When and how to raise capital is probably the most common questions I get from founders during mentoring sessions. There are two problems with this situation, as it leaves out the two important questions: why do you want to raise capital? and is your venture investable?
I end up giving a brief overview of the types of investors from angels to corporate venture funds. I then probe to find out why the founder is thinking about investors instead of customers. I may point them to David Chang’s presentation on raising money, the best one I’ve seen.
Jim Price is a successful serial entrepreneur and the author of the book Launch Lens – 20 questions every entrepreneur should ask has a very helpful model. His article Who Would Invest in Your Startup, and Why? from Entrepreneur answers his own question with the sub-title: the type of funding you should pursue depends on your business’s value and scalability.
He boils the question of fund raising into two questions: are you thinking of starting a business or are you looking to grow your existing venture? Here’s his fundability model:
Capital efficiency refers to the return on the investor’s dollar, such as startups that don’t require a lot of money to launch or on-going ventures that can be scales significantly by raising only a model amount of capital.
The valuation multiples – the Y-axis – presents the biggest challenge for most founders: how do you value your company? Typical measures such as the last twelve months of profit or revenue may work well for a business that has customers and is established in its market. Valuing a pure startup is far more difficult. Please see my post The toughest task in tech – valuing a startup for help with this onerous task. Jim Price lists three characteristics of ventures that achieve high valuation multiples: high growth potential, sustainably high profitability and strong differentiation versus competitors.
So let’s look at his tool for assessing fundability. The top right quadrant, which every B-school student knows is where you want to be, is Venture Capital. What Price doesn’t mention is by far the most expensive capital there is. VCs look for companies that don’t cost a lot to launch or scale, but have high potential to be very large companies.
Patient Capital may be required in a company addressing a smaller market or have some other limit on scaling potential. Patient investors are friends and family, angels who have an affinity for your market, corporate investors who see your venture bringing them strategic value, or federal or local grants or loans.
The bottom right is Bootstrapping. These tend to be lifestyle business that grow very slowly but may generate enough cash to provide the founder a reasonable lifestyle, but since they don’t scale, can only be sold for a low multiple, typically 1X revenues or 10X profits.
Of course the place no one want to be is the Dead Zone. Your venture can be stuck there for a variety of reasons, but it usually means that the team isn’t considered capable of growing a venture, the market is far too small, and/or the idea is deemed unworkable. Trust me, I’ve had a few of these and the best thing you can do is “know when to hold ’em and when to fold ’em.”
What I like about this tool and would recommend it to founders is that it’s a great reality check on what type of company you want to build. And there is nothing wrong with being completely off the chart with a venture that is funded by customer revenues, for example. Or perhaps your venture is better suited to non-profit status, which opens up the world of foundation and government grants and charitable donations. Or, as has been the case with a few founders I’ve mentored, there’s the realization that one shouldn’t give up their day job.
I’ve yet to read Jim Price’s book, but it gets 5 star reviews on Amazon, so you may want to check it out. Either way, you need to invest a lot of time in figuring out where you fit in the fundability matrix and if you aren’t happy with where you land, figuring what you can do to move yourself into the top two quadrants. This is where mentors experienced in raising capital can help.
One of the best things about using a simple tool like the Fundability matrix is that it can be shared between founders or between a founder and their mentors. This is a much more efficient process than having a mentor deliver a lecture on the types of investor leaving the founder at sea on the most important question of all mentoring sessions: What should I do next?
Mentorphile 
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