5 Milestones to Reach Before Raising Venture Capital

June 8, 2009

I meet lots of web entrepreneurs who tell me they want to raise venture capital. Most of these people are first time entrepreneurs and they just assume that once they’ve got an idea, the next thing to do is raise venture capital. That’s naive.

I always ask myself: “Is this person/company ready to raise money?” 99 times out of 100 the answer is “No”. So, when is the time for web entrepreneurs to raise venture capital?

1. The Time to Raise Money Is When You Don’t Need It

This may seem counterintuitive on many levels, but the time to raise money is when you don’t need it. What I mean by “don’t need it” is you can carry on without it or you have alternatives (like other people who want to invest or a house you can mortgage).

Many entrepreneurs don’t understand the value of finding their way without venture capital. Or they think they need the money more than they actually do. Or they think they need it sooner than they do. Or all of the above!

The result is that they spend a lot of time too early in their business’s life cycle focused on serving venture capitalists (VCs) instead of serving their customers.

Raising money is a negotiation. You need options when you are sitting at the bargaining table. Most importantly, you need a legitimate path without capital.

2. Talk to Venture Capitalists When You Have a Working Product or Prototype, Not Before

There are exceptions to every rule but unless you have built a successful business before or your business requires millions and millions of dollars to build version one of your product (think microchips), don’t talk to a VC until you have a working product or prototype.

I’ve met entrepreneurs who tell me, “I’ve got this great idea. I’m going to start shopping it around to VCs.” Thanks to the web, it’s incredibly cheap to build a business. VCs know this too and their role in building businesses has changed since the first Internet bubble.

Back then, entrepreneurs with ideas needed VCs to pay for infrastructure, servers and bandwidth. These things used to be expensive but today they’re not. The consequence: VCs have no incentive to fund ideas. They can wait until later in the process of building a business. And it’s important that they do, because they want to be sure.

3. Knowing Your Customer Better Than Anyone Makes You Enormously Valuable to Investors

This is the most misunderstood milestone on the path to raising venture capital for both VCs and entrepreneurs: the “I know my customers better than anyone” stage. If you know your customers or perhaps you’ve scratched your own itch and you ARE your customer, you are now enormously valuable to yourself and anyone who is going to invest in you.

The difference between VCs and entrepreneurs is customers: entrepreneurs have them, VCs don’t. Knowing your customer is going to make you a better strategic decision maker and product designer than your VCs could ever hope to be. Remember Facebook Beacon? From what I gather, Mark Zuckerberg was against it because he knew his customer. The VCs on the other hand… let’s just say that Beacon looked great on paper.

Knowing your customer better than anyone is valuable. You should use it as a bargaining chip when it does come time to negotiate, but you have to invest in it. You need to phone your users, and take them out to lunch – surveys are not enough. It doesn’t come fast or easy. So build your product and get to know your customers.

I’d suggest 100 conversations (not emails!) is a good start. And don’t try to tell me they won’t talk to you on the phone. Have you asked? Email them an invitation to speak with the founder of the service they are using about their experience. Your early adopters will be all over that.

4. Make Sure You Have Traction, and Your Friends Using the Service Does Not Count

If you have a product and you know your customers better than anyone, you are on your path to traction. But if people don’t become repeat users of your site or service, then you need to make sure they do.

Do your customers refer you? Do you have early adopters who champion you? Do people write you up in blog posts or on Twitter of their own free will? And do they do so repeatedly? Do people actually pay for your service? Those are signs of traction.

VCs have enough good opportunities in front of them that they can choose from companies that have traction. You better make sure you do, and having friends that use the service doesn’t count.

5. Finally, when: you know what you’re getting yourself into

Don’t raise money if you think it means you’re going to be able to stay in control. Raising money is the first step on the path to loss of control – know that. It starts with equity and a board seat.

It’s my belief that if you raise money once you’ll raise money three times. If that’s the case, you might like the terms of round one, but have you thought about the terms of rounds two and three?

If you have thought about it, and you like your place at that stage of the race, proceed. If not, don’t. You should be asking yourself, “Do I want to build something big or do I want control?” If you want control, you’re going to be very unhappy with the venture capital path. Before you proceed, it’s time for a gut check.

Disclaimer: I have never raised venture capital and FreshBooks has no institutional backing. That said, I have raised money and I do spend a lot of time thinking about capital, and I handle a lot of calls from VCs who would like to invest in FreshBooks. Bottom line: take my advice as you will.

about the author

Co-Founder & CEO, FreshBooks Mike is the co-founder and CEO of FreshBooks, the world’s #1 cloud accounting software for self-employed professionals. Built in 2003 after he accidentally saved over an invoice, Mike spent 3.5 years growing FreshBooks from his parents’ basement. Since then, over 10 million people have used FreshBooks to save time billing, and collect billions of dollars. A lover of the outdoors, Mike has been bitten so many times it’s rumored he’s the first human to have developed immunity to mosquitoes.