Startup or Bustup?
Lets set the stage.
Joe has an idea but lacks the funding to bring the idea to reality. An investor brings money to the table to help Joe bring his idea to fruition. A split of 55/45 is negotiated, with 45% going to the investor. Fast forward a few years and we have a startup that has a developed product, a few thousand users but no revenue and very little cash left to keep the startup running.
There are three choices:
Fold – accept that the idea didn’t gain traction, convince the investor to take the loss and move on. Sometimes, even though your heart may not find this to be an acceptable resolution, it might be the right answer. Unless you’ve got a lot of charisma and a well defined business model, you might find it difficult to obtain funding from him and his acquaintances for new projects. Investors understand that ideas fail and knowing when to cut the cord is a valuable skill.
Accept more investment capital – while the idea hasn’t gained enough traction yet, another investment will dilute the existing holdings based on the valuation of the company and the amount of cash received.
Bootstrap – hunker down, define your business model, hustle, and do it.
Lets assume that you don’t fold because the idea has merit, it just didn’t have enough time to gain enough traction.
In this situation, deciding to take an investment carries with it two problems. Your investor’s percentage gets diluted as does the founder. However, due to your equity split, the founder faces the additional problem of losing majority control of the startup. This is where it gets interesting.
As a founder you have to ask yourself, are you an entrepreneur with other ideas that you can develop if you are ousted, or, is this idea your baby?
A new investor may not be privy to the the reasons why the company didn’t gain the traction or why you ran out of money, but, in the back of your mind you might think that since you’ve lost the majority vote, you could be replaced at any time. If you’re doing a good job and you have the vision, why would your investors opt to replace you? Perhaps they will bring in someone to push you, but, they invested in you and your idea. If you have the passion, very few people they would bring in to replace you would have that gift. If they do remove you, you’ve got other ideas that you can now pursue. If you aren’t replaced, and the company later becomes very successful, you might not have made as much money as you could have, a successful exit for your investors raises your clout – making it much easier to find investments for your next idea.
Bootstrap. If you know the idea has the ability to start producing income shortly, by all means, deploy. If you’re confident in the idea, find bridge financing to get you to sustainability. Once you’ve worked out a revenue model and start collecting revenue from clients, your ability to find investors goes up dramatically – if you need investors at that point.
Only you can decide which path is the right one.