Match your capital needs to the right source of capital

Match your capital needs to the right source of capital

A big mistake I see early stage entrepreneurs make is going after the wrong type of capital for what their startup needs.  Following are examples of capital needs your company may have that are not a good fit for angel investors or most venture capital.

Research

Few investors will fund early research for innovations, especially for first time entrepreneurs. It is not unheard of, however, for venture capital to fund the research of an experienced entrepreneur who has an innovative idea and a proven track record.; but that's rare. Instead, most early stage research is funded through government grants and non-profit institutions. Early stage research can get support, but not often substantial grants, through incubators that provide equipment, laboratory or other space, and materials.


Customer testing

Customer discovery is a broad  category and continues on throughout the life of the company, and some of it can be funded by investors. Early stage companies should conduct as much customer discovery as possible before seeking any funding, and in most cases this is free to do. Large-scale customer surveys are expensive and are more effective when performed later in a company's lifecycle. Most early stage companies do not do enough customer discovery. Some accelerators are very good at this and it is worth seeking them out for this work.

Working Capital Needs

Accounts Receivable - There are numerous industries where the accounts receivable terms are challenging for early stage companies that need cash. Most companies come up against this problem quickly when they get their first large, corporate customers and they realize that the payment terms from are typically a minimum of 60 days. There are strategies to mitigate this situation such as charging set up charges and other upfront costs, but regardless of those strategies, entrepreneurs should not look to an investment  from angels or VCs to manage this working capital need. Giving up equity in your company for working capital is an expensive way to finance something.  Banks are better for working capital needs, but you may not have enough collateral for them.  Some investors, however, might see accounts receivable as an opportunity to support a company by offering short term financing at risk-adjusted terms.  It is better to look to your customers and possibly suppliers to ease your terms to make this liquidity crunch not as dire. 

Inventory - Early stage investors typically do not like their investment going to build up inventory; however, I have seen  some early stage companies use investment for a market push.  Giving up equity in your early stage company for a working capital need is an expensive way to finance. Companies should explore working with their suppliers to obtain the most favorable terms. Most suppliers won't extend favorable terms until your company has grown, which is a Catch-22 situation.  However, I am surprised at the number of entrepreneurs who don't even ask around for better terms from their suppliers. Most of the ones I work with who ask for concessions, receive them.

Clinical Trials and other Regulatory Requirements

It is essential to understand the complete regulatory requirements for your product. An example is the field of medical devices which can rely on the 501k regulatory process in the United States.  This means (basically) that if a product has a predicate device (even in a different application) then the path to approval by the FDA is shorter and easier.  However, some medical device companies have found that FDA approval is not enough to convert to market acceptance of the product, and they need to perform clinical trials to gain wider adoption.  In addition, the different government regulatory agencies will limit what you can claim about your products performance, so sometimes a clinical trial is needed to support the claims you want to make in the marketplace.

Understand your regulatory pathway because some angels and VCs do not want to fund this, but other will.  Know who your audience is before approaching them.

Matching your capital needs to the right investor is key when growing your company. Make the right match so you don't waste your time.