside funding altogether? Not one bit, but it's something to consider if you ever plan on asking someone for cash.

What Should Your Team Look Like?

Recruiting cofounders isn't the best idea. These things tend to happen naturally – two existing colleagues or friends with compatible skills get together to create a product for a problem they both see as solvable.

But at the same time, there may be a group of people you regularly work with and the issue becomes who do you share the idea with or who do you approach with it and "recruit" to join your team. They're not a perfect stranger, but nor are they your best friend with whom you've done everything for years of your life.

Here are three things to consider when you reach this point:

1. What Resources Do You Have? – Is there anything you are missing from your skillset, financial resources, access to tools or equipment, or otherwise that someone could bring to the table? This is a good place to start, though, don't make the mistake of bringing someone on board strictly because they have cool stuff you can use – this is someone you will be building a business with, keep that in mind.
2. Is There a Likely Candidate Already? – Is there someone you have worked with in the past or who you know would be interested in what you are putting together? These things tend to happen organically; it's more a matter of inviting those you already work with into your circle and not pushing them away as a means of getting them on board.
3. Do You Want a Partner? – Don't assume at this point that you NEED a partner. Yes, there are several benefits that you gain from having a larger team with several people on it, but there are also several downsides. Differing visions. Splitting the profits. Fighting over direction. For as many startups succeed with multiple people, more fall apart because of the natural clash that occurs between any two intelligent, driven people.

At the end, the choice of whether to bring on a cofounder (or two) is up to you. It's your idea. Your company. Your future. You do what you think will work best for you. But don't dismiss it strictly for monetary reasons and don't make the decision strictly because others do as well. Do what's best for you.

Funding

Every company needs two things to get off the ground – people and money.

We've covered the first half so now it's time to talk funding. Where is the money going to come from to get your product built, your website online, and your first few users signed up?

That money – and there will be a good amount of it you'll need to get started – needs to come from somewhere.

But the amount of money you need is often severely overestimated. And the glamor and excitement of multi-series funding can blind a new startup founder from the fact that all that funding has just as big of a downside as it does upside.

For the majority of this book we've discussed self funding – pulling from personal resources to get your project off the ground.

It makes the most sense at this scale. Why take money from someone that will have huge expectations for how you use it and what they get out of it, when you could do it yourself and retain 100% ownership of your business?

But that's not always an option. Especially if you're not a programmer and will need to hire someone to handle the heavy lifting of building your project, you're looking at expenses of several thousand dollars.

Most people don't have that much cash just lying around. It has to come from somewhere.

As a startup, there are plenty of places to draw from – Angel Investors, Venture Capital, Crowdfunding, or a good old fashioned loan. But realistically, there are fewer options than these – if only because so few companies actually get VC funding or straight small business loans for their startup idea.

Let's take a closer look at each, what they entail, how they work, and whether they would be a good fit for your company.

Self Funding and Angel Investors

Self funding or bootstrapping is hard. It's slow going, it requires incredible flexibility and creativity and it frequently doesn't work.

But it also gives you so much freedom – freedom you don't get when you have a big wad of someone else's money in your pocket. So there are big upsides and big downsides here. You can do what you want, but you have no cash in hand to do the big new stuff you really want to try, and more often than not you need to work your fingers to the bone because you'll be the only employee for a long time.

On the plus side of all this, when it works, the product tends to be really freaking good. It has to be. You don't have the time to roll out a crappy product. It HAS TO be good and you have to be creative to get it into the hands of the people who will like it.

There's no money for all that marketing junk that bigger companies throw around. You can't spend $20,000 a month on Facebook Ads or roll out testing with people around the world through paid free trials. It's not going to happen.

But without those resources, you're forced to be more frugal. You can't afford offices in San Francisco or brand new iMacs for the team, so you don't do it. Everyone uses their own crappy laptop. Everyone works out of a garage or a loft or their own apartments.

That kind of financial constraint can drive innovation and force you to do more with less. It removes distractions and requires you to develop new processes to solve problems.

You have to make a really good product and build word of mouth to that product. Simple as that.

And when it works, it works really well. Github, Grasshopper, WooThemes, AppSumo – they're all bootstrapped, self-funded startups and they had to cut a ton of corners to get where they are today, but the result was enhanced creativity and products that evolved and grew with time to match the needs of their current customer base – the ones they couldn't afford to lose.

There's a freedom here too.

When you don't owe someone money, you can walk away whenever you want. It only affects you (until you start hiring) and while you might have a bunch of cash out of pocket on the line, it's still your cash. No one is going to investigate or dig through your resources if you decide to shutter up. You're the only who cares so you get the final say.

But it's also a double edged sword. You have that freedom. You are forced to innovate without resources. And yet, without those resources, you may sometimes come up just short of what you need to be successful.

Part of the process here is knowing when you need to ask for help – when you need to take it to the next level and bring in outside resources that will help you create what you've envisioned.

Angel Investors

Supplementary to this are angel investors. This is outside money, but it's not like Venture Capital, because it comes from a single investor.

Most Angel Investors are wealthy people who like cool ideas and will invest in those ideas if they think they are worth backing. The terms are often friendlier, the fear of failure lower, and the interaction is more one-on-one. Your mom could be an angel investor.

That's not to say that every Angel Investor is going to write you a blank check to do whatever you want with. But the strict, sometimes business gutting terms that come from VC firms don't tend to be included in Angel contracts. They're a lot friendlier and subject to your situation. You may know a wealthy family friend or neighbor willing to invest that other startups wouldn't have access to. It's a case by case situation.

Venture Capital

Too many startup founders treat venture capital like the golden goose – an elusive treasure that will solve all their problems.

Unfortunately, that's not quite what you're getting.

First, Venture Capitalists only back about 5,000 projects a year on average. If that sounds like a lot, keep in mind that between 4-6 million new businesses are started every year.

The money goes to a select few, and you may not even want it.

Because of the extremely limited supply and heavy demand, seeking VC funding becomes a full-time job. This is about as big of a roll of the dice as there can be. You'll be investing 40+ hours a week to make this happen, with ZERO promise of return. Combine that with an existing day job and prepare for a long, arduous process that may not pay off. On top of everything, you're taking time away from the product and growing your business – all at a critical time in the business lifecycle. This is the last time to step aside and focus only on the cash.

Funding typically happens over the course of several rounds. During each round of funding, the venture capitalist firm you're working with will offer a certain amount of money based on what they see the value of your company. You in turn "give them" a percentage of that company.

So they give you cash. You give them a part of your soul. Tough trade.

Just how much of the company do the VCs end up with after these funding rounds?

Most startups will never get Venture Capital, and practically none will get a second or third round, but on average you're looking at giving up between 20-40% during that first round of funding. You could own as little as 20% of your own company by the time the third round happens (and again, it's VERY unlikely you reach a third round unless you are crazy successful).

Keep in mind too that even if you get 20% of a really big company, the chunk you own is likely to be non-preferential stock. On exit when a sale or IPO happens, the VC firm will get their share before you.

Which means…after a decade of your life is poured into this company, you could end up walking away with little or nothing.

Now, most will say something to the effect of – 60% of something is better than 100% of nothing – and I for the most part agree.

The problem isn't that the VCs own part of your company (though I would say that this is in fact a problem to some degree), it's that VCs are the most corporate backers out there.

These people do this for pure profit and they don't care about how you do or what the future of your business holds. They're playing a numbers game – assuming one out of every X startups will actually succeed.

So they fight for the best possible terms in every transaction. They will pick and peel and pull at you until they get those terms and you'll be left with a fraction of the company you started.

And once these companies get their hooks in you, their goal is to see you profitable, and burn through your cash so you have no choice but to seek more. Mandatory consultants, deals brokered with other portfolio companies, highly "recommended" hires that cost you a small fortune – these are only some of the "perks" to which you can look forward.

Remember, this company isn't only yours once you bring in outside investors. The cost of doing that will haunt you, especially if your project is successful.

Can VC work?

Yes, and it has for quite a few companies – many of them just stumbling around with a new idea when they go to them for money the first time. It's not impossible to make it work, but it's painful and it's almost never the best option.

If you really want to do it – and if you feel this is the best way to grow your business and get the capital needed to create growth, do it right.

Get a business advisor. Get a lawyer. Get an accountant. Invest money up front and make sure there are professionals poring over every piece of paperwork before and after you. Make sure you don't sign anything until you know for certain what it will mean for you.

Do this because it's the only way to ensure you don't get taken advantage of in this process. Don't be afraid this will scare people away…because if it does, they're only trying to swindle you.

Also, talk to more than one investor. Don't let a single person woo you with flashy dollar signs and big project scope that will evaporate as soon as you sign. Make sure you have professionals on your side who can at least tell you what you're in for and compare the different options available from investors. If one investor is willing to look at your company, it's likely that others will be as well.

The last thing you want is to work with only one investor who can then run the table with you and get whatever they want from the deal.

Doesn't sound like much fun, does it?

That's because it's not. The bottom line is that VC sucks and if you have a choice (which you do), you shouldn't pursue it.

Can it work? Yes. It has worked and will continue to work for a lot of businesses, but it's a longshot bet on top of what is already a longshot in starting a new business.

The headache, extra paperwork, and potential downsides of taking that money will come back to haunt you. Success or not, your company will suffer because of it.

JOBS Act and Crowdfunding

The JOBS Act was passed in 2012 and contains 7 titles that are designed to help small businesses get more capital.

There is a bunch of stuff in the law, most of which has little or no impact on you and your business, but there are two titles in particular that can affect you.

Title II – Access to Capital for Job Creators

Title III – Crowdfunding

Specifically, I want to talk about Title III (because most agree that Title II just makes a mess of the process and few if any companies will realistically try to use it).

What Title III does is essentially create a public market for private companies. This gives anyone the ability (not just corporate investors) to put money into small companies – crowdfunding at its most fundamental.

Right now, in order to invest in exchange for stock in a company you must earn at least $200/year or have $1m in the bank.

Right now, "crowd" funding happens with a very small crowd of very wealthy individuals. The new law will make it possible to open up to a large group of less wealthy people who want to engage in this kind of investment.

The problem of course is that like any freshly minted law with too many hands on it in the development process, nothing about this is easy.

There are several hoops investors and companies alike need to jump through to make these investments – even without the preliminary investor requirements. Like most new laws, this one is designed to protect investors, probably too much.

So is it a good way to raise capital for your business?

Not yet. The idea behind this is great, but execution is questionable and is going to cause you more headaches that it's worth with the other options that are already out there.

The bottom line is this. The JOBS Act, once in full swing, will offer a crowdfunding-for-startups style platform that will allow startups to acquire capital from investors on a much broader basis. Instead of a small number of large cash infusions, you'll be looking at hundreds or even thousands of investors at much smaller amounts.

A site like Kickstarter (possibly Kickstarter) will be needed to facilitate this exchange, but once they do, it will become possible to grow much faster. But just like with Kickstarter, most projects won't get funded. You need the network, marketing platform, and resources to go out and make a name for yourself enough to drive that kind of traffic to your project.

It will only really help you if you are already popular and have the opportunity to capitalize on that popularity to raise money. There's a very small niche of companies that have a large, loyal following and no existing investors or capital to draw from.

If you happen to land in that magic buffer zone, then by all means, dig into the JOBS Crowdfunding option, but if you're among the millions of others who don't fit the bill, this one is just too much work. You'll probably spend more money than you'll make just getting this setup.

Getting a Loan

There's a good reason why this is last on the list.

Yes, there are a number of systems out there in place to help small businesses get capital – often with federal backing. But those systems are almost always setup to help brick and mortar or more traditional businesses.

Heck, that's why the JOBS Act was passed – to create capital opportunities for smart young people like you.

A traditional business loan requires a number of things. You need collateral. You need a business plan. You need financials. You need an idea of how you're going to return not only the money you borrowed, but generate the profit you project to the bank or lender when you get that loan.

It's not easy to put all that documentation together, and it's a lot harder when your product is intangible – a piece of software or a digital service that doesn't yet exist or is in the early prototype stages. As someone young and inexperienced, with little or not collateral, you'll have a hell of a time convincing any bank or lender to give you a lump sum of money to build your product, especially because these loans tend to have minimums needed to get started.

With all that said, there are some situations in which loans can work, especially with the advent of microloans for small businesses.

Your product shouldn't need a lot of money to get off the ground. You only need a few thousand dollars for a working first version and that’s where freshly minted startups have managed to pull loan money in the past – from micro lenders like Accion or PayPal that offer loans below $20,000 (the average is around $12,000) for the basic startup costs of a business for which you feel very strongly.

Are the terms great? Not particularly – you'll probably be looking at 11% or higher in interest, but if you've already tapped your friends, family, and anyone else you know and you can't put it on a credit card, micro loans are an option at this stage to get the capital needed to get your idea off the ground.

Keep in mind that if you take a loan, you have to pay it back. A venture capitalist, while bent on making the most money possible from your company and therefore heavily involved in ways you probably won't like, is still an investor and if your company tanks, they are out of luck.

The same cannot be said for the bank. Your personal credit (or that of your parents or other family if someone cosigns) will be up against that loan. That's why it's so hard to get a big one.

No matter how good of an idea it is, you don't want to bet your future on it. Bankruptcy is a life-changing thing – keep in mind that neither student loans or mortgages go away in bankruptcy and if your project leads you down that path, you'll be in for a rough few years.

If you're really intent on getting a loan for startup costs, it's possible at smaller amounts with higher rates – just be ready for the personal responsibility it will involve.

Funding Your Business

You have a young business in need of capital and there are a LOT of ways to get it. But the noise can be deafening. How do you know which of these methods is best for you?

Most of them suck – you lose control, time, or money…sometimes all three. How do you get the capital you need to grow your business and build a new product that will help you really get your name out there without going into bankruptcy right off the bat?

It will depend a lot on your situation and the nature of your business and your capital needs.

Ultimately, funding will be an obstacle you come back to time and again. The less you spend though and the more you do yourself, the better you'll be able to manage spending and get these things done without dumping a fortune into your company or giving away half the company to get off the ground.

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